From the September 2003 issue of Investment Advisor • Subscribe!

DB Plans: Issues & Opportunities

Defined benefit plans are still big business. Sure, they and their sponsors are facing big issues, but you can be part of the solution

What's all this fuss about defined benefit (DB) plans? Aren't they ancient history? The truth is that there are plenty of DB plans out there, holding plenty of assets. Retirement Resources Inc. estimates that there were 46,400 plans with assets of $1.62 trillion as of the end of 2002.

What you probably do know is that many of those plans are facing some tough issues. During the lengthy bull market, many employers were able to essentially take a "funding holiday." Investment returns exceeded actuarial return assumptions, so contributions weren't required in many plans. Now, three years of negative equity markets combined with record low interest rates have reduced plan assets while plan liabilities are increasing.

In 2000, for example, only 14% of plan sponsors had to make contributions to their DB plan. By 2002, over 70% were required to make contributions. Add the rash of corporate scandals in 2001 and 2002, and you can almost feel the pressure building on plan sponsors.

Many DB plan sponsors are considering bundling the various services that support their pension plans to reduce expenses and save scarce internal management time. These services include recordkeeping, actuarial valuation services, and investment management, as well as investment consulting services. Plan sponsors who offer both a defined benefit plan and a defined contribution plan have the most to gain by bundling these two plans together with one provider. According to a 2002 study by Spectrem Group, 37% of employers with both defined benefit and defined contribution (DC) plans will consolidate their plan services with a single provider or will consider it within the next 12 months.

There are billions of dollars in assets under management and hundreds of millions of dollars in revenue for plan advisors up for grabs, so now is the time to focus on this long-neglected market.

Bundling, Defined

Plan sponsors with defined contribution plans figured out years ago the benefits of consolidating or bundling all or most of their services--investment management, recordkeeping, participant communication--with one provider. However, defined benefit plan sponsors have continued to use a multitude of providers for their services--estimates are that only 35% of DB plans with more than $1 million in plan assets are either fully or semi-bundled. According to the 2003 Chatham Defined Benefit Bundled Service Report, the number of bundled plans is expected to grow at a 12% compound annual growth rate over the next two years, creating more than 1,900 new bundled plans by the end of 2004. More than 75% of these plans will consist of less than $50 million, but will represent assets of almost $15 billion and $166 million in revenues, according to the Chatham report.

Benefits to bundling defined benefit and defined contribution plans with a single provider can include:

o Coordinated plan design for DC and DB plans

o Administrative cost savings of 20% to 30% per year

o Far less time and administration required on the part of the plan sponsor

o Faster, more streamlined administration of contributions, distributions and retiree payouts

o One lead contact person from the provider for both plans

o Where possible, a single data feed for payroll contributions

o Simultaneous updating of benefits, where appropriate

o More convenient access and information for participants, including consolidated plan statements, one call center, one Web site, and the ability to calculate income replacement ratios using data from both plans and estimated Social Security benefits

o Fosters improved employee appreciation of both plans

o Simplified communication of plan benefits to employees

Plan sponsors who choose to bundle all defined benefit plan services together also receive numerous benefits, including:

o Cost savings of 10% to 40% per year

o Far less coordination required on the part of the plan sponsor

o More streamlined administration of contributions, distributions, and payouts

o One contact person from the provider

Plan sponsors can also choose a semi-bundled arrangement in which they move the bulk of their plan services to a single provider but choose to keep certain services, such as actuarial advice or investments, with an additional provider.

Marketing Bundled Services

Many plan sponsors are feeling overwhelmed by funding issues they're facing this year and are looking for help. You're in an ideal position to help ease their burden.

First, here are some steps you can take to gauge the direction and progress of an employer's defined benefit plan:

Review the plan design as part of a total retirement benefit program review. Many 401(k) plans were set up several years after the DB plan was established and the two plans may not have been reviewed to see how the benefits integrate together to meet the employers' income replacement goals.

Ask the actuary to review actuarial assumptions and funding methods.

Ensure that their investment strategy is in line with their plan's liabilities.

Look at ways to reduce administrative costs through bundling the DB services.

Discuss the potential for consolidating the administration of their defined benefit and defined contribution plans with one or two providers.

Identify potential funding issues when a plan's ratio of assets to current liability is less than 80 or 90%. This is known as the "Gateway Percentage." Dropping below this percentage may require a larger-than-normal contribution. The sponsor may also be required to distribute notices to plan participants outlining the current funded status of the plan. By counseling sponsors to make additional small contributions at the appropriate time, a sponsor may be able to avoid this additional contribution and participant notices.

Before recommending a provider to handle a combined defined benefit/defined contribution plan, be sure to ask the provider these questions:

Which services can the provider handle directly, which are outsourced to a third party, and which must be handled by the sponsor directly?

Will there be a single contact for both plans?

Is the service provider's technology platform flexible enough to handle both DB and DC plans?

How long has the provider been in the business of servicing both DB and DC plans?

Once you have these answers, you can help your client find the right provider. Educating your clients on the benefits of bundled DB plans and combined DB/DC plans can lead to reduced costs and administrative hassles for them and a significant boost to your bottom line.

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