EMPLOYEE BENEFIT FUNDS - PART III – HOW DID ‘ERISA’ AFFECT RJR?

The first challenge that ERISA posed for pension plans was making a realistic forecast of future payouts over the next forty years and beyond. This was no small task, and an outside actuarial firm did the calculations. (More about the challenges in making this forecast in a future post.)

ERISA addressed a major shortcoming of the old system - vesting.  Like many pensions, RJR had no vesting rules. A worker was entitled to a pension only if he worked until age 65. If the employee left the company for any reason before age 65, he got no pension.[1] Companies needed to put rules in place to assure that workers could begin earning pension benefits after a reasonable time as an employee.  These rules varied among companies, but RJR’s was typical – the pension used a method called ‘cliff vesting.’  If the employee stayed on the payroll 10 years, then he immediately became entitled, ‘vested’ in a benefit. That meant that after just 10 years’ service an employee was entitled to at least some monthly pension at retirement, even if the employee left the company. Of course, the longer the employee worked the more pension benefit he accrued. RJR’s pension benefit was generous, providing an annual pension of 1.75% of final pay for each year of service up to 40 years.[2]

RJR, like many companies, had an underfunded pension plan. The chart below shows the annual pension contribution each year beginning the year ERISA became law.

Contributions increased from $21 million in 1974 to $114 million in 1982, more than 5-fold, 23.5% a year.  The cumulative contribution in the eight years was $542 million. Acquisitions and other technical factors increased the contribution amount, but the lion’s share was the result of ERISA.

[1] As a new employee when I went to orientation in a tobacco factory in 1965, the factory supervisor pointed out a worker.  The supervisor said, “That man is 60 years old with 55 years’ service, but he cannot retire for another 5 years.” The man had been a child in 1910, and each day his mother brought him to the factory where she worked.  With no child labor laws, RJR put him on the payroll as a floor sweeper, and he remained an employee for the next 55 years.

[2] Final pay was defined as the average of the last 5 years. For example, a person who retired with final pay of $60,000 a year and 30 years’ service would receive $31,500 a year for life.