The Retirement Plan Less Taken

U.S. employers may not be returning to defined benefit plans, or pensions, anytime soon, but fewer companies last year moved away from pensions to offering only a defined contribution plan, or 401(k), than in any other year in the past decade.

The change is especially noticeable in a few industries that are bucking the retirement plan trend, according to a recent analysis by professional services firm Towers Watson & Co. (Editor’s note: Both authors work for Towers Watson.) For instance, more than half the companies in the insurance and utility sectors still offer defined benefit and defined contribution plans to new salaried employees.

According to the Towers Watson analysis, only 118 Fortune 500 companies offered any type of defined benefit plan to new hires at the end of 2013, the most recent year for which figures were available, down from nearly 300 companies 15 years ago (Figure 1).

Figure 1: A Change in Plans
Source: Towers Watson

Among these companies, 84 offered a hybrid plan and 34 offered a traditional plan. While the number of Fortune 500 companies with open defined benefit plans reached a record low in 2013, the number of companies — five — that moved away from defined benefit plans last year is the lowest number that shifted to defined contribution plans in more than 10 years.

Moreover, nearly half of Fortune 500 companies that no longer provide defined benefit options to new hires still have active employees who are accruing benefits, according to Towers Watson’s analysis.

Traditional pension plans have taken the hardest hit during the shift, while hybrid pension plans have held relatively steady, the analysis showed. Half of the employers sponsoring a defined benefit plan during this 15-year period maintained a hybrid plan — typically a cash-balance plan. More than half (57 percent) of employers that established a hybrid plan either before or after 1998 still offered a hybrid plan to new hires in 2013.

With the new hybrid regulations announced in September 2014, it seems employers will have even fewer reasons to abandon those plans.

The defined contribution-only sponsorship rate is partly attributable to changes in the Fortune 500, the analysis showed, as more employers joining the list over the years have never sponsored a defined benefit plan.

More than half (278) of the employers in this analysis were in the Fortune 500 in 1998, and 25 percent of them offered only defined contribution plans at that time. Moreover, traditional defined benefit plan sponsors have been more likely to remain on the list: 26 of the 34 traditional plan sponsors in the 2013 Fortune 500 also made the list back in 1998, the analysis showed.

While the shift to a defined contribution-only environment has been widespread, some sectors are more inclined to make the switch or have never offered a defined benefit plan.

Most Fortune 500 employers in the utilities and insurance sectors still offer defined benefit plans to new hires. Utilities are typically heavily unionized and have chosen to keep their retirement structure consistent between their union and nonunion workforces, the analysis showed.

Insurance sector employers face different external pressures, according to the analysis. Their employees, because of their training and the nature of their work, may be more inclined to understand and appreciate defined benefit plans relative to workers in other sectors.

Defined benefit plans, however, are not a one-size-fits-all solution. The high-tech, services and retail sectors have historically had low defined benefit sponsorship rates, and defined contribution plans are likely a better fit for their business needs, Towers’ analysis showed.

Overall defined benefit plan sponsorship for these sectors never exceeded 36 percent, the analysis showed, as their relatively high turnover makes portability more important.

In general, plan design trends are affected by economic conditions and workforce demographics. Between 1998 and 2013, the most striking changes have been in the automotive and transportation, food and beverage, manufacturing, finance and communications industries, which had a significant uptick in defined contribution-only sponsorship.

Most employers take one of three broad approaches to transitioning to a defined contribution-only environment. The first is to close the defined benefit plan to new hires, meaning all participants as of a certain date continue accruing benefits, either at the same or a reduced level. The second approach is a partial freeze, in which only participants who meet certain age and service requirements continue accruing benefits in the defined benefit plan.

All other participants are switched to the retirement plan offered to new hires. The third approach is a complete freeze, where the sponsor stops all defined benefit accruals and moves all participants to the retirement program offered to new hires.

Of the employers that adopted a defined contribution-only approach since 1998, 42 percent closed the defined benefit plan to new hires, 7 percent partially froze the defined benefit plan and the remaining 51 percent froze the plan completely, according to Towers Watson analysis (Figure 2).

Figure 2: How to Transition
Source: Towers Watson analysis of 2013 Fortune 500

Employers varied the details within the three broad transition approaches. The most frequent approach (39 percent), the analysis showed, was freezing the plan completely and enhancing benefits in the defined contribution plan for all workers.

The transition also plays out in a reduction of retirement benefits as a percentage of pay. On average, a newly hired employee received retirement benefits worth 9.3 percent of pay at a company with a hybrid plan vs. 5.7 percent of pay at a defined contribution-only company (Figure 3).

Among defined contribution-only companies, employer contributions vary significantly, the analysis showed, from an average 4.7 percent at companies that were always defined contribution only to 6.7 percent at those that once sponsored a pension.

Figure 3: New Hire Allocations
Source: Towers Watson analysis of 2013 Fortune 500

The shift to defined contribution plans as the primaryretirement vehicle over the past 15 years has placed more responsibility and risk on employees, the analysis showed. Employees must increasingly take ownership of managing their own contribution levels, investments and distributions.

Yet employers recognize risks for themselves as well. Most notably, these risks include workers delaying retirement when market performance is poor, which in turn can result in higher benefit costs and less mobility within their organizations.