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September 2010

U.S.: Insider

Pension Freezes Continue Among Fortune 1000 Companies in 2010

By Brendan McFarland and Erika Kummernuss

From 2009 to 2010, the number of Fortune 1000 companies sponsoring a frozen pension plan increased by 4%. After peaking in 2006, the overall freeze rate has remained relatively constant over the last three years, as the economic climate has remained uncertain. Meanwhile, the number of sponsors of defined benefit (DB) plans (both active and frozen) in the Fortune 1000 has continued to decline modestly, as new entrants to the list are more likely to sponsor only defined contribution (DC) plans.

This shift from DB to DC plans has been ongoing for more than 10 years now, driven by a variety of plan sponsor motives, including addressing financial difficulties, aligning retirement packages to better compete in a global market and reducing risk. Notably, regulatory uncertainty around hybrid DB plans, such as cash balance designs, has significantly contributed to the trend. The shift to DC plans typically transfers retirement responsibility from employers to employees, most of whom will manage their own contributions, accumulations and eventual withdrawals under those DC arrangements.

Towers Watson has been collecting data on DB sponsors in the Fortune 1000 for many years, with a particular focus on firms that have frozen their plans. In a DB plan freeze, the company typically retains the plan but stops future accruals for all or some workers. Freezes can take various forms. Traditional pensions, which use a pay-and-service-related formula, can halt the years-of-service component of the formula, freeze the pay portion to disregard future salary increases or both. In a hybrid or other account-based pension plan, companies typically stop making pay credits to the accounts, but balances continue to accrue interest.

Many large companies sponsor more than one pension plan. Some maintain different plans for unionized and salaried workforces, and others have multiple plans due to mergers and acquisitions. So a sponsor of a frozen plan might also maintain an active DB plan, which is indeed the case for some firms in this analysis. We identify the total number of DB plan sponsors, the number that have frozen at least one pension plan and the number that have never frozen a DB plan.

DB sponsorship and freezes among the Fortune 1000

In this analysis, firms are classified as DB sponsors if they maintain DB plans, even if the plans are frozen. Between 2004 and 2010, DB sponsorship among the Fortune 1000 declined from 63% to 59%. Turnover in the Fortune 1000 list plays a large role in the decline. Historically, companies edged off the list have tended to sponsor DB plans, while their replacements have not. Of the 74 companies new to the Fortune 1000 in 2010, 51 sponsor only a DC plan and 23 maintain a DB plan (11 of which are frozen). Of the 74 companies that dropped off the 2009 list, 38 sponsor only a DC plan, while 36 maintain a DB plan (14 of which are frozen).

Plan terminations also contribute to the decline in DB sponsorship, as some companies have offloaded plan assets and liabilities to third parties over the last several years (see “Terminated plans” below).

The percentage of Fortune 1000 companies that sponsor DB plans and have not frozen any of them has fallen significantly over the last seven years. In 2004, 59% of Fortune 1000 companies maintained DB plans and had no frozen plans, compared with only 38% in 2010. Over the seven-year period, the number of Fortune 1000 sponsors of at least one frozen plan has more than quadrupled — from 45 in 2004 to 208 in 2010 (as shown in Figure 1). Between 2004 and 2010, the percentage of DB plan sponsors with one or more frozen pension plans rose from 7% to roughly 36%.

Figure 1. DB sponsorship among Fortune 1000, 2004-2010

Fortune 1000 list year

Number of DB plan sponsors

Sponsors of actively accruing DB plans with no  frozen plans

Sponsors of one or more frozen DB plans

2010

586

378

208

2009

607

417

190

2008

624

455

169

2007

638

500

138

2006

627

514

113

2005

627

556

71

2004

633

588

45

Source: Towers Watson.

Timing of freezes and composition effect of 2010 Fortune 1000

Pension freezes among Fortune 1000 companies began accelerating in 2003. Figure 2 shows the incidence of pension freezes from 1989 to 2019 (including planned freezes) for the 2010 Fortune 1000. Thirty-one companies froze a pension plan in 2007, 23 in 2008 and 28 in 2009. There have been 18 freezes so far in 2010.1

Figure 2.  Incidence of pension freezes in Fortune 1000, 1989-2019*

*Announced and planned after 2010.

Source: Towers Watson.

We next examine companies that have remained on the Fortune 1000 list since we began our study seven years ago (see Figure 3). This analysis is one way to highlight the effects of turnover in the Fortune 1000 on our results.

Figure 3. Current DB sponsorship for Fortune 1000 companies since 2004

Companies in Fortune 1000 since 2004

Number of DB plan sponsors

Sponsors of actively accruing DB plans with no frozen plans

Sponsors with one or more frozen DB plans

723

472

311

161

Source: Towers Watson.

Plan sponsorship for the seven-year Fortune 1000 group looks slightly different from sponsorship for the 2010 group (see Figures 1 and 3). The percentage of companies sponsoring DB plans is higher among the seven-year group than among today’s Fortune 1000 (65% versus 59%), and the percentage of DB sponsors that maintain one or more frozen plans is somewhat lower (34% for our seven-year group compared with 36% for the 2010 Fortune 1000 DB sponsors).

We next look at three retirement-expense accounting measures (where full financial data were available for comparison) for the seven-year Fortune 1000 group.

Figure 4 shows service cost, which is the actuarial present value of pension benefits accrued during the year, net pension expense and DC expense for fiscal years 2003 and 2009.2 These values are calculated on an average basis for three categories of DB plan sponsors: those with no frozen plans, those that first froze one or more of their plans between 2004 and 2010, and those that froze at least one plan before 2004.

Figure 4. Service cost, net pension expense and DC expense for seven-year Fortune 1000 group ($ thousands)

2003
  Count Average service cost Average net pension
expense		 Average DC plan expense
All
companies		 335 $54,414 $56,888 $35,723    
No frozen DB plans 227 $57,948   $56,078  $34,799
First froze DB plan in 2004-2010 82 $60,763 $75,012 $41,856
First froze DB plan before 2004 26 $3,532 $6,801 $24,441
2009
  Count Average service cost Average net pension
expense		 Average DC plan expense
All
companies		 335 $57,395 $86,070 $56,888   
No frozen DB plans 227 $74,171   $101,633  $49,337
First froze DB plan in 2004-2010 82 $28,704 $67,772 $84,356
First froze DB plan before 2004 26 $1,412 $7,902 $27,947

Source: Towers Watson.

From fiscal year 2003 to 2009, service cost for pensions increased by roughly 5% for all companies in this analysis, while DC expense shot up 59%. The growth in service cost overall is primarily attributable to companies that have not frozen DB plans. Service costs rise due to salary increases, declines in the interest rates used to calculate the service cost component and other factors.3 Over this period, service cost increased by roughly 28% for sponsors of actively accruing pensions, but decreased by 53% for sponsors that froze at least one plan.4

While DC plan expense rose for all companies, the increase was 102% for DB plan sponsors that first froze a pension plan in the last seven years, compared with 42% for DB plan sponsors that have not frozen a DB plan. This is not surprising. After freezing a DB plan, most companies enhance their matching or nonmatching DC contribution and/or adopt plan features to boost participation in their DC plan.

Pension expense is the total measure of expense for a DB plan. In addition to being influenced by the same factors as service cost, pension expense is greatly affected by the plan’s funded status. At year-end 2009, average pension expense had declined by 10% in companies that had first frozen a pension in the last seven years, likely due to the reduction of service cost offset by increased expense due to declines in funded status. At the other end of the spectrum, DB plan sponsors that had not frozen a DB plan reported an 81% increase in pension expense by the end of fiscal 2009, with much of this increase likely attributable to declines in funded status.

From 2003 to 2009, average retirement expense (net pension expense plus DC plan expense) increased by 54% for all companies, 30% for companies that froze a DB plan and 66% for DB plan sponsors with no frozen plans. Note that although the changes over the period are very different, average costs in 2009 are virtually the same for those that have never frozen a DB plan and those that froze a plan after 2003.

Industry analysis

In the past, most companies that froze their DB plan were in financial distress. More recently, pension freezes have spread across all sectors, although some industries experience higher freeze rates than others (see Figure 5).

Industries with higher DB sponsorship rates are less likely to freeze a plan than those with lower sponsorship rates. The utilities industry is a good example. It has high rates of DB sponsorship and very few plan freezes. Plan sponsorship rates are generally linked to companies’ financial success and stability, as well as to the rewards strategy commonly employed within the industry.

Figure 5. DB sponsorship in the 2010 Fortune 1000 by industry                              


Industry (sorted by % of DB sponsors)

Firms in Fortune 1000

Number of DB plan sponsors

Firms with no pension freezes

Firms that have frozen one or more DB plans

% of firms that are DB plan sponsors

% of firms with no pension freezes

% of firms with one  or more frozen DB plans

Aerospace and defense

7

7

6

1

100.0%

85.7%

14.3%

Utilities

63

59

53

6

93.7%

89.8%

10.2%

Food and beverage

32

29

23

6

90.6%

79.3%

18.8%

Manufacturing

155

128

88

40

82.6%

68.8%

31.3%

Automobiles and transportation equipment

21

17

10

7

81.0%

58.8%

41.2%

Natural resources

64

48

35

13

75.0%

72.9%

27.1%

Energy

34

22

16

6

64.7%

72.7%

27.3%

Wholesale

39

25

12

13

64.1%

48.0%

52.0%

Insurance

64

40

32

8

62.5 %

80.0%

20.0%

Financial services

66

40

19

21

60.6%

47.5%

52.5%

Transportation

32

19

11

8

59.4%

57.9%

42.1%

Communications

53

29

13

16

54.7%

44.8%

55.2%

Pharmaceuticals

22

9

6

3

40.9%

66.7%

33.3%

Professional and business services

65

26

13

13

40.0%

50.0%

50.0%

High technology

78

29

12

17

37.2%

41.4%

58.6%

Retail

113

37

17

20

32.7%

45.9%

54.1%

Health care

50

14

10

4

28.0%

71.4%

28.6%

Property and construction

22

5

2

3

22.7%

40.0%

60.0%

Tourism and leisure

17

3

0

3

11.8%

n/a

100%

Education

3

0

0

0

0.0%

n/a

n/a

Source: Towers Watson.

Over the last year, the percentage of companies with one or more frozen plans has increased in most sectors, with the communications and retail sectors having realized the largest changes.

In 2010, 55% of DB sponsors in the communications sector maintain at least one frozen DB plan, compared with 43% last year and 30% in 2008. Between the 2008 and 2010 analyses, the percentage of sponsors in the retail sector with one or more frozen DB plans jumped from 36% to 54% — an 18-percentage-point increase. The retail sector has one of the lowest DB sponsorship rates of any sector.

Closing plans to new hires

Over the last several years, Towers Watson has also tracked Fortune 1000 firms that close a DB plan to new hires. When a DB plan is closed, current employees continue to earn pension benefits, but employees hired after the close date cannot participate in the plan. If a company closed a DB plan but also froze another plan or closed the plan before freezing it, it is considered to have frozen a pension plan for this analysis. Between 2005 and 2010, the number of companies that closed at least one DB plan to new hires rose from 25 to 85. Only 29% of Fortune 1000 companies maintain a DB plan and have neither frozen nor closed one of the plans to new hires. Of DB plan sponsors, 50% now have at least one plan that is either frozen or closed to new hires — up from 44% last year.

Terminated plans

In addition to freezing and closing DB plans, some firms in the Fortune 1000 have chosen to terminate their DB plans, which also contributed to the decrease in companies that maintained a DB plan over the past year. In a terminated pension plan, all benefits are settled by transferring assets and liabilities to a third party (typically an insurance company), paying all benefit obligations directly to participants or some combination of the two approaches.

Therefore, a termination implies a plan freeze has already occurred. Eleven Fortune 1000 companies have terminated one or more pension plans or are in the process of doing so. Eight of the 11 companies either started or completed this process within the last two years. In one termination, the company had to unload its pension liabilities to the Pension Benefit Guaranty Corporation5 due to financial distress. The other companies voluntarily terminated their plans.

Conclusion

The march of pension freezes continues at a steady pace. Only 38% of Fortune 1000 companies currently maintain a DB plan and have no frozen plans — a stark decline from 2004, when 59% of Fortune 1000 companies had not frozen a DB plan. Many companies today are opting to provide DC plans as the sole vehicle for accumulating retirement income.

The shift from traditional DB plans to DC plans has redirected a share of employer funding away from older workers, thereby enabling younger workers to make more significant contributions toward a financially secure retirement. Nonetheless, events such as the 2008 stock market crash highlight some potentially problematic effects on workforce patterns created by DC-only platforms. Many DC plan accounts suffered major losses during the recent financial crisis, forcing some older workers to postpone retirement to recover from market losses and rebuild their retirement nest eggs.

Despite ongoing pension freezes, companies in industries with high DB plan sponsorship rates have been more likely to keep their plans alive than other companies (except for the troubled auto and finance industries), and this pattern could continue into the future. Some of these plan sponsors may have taken steps to minimize the risks associated with DB plan sponsorship so they can enjoy the advantages of DB plans over DC plans. DB plans provide greater reliability and security for workers, and offer sponsors unique opportunities for long-term financial efficiency and workforce management.

1 If a plan is frozen as of December 31, we consider the freeze to occur the following year (e.g., if a sponsor freezes a plan on December 31, 2009, participants have already accrued their 2009 benefits, so we consider 2010 the year of the freeze).

2 Net pension expense consists of service cost and all other components, including net interest on unfunded liability and amortization of past gains/losses and plan amendments. DC expense includes matching and nonmatching employer contributions for the year, which in some cases are offset by forfeitures for terminating participants who are not fully vested.

3 Decreases in discount rates increase service cost. Discount rates at year-end 2002 averaged 6.7% compared with 6.3% at year-end 2008.

4 The service cost is non-zero for these companies as well as the group that froze a plan before 2004 because some companies freeze a DB plan for one group of workers (typically salaried) but keep the plan actively accruing benefits for other workers (typically union or hourly employees) or subsidiaries.

5 The Pension Benefit Guaranty Corporation is a federal insurance program funded by DB plan sponsors that protects the benefits of participants in private DB plans if a company’s pension plan defaults.