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Q Does our defined benefit pension plan align with our human resource strategy?
A This question comes from a manufacturing company that is currently contemplating a replacement of its defined benefit program. The company currently sponsors both defined benefit and defined contribution plans for its salaried employees.
In a prior column (BI, Nov. 13, 1995), we looked at how demographic trends will influence the alignment of a defined benefit plan with human resource strategies. We noted that contrary to conventional wisdom, workers are becoming less mobile; this calls into question the need for a portable defined contribution plan to attract more mobile workers.
We also saw how the largest growth in the U.S. workforce is among older workers. This trend is attributable to the aging of the baby boomers. This has implications for attracting employees since older workers find defined benefit plans to be more important than defined contribution plans.
In this column, we will look at issues that are specific to the alignment of the company's retirement plans to its human resource strategy. This company needs salaried employees with two critical skills: manufacturing process knowledge and customer relationship management skills. This company's business strategy is supported through the retention of salaried employees with critical skills for long periods. The defined benefit plan supports this retention strategy. The company's defined benefit plan retains employees because the employee's defined benefit value increases with time. The benefit value increases at age 55 by nearly 1.5 times the age 55 pay. This dramatic increase is generally understood by employees and serves to retain employees to at least age 55.
The increase is attributable to the company's subsidized early retirement benefit. Under the plan, a participant can retire at age 55 and receive an unreduced benefit. A defined contribution plan cannot match this spike in benefit value due to the contribution limits under a defined contribution plan.
In order for the company to run its business, the company also needs employees to retire in an orderly fashion. Orderly retirements are needed to keep promotional channels open for younger employees. In addition, older employees not meeting minimum productivity levels need to be replaced with more productive employees.
The defined benefit plan supports an orderly retirement strategy. The plan delivers an increase in benefit value after age 55, with the benefit value increasing by approximately 10% of pay per year. However, after age 60, the benefit value decreases. This occurs because the increased value in the employee's benefit, due to increasing pay and service, are worth less than the value of a year's pension payment, which the employee did not receive because of continued employment. Employees understand this decrease in value and generally retire from this company between the ages of 55 and 60.
A defined contribution plan does not offer the same incentives for orderly retirement. Benefit values increase every year due to investment returns and additional contributions. The incentives in a defined contribution plan are entirely for continued employment rather than orderly retirements.
Research by Gregory Lozier and Michael Dorris bears this out, as illustrated in the accompanying chart. It displays retirement ages for faculty members at colleges and universities during the 1980s, a period during which these institutions could impose a mandatory retirement age of 65. Figure 3 shows retirement ages of slightly over age 65 when only a defined contribution plan was present, indicating that faculty would not retire until required. But when a defined benefit plan was present, faculty members had an incentive to retire before the mandatory age.
A defined benefit plan supports this company's human resource strategies much better than a defined contribution plan. But other employers have different human resources strategies. For example, some employers want to attract younger employees and retain them for a 5 to 10 year period, after which time their skills are expected to be obsolete. For such employers, a defined contribution plan may support its human resource strategies better than a defined benefit plan. Whatever the human resource strategy, one goal of retirement plan design should be alignment with these strategies. By aligning retirement plans and all human resource practices and policy, organizations can achieve competitive advantage, which is really the name of the game.
Would you like advice from an experienced colleague on a risk management, benefits management or actuarial problem? Four quarterly features in the Perspective section of Business Insurance can give you some answers.
Ask A Casualty Actuary, Ask A Benefit Actuary, Ask A Benefit Manager and
Ask A Risk Manager answer written questions from readers on risk and benefits management issues and actuarial problems.
This month's column on actuarial issues in the benefits field is written by William J. Miner, an actuary with Watson Wyatt Worldwide in Chicago. Richard E. Sherman, president of Richard E. Sherman & Associates Inc. in Ashland, Ore., answers actuarial questions in the casualty field. Susan M. Werner, director of risk management at Hardee's Food Systems Inc. in Rocky Mount, N.C., answers risk management questions. Dennis J. Nirtaut, managing director of compensation and benefits for Arthur Andersen & Co. S.C. in Chicago, answers questions on employee benefit plans.
Address your questions to ASK, Business Insurance, 740 N. Rush St.,
Chicago, Ill. 60611. Please give us your name, title and employer; however, Business Insurance will consider unsigned letters.