As more companies decide to freeze their traditional pension plans, it's important to view the pros and cons of the frozen-plan option -- and make sure the right communication strategy is in place should you choose it.
The roll call of companies that have recently announced the freezing of their traditional defined-benefit pension plans is something of a who's who in American business -- from GM to IBM, Alcoa to Verizon, and the list is growing.
This represents a competitive trend, prompting many employers to take a hard look at freezing their DB programs -- which provide a fixed, employer-funded benefit at retirement -- in favor of defined-contribution plans such as 401(k)s. Most DC plans are funded by employee contributions (with or without employer-matching funds) and require employees to take on the responsibility of managing their own DC investments to maximize their returns.
This trend is by no means strictly a troubled-company phenomenon, but is driven by a number of factors. For one, benefit costs are growing much faster than wages, according to government statistics. In addition, retirees are living longer, and a steady decline in interest rates since the mid-1990s has led to the growth of pension liabilities.
For many older companies, DB pension-plan liabilities are large relative to their current operations. This means pension results have a significant impact on the overall financial results of a company. Proposed new accounting standards will mark pension liabilities to market, further aggravating this problem. (In accounting terms, "mark to market" is the act of recording the value of a security, portfolio or account at its current fair market value rather than its book value). Freezing the accrual of benefits in the DB plan prevents this problem from getting worse, but it does not get the company off the hook for the liability accrued to date.
In a recent Mercer Human Resource Consulting survey of more than 100 employers considering changes to their DB plans, more than 80 percent ranked "reducing cost volatility" as a factor in their pending decisions. As for the plan changes under consideration, nearly 60 percent of respondents were considering either freezing their DB plans for all participants or closing the plan to new employees.
Pros and Cons
Despite the trend, there are pros and cons to consider in freezing a DB plan and shifting to the DC approach. For the employer, on the pro side:
* There's very little cost volatility in the DC portion of a retirement plan, since it is immune to the interest-rate changes that affect DB plans.
* DC plans have no unfunded liabilities that could reduce shareholder equity.
* DC plans are relatively simple to communicate and understand.
* DC is consistent with the pay-for-performance principle of today's business.
* Employee control of DC plans is consistent with today's consumer-directed trend.
As for the cons of freezing a DB plan and moving to DC:
* Cost predictability and stability may take years to achieve, since accrued DB liabilities will continue to be significant.
* With DC, there's a higher net cost to delivering a given level of retirement benefits since (a) DC plans typically earn lower returns than DB plans and (b) there's no spreading of mortality risk with DC as there is with DB plans.
* There can be significant transition impact on mid/late career employees, potentially leading to delayed retirements.
Communication Needed At All Levels
Once the decision is made to freeze the DB plan, a successful transition requires enacting a solid change-communication program that demands the best efforts of HR executives.
For starters, the communication strategy is determined by the type of DB change: Will it be for all current employees? All employees except for a grandfathered group? Only some employees, such as those in selected divisions or lines of business? Will some employees be frozen, while others receive a choice of plans? Or will the freeze apply only to future employees (a "closed" as opposed to frozen DB plan)?
While communicating to affected employees is vital, companywide communication is also necessary to make clear the changes are important to the long-term viability of the organization. A DB freeze-communication strategy should follow several key guidelines.
Have a plan for employee change as well as benefit change. Workers should process the change on three levels -- with their heads ("I understand what's changing and why"), their hands ("I know what to do and how to do it") and hearts ("I believe that the change will be good for me and my company"). For this reason, it's vital to both engage and educate employees.
Helping employees understand why a DB freeze is necessary involves honesty and clarity about the drivers for change. Communication should present the causes for change as business challenges that must be managed on an ongoing basis. Combining messages addressing the business rationale for change with a recognition of the employee perspective is the best formula for engaging employees and preparing them for change.
Preparation requires follow-through, of course, and employees will need the right information and tools to understand the impact of the benefit changes and make financial decisions, if they are needed. For example, benefit comparisons between DB and DC plans are inevitable, so it's crucial to provide personalized information and projections for employees. The most useful information and tools provide benefit modeling and comparison capabilities, which allow employees to make decisions from a broader, or "total retirement," perspective. These resources provide transparency in terms of financial resources employees now have available and what their future financial and retirement needs will be.
For employees nearing retirement, frozen benefits will be significant, and they will need easy access to their total retirement-benefits information order to plan effectively. Making frozen-benefits information available as part of an ongoing 401(k) website or separate frozen-DB-plan website is important.
Minimize employee and public relations risks. At the same time, the power of the Web can work against companies that freeze their DB plans. The online world easily connects disgruntled employees; it also affords the media quick access to information about your company. Indeed, a key risk of freezing your DB plan is a sudden lapse in employee morale and engagement, which lessens productivity. Also, some employees will be concerned they are unprepared to make required financial decisions. Required is a comprehensive communications plan -- including a media strategy, leadership training, employee meetings, and benefits and financial information -- that is tailored to the needs of a company's workforce demographics and culture.
In addition, some businesses that operate in a non-union environment may be vulnerable to unionization efforts because of a change like this. A high-visibility, high-touch campaign to support businesses or divisions at high risk is called for. And the move from DB to DC may result in difficulties in attracting and retaining talent -- such as senior workers who value their DB plans, and sought-after employees from companies whose total-rewards packages may seem better because of their traditional pension benefits. The challenge here is to stress the competitiveness of your total-rewards strategy as it pertains to all elements of compensation and benefits.
Involve leadership. Company leadership should be prepared to visibly support and respond to employee concerns about the DB freeze. Depending on the culture of an organization, leadership could include the executive suite on down to line supervision -- whoever wields the most influence in the organization. Leaders should have a clear idea of their roles and responsibilities in communicating the change, and should be scripted and practiced in delivering clear, consistent messages.
Ultimately, a decision to freeze a traditional DB plan marks the beginning of a new era in retirement-plan management and communication for any company. Among many things, it requires getting the information right for affected employees -- in a timely, bite-sized, easy-to-understand manner, and delivered to employees' "doorstep" wherever they may be in today's dispersed workforce. Most of all, it requires that executive leadership own and champion the change, standing firm and staying on message, so that making the transition to a more complicated retirement-benefits horizon won't lead to a state of confusion.
Asghar Alam is America's retirement leader for Mercer Human Resource Consulting. He consults primarily on retirement strategy and financial management issues for pension plans. He can be reached at email@example.com, or by phone at 212-345-7435.
Bruce Finley leads the communication business in the U.S. Northeast Zone for Mercer Human Resource Consulting. He advises clients on a wide range of HR communication issues in organizations undergoing change. He can be reached at firstname.lastname@example.org, or by phone at 212-345-7565.
Postscript: Employers considering freezing their DB plans may want to consider a Retirement Shares Plan, a little-known type of defined benefit plan that may be more applicable to today's economic conditions and technology situation.