Thursday, November 19, 2015

Who Put the Dagger in the Heart of Defined Benefit

What happened to defined benefit (DB) plans? We, at least those of us who can remember those times, saw a rise of them from the passage of ERISA in 1974 until the Tax Reform Act of 1986 (TRA86). They were viewed as an affordable way for companies to provide an excellent retirement benefit to their employees, especially ones that showed loyalty to those companies. In fact, most current retirees who have been retired for at least 10 years retired in part because they had those DB plans. And, companies that sponsored them and did so responsibly did not go out of business because of them.

Unfortunately, the number of DB plans has dwindled significantly. There was not a single killer, though. The list is long. It includes:

  • Congress
  • The Pension Benefit Guaranty Corporation (PBGC)
  • The global economy
  • The e-commerce economy
  • The temporary worker for hire economy
  • The Financial Accounting Standards Board (FASB)
  • The Securities and Exchange Commission (SEC)

What did Congress do that was so bad? Frankly, that crew of 535 individuals that changes in makeup from time to time did a lot. Between them, they rarely have anyone among them that knows much about DB plans. And, today, because their staffers who give them what they think is excellent guidance tend to be young, the advice that they actually get is colored by propaganda of the last 30 years or so. 

Nevertheless, Congress passed laws ... lots of them. And, lots of them included DB provision and each one was worse than the last. More than anything, though, because Congress intermingled retirement policy with tax policy so intimately, it eliminated plan sponsors' ability to fund DB plans responsibly.

Back in 1987, just one year after passage of TRA86, Congress, in its infinite wisdom, decided that the status quo, having existed for about a year, needed change. Included in that necessary change was limiting the amount that companies could contribute (and deduct on their tax returns) to DB plans. We were switched from a regime that was sound actuarially to one that never was and never will be.

Think about. Suppose you agree to pay someone an amount in the future. Shouldn't you be setting aside money regularly to pay for those future benefits? Of course, you should. And, DB funding used to be based on funding methods that allocated costs intelligently to the past, present, and future. But OBRA 87 began the path to dismantling those methods as Congress thought it better that DB deductions would be limited so that it could spend more money elsewhere. Thus was limited the ability of companies to responsibly fund their plans. And, as a result, as interest rates fell and there were a few significant downturns in equity markets, DB plans became [often] severely underfunded. Finally, the way these regimes worked, companies had no room to make deductible pension contributions in years that they could afford to, but were required to make large contributions in years that they could not afford them.


For those that don't know, the PBGC is a corporation, run under the auspices of the Department of Labor, that was established by ERISA to protect the pensions of participants in corporate DB plans. The PBGC was and is funded by premiums paid by plan sponsors. 

While the purpose of the PBGC has always been to protect pensions, it has behaved over the last 30 years or so as if pensions should be in place to protect the PBGC. To the PBGC's policymakers, nothing would be a greater tragedy than the PBGC projecting that it would run out of money.

So, the PBGC lobbied Congress. And, with that lobbying, the PBGC got increased ability to intervene in business and in corporate transactions. It got increased premiums. It got even high premiums for underfunded DB plans, often ones to which the sponsors wanted to make contributions when business was good, but were precluded from doing so.

What happened?

The PBGC tried to commit suicide.

You see, as the PBGC helped to make DB plans less attractive for employers, employers froze entry to or terminated DB plans. This meant that there were fewer participants in DB plans on whom premiums were paid to the PBGC. Companies that couldn't terminate DB plans were the ones that had plans that were so underfunded that they didn't have enough money to fully fund them. Often, the PBGC had to assume responsibility for those plans. So, as the PBGC incurred more liabilities, it also got less premium revenue. It's awfully tough to run  a business that way.

Various Economies

As the US economy has become more global, more electronic, and more temporary, DB plans have lost some of their appeal, When a company was competing primarily with other US companies, providing excellent retirement benefits was important to attracting and retaining good employees. But, non-US companies didn't have to do that and as competition from offshore became fierce, retirement benefits became less of an issue.

And, as employers began to show less loyalty to their employees and were less worried about retaining them, retirement benefits lost some of their appeal. The prophecy was somewhat self-fulfilling; as retirement benefits lost some appeal, they continued to lose appeal.


Accounting for DB plans use to be more cash based than accrual based. In 1985, the FASB gave us Standards Number 87 and 88 that instructed companies how to account for DB plans. Previous to then, companies used Accounting Principles Bulletin (APB) 8, under which most companies expensed as part of P&L their cash contributions. The FASB saw this as incorrect.

So, we moved from a regime under which pension expense was somewhat controllable (a company by building up a surplus in good times could contribute less in bad times and thereby have some control over their pension expense) to one that had components that became quite volatile as the economy did. CFOs abhor volatility and thus had one more reason to not want DB plans.


The SEC didn't get deeply involved in pensions until recent times. But, when they did, they got them all wrong.

Primarily, the SEC's involvement with pensions has been in corporate proxies. For the last 10 or more years, companies have been required to provide as part of their proxy materials a table of Summary Annual Compensation for (generally) their top five paid employees. Included in compensation is the increase in actuarial present value from one year to the next of defined benefit pensions both qualified and nonqualified. 

Often times, that increase is largely due to a decrease in underlying discount rates or more recently, to a change in mortality assumptions. Yes, according to SEC rules, when the Society of Actuaries publishes a new, more up-to-date mortality table, that represents compensation to executives. And, of course, the media loves to look at those numbers as if someone had written checks for those amounts in those years to those executives. And, some investors look at those numbers and want to use them to explain how the companies in which they invest overpay their executives. (This is not to say that they don't overpay their executives, but when a large piece of the overpayment is simply due to year over year changes in actuarial assumptions, the logic is bad.) 

There are better ways. Actuaries understand them. And, actuaries, in some cases, have tried to explain them to the SEC. But, the SEC has chosen to listen more to attorneys, accountants, lobbyists, and unions. They carry more sway and are more emotional about this issue, but generally speaking, they don't get it.

I'll write about a better way in another post soon.

But, in the meantime, now you know where the dagger came from. DB plans use to allow people to look forward to retirement. For most, they don't anymore.

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