PensionReforms' summary and comments
This 2007 report looks at the impact of changed reporting requirements for Defined Benefit, Tier 3 retirement saving schemes in the US.

By 2007:
"Defined benefit plans in the private sector are on the decline.  Although they still cover about 21 million workers and pay benefits to 23 million retires, the proportion of the workforce covered by these plans has dropped by more than half (from more than 40 percent to less than 20 percent) since 1980."

The pace of decline had quickened by 2007, driven by what the report calls ".the financially devastating impact of the 'perfect storm [plummeting share prices],' legislation that will require underfunded plans to increase their contributions, and accounting changes that will force fluctuations in pension finance onto the earnings statement."

The legislation referred to is the Pension Protection Act of 2006.  It was designed to reduce the choices employers had about the way they showed Defined Benefit scheme 'surpluses' or 'deficits' on their own financial statements.  The objective, in summary, was to see Defined Benefit, Tier 3 schemes fully pre-funded within seven years.  Restricting employers' ability to smooth deficiencies will increase the volatility of annual contribution requirements.  The full effect of the changes will also have significant balance sheet and earnings statement implications because of the requirement to value the Defined Benefit scheme's assets on a 'mark to market' basis.

"Such volatility is not acceptable to corporate managers, and may in large part explain why large healthy companies have taken steps to end their defined benefit plans.  The fact that these steps took the form of freezes rather than terminations simply reflects the fact that with underfunding caused by the perfect storm and very low interest rates, firms could not afford to pay off all their liabilities immediately.  Freezing their plans provided the option to terminate gradually. As funding levels improve, terminations are likely to replace freezes."

The report quotes predictions as to the effect of all this on the future of Defined Benefit schemes in the US:
"McKinsey & Company . suggests that as much as 75 percent of private sector defined benefit assets will be in frozen or terminated status by 2012.  When the United Kingdom adopted regulatory and accounting rules similar to those recently adopted in the United States, the percent of assets in terminated or frozen status soared from 35 percent in 1998 to 70 percent in 2006.  It may well be that the only defined benefit plans left standing in the private sector five years from now will be cash balance plans or some other form of hybrid. The age of the traditional defined benefit plan seems to be over."

As PensionReforms has previously noted, regulators have a legitimate interest in monitoring pre-funding levels of 'accrued' benefits - those relating to membership already completed.  Taxpayers afford employers and scheme members considerable tax advantages and can therefore claim an indirect stake in outcomes (not just consumer protection and disclosure).

If the 2006 US changes weren't the last straw then the 2008 global economic crisis probably will be.  PensionReforms thinks employers will continue to exit Defined Benefit schemes and pre-funding levels will continue to fall - the unintended consequences of legislation that was seemingly intended to protect members.

This could be the deserved demise of Tier 3 DB schemes.  But the bigger issue for employers should be whether they have DB schemes at all.  It should matter that employers know how much they are paying their employees in total this year and next.  To find out the total where there is a DB scheme, employers should run actuarial numbers for each current employee in that employee's personal circumstances.  They will probably be surprised at the total and may wonder whether they really need to pay as much to get that job done.  What they will also discover is that DB promises distort total remuneration.

Two otherwise equivalent employees (same job, same direct pay) will have widely different total remuneration, including the value of the DB promise: an older employee will have more than a younger one; a female will have more than a male; an employee with more rapid pay increases will have more than one whose real remuneration has plateaued and, in the presence of an automatic survivor pension, the partnered will have more than the unpartnered.  Those who haven't joined are probably not compensated for the missing pension-based remuneration.

PensionReforms thinks that employers should instead focus on the total and let employees decide whether, how and how much to save for retirement.  That means getting rid of DB promises, not because they can be costly and uncertain but because they are distortionary and unfair.  Moving to Defined Contribution arrangements will also simplify matters for employers, their owners as well as tax and regulatory authorities. 

From a public policy perspective, the tax advantages of DB schemes advantaged the higher paid and so were regressive.  DC schemes are also regressive but are likely to be less generous and more open about it.  That seems to be another reason not to mourn the passing of DB Tier 3 schemes. (File size 178 KB; 50 pp) 340