In 1890, the superintendent of the census announced the closing of the American frontier, an event marking the completion of the settlement of the West and prompting Frederick Jackson Turner, a historian, to observe how the settlement of the frontier had shaped America's special character.
The freezing of the main plan of the United States Steel Corp., a pioneering program, represents a closing of another type of frontier, the corporate defined benefit pension landscape.
In this case, the defined benefit frontier is being depopulated by corporate plan sponsors replacing their traditional pension programs. There is no doubt corporate defined benefit plans gave employee benefits, investment management and the markets special characteristics, becoming a source of innovation, growth and economic vitality.
Corporate defined benefit plans continue to exist but their heyday has passed as hundreds of sponsors closed or froze them.
“It's almost time to erect a headstone for corporate defined benefit plans,” said Jeremy Gold, consulting actuary and principal, Jeremy Gold Pensions.
Employee management approaches and market forces have transformed retirement plan design and financing, moving it more exclusively to defined contribution plans, shifting all of the risk to participants instead of the corporate plan sponsors.
But the transition doesn't mean defined contribution plans cannot step up to fill the void left by defined benefit plans in securing participant retirement income.
The challenge that policymakers and plan sponsors have been grappling with is how to replace defined benefit plan advantages in a marketplace that has moved to a defined contribution framework.
For plan sponsors, the answer is to adapt to defined contribution plans the best features of defined benefit plans, such as contribution timing and amounts, asset allocation decisions and benefit withdrawal strategies.
In terms of investment management innovation and market stability, defined contribution plans can step up as sources of long-term, patient capital in public equities to encourage sustainable corporate business strategies.
But under fiduciary and regulatory imperatives, defined contribution plans face challenges filling the void of defined benefit funds in providing capital to alternative asset classes and strategies, or pioneering investment innovations by applying new academic ideas.
The demise of corporate defined benefit plans has been proceeding for at least 15 years, so U.S. Steel's Aug. 21 announcement that it would freeze benefits accruals for salaried and other non-union employees in its main defined benefit plan, effective year-end, could have been expected. That plan was closed to new participants in 2003.
The U.S. Steel and Carnegie Fund was a trailblazer. With its creation in 1901 by Andrew Carnegie, steel entrepreneur and philanthropist, it was one of the first corporations to offer a pension plan to its workforce. But its real innovation was providing initial funding for the plan, and pioneering the investing of assets and use of investment earnings to pay retirement benefits, an approach that became a model followed by other corporate pension plans and applied with increasing sophistication, according to a P&I Dec. 27, 1999, story.
The U.S. Steel plan pioneered in allocating pension assets to equities in the early 1950s, when plans typically were invested solely in bonds.
Following in U.S. Steel's path, defined benefit plans transformed institutional investment management as they moved assets away from insurance companies and bank trust departments, leading to the creation and growth of the institutional investment management industry.
They pioneered breakthrough applications of academic ideas, including use of modern portfolio theory to diversify to reduce risk while enhancing expected returns, and efficient markets to create index funds for passive investing, departing from long-used active management approach, all to better secure retirement income while improving performance.
But corporate defined benefit plan sponsors couldn't overcome economic forces and changing corporate workforce attitudes that undermined retirement program sustainability.
Corporate plan sponsors faced sticker shock, as Mr. Gold puts it, on the cost of the defined benefit programs. The near-zero interest-rate monetary policy of the Federal Reserve System has raised the value of liabilities and projected contributions.
But interest rates have fallen pretty much steadily since 1981, increasing the cost of funding pension liabilities. In addition, inflation has been falling and longevity rising, meaning corporate plans have to pay pension liabilities with more expensive dollars, and longer.
In addition, Congress, through the Employee Retirement Security Act of 1974 and subsequent amendments, forced tougher long-term funding, while the Financial Accounting Standards Board tightened reporting rules to move corporations away from actuarial to market-value approaches, which increased volatility to corporate balance sheets and stock prices.
Further, corporations shifted their work-force management interest away from defined benefits to conform with newer trends. Corporate executives generally stopped valuing the defined benefit plans, which had promoted career-long employee loyalty, and moved to view employees as more transitory to keep pace with a more dynamic, competitive, global marketplace.
Defined contribution plans fit better in the new workforce marketplace, especially because their benefits are portable, unlike defined benefit pensions.
Plan sponsors need to build on that defined contribution advantage to improve outcomes and decision-making. They should offer participants choices to ease decision-making, such as auto-enrollment, to start participants in plans at the beginning of careers; auto-escalation, to provide a mechanism for participants to step up contributions to try to make sure they are on a better track to save enough to reach their outcome objectives; target-date funds, to determine age-appropriate asset allocation for participants; and lifetime income options, to account for increased longevity and generate retirement payments for participants. Some are doing so.
In moving to defined contribution plans, corporate plan sponsors, as fiduciaries, must embrace best-practice oversight and make decisions keeping in mind that participants bear the risks that can undermine their efforts to secure their retirement income objectives.
Plan sponsors have not consistently met fiduciary standards, as demonstrated in the U.S. Supreme Court ruling last May in the Tibble et al vs. Edison International et al case, as well as lawsuit settlements over excessive defined contribution plan fees. They must improve.
Progress tends to be led by visionary individuals and individual companies. What entrepreneur and company will become the new Andrew Carnegie and U.S. Steel to provide innovation in the frontier of designing and financing of retirement benefits in an increasingly dynamic and globalized economy? That company will serve as a model for others to follow. n