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Can Consolidation Fix Pension Plans?

detail of UPS truck logo
photo by Ryan McKnight

UPS may have branded itself “United Problem Solvers,” but one problem continues to bedevil the shipping company’s management: how to meet its hefty retirement plan obligations.

UPS recently became the latest major U.S. company to take drastic action to limit rising pension obligations. In June, it announced it would freeze pension plans for about 70,000 nonunion employees in five years, moving their existing funds into 401(k) accounts. The decision is meant to address the company’s nearly $10 billion retirement fund deficit.

At Palisades Hudson, we have written for years about the risks inherent in defined benefit pensions for public employees. We have also discussed the risks for private sector workers with the same sort of plan. Defined benefit plans rely on employers, public or private, making promises they may prove unable to keep, especially in the face of historically low interest rates. Workers can end up counting on a benefit that it simply won’t be possible to pay. According to consulting firm Mercer, the collective deficit in Standard & Poor’s 1500 companies’ pension plans reached $408 billion at the end of 2016.

This is a complex problem. But the U.K.’s Financial Conduct Authority offered a new suggestion in June when it released a report calling for the government to remove barriers preventing pension funds to merge. For defined benefit plans especially, the FCA found that pension funds faced complex regulations and certification requirements that made pooling extremely difficult. The agency suggested that simplifying the process would encourage funds to merge and take advantage of the resulting economies of scale.

As in the United States, many British pension funds have struggled to pay their members. Larger funds would facilitate lower fees and broader investment choices than those available to relatively small operations, so the theory goes.

The agency isn’t wrong that size confers some benefits. Bigger plans have more leverage to lower expenses, which will help plan participants keep more of their savings. But the difference will typically be a fraction of a percent. Michael Johnson, a research fellow at a U.K. think tank, criticized the plan to consolidate British pension funds as insufficient to tackle the underlying problem. “What we are witnessing is mere tinkering,” Johnson said, according to the Financial Times.

I think “mere tinkering” is a fair way of putting it. If your retirement plan either succeeds or fails because of a few basis points of additional return, you are already cutting things way too close.

Companies and governments alike can see the dangers of defined benefit plans. This is why they are becoming less common; according to a report from Willis Towers Watson, the percentage of Fortune 500 companies offering a defined benefit plan to new hires fell from about half in 1998 to 5 percent in 2015. And freezing a pension plan is often a death knell, with the time between freezing and closing a plan averaging 4.5 years.

Some of the reasons that companies and governments are struggling to meet pension obligations may change; interest rates will inevitably rise again, but how far and how fast remain unknown. Other problems, such as extended life expectancy, are unlikely to go away. A lot of smart people worldwide are scrambling to identify and implement solutions before the promises are broken and, inevitably, retirees caught short put a massive strain on the social safety net.

The FCA’s idea that consolidation will offer some advantages isn’t wrong, exactly, but it is highly unlikely it will do enough to stop the ballooning gap between the promises and the realistic payouts of defined benefit retirement plans. Here in the U.S., defined benefit plans in the private sector are already an endangered species and, if companies like UPS are any indication, one heading quickly for extinction. Pooling small struggling plans into larger ones will almost certainly prove to be too little, too late.

Managing Vice President Paul Jacobs, of our Atlanta office, is among the authors of our firm’s recently updated book, Looking Ahead: Life, Family, Wealth and Business After 55. He wrote Chapter 12, "Retirement Plans"; Chapter 15, "Investment Approaches And Philosophy"; and Chapter 19, "A Second Act: Starting A New Venture." He also contributed to the firm’s book The High Achiever’s Guide To Wealth.

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