Despite the move from defined benefit to defined contribution plans within corporate America, DB plans still weather storms and outperform DC plans over time.
According to a Tower Watson report “DB Versus DC Investment Returns: The 2009 – 2011 Update,” DB plans outperformed DC plans in 2011 by the widest margin since the mid-1990s.
Dave Suchsland, a senior retirement consultant with Towers Watson, says this performance gap is significant for several reasons. “DB plans have better access to investment professionals, more diversification of asset classes (e.g., individual in DC plan can’t typically invest in private equity), and fees are often lower than in DC plans,” he explains. “In addition, in 2011, the declining interest rate environment helped DB plans which have more exposure to longer duration fixed income investments.”
The narrowing gap was driven primarily by one specific year – 2009, which was the height of the financial crisis. The results are consistent with the trend over the last 17 years, where 13 out of 17 years, the DB plan has outperformed, says the report.
Even though equity markets saw the worst crash in a generation in 2008-09 (making it the worst investment year for both DB and DC plans), still DB plans outperformed DC plans by 2.7 percentage points. Equity markets rebounded during 2009, and on an asset-weighted basis, median returns were 5.4 percentage points higher for DC plans than for DB plans. During 2010 and 2011, DB plans again realized higher returns than DC plans — a differential of roughly one percentage point in 2010 and of three percentage points in 2011, the report goes on to say.
Suchsland does not think the performance issue will affect allocations or movement of money from one plan to the next. However he does see the numbers as an explanation for the efficiency of the processes of each pension vehicle.
“The results reinforce, that DB plans are a more efficient way of funding a benefit,” says Suchsland. “In order to fund the same benefit in a DB plan and a DC plan, a plan sponsor would need to contribute more dollars to a DC plan to make up for the return shortfall relative to the DB plan.”
The issue, he explains, is that the efficiency factor combined with the consistent shift of employers to DC plans where the projected benefit levels have been cut will “create longer-term workforce issues as more employees will be ill prepared to retire.”
Joel Kranc is Director of Kranc Communications, focusing on business communications, content delivery and marketing strategies. He has written and worked in the retirement and institutional investment space for 17 years covering North American markets, large institutional pensions and the adviser community. firstname.lastname@example.org.
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