Warren Buffet calls public-sector pension plan liabilities “time bombs.” Many state and municipal pension liabilities far exceed their assets. This is because of their failure to consistently fund the liabilities.

But this is not the problem facing community bank pension plans   

Community banks fund their pension plans aggressively, yet underfunding continues. Why?  

What Are The Problems?

While pension asset investment returns remain low, liabilities are increasing dramatically. 

The average age of employees at community banks as a demographic is uniquely older.  This fact results in larger benefit liabilities to fund.

Volatility of bank funding for a pension plan has become a significant issue, one further complicated by the Pension Protection Act of 2006. The act requires use of corporate bond interest rates and requires losses to be amortized over a short period of time. The result is a considerable compression of a bank’s funding obligation.

There is a high cost to low interest rates. For every 1 percent drop in long-term interest rates, the present value of pension liabilities increase about 15 percent regardless of the actual or assumed investment rate of return. When there are losses, the Act requires an acceleration of the funding requirements. However, when there are gains, the pension plan does not realize an immediate benefit. 

What Can Be Done?

Management and boards should not ignore the magnitude, volatility and unpredictability of pension plan costs. Based on strategic reviews of numerous community bank retirement programs, I am convinced this trend will continue. It is what it is, and no amount of smoke and mirrors will hide the fact that pension plans can be expensive. Unfortunately, smaller banks are more at risk. But pension plans of all sizes are subject to criticism of high cost with no apparent link to bank financial performance. 

This comes at a time when community bank profits are being squeezed by slow growth, shrinking margins and regulatory demand for higher capital. I suggest that management and board members deliberate three fundamental questions:

Does the bank want to be in the pension plan asset/liability management business and guarantee retirement benefits?

How much bank compensation should be apportioned to delayed-pay through retirement programs, versus immediate-pay through competitive salary and incentives?

What retirement plan design will help the bank attract, retain and motivate the employees essential to carrying out the bank’s business mission?

In order to control costs, I am working with my bank clients in restructuring their pension plans to eliminate high fixed costs and allow more variable funding of the retirement promise based on the bank’s profitability.

The typical strategy is to either reduce the benefit formula or to hard freeze all future benefit accruals. Then, implement enhanced, defined contribution 401(k) plans with bank matching and discretionary profit sharing contributions. SERPs are being implemented for the higher-paid key employees, providing annual fixed benefits, supplemented with discretionary performance based contributions. The resulting cost savings are reinvested in the bank’s new initiatives designed to improve profitability and competiveness. 

Unfortunately, many community banks attempted to lower pension costs by implementing a soft freeze. That is, no new participants were allowed to enter into the pension plan, creating two classes of employees: Those with pensions and those without.  This opens the door to possible future discrimination testing problems between high- and low-paid employees, as well as obvious jealously between the haves and have nots.   

The fallout of this Great Recession requires rethinking community bank retirement plan philosophy, favoring the elimination of uncontrolled costs symbolic of pension plans.

The old community bank career adage of, “Hamburger while you work and steak when you retire” is being recast as, “Hamburger while you work and retire, upgrading to steak with demonstrated financial performance.”

Arthur Warren is founder and principal of Walpole-based executive compensation firm Arthur Warren Associates.