Those Corporate Pensions Weren't Always So Great
(Bloomberg View) -- Spend a little time with the U.S. District Court case of Millsap v. McDonnell Douglas Corp., and it may leave you aghast at the heartlessness and mendacity of the people who ran the aircraft manufacturer (since acquired by Boeing Co.) in the 1990s. That certainly seems to have been the effect on Judge Sven Erik Holmes, who in his 2001 ruling in favor of James R. Millsap and the other workers who lost their jobs when McDonnell Douglas shut down its factory in Tulsa, Oklahoma, in 1994, fumed that the company had:
embarked upon a remarkable course of obstruction, inconsistent representations, and outright falsehoods. The sworn testimony at trial confirmed a history of deception and bad faith by the company and laid bare that discovery in this case was replete with the same duplicity that marked Defendant's treatment of its employees and the public at large.
The backdrop to the case was that government spending on defense procurement had begun declining in the late 1980s after a boom under President Ronald Reagan. In response, McDonnell Douglas Chief Executive Officer John McDonnell -- son of founder James Smith McDonnell -- launched an effort he dubbed "Hard Reality" in 1990 to cut company expenses by $700 million a year.
Pensions immediately became a major focus for executives looking to meet the target. The McDonnell Douglas pension plan was actually considered overfunded by the accounting standards of the time, but any reduction in pension liabilities went straight to the corporation's bottom line. Workers with 30 years of service at the company could start drawing a full pension at age 55, but they received relatively little if they left before that age. From Holmes's ruling:
From the beginning of "Hard Reality," MDC discussed ways to maximize its pension surplus by focusing on the relationship between plant closings and older, more senior workers approaching eligibility for pension and other benefits. Within two days of the announcement of "Hard Reality," Defendant was told by its outside actuaries that tremendous additional savings were available if the persons laid off were older and more senior. Thereafter, on almost a monthly basis, Defendant monitored the pension savings on its ongoing layoff and plant closing program.
The McDonnell Douglas plant with the oldest workforce was the facility in Tulsa, where production workers at an average age of 51 and average tenure of 19.7 years built sections of F-15 fighter jets. Ebbing demand for F-15s had recently been somewhat revived by a $9 billion, 72-jet Saudi Arabian order that Oklahoma politicians had vigorously lobbied President George H.W. Bush to approve. For aircraft production needs, Tulsa may not have been the optimal plant to close. But in terms of pension accounting, it was the best, so the company shut it down in 1994.
Courts generally don't interfere in plant closures and other such "business judgment" decisions, but Holmes -- who subsequently left the judiciary in 2005 to become vice chairman and chief legal officer of accounting and consulting firm KPMG LLP -- ruled that McDonnell Douglas's decision had been so clearly aimed at preventing the Tulsa workers from collecting pensions that it represented a violation of Section 510 of the Employee Retirement Income Security Act of 1974, which says it's unlawful to "discharge, fine, suspend, expel, discipline, or discriminate against" a pension plan participant "for the purpose of interfering with the attainment of any right to which such participant may become entitled."
Millsap v. McDonnell Douglas reportedly marked only the third time that a plant closure had been found to be in violation of Section 510. According to Holmes's ruling, the company could have gotten a summary judgment in its favor if it had simply disclosed "the financial basis of [its] business judgment to close the factory," but it failed to do so in even a remotely credible way.
In the end, the company (Boeing by that point) settled for $36 million. A $90 million claim for back pay from the time of the layoffs was, despite support from President George W. Bush's Labor Department, turned back by a federal appeals court. After legal fees and court costs, this left $24.7 million for the 1,100 workers, an average of $22,454. That's not nothing, but neither was it a lifetime pension, and there now appear to be a lot of former aircraft workers in Tulsa in their mid- to late 70s struggling to get by.
If this story is starting to sound a little familiar to you, that's because the Washington Post had a big article last month detailing the plight of former workers at the Tulsa McDonnell Douglas plant. The piece was pitched as "a preview of the U.S. without pensions," as the headline put it. It began with the story of Tom Coomer, a 79-year-old McDonnell Douglas veteran still working full time as a greeter at a Tulsa Wal-Mart because he can't make ends meet on Social Security, and intimated that this was likely to become the new normal as corporate pensions like the one at McDonnell Douglas give way to more or less do-it-yourself 401(k)s and individual retirement accounts. My fellow Bloomberg View columnist Ramesh Ponnuru has criticized this depiction as way too gloomy. I'm not certain he's right about that, but it does seem clear that the McDonnell Douglas Tulsa story isn't just a case of pensions good, 401(k)s bad.
If McDonnell Douglas had from the beginning offered a well-designed defined-contribution 401(k)-style plan with high default contributions and a generous company match instead of a generous but heavily backloaded pension plan, things might have played out much differently in 1994. For one thing, instead of being just shy of qualifying for a generous pension, a 54-year-old worker with 29 years of service might have had $100,000 to $200,000 in a personal retirement account that the company couldn't touch. Eleven years later, when that worker turned 65, $100,000 fully invested in the stock market since 1994 would have been worth more than $300,000.
The "ifs" and "mights" in the previous paragraph are pretty important, of course. After getting laid off in 1994, for example, that worker might have felt compelled to start dipping into his or her 401(k) -- which you can do penalty-free from age 59 1/2 -- well before age 65. Then again, it also seems clear that, if it had a defined-contribution retirement system instead of a defined-benefit pension, McDonnell Douglas would have had far less incentive to lay off all those workers before they hit 55.
Speaking on "Retirement Security in an Aging Population" at the annual meeting of the American Economic Association four years ago, James Poterba -- an economics professor at the Massachusetts Institute of Technology and president of the National Bureau of Economic Research -- nicely summed up what the shift from defined-benefit pensions to defined-contribution 401(k)s has meant in the U.S.:
Even when the penetration of DB plans was close to its peak, in the late 1970s and early 1980s, only about 50 percent of private sector workers participated in pension plans. The shift from DB to DC plans in the private sector has not had dramatic effects on the extent of pension plan participation, but it has changed the set of retirement-related risks facing individuals.
In a DB plan, the greatest risks are that workers will separate from their employer before they reach the late-career stage at which pension wealth accumulates most rapidly. In a DC plan, eligible employees must make many decisions about their retirement saving, and there are consequently many ways to deliberately or inadvertently avoid accumulating substantial retirement balances.
Corporate pensions in the U.S. were structured to reward a particular kind of worker -- the kind that spent his or her (usually his) entire career at a large company -- and leave most others in the cold. That was already getting to be an issue as women entered the workforce and men began switching jobs more frequently in the 1960s and 1970s. It became a crisis in the 1980s and 1990s as corporations were forced to face up to the cost of their pension promises.
It had long been assumed that the corporations that sponsored pensions would be around forever and could thus pay benefits out of cash flow. After automaker Studebaker-Packard shut down its last remaining factory in 1963 and defaulted on its pension obligations, it became clear that this assumption was flawed. Congress finally responded in 1974 with the aforementioned Employee Retirement Security Act, which created the Pension Benefit Guaranty Corp. to bail out troubled pension funds and enumerated some legal protections for workers, but also marked the start of a steady piling-up of disincentives for companies to offer generous pensions.
In 1985, the Financial Accounting Standards Board tightened the accounting standards for pension liabilities; in 1990, it added a requirement that companies recognize the cost of other retirement benefits such as health insurance. Companies rationally responded by doing what they could to reduce these costs. McDonnell Douglas was uniquely cruel and ham-handed in its approach, but most of corporate America was headed in the same general direction in the 1980s and 1990s.
It is possible to imagine an alternate reality in which Congress engineered a smooth transition from old-style pensions to a more sustainable, more portable setup. That's what it did for government workers with the Federal Employees' Retirement System Act of 1986, which for those hired after 1983 replaced the existing government pension with the widely acclaimed defined-contribution Thrift Savings Plan and a much smaller defined-benefit plan. In the private sector, the shift was far more haphazard, and accompanied by the kind of perverse incentives that left Tom Coomer and his former co-workers without adequate retirement income. This country still has a ways to go before it has a retirement savings system that works for everybody. But the path to such a system surely won't involve reviving old-style corporate pensions.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Justin Fox is a Bloomberg View columnist. He was the editorial director of Harvard Business Review and wrote for Time, Fortune and American Banker. He is the author of “The Myth of the Rational Market.”
Those settlement amounts and employee count are from an article in The Oklahoman at the time of the settlement. The Washington Post article I cite later in the column says it was workers.
I calculated that with an annual income of $40,409-(in dollars), which was the average annual wage for production workers in the aircraft industry in December annual employee and employer contributions totaling percent of wages and real investment returns equal to that of the S&P somebody working from through would have saved But the amount would be significantly lower with a more realistic lifetime earnings profile and there are probably some other issues with the way I figured things. I am not an actuary!
This is an oversimplification, given that the United Auto Workers union did push automakers to set aside money for pensions. But it wasn't able to get Studebaker-Packard to set aside nearly enough.
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