VideoThere was a time when the journey toward a financially secure retirement ran straight and smooth, both for employers and employees. Companies offered generous pensions to nearly all workers, and most workers logged many years of experience with a single company, confident that when it was time to exit the workforce, they would be well provided for.
That road developed some potholes in the 1980s, when companies began a marked shift toward defined contribution plans. Before long, the Pension Benefit Guaranty Corp. was sounding the alarm over a few companies' underfunded defined benefit plans. The loudest sirens were heard at automakers like Chrysler and airlines like United; the latter's declaration of bankruptcy and subsequent $8.3 billion pension-fund failure ranks as the biggest defined benefit collapse since the PBGC began guaranteeing pensions in 1974.
Nonetheless, accounting regulations gave companies plenty of latitude in how they managed their pension plans. Those that didn't have enough in the till to meet their obligations could smooth the value of plan assets (averaging them out over five years from 80 percent to 120 percent of the assets' fair market value). Those with overfunded plans enjoyed the perception of superior operating performance, with that pension cash hoard often masking a range of weaknesses.
But even favorable accounting treatment couldn't stem the move away from defined benefit plans. While 38 percent of Americans had a defined benefit pension as their primary retirement plan in 1980, by 1997 this percentage had dipped to 21 percent, according to the Pension Benefits Council.
That percentage is likely to drop even faster, thanks to the near-simultaneous advent of the Pension Protection Act of 2006 (PPA) and the Financial Accounting Standards Board's FAS 158. Together, the new federal law and accounting guidance have created conditions under which companies must deploy greater resources and expertise to efficiently manage pension assets. The PPA cut the number of years companies can smooth, limiting pensions as a strategic accounting tool; FAS 158 requires them to put their funded status on the balance sheet, which makes the costs more transparent to investors and thus harder to manipulate. In short, the new regulations have made pensions more complex to manage and increased the penalties for mismanagement.
That shift, say some experts, has fundamentally changed the way in which companies should regard defined benefit plans. "Pensions have gone from being an HR issue to a finance issue," says Stephen Bozeman, a principal at Barclays Global Investors (BGI) in San Francisco. "Your pension plan is now a potential liability, something that can actually bring the company down."
The specter of increased risk brought about by stricter funding and reporting requirements is leading some companies to look more closely at integrated pension management, which takes traditional pension outsourcing one notable step further: instead of outsourcing just the management of their defined benefit plans, companies outsource a portion of the underlying liability as well. As co-fiduciary, the vendor assumes a degree of liability in the event of a lawsuit. While this doesn't get the employer completely off the hook, in the event of litigation it provides the presence of an independent third party that has reviewed the transactions and investment strategies. And if the case is lost, there would theoretically be another party to split the settlement.
A growing number of firms, including Fidelity Investments, Frank Russell, Northern Trust, SEI Investments, UBS Global Asset Management, and Barclays Global Investors, are pitching more-sophisticated pension-management services. Providers say the number of queries from CFOs has skyrocketed since FAS 158 and the PPA. Nevertheless, the question remains: Is outsourcing something as sensitive as employees' retirement benefits in companies' best interest?
Some think not. "The downside to any form of outsourcing is the loss of control, which could have cost ramifications," says attorney John Martini, practice group leader for the Tax, Benefits, and Wealth Planning Group in the Philadelphia office of Reed Smith LLP. "As the fiduciary, you have an obligation to monitor the activities of the outsourcing provider. In a period in which stocks are losing value, even what appear to be the most prudent, reasonable actions — like outsourcing — will get scrutinized if the stock tanks and the sharks come out to play."
No surprise, then, that some companies are holding firm to their current strategies, at least for now. "We froze our defined benefit plan and continue to manage it in-house," says David Devonshire, recently retired CFO of Motorola Inc. (He retains the title of executive vice president.) "We've looked at outsourcing and are obviously well aware of it as a burgeoning trend, but we didn't feel a compelling need to do it. Of course, that can always change."
Other companies have been quicker to jump. "Managing pension plans is not a core competency for us," says Bill Dordelman, vice president of finance at Comcast Corp. The Philadelphia-based cable provider inherited a defined benefit plan following its 2002 acquisition of AT&T Broadband — but not, regrettably, the plan's in-house pension staff. "For us to create an in-house investment staff would be costly and inefficient," Dordelman says. "Outsourcing management of the plan to a firm that makes asset-allocation decisions on a day-to-day basis, and is willing to put its money where its mouth is in terms of being a fiduciary, made complete sense."
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