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RETIREMENT - Fighting the Freeze
Some defined benefit plans are well worth hanging on to.
Like many companies these days, Philadelphia-based FMC Corp. has been taking a hard look at its defined benefit pension plan. Although the $850 million progam is 94 percent funded, the chemicals manufacturer -- which posted $2.3 billion in sales last year -- owes its 12,000 retirees about $550 million. "It's an outsize liability relative to the size of our company," says Kenneth Garrett, vice president of human resources.
So beginning last April publicly traded FMC embarked on a seven-month review of its plan. Company officials conducted 16 focus groups drawn from among its 1,900 nonunion employees, evaluated what the competition was offering and considered the three options that corporations in all sorts of industries have been experimenting with to rein in pension costs: closing the defined benefit plan to new hires; freezing it so that even existing employees could no longer accrue new benefits; and enhancing FMC's existing 401(k) plan to cushion the impact of a close or a freeze on employees.
To his surprise, Garrett discovered that even the most drastic measure -- freezing the plan -- was no panacea. Although it would prevent future obligations from accruing, it would do little to address his top concern, the existing liability. (Annuitizing the liability, he says, would be too expensive and was never an option.) And with half of all FMC employees already over the age of 50 -- when defined benefits tend to build up at a dramatically faster rate for veteran workers -- freezing the plan risked alienating a substantial portion of the workforce.
Given these factors, FMC announced in December that it would probably close the defined benefit plan to new hires later this year but refrain from making any changes for existing employees -- at least for now. The reaction among the workforce, says Garrett, was relief.
Despite the Pension Protection Act's stricter funding requirements for defined benefit plans and the growing number of healthy blue-chip companies, like Hewlett-Packard Co., IBM Corp. and Verizon Communications, that are choosing to freeze their offerings, many companies are concluding that a freeze doesn't make sense. In the past couple of years, at least a third of the roughly 300 large companies that have asked consulting firm Watson Wyatt Worldwide to study the issue have decided to table a pension freeze. "There's a real 'ah ha!' moment when the board or the CEO says, 'Maybe we need to step back and think about it,'" says Alan Glickstein, a senior consultant at the firm.
Steven Kerstein, who runs the retirement practice at consulting firm Towers Perrin, figures that the 1,000 largest public companies by revenue in the U.S. have considered some sort of pension freeze. Nevertheless, he says, "more than half of them still have their defined benefits."
Why? Partly, it's the markets. Rising interest rates have reduced the present value of future plan liabilities. At the same time, the buoyant stock market allows companies to use market returns on their defined benefit assets to fund plans in lieu of
making contributions. Together these factors reduce the financial pressure on plan sponsors.
A flurry of recent studies underscores the newfound health of corporate pension plans. In January, Watson Wyatt estimated that defined benefit plans at the 426 firms that have been in the Fortune 1,000 ranking of the largest U.S. public corporations by revenue from 2000 to 2006 reached a projected aggregate funding level of roughly 100 percent last year -- the first time since 2001 (see charts). A separate study by Towers Perrin of the 79 Fortune 100 companies with defined benefit plans reached a broadly similar conclusion and estimated that these plan sponsors had a total funding surplus of about $23 billion at the end of 2006.
Given many companies' employee recruiting and retention priorities, this propitious market environment can help tip the balance in favor of keeping a defined benefit plan, especially because freezing the plan doesn't always fulfill a company's expectations or objectives. As Garrett learned, such a move would only eliminate the risks and obligations of FMC's future benefit accruals -- not the market and interest rate volatility associated with the company's existing pension obligations, which remain a long-term, deferred liability.
"Thinking through the employee relations associated with freezing the plan, it's fairly clear to us that we should be able to manage the liabilities along with our assets, barring any recurrence of the perfect storm we had at the beginning of 2001," says Garrett, referring to a period when interest rates and stocks fell at the same time, putting extreme pressure on pension funding levels.
Companies also cite a host of nonfinancial reaons to hang on to defined benefit plans. Given the portability of defined contribution plans like 401(k)s, industry observers acknowledge that such plans tend to be more appealing than traditional pension plans to the younger, skilled professionals whom employers in a knowledge-based economy seek to attract, especially in fields with high turnover, such as information technology. Nevertheless, in a significant number of industries, defined benefit pension plans can be a competitive necessity.
"If you're in a business where you're looking to support long-term employment, you want to reward people for working there 30 years," says Ari Jacobs, the global benefits practice leader at consulting firm Hewitt Associates. These industries include aerospace and pharmaceuticals, where employees specialize in long-term projects, and chemicals and engineering, where employers invest significantly in training their workers. In the oil industry, where labor is a small percentage of total outlays, the cost of a defined benefit plan becomes almost insignificant, consultants say.
A defined benefit plan might also help in recruiting midcareer professionals, especially those from the military, government or academia, where individuals generally receive a generous pension plan.
In addition, switching from a defined benefit plan to a defined contribution plan isn't always as much of a cost-saving measure as many companies think. During good economic times, it can be more expensive to run the latter type of plan: Because employer contributions are preestablished, employees reap the rewards of a bull market, not the plan sponsor. And most employers spend about the same or save only slightly by making the change to a defined benefit plan, experts say. That's because virtually all healthy companies that freeze their pension plans make up for the loss to employees by enhancing their existing 401(k) plans or adding new retirement benefits such as profit-sharing. If they don't, the morale problems can be debilitating.
Last June, Verizon froze its defined benefit pension plan for all management employees but simultaneously boosted its matching contribution for these individuals from 5 percent to as much as 9 percent of pay inclusive of a performance-based component. When IBM announced in January 2006 that it would freeze its defined benefit plan beginning in 2008, it also said the company would take the rare step of contributing to employee 401(k)s when it makes the change, even if the account holders themselves don't elect to make any contributions.
Robert Aglira, a partner in the retirement consulting business at Mercer Human Resource Consulting, a unit of Marsh & McLennan Cos., says one company he recently advised froze benefit accruals for all employees under the age of 40 but increased its 401(k) match from 50 percent -- typical of companies that match -- to 75 percent. The company also began making fixed 401(k) contributions of 5 percent of pay regardless of whether workers funded their own plans.
"They wanted to give as much to employees in the new program as they had in the defined benefit," explains Aglira, who says that the company viewed the 401(k) plan as more competitive globally and made the switch to mitigate its market risk. He adds, "They did not do this to save money."
FMC's Garrett says his company is also considering an enhancement to its existing 401(k) plan. The chemicals maker currently matches 80 cents on the dollar up to 5 percent of employees' pay, but may increase that match by an additional 5 to 6 percent of pay even if an employee contributes nothing. "If your competitors are offering a defined contribution plan with an enhancement and you're not, you're at a decided disadvantage," he notes.
Whether plan sponsors keep their defined benefit plan or make the switch to a 401(k), "the name of the game is not putting in the cheapest plan," says Stewart Lawrence, national head of the retirement practice at consulting firm Segal Co. "It's putting in something that your employees want." FMC's Garrett says that saving money wasn't a factor in his company's decision, and that existing employees couldn't be happier with the outcome.