Retirement Plan Changes and Employer Motivations

Transcription

1 Pensions in Transition Retirement Plan Changes and Employer Motivations 2012 Report

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3 Pensions in Transition: Retirement Plan Changes and Employer Motivations May 2012 Table of Contents Executive Summary 2 Key Findings 3 About the Survey 3 Retirement Plans for New Hires 4 Companies That Maintain DB Plans 8 Moving Away From DB Benefits: Sponsors That Froze or Closed Plans for New Hires in the Past Decade 13 Helping Employees Save: Employer DC Plan Contributions 17 Conclusion: What s the Plan For Today and Tomorrow? 19 Definition of Key Terms 20

4 Executive Executive Summary Summary Several factors have combined over the past decade to make sponsorship of defi ned benefi t (DB) pension plans less attractive to employers. Low interest rates, falling equity values, a deep economic recession and an uneven recovery have lowered pension funding ratios and led to large employer contributions at a time when many can least afford it. Moreover, the legislative and regulatory climate has added uncertainty to the mix, which in the eyes of some critics has erased the economic basis of offering such a plan. As a result, a large number of employers have made changes to their retirement plans and, in general, are increasing their reliance on defi ned contribution (DC) plans as the primary source of employer-sponsored retirement income for employees. As part of this transition, some companies have frozen or closed their DB plans to all or newly hired employees, or switched to a hybrid DB plan to reduce cost and perceived cost volatility. The impact of these changes on employees is signifi cant. DC plans make it more diffi cult for employees to plan for retirement given the fl uctuations in market returns (e.g., the 2008 recession reduced the value of plan balances), and employers have already begun to see an increase in the retirement age of their workers. At the same time, employees are more uncertain about their retirement security. More than half of employees responding to a recent Towers Watson survey indicated a willingness to trade some portion of pay for more generous retirement benefi ts. Among DB plan participants younger than 40, in particular, the survey found the number willing to pay for a guaranteed retirement benefi t jumped by nearly 70%, from 39% in 2009 to 66% in 2011.* The Towers Watson Pensions in Transition: Retirement Plan Changes and Employer Motivations survey of more than 400 DB plan sponsors fi nds that despite the shift, many active DB sponsors remain committed to offering a DB plan in the future. In fact, larger DB plan sponsors are less likely to move away from a DB design than their smaller counterparts. And certain industries (e.g., utilities, health care) are more likely to depend on DB benefi ts as a vital component of reward packages to attract and retain skilled workers. Meanwhile, employers providing DC-only retirement plans are looking to increase employee engagement with their plans in order to improve the retirement readiness of their employees. In some instances, they are adding DB-like features such as automatic enrollment and non-matching contributions to encourage employees to build adequate retirement savings. They are also taking steps to optimize plan performance. The fi ndings of the Pensions in Transition: Retirement Plan Changes and Employer Motivations survey illuminate the outlook for further retirement plan changes and the complex set of factors that will drive employers plan strategies going forward. *2011 Towers Watson Retirement Attitudes 2 towerswatson.com

5 Key Findings Plan design changes are being spurred by sponsors that are strongly and uniformly motivated to reduce cost and perceived cost volatility. Approximately two-thirds of sponsors that once offered a DB plan to new hires no longer offer these benefi ts. In our previous survey, motivations behind plan conversions were varied. Even though changes to plan management practices (not changes to plan design) would be a more effi cient way to reduce cost volatility, cost reduction and cost volatility reduction are the two primary reasons for almost all hybrid conversions, plan freezes and plan closures. Not all employers are abandoning DB plans in favor of DC-only offerings, even for new hires. Within the largest 10th percentile of plans (plans with over 42,000 participants), 45% of sponsors still offer a DB plan to new hires. This group also had the highest frequency of hybrid conversions since So while a large number of companies are changing from DB to DC only for new hires, a substantial population of employees are still earning DB pensions today. In addition, 68% of all respondents with active DB plans are committed to continuing them for the next two to three years, and 66% of all respondents have some portion of their workforce actively accruing benefi ts. Employers recognize that DC plans do not replace as much income as DB plans and are taking steps to help close the savings gap but not on their nickel. Ninety-eight percent of respondents that offer a DC plan provide some type of employer contribution. Fifty-two percent of respondents offer an employer match, and 42% offer both a matching and non-matching contribution. But there is no question that the funds employers are allocating to DC plans will not be suffi cient to produce the same retirement benefi t levels as their old DB plans. So employers are implementing tactics to encourage their employees to make up the difference. For example, 59% of DC sponsors use automatic enrollment, and about half of these sponsors have also adopted automatic escalation. About the Survey The Pensions in Transition: Retirement Plan Changes and Employer Motivations survey was conducted from October 2011 to December 2011 and includes responses from 424 DB pension plan sponsors at midsize and large organizations. Respondents were asked about changes to their retirement plans over the past 10 years, their motivations behind those changes and their future retirement offerings. This survey is a follow-up to the one we conducted in 2007, Retirement Plan Design: Past, Present and Future. Within the largest 10th percentile of plans (plans with over 42,000 participants), 45% of sponsors still offer a DB plan to new hires. Pensions in Transition: Retirement Plan Changes and Employer Motivations 3

6 Retirement Plans for New Hires During the 1990s, all the companies in our survey offered newly hired employees a DB plan but only about one-third of respondents offer a DB plan today. However, almost every company in this analysis offers its associates a DC plan, either as their main retirement vehicle or as a secondary plan paired with a DB plan (Figure 1). While the majority (64.1%) of organizations offer only a DC plan to new hires today, 16% offer a cash balance plan and a DC plan, with another 14% offering a fi nal average pay DB plan with a secondary DC plan. According to our 2007 survey, 40% of plan sponsors offered new hires a DC plan as their sole retirement vehicle. Figure 1. Types of retirement plans offered to new hires today 13.9% Final average pay plan 1.6% Career average pay plan 13.9% 1.6% 1.0% 1.0% Other traditional DB plan 16.3% Cash balance plan 1.6% Pension equity plan 16.3% 0.7% Stable value 0.7% Other hybrid 64.1% 1.6% 64.1% DC only 0.7% 0.7% n = 424 Companies took several paths since the beginning of 2000 to arrive at their current retirement plan offerings (Figure 2). Early Change Is Prologue Approximately 76% of sponsors that had a traditional DB plan at the beginning of 2000 took some action to change the retirement benefi ts for new hires. Looking at the fi rst action taken, closing the traditional DB plan was the most common action. Converting to a hybrid pension or freezing the traditional DB outright was also signifi cant. Most companies that converted to a hybrid plan in the past decade still offer that plan to new hires today. On the other hand, those companies that offered a hybrid plan prior to 2000 have stopped offering them to new hires today. Among companies that offered hybrids at the beginning of 2000, 64% removed this plan for new hires. This is somewhat comparable to the exit from traditional plans to a DC environment for companies that held them at the beginning of 2000, as 70% removed them for new hires. Many sponsors closed their plans to newly hired employees fi rst and then froze the plan at a later date. Figure 2. Path taken by DB sponsors to arrive at current offering for new hires (since January 2000)* Hybrid at beginning of decade (=96) Traditional DB plans at beginning of decade (=295) (n=29) (n=32) (n=35) Hybrid conversions in the past decade (n=61) Closed traditional plans (n=96) Froze traditional DB plans outright (n=68) (n=7) (n=7) Closed hybrid (n=36) Froze hybrid outright (n=39) (n=47) (n=36) (n=15**) Closed hybrid plans (n=21) Frozen hybrid plans (n=54) Active hybrid plans today (n=82) Active traditional DB plans today (n=70) Closed traditional DB plans (n=60) Frozen traditional DB plans (n=104) *Figure 2 excludes companies that moved to a DC-only environment for new hires during the 1990s as well as those that have terminated their DB plan. **Fourteen had hybrid plans at the beginning of the decade, and closed then froze them over the past decade. One converted, closed and then froze its plan this decade. 4 towerswatson.com

7 Since the beginning of 2000, 37% of respondents froze accruals for some or all participants, while 19% closed their plans to new employees. Six percent converted to DC plans prior to 2000; 11% converted from a traditional DB plan to a hybrid plan, and 24% have maintained their current plan design (hybrid or traditional) since At the end of 2000, the majority (70%) of respondents offered their new hires a traditional pension (with the vast majority offering a fi nal average pay plan). Final average pay plans are designed to reward employees who have long careers with the plan sponsor. Companies have moved toward more portable plans that are typically account-based (e.g., DC or hybrid), and today only 17% offer traditional DBs (Figure 3). The shift from DB (traditional and hybrid) to DC-only plans started to escalate in 2004 and hybrid plans became the predominant DB offering in 2011 (Figure 4). Figure 3. Last action taken since 2000 to arrive at retirement programs today 0.5% 11.1% 24.3% 6.4% 19.1% 37.3% 19.1% Closed DB plan to new hires 37.3% Froze DB plan 1.4% Terminated DB plan 6.4% Changed to DC prior to last decade 11.1% Converted to hybrid plan 0.5% Reopen DB plan 24.3% No change (traditional DB and hybrid more than 10 years ago) n = % Figure 4. Evolution of retirement offerings since the end of 2000* Traditional DB versus hybrid versus DC 350% 300% 250% 200% 150% 100% 50% 0% Traditional DB Hybrid DC only n = 424 *Figure 4 represents offerings to new hires. If a plan was closed or frozen as of December 31, we consider the close/freeze to have occurred the following year because benefi ts would have accrued for the current year. Pensions in Transition: Retirement Plan Changes and Employer Motivations 5

8 The transportation and communications sectors two industries hit extremely hard by the recent recession have the highest rates of pension freezes. From DB to DC and In-Between: Plan Design by Industry While the shift to DC has been widespread, companies in certain industrial sectors have implemented more profound plan design changes to meet the needs of their workforce and benefi t budgets. The energy/natural resources, insurance and utilities sectors are the most likely to offer a DB plan to new hires (Figure 5). Although DC-only sponsorship for new hires is similar for utilities and energy, the sectors DB design decisions were not. The predominant move of utilities that no longer offer DB benefi ts to new hires was to close their DB plan to new employees even as most energy sector respondents that no longer offered DB benefi ts to new hires froze their DB plans. There are various reasons for the high DB sponsorship rate in the utilities sector. Utilities are typically heavily unionized and therefore more likely to keep their retirement structures consistent between their bargaining and non-bargaining workers. In addition, many utilities workers have physically demanding jobs, and DB plans encourage them to retire at the appropriate time. Employers in both the energy and utilities sectors also tend to experience lower turnover than employers in other industries. Capital market performance, economic conditions and workforce demographics have contributed to plan design trends. The largest shifts from DB to DC plans were in the auto and transportation equipment, communications and high-tech sectors. The transportation and communications sectors two industries hit extremely hard by the recent recession have the highest rates of pension freezes among all sectors. Seventy-seven percent of pension freezes for organizations in these sectors occurred after the start of the recession. Figure 5. Plan types for new hires today by industry* Industry FAP CAP Other traditional Cash balance PEP Other hybrid DC only Aerospace and Defense 0% 0% 0% 0% 0% 0% 100% Auto and Transportation Equipment 4% 0% 0% 11% 0% 0% 85% Banks 15% 0% 0% 18% 0% 4% 63% Communications 10% 0% 0% 10% 0% 0% 81% Energy/Natural Resources 26% 4% 0% 14% 4% 4% 48% Food and Beverage 14% 0% 0% 14% 0% 0% 71% Health Care 10% 3% 3% 27% 1% 3% 52% High Tech 0% 5% 0% 5% 0% 5% 86% Insurance 21% 4% 0% 29% 4% 0% 42% Manufacturing 15% 0% 0% 12% 0% 1% 72% Retail/Wholesale 11% 0% 0% 11% 0% 0% 78% Services 11% 5% 5% 17% 5% 0% 56% Transportation 18% 0% 0% 9% 0% 0% 73% Utilities 21% 3% 0% 29% 5% 0% 42% Other 25% 0% 5% 0% 5% 0% 65% *Due to rounding, some totals may not equal 100%. 6 towerswatson.com

9 While many companies are changing from DB to DC only, the number of workers affected is not proportionately drastic because the large plans that cover the most participants still offer a DB benefit. Changes in high-tech company retirement offerings became more widespread during the past decade. High turnover and the desire for portable benefi ts have lowered the number of high-tech DB plan sponsors (open, closed or frozen) relative to many other sectors* and resulted in proportionately fewer concentrated changes to DBs in the sector. Another sector of interest, especially during the recent crisis, is the fi nance industry (banks and insurance companies). Even with government aid, banks took cost-cutting measures to preserve cash during and after the fi nancial crisis. There were worker layoffs, furloughs, salary freezes and, in some cases, salary reductions, but these companies also took steps to scale back retirement benefi ts. Today, 58% of insurance companies still offer DB plans, while only 37% of banks offer such plans. One Design Doesn t Fit All It Varies With Plan Size The type of retirement offerings differ by plan size, with smaller plans (fewer than 5,000 participants) more likely to have shifted to DC compared to their larger counterparts (Figure 6). Thirty percent of sponsors with fewer than 5,000 participants offer DB plans to their new hires, while 40% of sponsors with over 20,000 offer DB plans. In the largest 10th percentile of plans (over 42,000 participants), 45% of sponsors still offer a DB plan to new hires. This group also had the highest frequency of hybrid conversions in the past decade. So while many companies are changing from DB to DC only, the number of workers affected is not proportionately drastic because the large plans that cover the most participants still offer a DB benefi t. Figure 6. Plan types for new hires today by plan size* Total plan size FAP CAP Other traditional Cash balance PEP Other hybrid DC only Under 5,000 participants (n=141) 5,000 20,000 participants (n=156) Over 20,000 participants (n=91) 14% 4% 1% 10% 0% 1% 70% 15% 1% 0% 17% 3% 2% 61% 11% 0% 1% 25% 1% 1% 60% *Results for Figure 6 are shown for companies where plan size was available. Due to rounding, some values may not equal 100%. * Pension Freezes Among the Fortune 1000 in 2011, Towers Watson Insider, November 2011 Pensions in Transition: Retirement Plan Changes and Employer Motivations 7

10 Companies That Maintain DB Plans Among the DB plans offered to new hires, hybrid plans make up the majority (54%), whereas our last survey reported that traditional DB plans were the most common DB offering for newly hired workers (Figure 7). Figure 7. Hybrid versus traditional DB offerings today for new hires 46.1% n = % 53.9% Hybrid 46.1% Traditional Hybrid plans can offer a practical DB approach for sponsors seeking to reduce the volatility of funding and expense with an account-based design and a traditional equity-dominated asset allocation. Fortythree percent of active hybrid sponsors in our survey converted before 2000, and since 2000, there has been a steady stream of hybrid conversions (Figure 8). There was a notable decline in conversions during 2005 and 2006 due to regulatory and legal uncertainty about hybrids. After the Pension Protection Act of 2006 (PPA) was enacted, age discrimination claims and many other legal issues surrounding hybrids were resolved, and the number of conversions increased. Hybrid plans are the majority DB offering for new hires today, which is not surprising since 77% of companies that converted to them since 2000 still offer the plans. On the other hand, 64% of the hybrid plans that existed at the start of the last decade are now closed to new hires or frozen, which is just slightly less than the 70% of traditional DB plans that were not converted to hybrid plans. Figure 8. Timing of hybrid conversions since % 7% 7 6% 6 5% % 4 4 3% 3 3 2% 2 2 1% 0% n = 47 8 towerswatson.com

11 The majority of surveyed companies that converted to a hybrid plan since 2000 cited cost containment as the primary motivator, with 40% mentioning reducing cost and 30% citing lowering cost volatility (Figures 9a and 9b). But while the latter two priorities were important in our previous survey, enhancing employee perception and attracting/ retaining workers were just as critical. By contrast, attraction and retention motivators signifi cantly lag behind cost motivators today. When identifying all (not just primary) reasons for conversions, cost volatility and reducing cost are still main factors, but offering benefi ts similar to those of peers is almost as important. Over 50% of respondents said that offering benefi ts similar to those of peers is one of the top three reasons and most often it was the number two reason. Twenty-three percent, meanwhile, report portability as one of their top three motivators to convert. When identifying all (not just primary) reasons for conversions, cost volatility and reducing cost are still main factors, but offering benefits similar to those of peers is almost as important. Figure 9a. Primary reasons for hybrid conversions since % 2.1% 4.3% n = % 2.1% 4.3% 2.1% 8.5% 29.8% 40.4% 40.4% Reduce cost 29.8% Reduce cost volatility 4.3% Reaction to 2008 recession 2.1% Funding provisions from the PPA 4.3% Facilitate integration of merged or acquired entities 8.5% Offer benefits similar to peers 4.3% Enhance attraction of employees 2.1% Enhance benefit portability 2.1% Encourage certain patterns of retirement behavior 2.1% Other Figure 9b. Top three reasons for hybrid conversions since % 10% 20% 30% 40% 50% 60% 70% 80% Reduce cost Reduce cost volatility Offer benefits similar to peers Enhance attraction of employees Facilitate integration of merged or acquired entities Reaction to 2008 recession 4.3 Enhance benefit portability Encourage certain patterns of retirement behavior Funding provisions from the PPA Simplify administration Changes to accounting standards 4.3 Enhance retention of employees Other 4.3/ / / /10.6 6/2.1 First reason Second reason Third reason n = 47 Pensions in Transition: Retirement Plan Changes and Employer Motivations 9

12 Supporting a DB Plan Design There are many reasons why companies still offer a DB to their newly hired workers, but employee retention and supporting a paternalistic culture are the ones cited most frequently (Figure 10). Pensions are designed to provide income either at or throughout retirement in the form of an annuity and 78% of DB plan sponsors believe employees value these guaranteed benefi ts more than other features (Figure 11). In contrast, only 50% of DC-only sponsors held the same belief. Moreover, while 54% of DB sponsors believe employees value income throughout retirement, only 28% of DC-only sponsors do. Figure 10. Top reasons to offer DB plan today 0.7% 7.2% Beneficial for recruitment of new talent 7.2% 7.2% 42.1% Beneficial for retention of 7.9% valuable current employees 5.3% More efficient investment strategies can be employed 42.1% 29.6% Supports our company s 29.6% paternalistic philosophy 7.9% Valuable in workforce management helping employees retire in a timely manner 5.3% 7.2% Other n = % Don t know Figure 11. Retirement plan features employers perceive employees to value most Active DB sponsors 54.0% 5.9% 3.3% 2.0% 10.5% 24.3% 3.3% Ability to direct one s investments 2.0% Access to money before retirement 10.5% Benefit portability 24.3% Guaranteed benefits at retirement 54.0% Guaranteed retirement income at and through retirement 5.9% Don t know n = 152 DC-only sponsors 14.1% Ability to direct one s investments 28.1% 12.8% 14.1% 7.0% 15.7% 7.0% Access to money before retirement 15.7% Benefit portability 22.3% Guaranteed benefits at retirement 28.1% Guaranteed retirement income at and through retirement 12.8% Don t know 22.3% n = towerswatson.com

13 Should I Stay or Go? Attraction, Retention and Benefits While the evolution from DB plans to a preponderance of DC and hybrid plans has enabled employers to control benefi t costs, it has also impacted employees confi dence in their ability to retire. Employers need to balance cost control with offering the benefi ts necessary to hire and keep the right talent a goal whose feasibility has been complicated by increased levels of health care costs that are crowding budgets and spurring cuts. Even as the percentage of workers very or somewhat confi dent about having enough resources to live comfortably 15 years into retirement increased from 62% in 2010 to 68% last year, less than half (47%) felt this way about living well 25 years into retirement, according to the 2011 Towers Watson Retirement Attitudes Survey. Not surprisingly, the survey reveals that employers offering DB plans appear to have a leg up on their competitors, even among younger employees. In fact, the percentage of workers under age 40 who agreed their retirement program was an important factor in accepting their job has more than doubled in the last few years from 28% in 2009 to 63% in Among younger workers with a DB plan, nearly three-fourths (72%) cite their retirement plan as a strong incentive to remain with their employer almost double the percentage (37%) in The need to provide adequate but cost-effective benefi ts today is as urgent as it is tricky. More than half (55%) of the Retirement Attitudes Survey respondents said they are willing to pay more from each paycheck to ensure a guaranteed retirement (compared with 46% two years ago). Meanwhile, 53% said they would be willing to trade a portion of their pay in return for more generous benefi ts. Of course, providing the right level of benefi ts doesn t necessarily equate with simply asking the employee to contribute more, because the costs often greatly exceed contribution amounts. Rather, our research suggests the solution lies in optimizing the overall combination of benefi ts and compensation often referred to as total rewards. Importance of retirement plan for attraction and retention by age and plan type DB plan Age Feb June 2010 June 2011 DC only Percentage point Feb June 2010 June 2011 Percentage point My company s retirement program was an important reason I decided to work for my current employer <40 28% 43% 63% 35 pps 19% 17% 28% 9 pps 40s 38% 24% 43% 5 pps 21% 24% 22% 1 pps % 35% 40% 10 pps 27% 20% 25% 2 pps My company s retirement program is an important reason I will stay with my current employer <40 37% 63% 72% 35 pps 29% 26% 36% 7 pps 40s 61% 51% 61% 0 pps 32% 37% 33% 1 pps % 61% 68% 7 pps 37% 32% 45% 8 pps Source: 2011 Towers Watson Retirement Attitudes Survey Pensions in Transition: Retirement Plan Changes and Employer Motivations 11

14 Plan Design and Retirement Patterns From the employer perspective, one of the primary purposes of pensions is to help manage the exit of employees from the workforce in a timely and predictable manner. Concerns over increasing health care costs in retirement and decreased retirement confi dence after the recent fi nancial crisis are driving employees to work longer, regardless of retirement plan offering. Roughly 60% of all respondents report that in the past three years a portion of their workforce has worked longer than expected (17% say this is true for a signifi cant Figure 12. Have you made a formal decision to offer the DB plan to salaried new hires for the next two to three years? 2.0% n = % 5.3% 11.9% 6.6% 7.3% 48.3% 7.3% Yes moving from a traditional pension to hybrid plan 48.3% Yes formally committed to current DB plan 11.9% Yes but the future retirement plan design is undetermined 5.3% No plan to close plan 2.0% No plan to freeze plan 18.6% No but future retirement plan design is undetermined 6.6% Don t know Figure 13. What may lead you to freeze or close your active DB? 0% 20% 40% 60% 80% Reduce cost volatility Reduce cost Funded status Accounting standards 19.4 Simplify administration 11.8 Don t know Eliminate benefits employees do not appreciate 8.3 Enhance portability 6.3 Increase in interest rates leading to a decline in termination costs 5.6 Other 13.2 portion of workers, and 43% report the same for a small number of workers). Only 10% of respondents say their workers were able to retire earlier. For older workers, retirement patterns are fairly consistent even when plan types are different. This may be because this group of employees has been grandfathered into their current plan or because their pension benefi t was frozen near the end of their careers. Plan sponsors that have offered the DC benefi t for a longer period of time report more retirement delays. Over 30% of sponsors that moved to a DC plan prior to 2000 have a signifi cant number of employees working longer than expected. This compares to 17% of companies that have had a pension (open, closed or frozen) in the past decade. The Future of DB Plan Design Today, 68% of active DB sponsors are committed to offering a DB plan over the next two to three years (Figure 12). While this is 11% more than in our last survey, there are fewer active DB sponsors now. Traditional DB sponsors (80%) seem to be more committed to continuing to offer a pension than those that offer hybrid plans (60%). Among the active DB respondents committed to a DB design, 48% plan to keep their current plan design, while 7% expect to consider a conversion of their traditional plan to a hybrid. Promoting employee attraction and retention was the main motivator for 71%, while maintaining employee morale was important to 50%. It s important to note that these data suggest 25% of all sponsors (currently active DB and DC only) in the survey will still offer new hires a DB benefi t in the next few years. One-quarter of respondents that have open DB plans, meanwhile, are not fi rmly committed to their DB plan and a small percentage (7%) plan to close or freeze their plan during that period of time. The majority of these respondents have not determined what their future retirement offering will be or the path they will take to get there. Indeed, the recent economic crisis has strained DB plans and made cost a pressing issue for both active and closed DB sponsors. The reasons active sponsors cited as potential incentives to close or freeze their DB plan in the future were the same as those given by respondents that have already frozen or closed their DB plan: cost reduction or cost volatility reduction (Figure 13). n = towerswatson.com

15 Moving Away From DB Benefits: Sponsors That Froze or Closed Plans for New Hires in the Past Decade To better understand the growing shift to DC plans as the primary retirement vehicle, it s important to examine how and when companies adopted a DC design and their reasons for offering a DC only to newly hired employees over the past decade. As mentioned earlier in this report, sponsors have taken various actions over the past decade to arrive at a DC-only environment for new hires. Figure 14 depicts the last action these companies have taken toward their DB. The most prevalent action taken by plan sponsors that moved to a DC-only offering was to freeze pension accruals for all or some plan participants (65%), while an additional 33% closed their plan to new entrants but continued benefi t accruals, and 2% terminated their DB plan. Companies are shifting away from DB plans for many reasons, including sector competition, cost reduction and an intent to improve employee appreciation. However, 45% of plan sponsors that froze, closed or terminated their plans said their primary rationale was to reduce cost (Figures 15a and 15b). Employers are replacing their DB plans with DC plans at only a portion of the cost with only part of the benefi t of a typical DB plan. And these cost-reduction steps are clearly visible in the contribution amounts being provided to new employees. Figure 14. Last actions taken for companies that moved from DB to DC only 2.4% 2.4% Froze 64.5% Closed 33.1% Terminated 33.1% n = % Figure 15a. Primary reasons for the move from DB to DC since 2000* 0.8% 0.8% 4.9% 2.9% 0.4% 1.6% n = % 0.4% 3.3% 44.9% Reduce cost 44.9% 39.9% Reduce cost volatility 1.6% Reaction to 2008 recession 0.4% Funding provisions in the PPA 2.9% Facilitate integration of merged or acquired entities 4.9% Offer benefits similar to peers 0.8% Simplify administration 0.8% Enhance attraction of employees 0.4% Enhance benefit portability 3.3% Other Figure 15b. Top three reasons for moving from DB to DC since 2000* 0% 10% 20% 30% 40% 50% 60% 70% 80% Reduce cost Reduce cost volatility Changes in accounting standards 4.5 Reaction to 2008 recession Funding provisions in the PPA Facilitate integration of merged or acquired entities Offer benefits similar to peers Simplify administration Enhance attraction of employees Enhance retention of employees Enhance benefit portability Encourage certain retirement patterns Other.4/4.9/ /3.3/ /4.1/3.7 0/1.6/1.6.8/6.6/7.4.4/3.3/ First reason Second reason Third reason n = 243 *There were 27 respondents that moved to a DC-only environment before Results for these companies are included in overall trends, but excluded from the analysis of companies that have moved to DC since Pensions in Transition: Retirement Plan Changes and Employer Motivations 13

16 Figure 16. Motivations behind closing instead of freezing DB plans 1.3% n = % 19.2% 6.9% 5.5% 52.1% After cost reduction, cost volatility reduction spurred freezes and closures for 40% of plan sponsors. Only 5% of respondents were motivated to close or freeze their pension primarily to offer benefi ts similar to those of their peers a prevalent secondary motivator for other sponsors. But these actions have done little to reduce volatility because plan management practice changes, which reduce cost volatility, have been much slower. For example, the average target allocation to fi xed income among large U.S. sponsors was 34% in 2009, but had only increased to 40% by the beginning of So while sponsors indicate a desire to reduce cost volatility, they have made little headway in achieving this goal. 52.1% Beneficial for retention of valuable current employees 5.5% Valuable for workforce management, helping employees retire in a timely manner 19.2% Plan supports paternalistic philosophy of company 1.3% More efficient investment strategies can be employed 15.1% Other (employee relations, consistent with union plan, etc.) 6.9% Don t know Figure 17. Actions planned in the next two to three years for closed DB plans 16.7% 2.6% 1.3% 1.3% n = % 9.0% 55.1% 55.1% No action planned 9.0% Freeze benefits for all or some participants 1.3% Terminate plan 1.3% Reopen plan 2.6% Reduce benefits for those still accruing benefits 16.7% Other 14.1% Don t know Figure 18. Types of pension freezes: Full freeze versus partial freeze 0% 20% 40% 60% 80% Closing Versus Freezing the DB Plan An employer can take various paths to establishing a DC-only environment for new workers. One-third of respondents decided to close their plans to newly hired employees instead of freezing them. Figure 16 depicts the motivations of sponsors that closed their plans to new hires but allowed benefi t accruals to continue for participants hired before the close date. Retention of key staff is a primary reason that open DB sponsors maintain their approach but it s also why many sponsors close plans to new hires while maintaining benefi t accruals. Over half (52%) of respondents said that keeping accruals active for participants who were in the plan prior to the close date was benefi cial for retention. Nineteen percent of respondents, meanwhile, reported that continuing accruals for some or all participants aligns with the paternalistic philosophy of the company. The majority of respondents (55%) have no actions planned in the next two to three years. Only 9% of respondents indicated that they would freeze accruals for some or all participants who were in the plan prior to the close date (Figure 17). Most plan sponsors that have moved to a DConly environment since 2000 have frozen pension accruals for some or all plan participants. Threequarters of companies that froze their DB plan also froze accruals for all participants (Figure 18). Retention of key staff is a primary reason that open DB sponsors maintain their approach but it s also why many sponsors close plans to new hires while maintaining benefit accruals. Full freeze Froze benefits for certain pension-eligible employees, but preserved others n = towerswatson.com

17 The remaining quarter of companies froze their DB benefi ts for certain participants but preserved accruals for others (Figure 19). The most prevalent criteria for grandfathering workers into the pension were age, service or a combination of both, with 44% of respondents grandfathering participants when implementing a partial freeze. Another 38% of sponsors that partially froze their plans offered a choice to current participants, which in most cases was to stay with their DB plan (in some cases, a reduced DB plan) or move to an enhanced DC plan with a frozen pension benefi t. Of the 245 respondents that have moved to a DC-only environment for new hires since 2000, approximately half still have active participants accruing DB benefi ts. Indeed, while we noted that only 36% of respondents offer their new hires a DB plan today, 66% of all respondents still have some portion of their workforce actively accruing benefi ts. While most plan sponsors that moved to a DC-only plan have a frozen plan for some or all participants, freezing their pension was not necessarily their fi rst DB plan design change. Thirty-two percent of those with frozen pensions closed their plan to new hires at an earlier date and the average time between the closing and freezing of the DB plan was 34.3 months (about three years) (Figure 20). A signifi cant number of employers have frozen DB plans, so managing frozen liabilities is becoming a key business issue for many organizations. Most respondents (58%) with frozen plans expect to signifi cantly reduce plan obligations in the next two to three years by offering lump sum cash-outs or by starting a plan termination (Figure 21). Figure 19. Criteria for grandfathering (partial freezes) 0% 10% 20% 30% 40% Choice Points* Workforce** Age only Service only Other n = *Points are defined as the combination of age and service. **Workforce is defined as certain segments of the business Figure 20. Length of time between DB close and DB freeze Length of time between close and freeze Average 34.3 months 90th percentile 60 months 75th percentile 48 months 50th percentile 27.5 months 25th percentile 12 months 10th percentile 6 months n = Figure 21. Actions planned in next two to three years for frozen DB plans 0% 10% 20% 30% 40% Significant reduction of plan liability (e.g., offering lump sum cash-outs) Nothing Receiving quotes for group annuity contracts from insurance companies for termination 18.6 Reopen plan 0 Other 4.1 Don't know n = Pensions in Transition: Retirement Plan Changes and Employer Motivations 15

18 Figure 22. Conditions that could lead to the reopening of closed and frozen DB plans 0% 20% 40% 60% 80% Government subsidies Decrease in PBGC premiums Less volatile funding policies Accounting reform Limitation on tax-deductible 401(k) contributions Tax-deductible employee contributions Lowering excise tax on reversions of excess pension assets Significant drop in rates of retirement among older workers Increased demand from workers Trends among competing employers Nothing Our decision is final Don t know Approximately 25% of respondents would consider reopening their DB plan if it became essential to attracting new talent. However, most sponsors of closed and frozen plans that have stopped offering a DB benefi t to new hires have no intention of reopening their plan; this is particularly true for those with frozen plans (Figure 22). Now that employers offer DC plans to nearly all newly hired employees, organizations are taking steps to help workers save and invest better. Closed DB Froze DB All companies n = towerswatson.com

19 Helping Employees Save: Employer DC Plan Contributions Now that employers offer DC plans to nearly all newly hired employees, organizations are taking steps to help workers save and invest better. Ninetyeight percent of plan sponsors that offer a DC plan provide an employer contribution to their employees, usually through matching or non-matching contributions. While most companies still provide just a matching contribution (52%), a very large minority (42%) now offer both matching and non-matching contributions (Figure 23). Indeed, with the closing or freezing of DB plans, more and more companies are replacing (at least partially) the lost DB benefi t with a nonmatching contribution, whereas our prior survey showed 33% of respondents offering both. A non-matching contribution is similar to a pay credit contribution in a cash balance plan because employees will receive it regardless of whether they defer their own salary into the plan so adding one is one example of sponsors implementing DB-like features in DC plans. Matching Contributions Nearly all plan sponsors surveyed offer at least a matching contribution. For the companies that offer a match, the average is 4.04%, and the average maximum amount the employee must defer to receive the full match is 5.37% of pay.* Seventy-six percent of respondents that offer a match use a single-tier match formula. The most prevalent single-tier match formula is dollar-for-dollar, up to 6% of pay. The second most prevalent formula is 50 cents on the dollar, up to 6% of pay. Twentyfour percent offer a multitier match, with the most predominant being dollar-for-dollar, up to 3% of pay, and 50 cents on the dollar for the next 2% of pay. Non-Matching Contributions Forty-six percent of companies provided their employees with a non-matching contribution averaging 4.3% of pay, while the average nonmatching contribution provided by all companies in this survey is 1.99% of pay. Figure 23. Defined contribution plans for new hires today 2.1% 51.7% Matching contribution only (401(k) or 403(b)) 4.5% Non-matching contribution only 41.7% Both matching and non-matching contribution 41.7% 2.1% No employer contribution 51.7% 4.5% n = 422 *Matching contribution amounts are measured as the maximum amount of the match promised by the employer. Pensions in Transition: Retirement Plan Changes and Employer Motivations 17

20 While the majority of respondents have adopted automatic enrollment, about half of these sponsors have also implemented automatic escalation. DC Contributions at Companies With and Without DB Plans for New Hires The sole plan type offered to new hires by most companies in our survey is a DC plan, which does not provide as much income replacement as DB plans even with non-matching contributions. Seventy-seven percent of companies that offer both DB and DC plans to new hires make matching contributions to the DC plan only (Figure 24). However, employers that provide only DC plans to new hires are more likely to offer both matching and non-matching contributions (58% versus 13%) to supplement the lack of a DB plan. On average, companies that offer only a DC plan contribute a maximum of 6.5% of pay, while companies that offer both a DB and DC plan contribute 4.4% of pay to the DC plan. This twopercentage-point difference mostly due to the addition of the non-matching employer contributions is not surprising given the fact that DB plans provided by employers are almost always worth far more than the additional 2% DC plan contribution.* Starting the Savings Early: Automatic Enrollment Given the dominant role DC plans are playing in the fi nancial security of American workers, coupled with the apparent widespread lack of retirement readiness, participation in these plans continues to become more important. Automatic enrollment is essential to push employees to participate and save and 59% of plan sponsors that offer a DC plan to new hires (with or without DB) use this tactic. Twenty-fi ve percent of sponsors that have not yet adopted this feature (an additional 10% of all DC sponsors) said they plan to add it in the next two to three years. While the majority of respondents have adopted automatic enrollment, about half of these sponsors have also implemented automatic escalation, which typically increases the employee contribution annually. One in four respondents that use automatic enrollment but don t offer automatic escalation plan to adopt it in the next two to three years. Figure 24. Total employer contributions provided to DC plans today Companies with DB and DC plans versus DC only Plan type DB and DC DC only Provide matching contribution only 77% 37% Average match 3.9% 4.2% Provide non-matching contribution only 5% 4% Average non-match 6.8% 8.5% Provide both matching and non-matching contribution 13% 58% Average matching + non-matching contribution 8.3% (3.7% match + 4.6% non-match) 7.9% (4.0% match + 3.9% non-match) Do not provide contribution 5% Less than 1% Total average contribution provided by company 4.4% 6.5% *According to a recent study by Towers Watson, when companies shifted from a DB to a DC only, the employer commitment fell from 8% of pay in 2002 to 5.3% of pay in Although these companies increased their DC values by 2.7 percentage points (from 2.6% to 5.3%), this gain covered only half of the DB value lost by closing or freezing their DB plans. For further information, see Employer Commitment to Retirement Plans in the United States, towerswatson.com

21 Conclusion: What s the Plan For Today and Tomorrow? Despite a shift toward DC-only plans over the last 10 years, retirement plan strategy remains a matter of utmost concern to employers and employees alike. Employers are looking to reduce cost and cost volatility but also understand the impact that any plan changes can have on talent and workforce planning. Employees hit hard by the recent recession and slow recovery are focused on greater retirement security. And all this is playing out amid rising health care costs and a current evaluation of employers total rewards programs. Our survey fi ndings show that those companies with open DB plans are still committed to them and the benefi ts they provide to their organization and employees. Other Towers Watson survey fi ndings also show that there is room for improvement in DC plan design and management. Centrally important to these improvements is the need to spur behavioral changes with employees. Effective DC plans require that workers understand and take full advantage of them which is why organizations are moving beyond merely making these benefi ts available, and must continue to do so. Concern about the cost of retirement plans remains paramount. The challenge, therefore, is for organizations to help employees prepare for retirement and retire according to a fairly predictable schedule so that the fl ow of talent into and out of the organization can be managed effectively. The tension between cost and talent is not new and can have far-reaching effects on an employer, including its ability to attract and retain workers. In the end, an organization needs to fi nd the right retirement plan design that meets its own fi nancial and people goals. While those goals will differ from industry to industry or, more specifi cally, from employer to employer, the need to ready workers for their retirement remains strong and clear. It is that unwavering goal that compels some organizations to adopt new features and look for improvements in DC plans, and others to continue to sponsor or move to new types of DB plans. By helping to foster an environment where both DC and DB plans can thrive, employers can meet their own goals and help facilitate the secure retirement of today s U.S. workers. In the end, an organization needs to find the right retirement plan design that meets its own financial and people goals. While those goals will differ from industry to industry or, more specifically, from employer to employer, the need to ready workers for their retirement remains strong and clear. Pensions in Transition: Retirement Plan Changes and Employer Motivations 19

22 Definition of Key Terms Career average pay (CAP). A traditional defi ned benefi t plan that bases benefi ts on earnings during each year of participation. Cash balance plan. A hybrid plan that resembles a defi ned contribution plan. This career average plan expresses benefi ts in terms of hypothetical accounts that are credited with interest and cash balance credits (employer allocations) that may be ageand/or service-based. Closed plan. A defi ned benefi t plan is not offered to those hired after a certain fi xed date. Defined contribution plan. A retirement plan, such as a 401(k) or 403(b), in which the employee elects to defer some compensation into an account that he or she typically manages, including choosing investment options. In most cases, the employer contributes to the account as well. These plans generally allow employees to take their account balance with them when they leave the company, or transfer it to another employer-sponsored plan or IRA. Final average pay (FAP). A traditional defi ned benefi t plan that bases benefi ts on earnings averaged over the last three years or fi ve years of employment. Frozen plan. A defi ned benefi t plan in which either service, pay or all benefi t accruals have ceased for all or some of the plan participants. Hybrid pension plan. A type of retirement plan that guarantees the amount of an employee s benefi t, like a traditional DB plan, but describes the benefi t as a lump sum account balance. These plans generally allow employees to take their account balance with them when they leave the company, or transfer it to another employer-sponsored plan or individual retirement account (IRA). Matching contribution. Employer contributions to a defi ned contribution plan contingent upon an amount the employee contributes to the plan. Non-matching contribution. Employer contributions to a defi ned contribution plan regardless of whether the employee contributes to the plan. Pension equity plan (PEP). A hybrid pension plan with defi ned contribution characteristics. For each year worked, employees are credited with a percentage (credit may vary by age and/or service). The fi nal average pay plan expresses benefi ts equal to the fi nal average earnings multiplied by the sum of percentages earned during a career. Terminated plan. A frozen defi ned benefi t plan in which all benefi ts have been settled through the transfer of assets and liabilities to a third party (typically an insurance company), through payment of all benefi t obligations directly to participants, or both. Traditional defined benefit plan. A type of retirement plan that provides a guaranteed benefi t amount at retirement, typically in the form of an annuity. The amount of the benefi t is based on a formula, which is typically related to pay and years of service. 20 towerswatson.com

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24 About Towers Watson Towers Watson is a leading global professional services company that helps organizations improve performance through effective people, risk and financial management. With 14,000 associates around the world, we offer solutions in the areas of employee benefits, talent management, rewards, and risk and capital management. Copyright 2012 Towers Watson. All rights reserved. TW-NA towerswatson.com