Defined benefit pension plans have outperformed defined contribution plans in many years since the mid-1990s, according to a study by Towers Watson.
DB plans outperformed DC plans by an annual average of 76 basis points between 1995 and 2011. This performance gap shrank to 39 basis points from 2007 to 2011, thanks in part to the stock market boom of 2009, when the Russell 2500 Index increased by 34 percent and returns from DC plans reached 20.86 percent — their highest level since 1995. DC plans beat DB plans by 5.4 percent in 2009.
Still, Towers Watson analyzed more than 2,000 pension plans in 2011 and found that the median investment return was 2.74 percent compared with the median return of a negative-0.22 percent for defined contribution plans.
A shift in asset allocation between the two plan types also contributed to the trend. After equity markets peaked in 2007, DB plan sponsors started reducing their holdings in equities. By 2009, there was a considerable difference in holdings, with DB equity allocations down to approximately 48 percent and DC equity holdings up to around 62 percent.
As DB plan sponsors reduced their equity holdings, they turned to more fixed-income and alternative investments. Many invested in long-duration bonds as a hedge against mounting liabilities as interest rates steadily declined. This move paid off in 2011, when equity markets experienced losses and long-duration bonds performed strongly.
As the DB/DC performance gap illustrates, the shift toward DC brings with it significant workforce issues. The lower level of benefits typically offered in such plans, combined with weaker investment returns, means that fewer employees are likely to be prepared for retirement and that we'll see a growing population of the "working retired," Towers Watson said.
To address this concern, DC plans have been taking on more characteristics of DB plans, such as auto-enrollment and auto escalation in participants’ contributions. Some allow participants to opt for professional investment management, with investments in target-date funds.
All of these things can help plan participants improve their investment returns, which will become even more important as more workers without DB plans approach retirement. If no steps are taken to help employees secure an adequate retirement income stream, it will become increasingly difficult for employers to manage the flow of talent and maintain orderly retirement patterns. Such difficulties can have untold impact on any organization's bottom line, Towers Watson warned.