Pension pioneer U.S. Steel joins corporate wave

United States Steel Corp.'s freezing of its defined benefit plan puts it on a path to ending a pioneering retirement program that led to a transformation of both employee benefits and investment management.

The freeze to the $6.3 billion pension plan, which was announced by Pittsburgh-based U.S. Steel on Aug. 21, comes as no surprise to consultants and academics. Corporations have been moving away from defined benefit plans for much of the 2000s, generally first closing plans to new employees, as U.S. Steel did in 2003, and then freezing pension accruals for all active participants. By replacing traditional DB plans with defined contribution plans, companies could transfer market risk to workers and reduce corporate liability.

At the beginning of 1998, 299 companies on the Fortune 500 list offered defined benefit plans to new hires, according to a Towers Watson & Co. analysis. By June 30, 2014, that number had fallen to 111 companies. Over that same time frame, Fortune 500 companies offering only defined contribution plans rose to 389 from 195, according to the Towers Watson analysis.

“It's almost time to erect a headstone for corporate defined benefit plans,” said Jeremy Gold, consulting actuary and principal, Jeremy Gold Pensions, New York.

The U.S. Steel freeze is effective Dec. 31 for non-union participants in its pension plan, who will be moved to a defined contribution plan. The defined benefit plan is 87% funded, with $7.3 billion in pension obligations.

U.S. Steel executives couldn't be reached for comment.

The corporate embrace of defined benefit pensions has weakened for a number of reasons. Corporations faced pressure from a number of economic shifts, including funding demands from an almost steady drop in interest rates that raised the cost of pension liabilities; increasingly tougher funding rules under amendments to the Employee Retirement Income Security Act of 1974; economic shifts that weakened companies with large DB plans; and workforce trends encouraged more transitory employment less suitable to the longer-term basis of DB plans.

Dallas L. Salisbury, president and CEO, Employee Benefit Research Institute, Washington, said in an e-mail: “The trends since the early 1980s have been on a consistent downward trend line (for corporate defined benefit plans). Against that backdrop, firms like U.S. Steel and American International Group Inc. (which similarly to U.S. Steel in recent days announced a freezing of its U.S. plan effective Jan. 1) continued to be committed to maintaining open and robust (defined benefit) plans, complemented by (defined contribution) plans.“

Since the early 1970s, “I have heard private actuaries and employers and lawyers talk of "a nail in the coffin of DB,'” Mr. Salisbury said. “U.S. Steel and AIG do represent two more nails” now, he said.

More than 100 years ago the outlook was different for pension plans. The U.S. Steel defined benefit plan became a trailblazer and model in employee benefits and fiduciary investment. With its creation in 1901 by Andrew Carnegie, steel entrepreneur and philanthropist, U.S. Steel was one of the first corporations to offer a pension plan to its workforce, said Steven A. Sass, program director, Center for Retirement Research, Boston College.

But the real innovation came from how Mr. Carnegie financed the pension benefits. Mr. Carnegie provided initial funding for the plan to secure benefits, and pioneered the investing of pension assets and use of their investment earnings to pay retirement benefits. The approach became a model followed by other corporate pension plans and applied with increasing sophistication, according to a Pensions & Investments, Dec. 27, 1999, story.

The growth of corporate defined benefit plans transformed the landscape of investment management and the markets, making them more institutional and sophisticated.

In 1950, the U.S. Steel plan began to invest in equities, a fundamental departure from standard retirement investment practice of the time of allocating entirely to bonds. Anders M. Voorhees, chairman of the U.S. Steel finance committee, “believed common stocks offered better investment returns than bonds, and so offered the best chance of funding the coming tidal wave of liabilities,” triggered by new powers of unions to include pensions in collective bargaining negotiations, according to “The Money Flood,” a 2000 book by Michael J. Clowes, editor at large, Pensions & Investments.

United States Steel and Carnegie Pension Fund — a New York-based Securities and Exchange Commission-registered investment advisory firm not owned or controlled by U.S. Steel — oversees the plan and serves as its trustee, including setting its asset allocation.

Most of the plan's assets are in two limited partnerships internally managed by United States Steel and Carnegie Pension Fund: $2.6 billion in UCF Equity LP, an active equity portfolio mostly in U.S. stock with some international stocks, and $1.8 billion in UCF Fixed Income LP, an active fixed-income portfolio. The rest of the plan is allocated: $642 million in private investment partnerships investing in global equities; $333 million in timberland; $303 million in private equity; $300 million in real estate; and $332 million in other, according to its 10-K report.

The U.S. Steel 401(k) plan for salaried employees had $1.1 billion in assets as of Dec. 31 and offered 22 investment fund options, including U.S. Steel stock, according to the company's 11-K filing. Participants had a combined 10.8% of assets in U.S. Steel stock. For the other investment choices, the plan offers 13 funds from Fidelity Investments, three from Vanguard Group, one from each of T. Rowe Price Group, Morgan Stanley, and Federated Investors Inc. as well as a Marathon Oil Corp. and a Marathon Petroleum Corp. stock fund.

The U.S. Steel union 401(k) had $916 million in assets as of Dec. 31, according to an 11-K filing. It offered a similar mix of investment funds as the salaried plan, although not the Marathon stock. The union 401(k) participants had a combined 5% in U.S. Steel stock.

William Donovan, president, United States Steel and Carnegie Pension Fund, said it manages assets only for U.S. Steel and companies affiliated with it. United States Steel and Carnegie Pension Fund manages in total $10 billion in discretionary assets, according to its ADV filing with the SEC.

Defined benefit plans “are probably by far the largest institutional investor,” said Mr. Sass. The plans, because of their long horizons in financing benefits and deep pockets, have the ability to bear risk as well as diversifying risks.

But now “their horizons are getting shorter because they're getting mature,” Mr. Sass said. Now, “many of these plans are large relative to the size of the sponsor,” he said. Corporate DB plans “had a lot of beneficiaries and a lot of the legacy companies had declines in (active) employment. So the pension obligation was a very large obligation for these companies. And pension obligations can be quite risky” to finance.

Additionally, companies have been moving away from a career employment model in favor of a more dynamic workforce.

Mr. Gold said today's employers “view (their model today) as global ... not the idea of attracting and retaining employees.”

“The change in the business model led to a change in the (corporate) advantages employers could gain from a defined benefit plan,” Mr. Gold said. “They saw those advantages disappear. They also saw the sticker shock as DB plans became more expensive.”