Commentary: The associated costs of DB terminations

We at CIEBA read with interest the June 20 commentary by Joe Rankin, "Why many companies should terminate defined benefit plans." While we as fiduciaries for various active, partially frozen and frozen defined benefit plans understand the arguments made for plan termination, it's critical to recognize that: 1) DB plan asset allocation can significantly reduce funded status volatility at a cheaper cost than plan termination, and 2) DB plans still provide a clear benefit to companies, employees and society at large.

Mr. Rankin's June 20 commentary asserts that employers with frozen plans "still assume the liability associated with market volatility." As a group of some of the most experienced investment fiduciaries responsible for DB plan investments, our view is that this assertion ignores the fact that asset allocation can be adjusted to effectively eliminate this risk, and potentially at a lower price than that of a termination and annuity sale transaction. If this were not possible, insurance companies would also be unable to mitigate these same risks (a scary thought!). Many of CIEBA's members employ and observe firsthand the effectiveness of such strategies (also known as defeasance or hibernation strategies).

We also take issue with the assertion that "if sponsors choose not to terminate plans now, they will almost certainly pay out more in the long run than they would today." Obviously, insurance companies looking to sell the annuities that would be used to terminate a DB plan will only do so if they believe it is a good business transaction for them. Part of the insurance industry's evaluation includes a consideration of the profits it can earn on such a transaction. It is not at all obvious that this profit that the terminating sponsor will pay to the insurance company is less than the future costs to which Mr. Rankin refers.

In fact, many of the ongoing costs to which Mr. Rankin refers, such as investment management fees and actuarial services, are expenses the insurance industry will incur as well (and pass through in their pricing of an annuity). For example, insurance company portfolio managers don't work for free, and insurance companies will perform their own actuarial work for risk management and insurance regulatory compliance reasons. Many CIEBA members have reached the conclusion that a plan termination today is in fact a more expensive alternative.

Moreover, it also has been many of our members' experience that fully terminating a pension plan is not a realistic alternative (e.g., when the plan includes non-frozen participants, such as union employees). Buying annuities for active participants can be prohibitively expensive — if possible at all — as they represent hard-to-hedge risks, and insurance companies naturally demand a large premium to accept those risks. So, if a plan sponsor is unable to terminate a certain portion of their plan, they will incur those same costs that Mr. Rankin mentions (trustee fees, accounting fees, etc.), without the benefit of economies of scale.

Lastly, many plans might not be fully funded, and will have to contribute the funded status difference between the assets and annuity purchase price at the time of a termination transaction. In these cases, the terminating plan sponsor will have to divert cash flow to pension funding, instead of to other potentially worthwhile investment opportunities the company's shareholders might prefer.

In addition to our concerns with the underlying economics of a plan termination, we believe there are strong and persuasive arguments for why DB plans benefit companies, employees and the public at large.

There is a general notion in the investment community that DB plans aren't living up to their established purpose or that time has passed DB plans by. Simply put, DB plans have played — and continue to play — a critical role in providing a safe, secure and cost-effective retirement for many in the middle class, and these plans continue to help strengthen the U.S. and global economies.

The evidence demonstrates that millions of workers and retirees across the country still participate in pension plans. For example, the Pension Benefit Guaranty Corp. estimates that, in 2017, there were 23,400 private-sector pension plans covering approximately 38 million participants. Public-sector plans cover an additional 25 million workers and retirees in approximately 6,000 plans.

Many employers continue to offer pension plans because they understand the benefits to working families and their workers value them. Pensions are often a very cost-effective means of securing a source of retirement income. One study found that DB pensions deliver retirement income at a 48% lower cost than defined contribution plans. Furthermore, the irrevocable nature of a pension plan termination and the damage it could potentially do to employee morale should not be ignored.

And unlike most 401(k) plans, pensions help shield employees and retirees from the risk of market downturns and the possibility of living longer than expected. Given that, it is no surprise that DB pensions are an effective means of keeping older Americans out of poverty. Research by the National Institute on Retirement Security indicates that the poverty rate in 2010 for older households lacking pension income was nine times greater when compared to households with pension income.

Pension funds also are beneficial to the economy because they make the kinds of consistent investments in our economy that spur innovation and create jobs. CIEBA members, who comprise more than 100 of the nation's most experienced and thoughtful investment fiduciaries, invest pension assets with long-term horizons and with often sophisticated strategies, providing an important source of financing for economic development. Pension funds also provide an important source of liquidity during economic downturns when banks and other financial institutions have reduced lending capacity.

There is no question that government regulation and rising PBGC premiums have made it more difficult for employers to offer pension plans. That said, based on the most recent PBGC projections that the solvency of the single-employer PBGC trust fund has steadily improved, there is reason to believe we'll see a change of the recent trend of burdensome funding rules making it hard for DB plan employers to continue to offer their plans.

In conclusion, many employers continue to believe that it is important to provide their employees with the type of retirement security that only a pension plan can provide. We urge the DB sponsors considering a plan termination to carefully weigh the attendant termination costs, potential for in-plan risk-reduction strategies and to take a long-term, measured view with respect to the benefits of continuing to maintain their DB plans.

Dennis Simmons is the executive director of the Committee on Investment of Employee Benefit Assets, Washington. This content represents the views of the author. It was submitted and edited under P&I guidelines but is not a product of P&I's editorial team.