What Factors Affect Costs for Defined Benefit Pension Plans? By RICHARD WORKS
Defined benefit pension plans provide some financial security to retirees who receive monthly benefit payments throughout their retirement. These plans provide guaranteed income during retirement, and are often based on a formula that considers years of service and a percentage of a worker’s salary. Employers have traditionally offered these plans to their employees, but the high costs associated with these plans have caused some employers to switch to alternate retirement options. In March 2016, costs for defined benefit plans for private industry employers were approximately 53 cents per employee hour worked, on average. However, when only the employers that offer these plans are considered, the costs are much higher. In this article, we’ll explore how costs fluctuate and review trends in costs for employees with access to these plans. Employers typically pay monthly premiums for benefits such as health insurance, but defined benefit pension plans are different. Employers have some latitude in deciding when to make these payments, although they still must follow legal and accounting guidelines and requirements. Required employer contributions for defined benefit pension plans may fluctuate depending on a company’s investment returns. Those responsible for managing defined benefit plans must act in the interest of plan participants. Therefore, certain investments are restricted by regulation. An example of such restrictions is that a large percentage of funds cannot be invested in a company’s own stock. The investment performance of the pension fund plays a role in determining the amount and frequency of employer contributions. When plans are underfunded, employers have to catch up and may make additional contributions. When plans are overfunded, employers might not make regular contributions. If a plan earns a rate of return that is equal to or greater than the rate of return promised to retirees, then the plan may become fully funded without additional contributions made by the employer. Costs data for these pension plans are collected by the Bureau of Labor Statistics through the National Compensation Survey. The survey collects data on premiums, administration fees, and dollar amounts placed by employers into pension funds. These amounts may be from cash, stock, corporate bonds, and other financial instruments. These costs are converted to hourly rates by dividing the annual costs by the annual hours worked, thus producing the employer costs for employee compensation estimates. These estimates measure compensation costs in cents per hour worked for a specific point in time, and include all employees regardless of access to benefits. However, this calculation produces lower costs than when eligibility is considered. Benefit incidence rates (access or participation) can be applied to benefit 22
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costs estimates to obtain a measure that shows how providing access to a benefit may affect an employer’s hourly labor costs. Costs for only those employees with access to a benefit (termed ‘worker access costs’) can be derived by dividing the benefit costs by the benefit access rate. For example, if the costs were 48 cents per employee hour worked and 12 percent of employees had access to the benefit then the costs for employees with access would be $0.48 ÷ 12% = $4.00 per employee hour worked.
Costs and unionization In goods-producing industries, worker access costs have increased on average from $2.90 per employee hour worked in March 2010 to $4.46 in March 2016, and from $1.74 to $2.56 in service-providing industries. Employees covered by unions tend to have greater access to employee benefits; therefore, unionization may affect an employer’s costs for defined benefit plans. Data show that 70 percent of union workers had access to defined benefit plans in March 2016, compared with 13 percent of nonunion workers with access. However, the worker access costs for union workers were $4.06 in March 2016, compared with $2.38 for nonunion workers. For all workers combined, employer costs for providing employees with access to defined benefit plans were $2.94 in March 2016 (see table 1). Table 1. Defined benefit worker access costs by industry type and union representation with union representation access rate, private industry, March 2010-2016 Category 2010 2011 2012 2013 2014 2015 2016 All workers costs Goods-producing industries costs Service-providing industries costs Union workers costs Nonunion workers costs Union workers access rate Nonunion workers access rate
$ 2.05 $ 2.10 $ 2.26 $ 2.37 $ 2.63 $ 3.39 $ 2.94 $ 2.90 $ 3.18 $ 3.04 $ 3.28 $ 4.00 $ 4.48 $ 4.60 $ 1.74 $ 1.78 $ 2.06 $ 2.24 $ 2.29 $ 3.00 $ 2.56 $ 2.62 $ 2.74 $ 2.90 $ 3.32 $ 3.63 $ 4.44 $ 4.06 $ 1.67 $ 1.86 $ 1.86 $ 2.00 $ 2.23 $ 2.77 $ 2.38 69% 70% 69% 72% 71% 72% 70% 15% 14% 14% 13% 13% 13% 13%
Source: U.S. Bureau of Labor Statistics
The overall costs for retirement plans (and benefits in general) of union workers tend to be higher than those for nonunion workers. This is because more generous plans favored by unions have higher associated costs. For retirement planning, employers may offer both a defined benefit pension plan and a defined contribution savings and thrift plan to provide more generous retirement benefit to their employees. With defined contribution plans, such as a 401(k), an employee usually contributes a percentage of his or her salary to an individual account with a savings and thrift plan, and employers may offer to match an employee’s contribution up to a set maximum amount. These activities promote retirement saving as employees increase their retirement savings with additional funds from their employer. More generous plans contribute larger amounts in relation to employee contributions. Other factors that may influence employer contributions include how long an employee has worked for the company and whether the employer chooses a flat rate or a variable rate when matching the employee’s contribution. Among the industry sectors with a union presence in 2016, high levels of representation were found within transportation and utilities (20.5 percent), construction (14.6 percent), and manufacturing (9.6 percent). However, only 7.3 percent of the private industry as a whole had union representation in 2016. From the high unionized industries in 2016, transportation and utilities employed 6 million workers, construction employed 7.4 million, and manufacturing employed 14.7 million workers (see table 2). The states with the largest numbers of union members in 2016 were California (2.6 million) and New York (1.9 million). The lowest union membership rates were found in South Carolina (1.6 percent), North Carolina (3.0 percent), Arkansas (3.9 percent), and Georgia (3.9 percent). Variations in cost fluctuations can also be observed within the South Census Region. Data show that the West South Central division has had higher cost when compared to the South Atlantic and East South Central divisions. The East South Central division did experience an increase in 2012 that Table 2. Total employed and percent represented by unions in 2016 Industry Private Industry Transportation and utilities Transportation and warehousing Utilities Construction Manufacturing Wholesale and retail trade Wholesale trade Retail trade Source: U.S. Bureau of Labor Statistics
Total employed
Represented
115,417,000 6,048,000 5,073,000 975,000 7,488,000 14,783,000 18,515,000 3,288,000 15,227,000
7.3% 20.5% 20.0% 23.0% 14.6% 9.6% 4.8% 4.2% 4.9%