When Bemis Corp. saw the pension liability of its defined-benefit plan soar in late 2005 as a result of falling interest rates, the consumer-products packaging manufacturer decided to limit the accrual of new benefits to employees who were over 40 and had at least 20 years of service with the company. Other employees from then on would be eligible to put pretax savings into a new 401(k) plan, with Bemis contributing a share of its annual profits on their behalf.

The expectation is that the so-called soft freeze of its defined-benefit plan will halve the company's annual pension expense after eight years. In the months since the passage of the Pension Protection Act of 2006 in August, other companies have announced similar actions. DuPont, for example, plans to reduce the benefits in its pension plan for existing employees and close it to new ones as of January 1, 2008, cutting its costs by roughly two-thirds. Tenneco and Blount International plan similar changes and expect to save $11 million and up to $23 million annually, respectively.

Spurring this trend is a recent move by the Financial Accounting Standards Board, which issued the first of two sets of rules to require corporate plan sponsors to take pension assets and liabilities out of their financial-statement footnotes and include them in their reported results (see "Mismatched from the Start" at the end of this article). Taken together, the new rules enacted by Congress and FASB "will make the true cost of defined-benefit plans transparent to investors and accelerate the closing of defined-benefit plans by financially healthy plan sponsors," predicts Zvi Bodie, a professor of finance and economics at Boston University.

Indeed, that transparency may just nail the coffin shut on traditional pensions. According to Bodie, the combination of stiff new funding requirements for traditional plans and higher premiums on government pension insurance creates further disincentive for offering traditional benefits. And while the law is designed to improve the chances that companies will make good on existing pension promises, it may also encourage them to freeze or at least limit those promises and shift investment risk to employees through 401(k)s and other defined-contribution arrangements — as firms like Bemis have done. Basically, says Bemis's treasurer, Melanie Miller, "the law allows companies to do what they've wanted to do for some time."

No Real Obligation
It's no secret that defined-benefit plans have been losing favor among corporate plan sponsors. The percentage of full-time employees of large and midsize companies who take part in defined-benefit plans fell from 80 percent in 1985 to 33 percent at the end of 2003, while those in defined-contribution plans climbed from 41 percent to 51 percent. What's different now is that that shift has been further propelled by new legislation.

Sponsors now have the ability to automatically enroll employees in 401(k) plans and are protected from fiduciary liability when providing investment advice, even if it's from advisers with conflicts of interest. The law also rules that cash-balance plans are not age-discriminatory as long as they follow guidelines that were established to protect employees. As a result, says Tonya Manning of Aon Consulting, cash-balance plans are "now an option." In effect, the law reverses a 2003 court decision against IBM's conversion of a defined-benefit plan to a cash-balance plan, which cast a pall on similar moves by other sponsors. The Pension Protection Act does "a lot to make cash-balance plans viable," she adds.

Tightened funding rules for defined-benefit plans make the alternatives even more appealing. Although the new requirements will be phased in over the next five years, at the end of that period companies' plans must remain fully funded to get the backing of the Pension Benefit Guaranty Corp., the federal agency that insures defined-benefit plans. Previously, such plans needed to be only 90 percent funded at some point in the ensuing 30 years to qualify for PBGC coverage. Sponsors whose plans are considered underfunded (between 65 and 80 percent funded) face larger increases in what they must contribute, while those with plans in the worst shape (where funding is less than 65 percent and the plan is "at risk") will be subject to penalties.

To make matters worse from the perspective of costs, sponsors' ability to smooth the effects of underfunding when determining their status has been severely curtailed. The law cuts the number of years that companies register changes in the value of their pension assets and liabilities from five years to two in the case of assets and from four years to two in that of liabilities. Consequently, says Stephen Metz, a principal in PricewaterhouseCoopers's human-resources services group, "the biggest potential negative [of the law] is tremendous volatility in cash funding requirements."

What Is Fair?
For their part, most companies seem reluctant to make sweeping changes right away. A recent survey of large and midsize companies by Towers Perrin found that only 17 percent of the 126 respondents say they will close their defined-benefit plans to future hires, and only 5 percent admit they will freeze their plans as a result of the new law. Almost half intend to maintain their current plans without cutting benefits. Moreover, such companies as DuPont and Tenneco insist that their plan changes were in the works months before the law was enacted.

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