With the first of the Baby Boom generation having reached the traditional retirement age of sixty-five in 2011, the number of retirement age individuals is expected to grow by 10,000 each day for the next fifteen years.
By 2030, when the last of the Baby Boomers will have turned sixty-five, an estimated 18% of the US population, or sixty-five million Americans, will have reached retirement age.
Up In Smoke provides a startling examination of the status of each of our nation’s retirement systems and explores how a pending retirement crisis could threaten the US economy. Those nearing retirement, as well as generations to follow will increasingly be seeking an understanding of how we arrived at this difficult place and what hope lies ahead. Up In Smoke provides those insights.
Richard DeProspo is an investment professional with over 30 years’ experience advising state and local governments throughout the country. An expert on public employee pension management, he has lectured widely on the topic and advised numerous municipalities and public pension funds on the proper management of employee retirement liabilities.
Mr. DeProspo holds B. A. and M.B.A. degrees from the State University of New York. Up In Smoke in his first non-fiction work.
Corporate America's Hasty Exit from Retirement Pla
The rapid adoption of 401(k) plans by US companies in the early 1980s has left a generation of private sector workers unprepared for the expenses of retirement. The Baby Boomers are the first generation in 100 years to fund retirement solely through personal savings and Social Security. But what happened to corporate pension plans that had served previous generations so well in their retirement years?
Up in Smoke
One of the largest of these cases of the past thirty years, is that of United Airlines. When United received permission from the federal bankruptcy court in 2005 to terminate its four employee pension plans, Judge Eugene Wedoff sided with United, who argued to the court that the airline could not emerge from the bankruptcy process with its retirement plans in place. The ruling released United from $3.2 billion in pension liability for three years to 134,000 current and former employees. Those liabilities were transferred to the PBGC (interestingly, United’s total pension liability at the time was estimated by the PBGC at $9.8 billion74). United was soon followed into bankruptcy by Delphi Automotive, Delta and Northwest Airlines, with unfunded pension liabilities in the case of the latter two, estimated at $16 billion.
As part of United’s bankruptcy reorganization plan, the company migrated its current employees to a 401(k) plan, a move that the airline unions had steadfastly opposed. It remains an open and unanswerable question whether the bankruptcy would have still been necessary had United converted its defined benefit plan to a 401(k) plan in the early 1980s, following the lead of many other major US companies at the time. Perhaps United would have filed anyway, and perhaps the fact that early movers to 401(k) plan conversions like Honeywell, Hughes Aircraft, PepsiCo and Johnson & Johnson have not similarly filed for bankruptcy protection, is simply coincidence. Or to be fair, it may simply be a function of industries with more favorable underlying economics.
Be that as it may, while many public companies have divested themselves of their defined benefit liability through the bankruptcy process, a great number of healthy US companies have similarly sought to limit exposure to defined benefit liabilities by freezing existing plans. While an outright conversion of an existing defined benefit plan to a 401(k) style plan is rare, and would face formidable legal challenge, companies have actively sought to freeze future benefit accruals to current or prospective employees by closing their plan to new entrants. Occasionally, these freezes have also encompassed the existing accrued pension benefits of existing employees, allowing those earned defined benefits to be paid out upon retirement, while future benefit liability would be funded through a 401(k) plan.
According to data compiled by the Center for Retirement Research (CRR) a total of seventeen large and healthy US companies froze their benefit plans in the period 2004 -2006. Included among this list were IBM, with 117,000 participants affected, Verizon Communications with 50,000, Sprint Nextel with 39,000 and Hewlett-Packard with 32,000 participants impacted. Each of these plan conversions were termed “partial” freezes, meaning the existing defined benefit plan was closed to both new employees and some existing employees (the exception was in the case of IBM, where the plan was closed to all new and existing employees). This list also excludes companies like GM and Northwest, then not in bankruptcy but facing considerable financial pressures, who also announced a freeze of their salaried pension plans. In its 2008 survey of defined benefit sponsoring employers, the Governmental Accounting Office found that half of these companies surveyed had partially or completely frozen their plans75.
The act of otherwise healthy companies choosing to freeze their pension plans has accelerated in more recent years with Macy’s, Allstate, News Corp, Lockheed Martin, Walt Disney, Boeing, Bank of America, Kraft and Clorox all joining a long list of household names seeking to limit defined benefit plan exposure.
So why are so many companies seeking to limit their defined benefit liabilities to employees through bankruptcy or by freezing their existing plan? The answers are, at least in part, somewhat obvious. In an increasingly competitive business environment, many companies are seeking to limit their overall compensation expense. CRR found in its study that reducing the employer contribution to defined benefit plans, on average, reduced pension costs from 7–8% of payroll to a far more modest 3%, under a 401(k) employer match. Since these plan freezes were not met with salary increases to offset the reduced benefits, total compensation expenses were lowered. This shift in retirement liability, according to CRR, was far more likely to hurt mid-career employees than new hires, many of whom tended to prefer the portability of a 401(k) plan option. This would suggest very little impact of the freezes upon companies’ ability to recruit and retain new hires.
Companies are also acutely aware of the changes in longevity and their impact on benefit payouts, as well as the increasing risk of managing those future liabilities through investments. The rapid declines in the stock market of 2000 and 2008 accelerated this concern for companies, who subsequently sought to “de-risk” their defined benefit pension plans.
But the Center for Retirement Research also found that a key goal in freezing plans was often an effort to restructure total compensation due to projected increases in health care costs. While this is especially true in those instances where companies would provide post-retirement health care benefits, the rapid growth in health care spending for even current employees has pressured the total compensation expenses of companies in recent years. On average, health care benefits had risen from 2.4% of total compensation in the 1970s to 8.4% by 2004.
Another important reason for the change was the introduction of governmental regulations, beginning with the Revenue Act of 1978 that ostensibly favored retirement tax breaks for individuals, but also favored corporations. Allowing employees to contribute to a 401(k) retirement plan with pre-tax dollars allowed companies to ease the burden of their own responsibility for retirement funding. With more and more businesses offering 401(k) plans, competitive pressures to provide defined benefit plans quickly evaporated.