ByLike many small and mid-sized manufacturing companies in recent years, Reinhold Industries was caught in a classic squeeze with its traditional defined benefit plan.

Costs for the Santa Fe Springs company were rising as retirees were living longer and investment returns on its pension plan were falling along with interest rates. So, two years ago, Reinhold officials decided to freeze the company's pension plan and encourage employees to put money in a 401(k) plan.

"Maintaining a defined benefit pension plan is expensive and difficult to administer, especially for a company our size," said Brett Meinsen, vice president and chief financial officer with Reinhold.

The maker of aircraft seat components, rocket nozzles and sheet molding compounds has 125 employees, posted $37 million in revenues last year and has a market capitalization of $47 million.

Those figures are a far cry from the multi-billion dollar companies that now comprise the last remaining bastion of defined benefit plans, including Los Angeles-area firms Edison International and Northrop Grumman Corp.

Indeed, over the last several years there has been a wholesale abandonment of defined benefit pension plans at small and mid-sized manufacturing firms in the Los Angeles area. The firms typically have workers who serve for 20 years or longer and then live for two or three decades after retirement, leading to tremendous pension benefit outlays. The companies are also increasingly under pressure from foreign competition to cut costs or go out of business.

As a result, many of these firms have decided to limit their retirement liabilities and switch their employees to defined contribution plans.

"For the last three or four years, small and mid-sized manufacturing companies have been freezing contributions to defined benefit plans. They are just trying to stay in business," said Matt Bartosiak, manager of the consulting helpline with Employers Group, a Los Angeles-based human resources consulting firm.

Inherited pension plan
For much of Reinhold's existence, the company never offered a defined benefit plan. Only after asbestos maker Keene Corp. which did have such a plan bought Reinhold in 1984 did the latter start to offer the same plan to its workers. Under the plan, employees became vested after five years with the company, with benefit payouts based on years of service and on the highest five years of compensation.

When Keene went bankrupt in the early 1990s and reorganized with Reinhold as its primary business, Reinhold was left holding the bag on the retirement benefits for Keene workers. "Most of our pension liability was inherited from Keene," Meinsen said.

Reinhold wasn't alone in this predicament: many manufacturing firms that bought out competitors often inherited pension liabilities that they were eager to reduce or eliminate entirely.

In Reinhold's case, several factors converged to spell the end for the defined benefit plan. First was the recognition that liabilities were growing as workers lived longer after retirement. An assembly line worker who retires at 55 can reasonably expect to be drawing benefits for the next 25 or 30 years.

Then, after the stock market crash of 2000-01 and the Sept. 11 terrorist attacks, the Federal Reserve Board began lowering interest rates amid signs of a slowing economy. Reinhold's pension investment policy stipulated that much of the pension dollars must be placed in conservative investment vehicles, which are interest-rate sensitive. When interest rates began to fall, the investment returns for the pension plan fell with them,

"Five years ago, the plan was fully funded. But because of the decline in discount rate assumptions, we are now significantly underfunded," said Meinsen. He added that even today the plan is underfunded by $5.8 million.

While that's a far cry from Edison's pension plan shortfall of $219 million, or Northrop Grumman's pension underfunding of $1.2 billion according to a 2006 study from Milliman Consultants and Actuaries Reinhold is a much smaller company, without the deep pockets to put in the extra cash.

Faced with these trends, many companies would decide to freeze their defined benefit plan. But Reinhold had an additional incentive: it was trying to make itself more attractive to potential buyers.

In 2003, Reinhold management hired Chicago investment banking firm William Blair & Co. LLC to sell the company. The main reason for putting the company on the market was to increase its market capitalization.

"We have very little public float, so our major shareholders would find it difficult to sell a large portion of their holdings without destroying the main stock price," Meinsen said.

But instead of finding buyers, William Blair found issues at Reinhold itself that were scaring away potential buyers. Among them was the defined benefit pension plan. Such plans are of particular concern at manufacturing companies because workers tend to be older and stay longer.

So, as of Dec. 31, 2004, Reinhold executives imposed a "soft freeze" on the defined benefit pension plan. Under this common type of freeze, all pension benefits accrued to that point remain intact, but no new participants are enrolled in the plan and existing participants don't accumulate any more years of service toward the plan.

Instead, all retirement benefits accrued after January 2005 have been directed through Reinhold's 401(k) defined contribution plan, which includes a company match. The main difference, of course, is that under a defined contribution plan, it's up to the employee to determine whether he or she wants to participate and how much to put into the plan. The national pension reform act signed into law last month allows companies to automatically enroll employees in 401(k) plans, something that Meinsen said the company was not considering at this time.

Reinhold's decision to freeze the defined benefit plan in no way reduces the company's current liabilities under that plan, which is still underfunded. Under the national pension reform act, the company will have seven years to fully fund the plan, meaning it will have to put in more cash each year.

But the liabilities will not increase. "It gives us more certainty, which is key for any potential buyer," Meinsen said.

For reprint and licensing requests for this article, CLICK HERE.