Without a defined benefit pension plan (DB plan) employers don’t have control over the timing of their employee’s retirements. Older employees may not be able to afford to retire, will remain on the payroll and may never retire. If they don’t save enough to retire, they can block upward mobility and not allow employers to hire younger and more technologically advanced employees. The Age Discrimination in Employment Act (ADEA) says that it’s illegal for an employer to discriminate against employees age 40 and older. ADEA may override the “employment at will” status in many states. Firing older employees for justifiable cause may be difficult and lawsuits may occur. Unfortunately, employers will have ‘retirees’ on the payroll (not able to retire) longer than they like.
Employers should offer financial planning services and education for employees. This will help employees estimate how much they need to retire and save accordingly. Planning must be personalized and include a range of scenarios that contemplates a reduction in Medicare benefits and a realistic return on investments. These planning services may lead to timely voluntary retirements which will benefit employers as well as employees. But planning may not be enough.
Is it time for employers to consider a return to DB plans? This is the best possible benefit for employees. Employees don’t have the financial expertise to invest their own assets and take on the investment, longevity and planning risks. Employers and their advisors can do a much better job.
We know that CFOs worry about meeting future funding needs, fluctuations in unfunded balance sheet liabilities and volatile cash contribution requirements. This was indeed the case when DB plans were historically invested without regard to the pension liabilities and eliminating pension risks. Companies would typically invest 60% of assets in equities and 40% in bonds and hope for the best. No wonder CFOs were frustrated when the stock market didn’t continue on a steady climb and interest rates fell. This caused massive unfunded liabilities, pension expense and cash contributions.
So, many employers terminated or froze their DB plans and moved employees into 401(k) plans. This was great for the companies but not so great for the employees. In the last 10 years, the S&P 500 stock index has been flat and negative when you count inflation. In addition, we have the great recession and housing price collapse. Employees can’t afford to save enough to duplicate their former DB benefits and with no investment growth, they keep falling behind. How will they ever retire?
Maybe the old DB plans weren’t so bad after all! Liability driven investing is an investment framework of managing DB plan assets relative to the DB plan’s liabilities. In this way, liabilities become the benchmark and the reference point in assessing the DB plan’s portfolio risk and return characteristics. This can substantially reduce or eliminate the CFOs concerns about future funding needs, fluctuations in unfunded balance sheet liabilities and volatile cash contribution requirements.
A return to DB plans could become a “win-win” situation with employees again retiring off the payroll.