Re-engineering of plans under way
How is it possible to cut pension costs yet at the same time to remain attractive to employees? This is the conundrum faced by American employers. There is no ‘sure’ answer. What is certain is that the great majority of US pension fund sponsors are changing their benefit strategy.
According to a new survey of 242 American employers by Mercer Human Resource Consulting and Mercer Investment Consulting, ‘Coping with the economy’, 96% report making or considering plan changes. The most important trends emerging from the survey are a further reduction of importance of defined benefit (DB) plans and an increased concern about sponsor fiduciary duties in defined contribution (DC) plans.
DB plan sponsors have been shocked by three years of dismal financial markets (the survey was made in July-August 2003, before the rising of the ‘new Bull’): the decline of both equities and interest rates has reduced the value of pension funds’ assets and increased the burden of their liabilities. Trying to stay in control of the associated risks, in the 12 months ended in August 2003, 24% of employers have closed the plan to new participants and another 49% are planning to do the same within six months. Freezing the plan has been the choice of 19% in the last 12 months and will be decided by another 49% within six months. Another popular move was converting from a traditional plan to a hybrid design like a cash balance or a pension equity plan: almost one third did it within the last three years and 49% were thinking of doing it. But that was before the IBM court decision, which found the group guilty of violating the ERISA age-discrimination rules, while converting its old DB plan to a cash balance. So now employers are re-evaluating their strategy.
Also DC plan sponsors have made adjustments to the new economic environment: 60% changed their plan within the last three years. The most common change, undertaken by 68% of those who made changes, was the introduction of catch-up contributions; another 53% increased the limits on employee elective deferrals; 26% increased matching contributions or added a discretionary match. More than two thirds of employers are considering DC plan changes.
Within DC plans the most interesting new trends have been the increasing emphasis on employee education and the diversification of company stock contributions. “With the continuing uncertainty about equity markets and increased scrutiny of retirement plan governance practices, DC plan sponsors are under mounting pressure to take a hard look at their investment fund lineups to make sure they remain appropriate,” says Jeff Schutes, who leads DC consulting in the US for Mercer Investment Consulting. “They are also under pressure to make a higher level of investment education and advice available to their employees.” Already 24% of sponsors offer their employees a customised investment-advice programme, covering mostly issues like investment diversification (54% of programmes) and long-term savings strategies (47%). The problem is that the utilisation rates for these programmes are quite low – less than 25% on average, although in the last 12 months there has been a slight improvement. So one third of the survey respondents declared they were planning to implement a campaign to increase utilisation. Moreover the general participation of eligible employees in DC plans is still low: in plans where 90-100% of employees are eligible, only 12% elect to participate. Only 20% of DC plan sponsors indicate that participation levels have increased in the last 12 months.
Offering company stocks remain prevalent in DC plans. In three plans out of four, investment in company stocks is optional for employee contributions; in 37% of plans some or all of employer contributions are mandatory invested in company stocks. But after Enron both employees and employers are more aware of the risks of investing a significant portion of retirement savings in company stocks and are opting for a greater flexibility and diversification. In the last 12 months 29% of the sponsors that offer company stocks have expanded participants’ rights to diversify into other investments; 5% simply have eliminated the mandatory investment of employer contributions in the company stock fund.
Respondents to the Mercer survey gave also a glimpse into the employee behaviour in terms of investment choices. Thirty percent of sponsors report that the majority of plan participants have moved account balances from equity to fixed income securities during the last 12 months; 31% say that transfer activity between stocks and bonds has stayed about the same.