Reasons Behind DB Plan Cost-Cutting Trends

Ford Motor Co. recently announced that its change to mark-to-market accounting for its defined benefit (DB) plan will add $1.5 billion to its earnings, and Baystate Health announced that freezing its pension plan provided $69.7 million in revenue, preventing it from recording an operating loss.

These are not new trends. Other DB plan sponsors have switched accounting m,ethods, and reports of pension freezes have become common in the last 10 years.

Alexa Nerdrum, a senior retirement consultant in Willis Towers Watson’s Southfield, Michigan office, says the move to mark-to-market accounting means pension gains or losses are recognized immediately rather than amortized over several years. By adopting that accounting method, plan sponsors move prior year losses from current results. She tells PLANSPONSOR this is a more true measure of a DB plan sponsor’s financials. Removing amortization removes long-term market fluctuations and when DB plan sponsors use this accounting to project into the future, it improves their ability to budget for the plan, she adds.

Other than for financial reasons, Nerdrum says Will Towers Watson has seen clients move to mark-to-market accounting to align with international accounting standards or to align their measures with their competitors’.

Freezing a pension plan can help plan sponsor company’s financials by removing the liability of future benefits yet to be earned off the balance sheet, which is required to be reported under current rules, Nerdrum explains.

Nerdrum notes that when the Employee Retirement Income Security Act (ERISA) was passed, there were different ways required contributions for DB plans were calculated and liabilities recorded than now. “Accounting rules have changed, and some of operational costs have skyrocketed,” she says, noting that Pension Benefit Guarantee Corporation (PBGC) premiums have “increased exponentially” over the last decade.

Legislative rules for valuing the cost of DB plans have changed as have funding rules; in the past employers could take a contribution holiday, which may have led to lower funding in subsequent years, according to Nerdrum. She adds that market uncertainty also drives increased costs for DB plans.

Nerdrum admits that DB plans are complex and require sound governance as it relates to managing the cost, but Willis Towers Watson sees many employers still committed to maintaining active DB plans. “We’ve done research and found 20% of Fortune 500 companies still offer a DB plan to new employees, and 29% of Fortune 100 companies do. They believe in [DB plans’] value,” she says.

DB plan sponsors can manage the cost of their plans with sound governance and funding and investment policies, Nerdrum asserts. And, they need to understand risk and establish an investing policy that will consider the lifetime of the plan.

DB plan sponsors can also take advantage of opportunities to change to a less costly plan design, and they can get rid of some of their liability by transferring some to an insurance company or offering a lump-sum window to certain participants.

“There is constant discussion in the industry and Congress about how to make these plans more sustainable, and I think those discussions will continue. The industry and Congress wants to see reform,” Nerdrum concludes.