"Defined benefit plans as we know them will be gone, not only in our industry, but also in America." So said Gordon Bethune, chief executive officer of Continental Airlines, two weeks ago, reacting to the news that United Air Lines was not going to contribute to its defined benefit pension plans while in bankruptcy, and possibly not when it emerges from bankruptcy.
Mr. Bethune might not know it, but the corporate defined benefit plan had been heading for extinction since the mid-1980s, the victim of environmental changes that permanently damaged its habitat. The cash balance plan, a hybrid developed as an adaptation to the new environment, and one that might preserve the species, is being attacked by friends of defined benefit plans who regard it as malformed and illegitimate.
How close are corporate DB plans to extinction? Their number has declined to 27,000 today from 112,000 in 1985. The percentage of the active private sector workforce covered by such plans has plunged to 17% from 44% in 1974.
The first environmental change was the introduction of a competitor that appeared to offer similar benefits at far lower cost to the employer — the 401(k) plan. At first the 401(k) seemed to complement the DB plan, and so it might have remained but for other environmental changes.
The second change was a heightened level of economic competition. Within the United States, high-cost companies with well-funded DB plans became vulnerable to takeover efforts from leveraged-buyout companies, which often targeted surplus assets in the plans. While government soon took action to halt pension surplus-driven takeovers, the LBO boom had focused management attention on efficiency and cost.
Outside the United States, competing companies, especially in Asia, weren't burdened by the costs of DB plans, usually even when they set up U.S. operations. As a result, U.S. companies looked for ways to minimize pension costs. Some boosted investment return and discount rate assumptions, greatly reducing contributions. Others dropped DB plans and started 401(k) plans.
A third environmental change occurred when government looked for ways to limit what DB plans were costing the Treasury Department.It reduced the maximum funding level, and thus the leakage of revenues into DB plans from that flowing to the Treasury from corporate earnings.
Then, in December 1987, with no hearings on the likely impact, Congress reduced the full funding limit to 150% of accrued benefit obligation from 150% of projected benefit obligation. This kept companies from strengthening DB plans in good years so they could withstand bad, and as a result, many DB plans became severely underfunded in the 2000-2003 bear market. The costs of playing catch up convinced many company executives to drop the DB plan as soon as possible.
Government action sparked another environmental change: Congress, in 1991 and 1993, greatly reduced the amount of pension that could be funded on a tax-deferred basis. In effect, these changes cut top corporate executives out of the DB plan. As a result, they established non-qualified plans and stock option plans for themselves, and simpler and cheaper 401(k) plans for employees, and lost all interest in the DB plan. It became simply a cost rather than a benefit.
Is there any hope of reviving the species?
Probably not. The world will continue to become more competitive, and no company, either in the United States or outside, has any incentive to take on the heavy burdens of a DB plan.
Even if the government reversed previous changes, corporations have found the 401(k) plan a less expensive, less demanding alternative.
And it's ironic that employees seem to prefer the new species of retirement plan, although it might not be as good for them.
It just shows how environmental change can alter the nature of things, including perceptions, and how difficult it is to reverse those changes.