In the case of United Airlines, the company has been able to secure bankruptcy financing by agreeing to suspend payments to its already severely underfunded pension plans. The defined benefit plans are one of many factors weighing down the airline's cost structure because United must compete against carriers offering less expensive plans.
Aside from sometimes adversely affecting retirees and employees, termination of United's pension plans would increase the financial burden on the Pension Benefit Guaranty Corp. (PBGC)—the government-established insurance fund that will continue to pay at least a portion of pension benefits. Over the past couple of years, the PBGC has assumed responsibility for a number of severely underfunded plans. ....
Prior to the 1980s, most employer-sponsored pension plans were traditional defined benefit plans. With a defined benefit pension plan, a firm guarantees a monthly or lump sum payment to workers after retirement. The dollar amount of this payment depends on a predetermined formula, typically based on a worker's salary during the last few years of employment and the number of years on the job.
Companies completely fund defined benefit plans, and all aspects of the plan are solely under the firm's control. Unless the firm goes bankrupt, monthly payments to retirees are not tied to the quantity of funds set aside by the firm. Therefore, the company bears the entire risk of making pension payments.
[But, when the firm does go bankrupt, highly paid employees--such as airline pilots--with large promised retirement benefits, will bear part of the risk, because the PBGC has a cap of about $3,700 per month on its guarantee.].... The number of employer-offered defined benefit plans has declined dramatically, falling from 148,096 in 1980 to 56,405 in 1998, the last year for which these numbers are available....
....Since the mid-1980s, companies have increasingly switched to defined contribution plans that give employees even more control and responsibility for their pensions. With defined contribution plans, the most common form of which are 401(k) plans, employees accumulate money for retirement by making pretax contributions from their salary.
....With a traditional defined benefit plan, the company bears all the risk of having sufficient assets to meet pension obligations. When the stock market falls and asset values plunge, it is the firm's responsibility to add funds to fulfill pension payments. Usually this requires diverting income from current revenue into pension plans, an action that may have implications for the viability of a company that is already in dire financial straits.
[Again, that means the employees ultimately do bear part of the risk.]....Defined benefit plans can boost profits during periods of prosperity and add to losses during economic downturns, amplifying cyclical swings in the company's balance sheet. This can exacerbate financial problems and impede a firm's ability to stay competitive.
.... many companies with defined benefit plans have weathered the recent economic downturn without significant disruption to their business. It is primarily in industries already in significant decline—such as steel, or those suffering from extraordinary events, such as airlines after September 11—that the recent economic events have precipitated additional burdens on the long-term viability of numerous firms and their pension plans.
....Although the government does not directly insure private pensions, ERISA created the self-funded PBGC to take over the payment of benefits in the event a plan ends without sufficient money to pay beneficiaries. The PBGC is financed from premiums paid by the companies it protects, from the assets of pension plans it has taken over, and from investments of any surpluses or assets.
....the PBGC is likely to assume additional pension plans and its deficit will worsen in the short run. However, outside the steel and airline industries, a massive failure of defined benefit plans that would precipitate an S&L-style bailout of the PBGC is unlikely.
The current economic recovery—in addition to temporary legislative relief and a transition to defined contribution plans in which employees bear more of the risks surrounding pension incomes—will help all except the most troubled companies get back on solid footing.
Social Security more closely resembles a defined benefit plan, but without the guarantee of the PBGC. George W. Bush's private accounts would be defined contribution plans.