Question

Respond to the following in a minimum of 175 words PLEASE TYPE RESPONSE:

Today, approximately three-fourths of workers covered by pension plans are covered by defined contribution plans, roughly one-fourth by defined benefit plans. This represents a radical shift from previous years when the traditional defined benefit plan was far more common. In fact, many new companies are terminating long-standing defined benefit plans and substituting defined contribution plans. Can provide the three main reasons why companies are shifting and give examples?

Answer 1

*Increasing costs of defined benefit plans:

Defined benefit plans are implicit contracts in which the expected present value (discounted)
of wages and pension payments must be at least equal to the expected present value
(discounted) of wages a worker can earn in the spot market. As the workforce has aged,
the costs of funding a defined benefit plan have risen because the level of accrued benefits is higher and the post-retirement period has lengthened due to early retirements and increased longevity. In theory, these factors should not be a problem; firms forecast the post-
retirement payments and set the wage schedule and benefit parameters to keep the present
discounted value of compensation equal to the productivity of the worker over the life of
the contract. In practice, it may be difficult for firms to adjust compensation in response
to shocks to forecasted values of longevity, benefit costs, or asset returns.Reasons for
this difficulty include regulatory constraints, litigation risk, and the impact on employee
morale. In addition, some evidence has suggested that workers value a dollar of defined benefit pensions less than a dollar of wages (despite the tax preference for Defined benefit pensions), which may limit the ability of firms to substitute across types of compensation. Thus, increasing costs could give firms an incentive to terminate defined benefit plans. However, the longevity increase has also raised the cost of funding worker retirement via Defined contribution plans. If workers had full information and valued Defined benefit and Defined contributions plans the same way, the value of the two plans would essentially be the same in equilibrium, and firms would be unable to reduce costs by switching to a Defined contributions plan. Thus, in order for increased longevity to lead to a shift from DB to DC plans, workers must value DB and DC plans differently.

* Change in the industry composition of employment:

Many of the largest DB plans have been in manufacturing industries such as
steel and auto production, and in other heavily unionized industries. As these industries
have declined, the prevalence of DB plans has diminished.

* Increase in labour mobility:

Although there are a range of opinions, the preponderance of the evidence in the
U.S. suggests that worker mobility has increased over the past 30 years. Explanations
include changes in the industry composition of employment, technological change, and
changes in the demographic composition of the labour force toward workers with less
stable labour supply. More-mobile workers find DC plans relatively advantageous
because benefits in these types of plans accrue more evenly through their career and are
entirely portable should the worker separate from the sponsoring firm or leave the
workforce for a period.

Note: DB refers to defined benefit and DC refers to defined contributions.