The real reason that CFOs like Defined Contribution better than Defined Benefit

 

It’s reporting season for most big corporations, and we’ll be issuing the latest update on the $20 billion club¹ just as soon the final 10-K reports are available. Meanwhile, as I plough through all the reporting to pull the numbers together, it’s been a stark reminder of the sponsor’s perspective on the difference between defined benefit (DB) and defined contribution (DC).

The analysis and discussion of the DB plan financials included in the corporate accounts of these large plan sponsors typically runs to 10 or more pages. There is a breakdown of the expense associated with the plan, as well as analysis of the sources of gain and loss in the assets and liabilities and a description of the investments held in the plan. All of this is necessary because all of this is relevant to investors: the corporation is responsible for the balance of cost of the plan so the ups and downs of plan experience flow through to the economics of the corporation. Every dollar of gain or loss in the plan means a dollar less or a dollar more that the corporation is going to have to put in to ensure the benefits get paid. All of the complications and uncertainty of the DB plan finances flow through into the plan sponsor’s financials.

The DC plan, meanwhile, gets about two lines. Basically, the analysis says: “We contributed $X”. That’s it. That’s all that investors need to know, because in essence that’s the full extent of the impact of the DC plan on the corporation’s financials. One number: end of story.

And that’s not because the DC plans are not big at those corporations. Even though the $20 billion club is the group of corporations that have the largest DB plans, they are also, on the whole, the corporations with the largest DC plans: according to a recent P&I survey², eight of the ten largest U.S. private sector DC plan sponsors are companies that are in our $20 billion club.

And that, in a nutshell, is the real reason DC has taken over from DB as the primary vehicle for retirement provision among U.S. corporations. Instead of an impact which takes ten pages to describe, the corporation pays its share of the cost and is done. Of course, the responsibility of the plan sponsor does not quite stop there—and I’ve written in the past of the dangers of taking a “good enough” approach to DC plans—but there’s no question that the way a DC plan feeds into the corporate financials is much much simpler than a DB plan.

In practice, DC provision is cheaper for sponsors, too. It is notable that of the $24 billion of contributions made to the primary U.S. DC plans of the $20 billion club in 2012³, roughly 70% were employee contributions, not employer contributions. But the decision about how high to set the benefit is separate from the decision to go with DB or DC: it does not follow automatically from the nature of DC versus DB, being more a reflection of market norms and the choices made by sponsors as they switch from one to the other. It’s the simplicity of DC that has led to its taking over.


¹The $20 billion club consists of 19 U.S. publicly listed corporations that had over $20 billion of worldwide pension liabilities as of the end of financial year 2011.
²Accessible to paid subscribers of Pensions & Investments
³This is based on form 5500 data. These reports are available much later than 10-K reports, hence 2012 represents the most recently available data.
USI-18946-12-17

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