United Airlines recently moved to default on its pension obligations and shift the burden of payment to the Pension Benefit Guaranty Corp. -- an agency, widely viewed as underfunded, that charges premiums which undervalue the risks it shoulders. Observers are concerned that United may be the first of a cascade as similarly financially strapped airlines (the older companies, the "legacy carriers") offload their pension obligations.

"Given the rise of low-cost carriers like Southwest," says accounting professor Joe Comprix of the W. P. Carey School of Business, "legacy carriers have no choice -- they must lower their costs. Otherwise, their higher costs will lead to loss of market share to the discount carriers. The legacy carriers will also be squeezed by United's actions, which gives United a competitive advantage versus the other legacy carriers. Given the size of the pension liabilities at the major carriers and the competitive pressures that they face, I would be surprised if more airlines do not follow United's lead and drop their pension liabilities onto the PBGC."

This is not a new pattern. Under similar circumstances in the 1990s another aging industrial sector, steel, followed the same path. One of the contributing factors, then as now: competition from foreign companies with lower costs.

"The U.S. steel industry was unable to compete with foreign rivals," Comprix points out, "without shedding benefit obligations through bankruptcy proceedings."

"It is difficult to isolate the effect of foreign competition," cautions management professor Luis Gomez-Mejia, "but clearly this is a burning issue in many industries as firms become global. This is a major concern not only in the United Stated but also in Western European countries."

Marianne Jennings, a professor of legal and ethical studies at the W. P. Carey School, concurs about the difficulty of assessing where different pressures come from. She warns that it may be just as difficult to calculate the risks and benefits of this kind of restructuring. Companies may reap short-term benefits from shedding pension obligations but incur long-term costs that are difficult to quantify.

"This practice may well be in response to foreign competition," she says, "or it may just be international market realignment issues. There are several key issues that executives may not have thought through -- the impact of these decisions on the morale of the current work force, for example -- and even the quality of the work force as those employees who can seek placement at organizations in which they feel safer. There are presently non-quantifiable costs associated with reneging on these promises, and executives need to think through the long-term issues."

The next industry forced to restructure how it deals with pension benefits may well be the U.S. auto industry. In May, debt issued by both GM and Ford was lowered to junk-bond status by Standard & Poor's (S&P). This low point has been several decades in coming. Both automakers lost their AAA ratings in the early 1980s -- the only automaker which S&P currently rates AAA is Toyota.

"Companies must be able to compete," management professor Angelo Kinicki stresses. "Part of this competition entails the cost to produce a product or service. Given that many American firms are saddled with legacy pension costs and retiree benefits, they will be less able to compete. General Motors, for instance, cannot compete with the likes of Toyota due to its $2,000 per car disadvantage, part of which is due to the legacy costs associated with pensions and medical benefits for retirees. The plain truth is that competition spans the globe, and American companies must compete with organizations that operate in different cultural and political environments."

Comprix puts this in the context of the smaller market share that many American companies have faced in recent years. "No one would worry about GM's ability to pay its benefit obligations," he points out, "if it still had a 50 percent share of the auto market -- along with its old profit margins."

Comprix is not optimistic about the prospects of the American auto industry, but he is skeptical about a domino effect on pensions in the automotive sector. There are still some weights on the other side of the scale, culturally as well as economically, he says.

"I don't look for a similar outcome in the auto industry anytime soon," he says, "because the major auto companies still have a large cash position and because of the political costs involved."

 

Pensions versus Social Security:  a parallel debate

In February 2005 the Divisions of Research & Statistics and Monetary Affairs at the Federal Reserve Board in Washington, D.C., published a paper titled "Are Firms or Workers Behind the Shift Away from DB [Defined Benefit] Pension Plans?" The authors, Stephanie Aaronson and Julia Coronado, wrote it as part of the Finance and Economics Discussion Series.

In their introduction, the authors note that "between 1979 and 1998 there was a 17 percentage point decline in the proportion of employees covered by traditional defined benefit (DB) pensions and a 12 percentage point rise in the share of employees covered by defined contribution (DC) plans."

Citing similar data, some analysts argue that what we are seeing today is an accelerating transition away from the defined-benefit pension system. This system dominated the post-WWII American pension landscape, where businesses took responsibility for managing pensions and guaranteed a certain level of payment, often as a percentage of a pre-retirement salary average, usually with cost of living protection. According to these analysts, this is a shift that we would do well to accommodate to rather than fight. In their view, shifting to defined-contribution plans is good both for businesses -- which would shed both oversight responsibility and liability -- and for an increasingly mobile work force as well -- which would benefit from the portability of IRA's and 401(k) plans.

On the other side, organizations like labor unions, representing less affluent constituencies, argue against defined-contribution plans in a mirror image of the national debate over privatizing Social Security. One key strand in this argument is the issue of who bears the investment risks in both public and private pension systems. A position paper on pensions published on the web by the American Federation of State, County, and Municipal Employees (AFSCME) underscores the question.

"The basic purpose of a retirement system is to provide a secure and predictable level of income for former employees after retirement," the article concludes. "Defined-benefit plans do this. Replacing defined benefit plans with defined-contribution plans effectively shifts the risk of investment from the employer to the employee and jeopardizes the retirement security of the individual."

The language above echoes the debate on who bears the risk or reaps the benefit of Social Security privatization. Jennings also sees a link between the rhetoric of President Bush and his supporters in the Social Security debate and the shift away from DB pensions. And she suggests that companies would do well to pay attention not only to whether to make that shift but to how they accomplish this change. The hard landings and disruptions caused by reneging on pension promises can hurt businesses as well as employees and retirees.

"If they want to phase out defined-benefit pensions," she says, "that alternative could be pursued with fewer morale implications. Beginning a new program with new hires is one approach."

"This phase-out may go with the realignment and the Bush notion of the 'Ownership Society,'" she continues. "Perhaps we do need to have individual ownership and self-management that then cannot be taken away by an employer."

"Part of the problem with Bush's plan," Kinicki says, "is that it needs to include an educational component. Many people do not posses the knowledge or savvy to properly invest on their own. Who will help people to make the right decisions?"

He also expresses concern about the proper balance between personal, corporate, and governmental responsibility for pensions and for retirement security in general.

"What about personal accountability?" he asks. "Why aren't people saving more instead of spending beyond their means?  It seems that the U.S. has gotten all caught up in consumption and many people simply can't afford to maintain their lifestyles. I don't see why organizations should be held culpable for this situation. On the other hand, organizations push their products upon society through marketing and people buy things that they really can't afford. Over time, this leads to more spending and less savings. So who should pay the retirement and health-care bill?  If organizations will not, it seems like our government will be forced to deal with this issue by raising taxes."

Gomez-Mejia has similar concerns about balancing responsibility between the key stakeholders.

"Social Security was a so-called safety net," he says, "providing minimum standards and assuming people would be responsible to save beyond this minimum. Firms filled in the gap during the postwar era and before globalization took off as it has. But now we probably will see a move back to dependence on Social Security and the government to provide minimum standards, with responsibility shifted to individuals to save to go beyond the minimum. But unfortunately, most people are unable or unwilling to do that unless there is a program in place that forces them."

How we resolve these issues -- as an economic question and as a political question, individually and collectively, in the public sector and in the private sector -- will be key in determining how many Americans will spend their retirement years.