From The Gold Standard To a Vague Memory

The defined benefit pension plan was once the gold standard of retirement benefits. It was offered by the best employers, sought by virtually every employee, and the center of many difficult contract negotiations. “There once was a time when…you could expect to be rewarded for your loyalty and hard work with a gold watch and a steady stream of checks lasting the length of your retirement.”1

The classic pension plan offering a monthly benefit check for life began to disappear for a number of reasons. One of the underlying problems was the demand from employees for ever increasing monthly benefits. The willingness of employers to agree to benefits requiring unrealistic investment returns created additional risk.2 Employers found the ongoing liability created by such plans and the growing size of annual contributions to fund increasing life expectancies to be a drag on earnings. IBM announced a freeze on its defined-benefit plan, the first step in its elimination in 2006.3 Today, a classic defined-benefit plan is difficult to find!

Overpromised and Underfunded

The problem created by making future promises of ever increasing pension benefits did not become apparent early on. The Baby Boomer generation provided a significant increase in the number of employees upon which the defined benefit plans were based. However, there was coming a time when the future promises were to become a present reality. As life expectancies increased, the number of people receiving monthly benefits failed to diminish as they had in years gone by. With retirees from the Greatest Generation living longer and an increasing number of Baby Boomers reaching retirement and receiving benefits, a deep drop in investment returns created the perfect storm eroding the assets supporting both corporate and public pension plans. “Fast forward to 2016, and we learn the reality is most employee pension plans are either underfunded or the assumptions made on the rate of returns is unrealistic.”4

Politicians appear oblivious, or reluctant, to address the underfunded nature of pensions. The State of Illinois currently has $130 billion of unfunded pension obligations. Rather than address the issue, the State Legislature passed a budget calling for a $1.5 Billion reduction in state contributions to the pension plan5, making the problem worse. The Commonwealth of Kentucky faces an unfunded pension crisis of at least $40 billion.6 Such a deficiency in the assets of the plan does not happen overnight, but “where politicians are involved, the incentive towards magical thinking is even greater.”7 The chair of the Kentucky Senate budget committee said the Commonwealth is at a point, “where we cannot make pension payments and deliver essential services.”8 What will be done about the current issue remains to be seen.

Is MY pension in danger?

Thankfully, there are many solid, well funded, well managed pension plans. The Christian Churches Pension Plan may be counted among those that are capable of keeping the promises made. There are appropriate questions for any plan participant to ask about their plan.

How realistic is the basic promise offered in the plan? This question specifically addresses the rate of return promised on the assets of the plan. Is the promise of monthly income benefits built upon an unrealistic rate of return? There are historic norms for returns in both stock and bond investments. From these returns, every plan will have expenses for the management of the funds and plan administration. Is the plan operated in a sufficiently thrifty manner allowing the historical norm investment returns to fund the promise made?

How sound is the funding of the plan? This question has two parts. The first addresses the overall funding of assets to meet the future obligations of the plan. A defined benefit plan is considered healthy if the current assets are at least 80 percent of the future promised pensions.9 The second element is also key, because a plan may be healthy now and become underfunded in only a few years. Are annual contributions made to the plan in sufficient measure for it to remain healthy and funded?

How solid is the asset management of the plan? Are the asset managers hired by the plan administration forced to pursue risky and expensive investments in order to achieve plan goals? Asset managers under pressure to over perform historical norms often find themselves underperforming the goals of the plan.

A defined benefit plan, if you can find one is still the gold standard. We believe Mr. Nolan enumerated valid concerns in his article in, but failed to mention many positives of defined benefit plans. A well managed, well funded plan will offer a solid, if not spectacular, return and a lifetime of monthly predictable pension income!

1 McWhinney, James E. The Demise Of The Defined-Benefit Plan. Investopedia.
2 Nolan, Hamilton. Defined Benefit Pensions Are a Foolish Dream. June 1, 2016.
3 McWhinney. op.cit.
4 Goldsman, Ryan. The sad decline of Defined Benefit pension plans. December 28, 2016. Financial Independence Hub.
5 Crain’s Editorial Board. Illinois: Land of still unfunded pension obligations. July 17, 2017.
6 Loftus, Tom. Can public pension benefits be cut? Kentucky officials looking into it. July 16, 2017.
7 Nolan, op.cit.
8 Loftus, op.cit.
9 Terzo, Geri. What Is a Fully Funded Retirement Plan?