IB#8-18

Introduction

Between October 9, 2007 and October 9, 2008, the value of equities in retirement plans dropped by about $4 trillion, with the decline divided equally between defined benefit and 401(k)/Individual Retirement Accounts (IRAs). The decline in the defined benefit arena was in turn divided equally between private sector plans and those sponsored by state and local governments. This brief explores what a loss of roughly $1 trillion of private sector defined benefit equities means for the individual participants and for the firms that sponsor those plans.

The brief is structured as follows. The first section shows that defined benefit plans still play an important role in the private sector. The second section describes how defined benefit plans insulate participantsfrom market fluctuations by absorbing the risk themselves. The third section explores how the absorption of that risk affects private plan sponsors in terms of increased contributions and raises the possibility of some stressed employers laying off workers or going bankrupt with inadequate pension assets, or healthy companies deciding to freeze their plans. The fourth section discusses how individual participants are protected in the case of layoffs, bankruptcies, and freezes but in all cases end up with less retirement income than anticipated. The fifth section concludes on two points. First, in terms of risk bearing, neither extreme may be workable – all risks borne by sponsors as in the case of defined benefit plans or all risks borne by individuals as in the case of 401(k) plans; some other approach to pension design merits serious consideration. Second, funding requirements that compel companies to increase their contributions dramatically during a recession increase the likelihood of layoffs and terminations.

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