The View From Here . . .

As the huge baby boom generation nears retirement age, private defined benefit pension plans, the type of arrangement that provide monthly benefits for life, are becoming increasingly rare. Employers have frequently discontinued these arrangements and a number of existing plans have come under financial stress. Yet all is not hopeless in this area.

Unlike 401(k) plans and other defined contribution arrangements, defined benefit pension plans provide lifetime security for participants. Simply put, beneficiaries cannot outlive their benefits, which are paid in annuity form until death. Moreover, in contrast to the situation with 401(k) plans, the investment risk is on plan sponsors rather than participants.

A good article in the October 30 New York Times Magazine by Roger Lowenstein outlines the problems facing the private pension system. Many employers have discontinued future contributions to plans, freezing benefit accruals. A number of major sponsors of existing defined benefit plans have sought to shed defined benefit plan obligations by bankruptcy filings, where most of the obligations are picked up by the Pension Benefit Corporation (PBGC), the beleaguered agency that insures the plans. The agency currently has a $23 billion deficit and the Congressional Budget Office estimates that the shortfall will increase, absent some changes, to $100 billion in the next two decades, with the possibility of a governmental bailout and sharply increased premium rates to employers. Also, pension funding rules leave much to be desired, often allowing sponsors of underfunded plans to avoid making needed contributions.

Nevertheless, despite this rather bleak environment for defined benefit plans, there are a number of important steps that can be taken to encourage employers to keep these plans functioning and even to establish new plans.

First, a key problem is that these arrangements are often not a significant component to the retirement of key executives in large corporations and these managers have an understandable tendency to give the plans low priority. The statutory limit on compensation that may be taken into account under defined benefit plans, currently $210,000, is often a fraction of the total pay for senior managers, thus sharply limiting their accrued benefit. Consideration should be given to raising this limit substantially, or even eliminating it, for defined benefit plans, while retaining it for defined contribution arrangements.

Second, while the funding rules should indeed be tightened (as the Bush Administration proposes), in an environment where plan managers assume all of the risk of investment losses, there should be some rewards as well for good investment results. Withdrawals by employers of surplus assets of clearly overfunded plans (with certain adjustments for risk parameters) should be permitted, at reasonable rates of taxation.

Third, if a government bailout is inevitable, employers with well funded plans should be allowed to seek private insurance and opt out of PBGC coverage rather than be forced to support the benefit promises of less prudent employers.

As Mr. Lowenstein points out in his article, defined benefit plans frequently provide a key backstop to middle income retirees of their social security benefits. With a degree of flexibility and creative thinking, the private pension system can be preserved, to the benefit of millions of participants.