A new chapter in the erosion of American workers’ pension benefits opened today, as Northwest Airlines Corporation’s 5000 pilots voluntarily approved a freeze on their defined benefit pension plan, and its replacement with a defined contribution plan. An overwhelming 82% of the pilots casting ballots voted to approve the freeze. Both Northwest and the pilots’ union had recommended this step.
What’s going on here?
I’ve written before about what seems to be an accelerating trend among US corporations away from defined benefit, and toward defined contribution pension plans. To review, a defined benefit (DB) plan is a “traditional” pension plan. When workers covered under a DB plan retire, they stand to receive a set pension benefit — most often a lifetime annuity — determined from a formula including their total years of service, their age at retirement, and some measure of their level of pay while they worked. A DB plan retiree may always wish the monthly checks were bigger, but such retirees mostly don’t have to worry about outliving their benefits or having them vary from year to year.
To fund the promise in a DB plan, the employer generally sets up a pension fund, a pot into which they contribute cash, investing it today to pay benefits in the future. If this pot of money isn’t big enough to pay the promised benefits, even after allowing for earnings on the investments, then we say the plan is under-funded. If an employer has an under-funded pension plan, then eventually it will either have to pony up more cash, try to reduce future benefits, or try to terminate the plan through bankruptcy. Short of bankruptcy, rolling back benefits that employees have already earned is virtually impossible, but employers can freeze their plans, essentially saying that after a certain date, employees won’t earn any further benefits. IBM announced such a freeze last week.
Both Northwest’s and IBM’s actions included freezing DB plans and creating or enhancing defined contribution (DC) plans. In DC plans, like 401(k)s, each participant has an individual account. Most often, employees contribute to their accounts from their own earnings, and the employers also often match those contributions. In many instances — Enron, most notably — the company match is in the form of company stock. In any case, in a DC plan, employees bear the risk of the investment performance of their own accounts, and they also bear the risk that they’ll outlive their money. On the other hand, a DC plan account is generally portable — if you change jobs, you can usually take your 401(k) account with you, but any DB pension benefits you might have earned often die.
All things considered, DB pensions are a better deal than DC plans for employees that work for a single company for a long time. That’s because a DB pension formula usually puts a heavy weight on seniority at retirement. So why would an airline pilot’s union, whose membership generally have a pattern of pretty stable service for a particular carrier, recommend to its members that they approve freezing a DB plan and switching to a DC plan? Only because it’s better than the alternative. Northwest’s pension plan is substantially under-funded, and Northwest itself is financially on the ropes — in fact, the carrier is in bankruptcy. It’s unlikely that the company can contribute the cash necessary to shore up the pension plan. If the pilots hadn’t agreed to freeze the existing plan, Northwest would probably have petitioned the bankruptcy court for permission to terminate the plan, a petition the court might well approve. If so, then the Pension Benefit Guaranty Corporation, the entity that insures insolvent pension plans, would likely take over the plan. Trouble is, PBGC generally pays benefits at reduced rates. So the pilots were in a corner; approving the freeze was the best choice under the circumstances.
Northwest, IBM, Delphi, even the debate over Social Security — are all part of a broader trend away from fixed, lifetime benefits for American workers. More and more we are on our own. It’s really a strong undercurrent in the general weakening of the economic position of labor in the US economy. It also represents a broader erosion of the ability of American workers to pool risk and take collective action. Each of us must take individual action, increasing our savings and learning how to invest, but there is also an urgent need for us to develop alternative means by which to take collective action.