Until recently, the cram-down—the process in which a company walks away from pension and benefit promises—had generally been confined to failed companies like Delphi. Struggling companies frequently terminate their pension plans and push the liabilities onto the Pension Benefit Guaranty Corp.
But now perfectly healthy companies—solvent, profitable, thriving, industry-leading, blue chip companies—are unilaterally moving to slash the expected compensation of nonunionized employees by "freezing" pension plans. They're doing so not because they have to, but because they want to—and because they can.
For several years, companies have been effectively freezing pension plans for new employees. New hires are offered 401(k)s instead of the defined-benefit pension plan available to more senior workers. The PBGC in December said that as of 2003, 9.4 percent of plans had been frozen in some way (here's the whole study) but that most of the freezing companies were small.
Now it's not just new employees but everyone who is starting to lose pension benefits. Last summer, Hewlett-Packard, as part of its latest turnaround effort, announced that as of this month the company would freeze both the pensions and retiree health-care benefits of many current employees and offer them larger matching contributions to 401(k)s instead. In December, Verizon made a similar move, freezing the pension for existing managers and boosting 401(k) contributions. A few weeks ago, IBM—a company that is thriving by any measure—followed suit. Alcoa this month said it was eliminating the pension for new hires. And last week, apparel company Russell Corp. said it would freeze its pension plan for all employees.
There is no legal problem with companies unilaterally freezing pension plans for nonunionized employees. When such pensions are frozen, workers don't lose benefits they've earned. Rather, they simply stop accruing new benefits. That's bad news for veteran employees. Frequently, final pension benefits—paid out as a lump sum or as a per-year payment for life—are a percentage of the employee's average salary over his or her last several years of service. Continuing to accrue benefits as you age and as your salary rises means you'll have a richer pension. For employees whose plans are frozen, the payments they'll start to receive when they hit 65 will be calculated as a percentage of their salary at the time of the freeze.
All the companies that are freezing pensions are replacing them with enhanced 401(k) plans. IBM claims its 401(k) is "one of the richest in U.S. business." But for people in their 50s, that's not much of a help. A 55-year-old manager only has 10 years to contribute, receive matching grants, and hope that investments grow. And instead of being guaranteed, as pensions are, 401(k)s rise and fall at the whim of the market. What's more, companies have been known to cut back or eliminate 401(k) contributions when they encounter a few tough quarters.
It's hard to read this trend as anything but a reduction in wages for employees. After all, benefits like pensions and health insurance are an important component of compensation, particularly for older workers. The companies that are freezing their pensions are gleefully telling shareholders how much they'll save. IBM said its moves "will result in worldwide retirement-related expense savings of $450 to $500 million for 2006, and $2.5 to $3 billion for the period 2006 through 2010." Verizon said it expects to save $3 billion over 10 years by freezing its plan.
The freezing trend also tells us something about the state of the labor market and of the attitude of employers toward managers. In theory, companies that unilaterally slash compensation for experienced employees and managers would seem to be at a competitive disadvantage in the marketplace. But IBM, Verizon, and HP are effectively telling veterans that they're expected to do the same job in the future at a lower effective salary than had been promised.
When it comes to compensation for top executives, publicly held companies like IBM and Verizon love to benchmark. They look at what other companies are paying their CEOs and then match or top it. But benchmarking also works in the other direction. When everybody else is cramming down their employees, the logic goes, shouldn't you? HP explicitly said it was freezing the pension to "better match industry benchmarks." By freezing their pensions, industry leaders like IBM, Verizon, and HP are effectively lowering the bar for everybody else.
Above all, the movement to freeze pensions is a sign that the cram-down is moving up the management ladder. Companies can't freeze pensions that have been agreed to as a result of collective bargaining agreements with unions. So they're going after the low-hanging fruit—benefits for nonunionized workers and managers—and gambling that the moves won't hurt their need to retain key people. If these trends continue, the only people in the companies who continue to get pension benefits in future years will be their overpaid CEOs.