Forgotten, but Not Gone

Freezing a pension plan doesn't make it go away.

Consider it another nail in the coffin of defined-benefit (DB) plans. In November, Congress drafted legislation that could require companies to fully fund their plans. Then, in December, the Financial Accounting Standards Board announced that it will consider tougher pension-accounting rules.

The potential for stricter regulations is causing a number of plan sponsors to consider throwing in the towel and freezing their pension plans. According to a Hewitt Associates LLC survey, 15 percent of DB sponsors are preparing to close their plans to new members this year — a so-called soft freeze — and 6 percent plan to freeze them altogether.

“[The new rules] are going to kill more defined-benefit plans,” says Dale Wallis, CFO of The Aerospace Corp., a nonprofit research-and-development center for the U.S. Air Force and the National Reconnaissance Office. The El Segundo, Calif.-based company put a soft freeze on its DB plan in 1993, and recently had to decide between ending the plan completely and unfreezing the plan to even out the benefits of veteran versus newer employees.

Regardless of the new rules, pressure to freeze DB plans has been mounting. “This is a natural reaction to our economic environment,” says Alan R. Glickstein, a senior consultant at Watson Wyatt Worldwide. He says low interest rates and a sluggish stock market have combined to hurt the performance of the plans.

Of course, DB plans have been a vanishing breed for some time. In 2004, 11 percent (71 companies) of the Fortune 1,000 sponsoring DB pensions had plans that were either frozen or terminated, according to a Watson Wyatt tally. That’s up from 7 percent (45 companies) in 2003 and 6 percent in 2002. Most recently, Alcoa, Verizon, Lockheed Martin, and IBM opted to freeze plans for all or a portion of their employees and open 401(k) plans in their place.

Freezing a pension plan is not as simple as closing the door to new benefits, though. The sponsor must continue to manage the assets to provide for retirees and for currently active employees who have accrued pension benefits. It also doesn’t provide immediate relief. Stuart Lawrence, senior vice president at The Segal Co., says most companies freeze plans in the hope of escaping the volatility in funding requirements that accompanies them. What they don’t consider is that such volatility doesn’t go away, though it also won’t get worse, says Lawrence. He recommends that companies keep a close eye on their pension plans long after they have been frozen, since most still need additional contributions, especially if they were underfunded before the freeze. And the risk profile can change over time.

As for Aerospace, it decided to buck the trend and reopen the DB plan. Wallis says he found that a combination of a traditional pension and a 401(a) plan, which does not require an employee match, could save the company money in the long run.

He says closing it was never a viable option. “Anyone who is considering freezing a plan needs to take a good look at 10 years down the road,” says Wallis, “and understand that by freezing today you won’t solve all of your problems.”

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