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Get Four
|  | JANUARY 9, 2006
By Nanette Byrnes The Rush to Shut Down PensionsWhen a well-funded giant like IBM joins the move to end defined-benefit plans in favor of 401(k)s, even more companies are likely followWhat a difference a year makes. Back in December, 2004, when IBM (IBM ) announced its intention to close its traditional pension plan to new employees, offering them the 401(k) plan instead, the company made it clear it did not wish to become a poster child for the broader demise of these old-fashioned retirement plans. Pensions already had been a painful public-relations black eye for Big Blue, which had been battling employees for years over changes made to the pension in the 1990s. More bad press was not what anyone wanted. But on Jan. 5, IBM thrust itself back into the headlines with its decision to go one step beyond its earlier move and "hard close" those old plans. That means not only new IBMers, but people who have been there for decades, would no longer be accruing guaranteed benefits. Instead, they would be part of a more generous 401(k), though any pension dollars already earned would still be theirs as well. Coming on the heels of a similar move by telecom giant Verizon (VZ ), it seems to be one more tolling of the bell for the promised pensions of old. Neither company is in the financial straits of the airlines and auto-parts outfits, which have been casting pension plans on the mercies of the government guarantor, the Pension Benefit Guaranty Corporation (PBGC). IBM is doing well, in fact, and its $48 billion U.S. pension plan is fully funded (see BW, 7/19/04, "The Benefits Trap"). UNPREDICTABLY EXPENSIVE. Employee activists are outraged. "It's difficult to understand how they're doing this in the context of wanting to be a world-class employer. You see companies of this stature, Verizon, IBM, seemingly in concert, in a race to the bottom for the defined-benefit system," says John Hotz, deputy director of the Pension Rights Center, a Washington consumer organization focused on retirement rights. "No matter what IBM wants to call it, it's a cut in employee compensation, and it's the sneakiest kind of pay cut, one employees won't realize the full impact of until they reach their retirement years." (See BW Online, 1/6/06, "Pension Plan Basics.") For many years, IBM had been able to count on earnings from its overfunded plan flowing to its net income, to the tune of $4 billion from 2000 to 2002. So why would Big Blue want to abandon something that has often been an earnings maker for it, and risk this kind of criticism? The first reason is that the pension had become unpredictably expensive. In late 2004, IBM was projecting that its 2006 pension expenses would be $2.7 billion, a jump of $500 million over its 2005 level. A year later, in late 2005, that projected 2006 number had gained $400 million, as a combination of rising short-term interest rates and flat long-term rates pressured the plan. Because many of IBM's 117,000 U.S. employees are in a form of defined-benefit plan called a "cash balance" plan, the rate at which IBM credits interest to their accounts moves with the short-term rates. In 2005, that rate was 3.1%. For 2006, it will have climbed to 5%, an added cost of $200 million. At the same time, those declining long-term rates -- in the U.S. and abroad -- were feeding into IBM's pension liability calculations, adding $400 million in expense for 2006. With the changes IBM is making, it's able to keep the 2006 expense between an estimated $2.5 billion and $2.6 billion. And over the next five years, the changes are expected to save $2.5 billion to $3 billion. "HERD MENTALITY." Besides making its finances more predictable, IBM argues, a 401(k) system is what its rivals offer and what employees expect these days. And though it acknowledges that 19% of its people will suffer some loss from the pension move -- mostly those who are close to retirement age but not old enough to retire by 2008 -- everyone enrolled in the 401(k) will be getting more. IBM has raised its contribution to a possible 10% of salary, very high compared to a typical plan. But the ultimate returns on those 401(k)s will depend on the performance of the investments the employees choose. IBM may be making headlines, but the trend toward freezing plans has been ongoing for years. According to human resources consultant Watson Wyatt Worldwide, 638 of the 1,000 largest companies had defined-benefit, or traditional, pension plans in 2001. Of those, only 5%, or 34 plans, were frozen to new entrants. By September, 2005, only 627 were offering the plans, and 13% of those, or 82 plans, had been put in the deep freeze. Still, IBM is likely to speed the march away from defined-benefit pensions. "There has always been a bit of a herd mentality in the whole benefits world," says Syl Schieber, director of U.S. benefits for Watson Wyatt. THE STREET APPROVES. Also expected to propel the drop-off is a series of accounting and legislative changes being contemplated by the government. In Washington, lawmakers are considering legislation that would raise the premiums companies must pay into the PBGC insurance system. Those premiums are in part based on how many people a plan includes, so blocking out new entrants lowers that impact for employers (see BW Online, 5/19/05, "A Much Deeper Pension Hole?"). In addition, rulemakers at the Financial Accounting Standards Board are expected to make a series of changes, including requiring companies to mark pension assets and liabilities to market, a step that will make pensions more volatile and bring underfunded pension obligations onto the parent company's books. It's not just groups like the Pension Rights Center that rue the changes in the pension universe. Matt Scanlan of Barclays Global Investors notes that so-called defined-contribution plans like 401(k)s tend to underperform traditional defined-benefit plans by 2% to 4% a year. That could result in a difference of hundreds of thousands of dollars to an employee over 30 years. "What companies like IBM and their colleagues are doing is requiring their employees to be their own chief investment officers, and our research shows that's not necessarily a good thing," says Scanlan. It may not be good for the employees, but Wall Street thinks it's good for IBM. Shares of Big Blue closed up $2.45 on Jan. 6, at $84.95.  Byrnes is a senior writer for BusinessWeek in New York
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