Nortel Pension Cuts

The Big Cajun Man over at Canadian Personal Finance wrote an interesting post about Nortel’s recent pension cuts. He puts it into historical context and captures the employees’ feelings of betrayal. I would add that whether Nortel’s actions were legal or ethical, they were predictable.

Complicating this story is the switch from a defined benefit pension plan to a defined contribution plan. A defined benefit plan guarantees employees a certain amount of money per month after they retire. With a defined contribution plan, the company sets aside a fixed amount of money per pay period for each employee, and the ultimate retirement benefits will be determined by how well the money is invested.

It would be easy to misinterpret Nortel’s actions as simply changing to a new system. Make no mistake that this is a significant pension cut. Nortel expects to save $100 million per year in the first four years with the new system.

Could we have seen this coming? With defined benefit plans, the company must set aside money in the pension plan to cover future expected pension payouts. But Nortel, like many other companies hasn’t been setting aside enough money.

Nortel's underfunding of pension obligations has grown over the years. It currently stands at about a billion dollars. If a company isn't setting enough money aside in the pension plan, you have to expect that they won't be paying all of the promised pension benefits. This doesn't make it right; it is just predictable. What’s worse is that the large shortfall in Nortel’s pension plan points to further cuts in the future.