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The New Old Benefit

June 6, 2008
Related Topics: Retirement/Pensions, Benefit Design and Communication, Featured Article, Compensation

Every few years, companies come up with a new perk or benefit to tout to current and prospective employees in an effort to recruit or retain talent.

Ten years ago, it was stock options. Today recruiters are pitching work/life balance and flexibility.

But a number of experts are predicting that an old benefit may make a comeback in the next several years as employers find it harder to recruit and retain employees. That benefit? The defined-benefit plan.

There is no debating the fact that dozens of employers have frozen or terminated their defined-benefit plans over the past few years because they have become too expensive and hard to manage.

In the last 10 years, 40 percent of employers have replaced their defined-benefit plans with defined-contribution plans as their main retirement vehicle for new hires, according to a survey of 300 large employers by Watson Wyatt Worldwide.

However, that same study found 59 percent of employers say they are committed to their defined-benefit plans.

And a Watson Wyatt Worldwide study published in May found that the pace of companies freezing their defined-benefit plans has slowed from 11 percent between 2004 and 2005 to 5 percent in 2006 and 4 percent in 2007.

"Very few companies that have frozen their pension plans have actually terminated them," says Alan Glickstein, a senior consultant at Watson Wyatt Worldwide. Part of the reason for this is financial—companies can’t terminate their plans unless they are 100 percent funded.

But the other reason that companies aren’t terminating their plans is because they want to keep open the option of making them available again someday, he says.

"A lot of companies are having workforce planning discussions and they are worried about being able to fill certain job categories as the baby boomers retire," Glickstein says.

Even if companies aren’t concerned about an all-out talent shortage, most employers recognize that they are going to have to fill holes in their mid- to upper-management positions as the baby boomers retire, experts say. This means that recruiting midcareer employees, who have 10 to 20 years of experience, is going to become essential.

"In 10 to 15 years, many companies are going to be needing to recruit midcareer people," says Dallas Salisbury, president of the Employee Benefit Research Institute. "And to attract those people, defined-benefit plans can be useful."

The recent Pension Protection Act, which became law last year, may make it more attractive for companies with frozen defined-benefit plans to reopen them if they need to, Salisbury says.

Under the new legislation, employers have to keep their defined-benefit plans 100 percent funded. This means that companies actually have a target funding rate of 120 percent so that if their investments drop in value because of market swings, they are still covered. Previously, employers could keep their defined-benefit plans 85 percent to 90 percent funded.

As a result of this new requirement, many companies will find that their plans will be overfunded much of time, Salisbury says.

"A lot of plans are going to have a lot of additional money," he says. "And if these are the companies that rely on highly technically trained employees who they can’t afford to lose, they may reopen or start new defined-benefit plans."

Making the decision
Even during the 401(k) boom of the past several years, there have been a few companies that have reopened their defined-benefit plans.

Aerospace Corp., based in El Segundo, California, is one of these employers. The government-funded research company supports the space program through research and development. As such, Aerospace is highly dependent on its ability to recruit and retain Ph.D.-level scientists and engineers.

But after freezing its defined-benefit plan in 1993 amid cost pressures, Aerospace realized that it had become more difficult to bring in talented employees and keep them, says Charlotte Lazar-Morrison, general manager of Aerospace’s HR division. Even with a very attractive defined-contribution plan, which included an employer contribution of 8 percent of employees’ pay, turnover was increasing and it was becoming harder to recruit talent.

Many of the large defense contractors offer a defined-benefit plan, and even though Aerospace’s defined-contribution plan was attractive for what it was, it didn’t work as a retention tool, Lazar-Morrison says.

"Since it was portable, employees could just take their retirement savings with them without a second thought," she says.

And with increasing competition for talent on the East Coast, where many smaller defense contracting firms had relocated, Aerospace realized it had to do more to prevent its employees from being poached, Lazar-Morrison says.

But bringing back the defined-benefit plan took some convincing on the part of management, she says. Especially since so many other companies were getting rid of their defined-benefit plans, it was particularly a hard climate for making the pitch.

"Our CEO really wanted to see the numbers and make sure we were doing the right thing," Lazar-Morrison says. "We brought in consultants and went through a lot of different alternatives."

One thing that the Aerospace’s executives had to grapple with was how it could offer a benefit to all of its employees so that there wouldn’t be any perceived inequity. Under the structure at the time, more senior employees were in the old defined-benefit plan, while new employees were in the defined-contribution plan. "Every once in a while, we would hear a comment about ‘Why don’t they have the same benefits as me?’ " Lazar-Morrison says.

In the end, Aerospace executives agreed that bringing back a new kind of defined-benefit plan would be best for workforce morale and retention, she says.

In 2005, Aerospace introduced a new defined-benefit plan that was a mix of its defined-contribution plan and its old defined-benefit plan.

The new plan offers a contribution equal to 4 percent of pay to the defined contribution plan and a benefit accrual in the defined-benefit plan equity to another 4 percent of pay. Two-thirds of benefit accrual is variable, while one-third is fixed.

While Aerospace hasn’t tried to measure the return on investment of its defined-benefit plan, HR executives have heard anecdotally that the company is getting more interest from job candidates because of its retirement program, Lazar-Morrison says.

Particularly since the average age of a new hire is 42, recruiters tell Lazar-Morrison all the time that the retirement benefit plan is a big hit.

To promote the value of the benefit even more, Aerospace is implementing a new online retirement planning tool that will allow employees to enter their benefit information and see how much they will have when they retire.

Since the company’s defined-benefit plan is a bit complicated, offering such tools, along with extensive communication, is essential to making sure that employees and prospects appreciate its value, Lazar-Morrison says.

"We will also run retirement estimates for recruits so it can be really clear for them what their take-away will be," she says. "When they see the real dollars, it’s easier for them to comprehend."

And Lazar-Morrison says that more college recruits are asking questions about retirement benefits during the interview process. "The younger hire is much savvier about these things," she says.

Some experts believe that with stock market swings, companies that offer defined-benefit plans will become even more attractive to both younger and older workers.

"The current market gyrations are terrifying a lot of employees," says Alicia Munnell, director of the Center for Retirement Research at Boston College. "At the same time, I can’t imagine employers wanting to take on the risk again during this volatility."

So for the time being, most employers will continue to tout the employer match for their 401(k) plans and the fact that they have health care coverage when they’re talking to prospective employees.

But soon, more of these companies are going to realize they will need to do more.

""Five to 10 years from now, the tight labor markets may really be difficult terrain to navigate for employers and they are going to need all of the tools they can get," says Norman Stein, a professor at the University of Alabama School of Law. "One of the most helpful tools for managing this challenge is the defined-benefit plan."

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