The death of the DB pension

Model served workers well, but it's time has passed
By Todd Humber
||Last Updated: 06/12/2009

We are gathered here today to mark the passing of an old friend. A gregarious chap who served generations of workers rather well, a fellow who helped the economy by investing in markets and funding the retirement of millions of workers. But, alas, he could not escape the clutches of Father Time. Farewell, defined benefit pension plan. You’ll be sorely missed, at least in some quarters.

In marking its demise, let’s take a look at the history of employer-sponsored pension plans, which are a relatively new phenomenon.

The first employer to take the plunge in the United States is generally believed to be the American Express company, which implemented its plan in 1875. The first formal plan to be jointly financed by employee and employer contributions was introduced by the Baltimore and Ohio Railroad in 1880.

On this side of the border, the history is similar — though the names and dates aren’t as clear. According to Statistics Canada, the first pension plans in Canada appeared toward the middle of the 19th century during a period of rapid industrialization. By 1900, only federal employees, railway workers and employees of some commercial banks were covered by pension plans.

Just a few generations have had the benefit of working in an era where the employer stepped up to help finance retirement. But, in the business world, that’s an eternity. And for many workers, pension plans have become the expected norm: “I put in 30 years with the company and the company will look after me in retirement.” That thinking worked, at least for a while.

But that notion is in shambles now. It’s plain to see the gold standard of pension plans — defined benefit (DB) — is going to be unaffordable going forward for the vast majority of employers, thanks to changing demographics. As the population ages — and lives longer — employers are struggling to cope with soaring retirement costs.

Just take a look at what’s happening to General Motors Canada. The Oshawa, Ont.-based automotive giant is fighting for its very survival and struggling to be competitive with other car manufacturers. Listen to GM officials and you’ll quickly hear them talk about the need to get out from under the burden of “legacy costs.”

“Instead of carrying one workforce, like our competition at Honda and Toyota, we’re effectively carrying three additional workforces out there and those will grow further,” said David Paterson, GM Canada’s vice-president of corporate and environmental affairs.

GM Canada has 34,000 retirees and 14,000 active employees. That number is only going to be more lopsided, as plants in Oshawa and Windsor, Ont., close in the next year.

Honda and Toyota, which haven’t been in business as long in North America, don’t have those legacy costs — they don’t have to support anywhere near the same ratio of retirees as GM. That reality has to be addressed in order for GM to be “viable” going forward, said Paterson.

The Ontario government is giving some thought to assuming GM’s pension liability as part of its aid package, according to reports in the Globe and Mail. (An unnamed senior Ontario government official told the newspaper last month: “One of the issues is going to be how much (financial assistance) is provided in cash and how much is provided in kind, in addressing the pension liabilities or otherwise. The legacy costs are a ‘big issue’ for the company.”)

It’s not clear what the current shortfall is in GM Canada’s pension fund but, as of November 2007, it was $4.5 billion, according to the same Globe and Mail article. And that was before the market collapsed. That’ll be a lovely tab for the taxpayers to potentially pick up.

You could argue the pension problem at GM only came to a head because the economy tanked. And you’d be mostly right — but the writing’s been on the wall for some time. The economic collapse merely accelerated the problem.

And GM is hardly alone on that front. Ford and Chrysler face similar problems, as do a multitude of other employers across the country that have a lot of legacy employees and a DB pension plan.

It wouldn’t be surprising to see — over the next few decades — private-sector DB plans disappear completely. But this doesn’t mean employers are getting out of the pension game. Far from it. They’re simply turning to defined contribution (DC) plans. (The lone exception will be the public sector. Since it doesn’t need to worry about profits — and has very powerful unions — it will hang onto DB plans. But benefits will have to be slashed at some point to cope with the soaring costs that come from workers living longer.)

While employees may lament the passing of the DB plan, employers certainly won’t miss it. But employees shouldn’t spend too much time mourning its demise. After all, DC plans have many advantages. They’re completely portable when switching employers and have the potential to bring greater returns — and, therefore, more income — than a DB plan.

There’s also no danger of the worker losing the money if the employer goes bankrupt which, given the current economic climate, is a pretty significant plus.

Yes, DC plans shift investment risk onto workers. But benefits administrators are getting pretty savvy at running them, introducing tools that shift investments from risky to stable as workers transition through their careers.

So take a moment to mark the passing of the DB plan. In an ideal world, it would have pulled through. But at least there’s a viable alternative ready to take its place.

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