DB Plans: Issues & Opportunities

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