There was a time when the journey toward a financially secure retirement ran straight and smooth, both for employers and employees. Companies offered generous pensions to nearly all workers, and most workers logged many years of experience with a single company, confident that when it was time to exit the workforce, they would be well provided for.
That road developed some potholes in the 1980s, when companies began a marked shift toward defined contribution plans. Before long, the Pension Benefit Guaranty Corp. was sounding the alarm over a few companies’ underfunded defined benefit plans. The loudest sirens were heard at automakers like Chrysler and airlines like United; the latter’s declaration of bankruptcy and subsequent $8.3 billion pension-fund failure ranks as the biggest defined benefit collapse since the PBGC began guaranteeing pensions in 1974.
Nonetheless, accounting regulations gave companies plenty of latitude in how they managed their pension plans. Those that didn’t have enough in the till to meet their obligations could smooth the value of plan assets (averaging them out over five years from 80 percent to 120 percent of the assets’ fair market value). Those with overfunded plans enjoyed the perception of superior operating performance, with that pension cash hoard often masking a range of weaknesses.
But even favorable accounting treatment couldn’t stem the move away from defined benefit plans. While 38 percent of Americans had a defined benefit pension as their primary retirement plan in 1980, by 1997 this percentage had dipped to 21 percent, according to the Pension Benefits Council.
That percentage is likely to drop even faster, thanks to the near-simultaneous advent of the Pension Protection Act of 2006 (PPA) and the Financial Accounting Standards Board’s FAS 158. Together, the new federal law and accounting guidance have created conditions under which companies must deploy greater resources and expertise to efficiently manage pension assets. The PPA cut the number of years companies can smooth, limiting pensions as a strategic accounting tool; FAS 158 requires them to put their funded status on the balance sheet, which makes the costs more transparent to investors and thus harder to manipulate. In short, the new regulations have made pensions more complex to manage and increased the penalties for mismanagement.
That shift, say some experts, has fundamentally changed the way in which companies should regard defined benefit plans. “Pensions have gone from being an HR issue to a finance issue,” says Stephen Bozeman, a principal at Barclays Global Investors (BGI) in San Francisco. “Your pension plan is now a potential liability, something that can actually bring the company down.”
The specter of increased risk brought about by stricter funding and reporting requirements is leading some companies to look more closely at integrated pension management, which takes traditional pension outsourcing one notable step further: instead of outsourcing just the management of their defined benefit plans, companies outsource a portion of the underlying liability as well. As co-fiduciary, the vendor assumes a degree of liability in the event of a lawsuit. While this doesn’t get the employer completely off the hook, in the event of litigation it provides the presence of an independent third party that has reviewed the transactions and investment strategies. And if the case is lost, there would theoretically be another party to split the settlement.