The Defined Benefit system is becoming a Cash Balance system

 

The defined benefit (DB) world is changing, and in ways you may not be aware of. Before your mind jumps to freezing DB plans, the latest risk transfer craze, or even the gradual shift to defined contribution (DC), consider this: Cash Balance plans have increased six-fold since the year 2000, while the number of DC plans has decreased by nearly 10%¹. Steadily over time, Cash Balance plans have taken over a sizeable chunk of the DB market and notched their own place in the U.S. retirement system.

In fact, around 20% of DB plans now call themselves Cash Balance. That’s huge, especially when you hear they made up just 3% of DB plans in 2000¹. While many of these plans used to be traditional, final-average-pay plans, most of the new benefits are based on Cash Balance formulas.

These “hybrid” plans (having a mix of DB and DC features) are not really new. They’ve been around for 30 years, and some very well known firms have adopted them. But why all the interest? The list of potential advantages to Cash Balance plans is long, from benefit portability to tax efficiencies (particularly for smaller employers). But there are some downsides as well, like plan underfunding (unlike a DC plan) and most risks still borne by the employer.

This trend is likely to continue, as data from public filings shows no sign of let-up for Cash Balance plans. Plus, there are other types of hybrid plans (e.g., Pension Equity plans) that have made a dent in the DB world. So it’s likely Cash Balance plans and their cousins will continue to grow, at least for now.

These plans work differently than traditional DB. You may ask how sponsors would approach de-risking as the plans mature, and whether LDI principles apply. These are great questions that require more than a simple answer, which is why Russell just published a paper on the topic to cover the basics and beyond. We’ve found these plans have more to them than immediately meets the eye, but we ought to get used to seeing them since the Defined Benefit system is looking more and more like a Cash Balance system.

Note: One of the nice things about working at Russell is the sabbatical program—a chance to take a prolonged break after each ten years of service. As a result, Bob Collie shall be away from the office until late July. The Fiduciary Matters hot seat will be filled by guest authors over that period.   


¹Based on Form 5500 filings published by the Department of Labor
USI-19871-12-17

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