From Defined Benefits To Defined Contributions / Firms save 2.7-3.6% of payroll per year research finds

Since the early 1980s, there has been a shift from defined benefit (DB) to defined contribution (DC) pension arrangements in the U.S. corporate sector. This shift has continued markedly over the past decade. In the late 1990s, assets in private sector DB and DC plans were each around $2 trillion. By the end of 2010, DB plan assets in the private sector amounted to $2.5 trillion, compared to $3.8 trillion of DC assets.

The shift towards DC plans has occurred through several channels. First, the majority of new firms have favored DC arrangements. Second, some private sector sponsors of DB pension plans have entered bankruptcy and terminated their plans, transferring unfunded liabilities to the Pension Benefit Guarantee Corporation (PBGC). Finally, many firms have limited or stopped new DB accruals by implementing a partial or complete freeze of these accruals. Firms undertaking a “soft freeze” have allowed DB benefits to continue to accrue for existing workers while offering new workers a DC plan only. Firms undertaking a “hard freeze” have stopped DB accruals entirely for all workers.

While workers do not lose defined benefits that they have earned up to the date of a hard freeze, their defined benefit pension ceases to grow with future work or pay increases. In place of the DB accruals, the employer offers a DC plan, making contributions that are specified as a share of payroll or that match employee contributions up to a limit. By 2011, 40% of DB pension plan sponsors in the Fortune 1000 had at least one frozen plan.

In a competitive, frictionless labor market, the freezing of pension benefits would not result in any cost saving for firms or reduction in total compensation for workers. Workers would simply receive contributions to DC plans that offset the loss of DB accruals, or alternatively they would demand and receive offsetting wage increases. In contrast, if under pre-freeze pay and benefit arrangements some workers are receiving compensation in excess of their marginal product (or would under the DB arrangement receive such excess compensation in the future), the firm could potentially realize cost savings through a freeze. If workers value DB benefits less than it costs the firm to provide them, there would be a surplus over which employers and employees could bargain and both parties could be made better off with a freeze.

The authors estimate expected DB accruals from the age-service and salary distributions of a large sample of U.S. corporate pension plans with more than 1,000 employees. Comparing the counterfactual DB accruals to the actual increase in 401(k) and other DC contributions for firms that freeze, they find only partial compensation to employees for the lost DB accruals. Net of the increase in total DC contributions, firms save 2.7-3.6% of payroll per year, and over a 10-year horizon they save 3.1% of total firm assets. Workers would have to value the structure, choice, flexibility, or portability of DC plans by at least this much more to experience welfare gains from freezes. The forgone accruals and net cost effects are initially largest for older employees but over time become largest for middle-aged employees who plan to stay with the firms until retirement. Furthermore, the probability that a firm freezes a pension plan is positively related to the value of new accruals as a share of firm assets. While there are differences in the age-service distributions of firms that freeze versus those that do not, we find that the differential accrual effect is largely driven by differences in benefit factors and the relative importance of labor in the freeze firm’s production function. The results overall support the hypothesis that pension freezes affect overall compensation and therefore that they change compensation costs relative to a worker’s marginal product.