Fundamentals of Human Resource Management 5th Edition by Raymond Noe, John Hollenbeck, Barry Gerhart, Patrick Wright

Exercise 21

Out of Money to Pay Pension Obligations
In what is expected to be the biggest default of a defined-benefit pension plan, American Airlines recently declared that as it entered bankruptcy, it would be unable to pay the pensions of 130,000 pilots, flight attendants, agents, and ground crews. The airline asked for permission to terminate the plans and replace them with defined-contribution plans called 401(k) plans. The money it had set aside in its defined-benefit plans-$8.3 billion to cover $18.5 billion worth of benefits-would be transferred to the Pension Benefit Guarantee Corporation.
American is hardly the only company struggling to fund its pension plans. In a recent survey of large companies with pension plans, the plans were only 78% funded.
Some governments have worse track records. State and local governments have a history of setting up pension plans for their employees, and many of these have been chronically underfunded. Often, the pension benefits for government workers-especially for police and fire fighters, whose physically demanding jobs are cited as a reason for retiring young-are generous compared with private-sector benefits. In San Diego, for example, the city government's future pension liability costs 11 cents of every payroll dollar. But because in the past San Diego underfunded its pensions, it actually needs to set aside 41 cents of every dollar if it is to catch up. Among state governments, the worst offender is West Virginia, which has funded only 43% of its pensions.
Why are government pensions so underfunded? One reason is that recent market returns have been poor. A bigger reason is that when governments are looking for ways to balance their budgets, they often find it easiest to make the cuts in pension contributions, on the grounds that they will make up the difference later, when the state's economy is stronger. But those later boom times seem to remain in the future.
Which is the best solution to underfunding of pension plans: a better process for funding them or a switch to defined-contribution plans? Does your answer depend on whether you are thinking of businesses or governments?