Are Defined Benefit Pension Funds Still Useful Recruiting, Retention Tools?

Art by Bill Mayer

The advantages of a defined benefit plan are “probably the most underappreciated employee benefit” by potential employees, says Jay Gepfert, the founding partner of Culpepper RFP, an independent third-party firm that assists in RFP evaluations of 401(k), 403(b), pension and benefit plan service providers.

In 2023, the private sector industries that continue to provide pension funds most notably include the energy procurement sector, big banks and biotechnology health care companies. The 10 largest private pension providers by market capitalization are Saudi Aramco, Berkshire Hathaway, Johnson & Johnson, Exxon Mobil, JPMorgan Chase, Proctor & Gamble, Eli Lilly, Pfizer, Merck & Co. and Bank of America, according to Yahoo Finance.

In the public sector, while some states are concerned about the cost of defined benefit pension funds, at least one other is considering restoring its pension offering in order to retain public safety and other state employees who are being tempted away by better benefits elsewhere.

How employees of different generations value pension benefits varies, with the ability to easily view and quantify account balances often seen as more tangible, and therefore more valuable, when compared to the abstract idea of a pension fund.

In 1960, U.S. corporate pension funds covered 23 million people in the U.S., or approximately half of the workforce and 12% of the total population. While contributions reached $5.6 billion, total pension plan assets rose to $57 billion, providing annual benefits of $1.7 billion, according to the Bureau of Labor Statistics, a figure that would be the equivalent of more than $15 billion in today’s money.

Fast forward to modern times and, as of December 31, 2021, there was $3.7 trillion in assets in private sector pensions in the U.S., according to data from the Federal Reserve.

“Conceptually, the pension plan was introduced at the time where I think there was much more of a paternalistic approach by employers to their employees,” Gepfert says. “Individuals stayed at their companies for much longer than they do nowadays. … That relationship between the employer and the employee is much more transactional. When that mindset changed, maybe 25 to 30 years ago, … the strategic approaches to how and what benefits you offer changed, … in terms of how you’re going to be running the company in a paternalistic approach.”

DB Plans No Longer Selling Points

A contributing factor to the drop in defined benefit plan usage by corporate sponsors may also be that the value of a pension for recruitment and retention has been diminished because employees fail to reconcile the value of the offering.

“I hear constantly from clients that both the [retirement plan] educators, as well as the participants, have a hard time communicating the understanding of what the value of a defined benefit pension is,” Gepfert says. “Whereas in the [401(k)] plans, the participant can go on a website every day and see what the value of their assets are.”

According to Russell Investments, 86% of corporate pension funds are currently healthy and will achieve full funding in three years, without changing an aspect of current asset allocation. When these corporate pensions reach full funding, many will likely seek to perform a risk transfer of the pension liability to an insurance company or otherwise de-risk the plan.

According to the National Conference on Public Employee Retirement Systems, in 2019 state and local government defined benefit plans in the United States covered about 14.6 million active employees and 11.2 million retirees, including teachers, police officers, firefighters, legislators, judges and other public employees. In addition, state and local defined benefit plans covered 6.9 million inactive or former employees, who will be eligible to receive benefits upon reaching retirement age.

Defined benefit pension systems are employed by public sector sponsors because “almost all state and local defined benefit plans … enhance the ability of state and local governments to attract and retain qualified employees.”

NCPERS concluded in a 2021 report that “switching to a DC plan would limit that ability, possibly exacerbating labor shortages in key service areas by increasing employee turnover rates. Higher churn rates, in turn, could lead to increased training costs and lower levels of productivity, possibly resulting in the need for a larger workforce.”

Other key elements of why public sponsors utilize defined benefit plans include: reducing the overall cost of providing lifetime retirement benefits to individuals; pooling mortality and other risks over a relatively large number of participants; and achieving lower investment and custodial fees then would be incurred otherwise. Additionally, defined benefit plans investment earnings may offset and supplement employer contributions to the system.

“Most pension plans are more cost-effective, and research shows that in an apple-to-apple asset allocation comparison, returns are higher in a pension vs. (k) plans,” Gepfert says, when asked about benefits of defined benefit plans. “Scale is the key to the game in any investment structure. More assets drive lower fees. That is one of the reasons that sponsors have been open to keeping plan assets of terminated or retired participants, it is to drive down the per-participant cost for the active employees.”

Alaska’s Attempts at DB Planning

Alaska did away with its original defined benefit plan system in 2006, after a deficit of billions of dollars brewed within the pension system. The state opted to give state employees a 401(k)-style option. Though in theory a solution to the problems facing the Alaskan legislature at the time, fast-forward a decade and a half, and in practice, the move has created a large problem: the minimal incentive for public sector workers to remain in Alaska.

Lawmakers, union leaders and worker advocates raised the alarm in 2022 that the state was facing a crisis of recruiting and keeping state workers. So, in January, the Alaska House of Representatives introduced House Bill 22, “An Act relating to participation of certain peace officers and firefighters in the defined benefit and defined contribution plans of the Public Employees’ Retirement System of Alaska; relating to eligibility of peace officers and firefighters for medical, disability, and death benefits; relating to liability of the Public Employees’ Retirement System of Alaska.” The bill will effectively enact a defined benefit plan for public safety employees in the state and was recently referred to the committee on state affairs.

There is a competing proposal in the Alaska State Senate, Senate Bill 11, which would extend beyond public safety employees, applying to state employees such as biologists and the vital snowplowers of the state’s transportation system. It would “[provide] certain employees an opportunity to choose between the defined benefit and defined contribution plans of the Public Employees’ Retirement System of Alaska and the teachers’ retirement system.” The Senate bill has since been referred to the state’s labor and commerce committee.

North Dakota May Face Similar Challenge

Mirroring where Alaska was approximately two decades ago, the North Dakota Public Employees Retirement System currently has a $1.9 billion shortfall and is only 65% funded.

The pension plan’s unfunded liability, and what exactly to do about it, is a pressing state concern, and North Dakota Senate Bill 2239 passed upon its second reading in February.

The bill requires a $250 million state contribution from the general fund in the 2023 to 25 biennium and raises contributions from state employees by 1% and employer contributions by 3.6%. The bill also expands the option of enrolling in the state’s defined contribution plan to all employees.

“The concern is: If we don’t do something now, there could be a situation not too terribly far down the road, 20 to 25 years from now, where the plan is insolvent,” said State Representative Mike Lefor in a recent interview with Bismarck, North Dakota TV station KYFR. “I truly believe that the younger generation wants to have defined contribution plans so that they can control their own money; a defined benefit plan doesn’t allow for that.”

North Dakota House Bill 1379, introduced to the North Dakota House of Representatives by a group that includes Lefor, along with House Bill 1040, seeks to put $70 million every two years from the state’s oil taxes into the pension fund beginning in 2025 to help close the funding deficit, while modestly raising local governments’ participating and employer contributions by 1%.

If there is one thing to be inferred from the examples of the North Dakotan and Alaskan state legislators, it is that while individual employees may prefer and enjoy the portability of defined contribution plans; within the public sector utilizing a defined benefit in staffing the positions deemed ‘essential’ during the pandemic era proves to be the best retirement plan afforded to sponsors, as it retains critical staff effectively.