Traditional pensions: Are they at risk?

Many defined-benefit plans are underfunded. Here's how to keep track of your benefits.

As Americans confront the reality of severely depleted retirement savings, a new financial specter threatening retirement security emerges: the solvency of defined-benefit pension plans. Experiencing their worst historic performance in 2008, both public and corporate pension funds have faced staggering losses, placing enormous financial pressure on state and local governments and corporations that fund them.

Bill Frieske, vice president of investment risk and analytical services for Northern Trust, projects an average 26 percent loss among these pension plans from January through October of this year. The average allocation for such funds is classified as a "moderate risk" portfolio: 45 percent US equities, 15 percent international equities, 35 percent fixed-income investments, and 5 percent cash or cash equivalents.

Corporate employers face an added challenge in addressing their pension fund losses. The 2006 Pension Protection Act (PPA), effective this year, requires corporate pension funds to be fully funded by the end of 2008. This high threshold will be difficult to achieve for many of the 700 largest corporate plans, which have fallen to an average of 83 percent funding, down from 100 percent at the end of 2007.

Once a corporate defined-benefit plan falls to between 60 percent to 80 percent funding, retiree lump-sum benefits will be restricted to 50 percent of payouts due retirees. Lump-sum payouts have been a popular option for those who have retired in recent years.

Some pension experts want Congress to delay implementation of the PPA rule requiring full funding until financial markets are stabilized. "If companies are required to infuse a massive amount of money into pension plans to meet the 100 percent funded requirement by the end of 2008, they may be compelled to freeze plans in the future to mitigate against future negative impacts," warns James Klein, president of the American Benefits Council, representing corporate pension plans.

Diverting company funds to fully fund defined benefit plans would create severe hits on corporate balance sheets and pressure earnings, notes Alan Glickstein, senior consultant for Watson Wyatt, a global consulting firm.

Public pension funds also face shortfalls regarding long-term funding of their direct benefit pension obligations. In 2008, Wilshire Associates reported that of the 56 state retirement systems which reported 2007 data, 75 percent were underfunded with an average funding ratio of 82 percent.

"Public pension funds are accustomed to thinking in decades, not years, smoothing their gains and losses over a five- to 15-year period," says Keith Brainard, research director for the National Association of State Retirement Administrators. "It may be a number of years before losses work their way into the valuation of public pension systems."

If investment returns do not improve by mid-2009, state and local pension funds may need to request higher contributions from employer members. Suffering record declines in income, sales and property tax revenues, some governmental entities may face tough choices: funding vital services, or increasing support for employee pension payments.

Pension consultants are now looking beyond the immediate crisis to propose new retirement fund designs.

"Hybrid plans … may emerge as the best practice," Mr. Glickstein says. "Employees will perceive such plans as 401(k) accounts, knowing what their assets are worth, but having a definite benefit assured at retirement. In such hybrid plans, the risk is on the employer and the employee never loses principal."

Those vested in a direct-benefit pension plan might employ these strategies to keep track of their benefits:

•Review your pension's Annual Funding Notice detailing funding level, current assets/liability values, and allocation of plan assets. Check the actuarial rate of return on assets – is it attainable? Learn more about your rights at

•Determine whether your plan has a cost-of-living increase, covering inflation.

•Check the pension's Summary Plan Description, a statement detailing your payment schedule. Contact the Department of Labor ( if your employer cannot provide this document.

•Verify your "vesting" status, length of work required before receiving benefits.

•Contact the Pension Benefit Guaranty Corporation ( if your company is bankrupt, or the Securities and Exchange Commission ( if there is a merger.

Dr. Kathleen Connell is a professor at Haas Graduate Business School, University of California, Berkeley.

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