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Utility companies are at a crossroads when it comes to managing their pension plans. They must determine the best ways to continue to offer this benefit while controlling the impact these plans have on the overall financial health of the organization.

For years, pension plans have been managed in a financial vacuum, held at arm's length from corporate strategy and finances. For a long time, these plans were safe, predictable, and self-funding.

Over the past five years, poor market performance and declining interest rates have turned pension surpluses into deficits. As a result, rising pension costs continue to be a growing problem for the utility sector, with the negative impacts felt in key areas of corporate finance such as cash flow, profitability, and credit ratings.

Competitive Necessity?

While companies in other industries continue to look for ways to freeze or terminate their defined-benefit plans, the majority of companies in the utility sector remain committed to these plans. This is a reflection of the high value their workforce places on defined-benefit pension plans, thus making it a competitive necessity in attracting and retaining employees.

However, more and more publicly traded utilities are saying that higher pension costs have affected corporate earnings. As organizations experience increased scrutiny from credit and equity analysts, pensions have moved up on the corporate agenda. Boards are becoming more actively involved in pension decisions, and many financial executives spend a considerable amount of time on pension plans-potentially distracting them from other business initiatives.

Further complicating matters is the fact that there are now heightened disclosure requirements. The Financial Accounting Standards Board (FASB) is considering changes to the accounting rules that would eliminate the elements that have allowed companies to artificially smooth over investment gains and losses. Additionally, proposed legislation could reform pension laws and result in increased expenditures for plan sponsors. As a whole, pension plans now are affecting key strategic decisions such as mergers and acquisitions, competitive positioning, and capital expenditures, with the strain on finances limiting the ability of many companies to invest in new initiatives and manage outstanding financial arrangements.

As the financial and strategic risks involved in pension finance grow, many utility companies have continued to manage their pensions in the same way they always have-expecting market conditions to improve and ultimately fix the problem. Now, faced with the reality that the traditional model of relying on strong investment returns isn't a "quick fix" for their current pension woes, many CFOs are realizing that the model needs to change.

The true solution lies in managing risk by trying to control the volatility around the pension plans and the impact the plans have on the sponsoring organizations. The focus on aligning all aspects of the pension plan with overall corporate strategies allows organizations to reduce volatility and risk, and to create clear accountability for pension partners, thus helping to make pension plans a predictable and more affordable benefit.

Why the Traditional Model Fails

The traditional pension management model is not designed to address today's biggest challenges for plan sponsors: