New Frontiers in Benefits: From Defined Benefits to Defined Contributions

Art by Jenn Liv

Defined benefit (DB) plans are increasingly giving way to defined contributions in a historic transition. The challenge for chief investment officers (CIOs): to navigate these uncharted waters and find innovative new methods of providing employee benefits as the sands shift.

Although there are still plenty of growth opportunities for DB plans, the steady stream of companies that have been transforming their DB plans by either closing them, freezing them to new hires, or transitioning to hybrid or full defined contribution (DC) plans, continues. In fact, in 2017, only 16% of Fortune 500 employers offered DB plans to new employees, according to a survey by advisory firm Willis Towers Watson. Looking at the continuing shift, 2008 saw 20% of Fortune 500 companies that offered a DB plan in 1998 freeze their pensions and 19% close their primary plan to new entrants. There hasn’t been much thawing. By 2017, those numbers spiked to 42% with frozen plans and 24% that closed their primary plan.

Yet CIOs know benefits can be a flashy lure for top talent and are still seeking ways to remain competitive. If there were a competition among employers who allocate the most money to new hires, those with hybrid plans would win at 9.7% percentage of pay, with 4.7% coming from typical DB pension value, and 5% from DC value. Second place would belong to companies that once carried traditional DB pensions and have transitioned to DC plans. They’re often more generous in their contributions, offering 6.6% compared to the average 4.5% DC-only salary match, according to Willis Towers Watson.

In many cases, CIOs are doing the research and finding ways to enhance their DC plans to keep their companies a magnet for new employee, and protect those who are converting to DC plan benefits.

“With most employers now offering a DC plan as the primary retirement savings vehicle, they have become very focused on how to improve their plans and deliver better outcomes to participants,” said Tammy Hughes, senior retirement consultant, Willis Towers Watson.

Key enhancements include adding automatic and Roth design features, boosting employer contributions, reducing investment choices, improving fee transparency, and adding health savings accounts (HSAs). Nearly three in four respondents (73%) of another Willis Towers Watson survey now automatically enroll new participants, compared with 68% in 2014 and 52% in 2009. Additionally, 60% of respondents provide an auto-escalation feature, up from 54% in 2014.

Debates have started about whether employers should shift from pure fund benchmarking to individual outcome benchmarking, which takes the employees investment practices into account. Others are debating whether auto enrolling or auto-escalating employees is truly a best practice if the employee is in debt. Those converting from DB to DC plans have the challenge of making a DC plan as similar as they can to their DB plan.

Robin Diamonte, CIO, and Kevin Hanney, director of pension investments, at United Technologies Corp., broke new ground by augmenting the large company’s plan to allow employees to opt for guaranteed income for life.

“It’s a new trend, and Robin and Kevin are really at the forefront. They are remarkably prescient,” said Doug McIntosh, vice president of investments for Prudential Retirement.

Diamonte told CIO, “We knew that future generations of our employees would have to rely on our DC plan as their main source of retirement savings, so we were determined to provide a state-of-the art DC plan.”

Similarly, Robert Hunkeler, International Paper’s CIO, helped modify his plan to change loan options, so employees wouldn’t have to immediately repay loans if they left the company or retired. “We have been offering plan loans to separated participants at least 15 years, if not longer,” Hunkeler told CIO.

He’s also been working to add improvements that help the employee navigate the complexities of retirement planning, adding a financial advisement, a spend-down service, and a long bond fund to improve the outcomes for those in retirement, among many other features.

Of course, there are drawbacks to switching to DC. The responsibilities tend to fall onto the employee who often doesn’t have an investing background. Getting employees to save enough and calculate the correct risk mix for their age remains a challenge. Employees who don’t save enough tend to “retire at their desks.” When they do, healthcare costs increase and upward mobility within a company decreases.

 There are also new risks when it comes to the 401(k) world, as investment risks are not necessarily as well aligned as they are on the DB side. So, when a CIO tries to innovate, there’s always a risk of their innovation failing. When it fails, their large companies are often considered low-hanging fruit when it comes to lawsuits, and attorneys can pounce on that failure, labeling it as an unnecessary risk that was taken with employees’ retirement cash. Fear of liability can strangle innovation.

Through our new DB to DC series, CIO intends to explore these issues, and dig deep into what our CIOs are doing, the debates they’re having, the new options they have available, and the innovations they’re introducing to DC plans.