Outlook 2005: Retirement plans

The defined benefit pension world got another blow when International Business Machines Corp., White Plains, N.Y., announced in December that it was closing its cash balance plan to employees joining the company after Jan. 1 and would only offer new employees a 401(k) plan.

Will more companies follow IBM's lead this year?

"IBM made a business decision given the regulatory uncertainty," said Stephen Mirante, a consultant with Watson Wyatt Worldwide, New York.

"It (IBM's decision) is indicative of the frustration of many sponsors of defined benefit plans" — frustration by what sponsors view as over-regulation of defined benefit plans in general and frustration by cash balance plan sponsors over the lack of guidance from the federal government.

"If we don't get clarity on the rules (for cash balance plans in 2005) we'll see more plan sponsors moving in that direction," he added.

"Sometimes we lose touch with the fact that the system is voluntary."

Because of the "cash balance limbo" referred to by Howard Fine, a consultant with Mellon's Human Resources and Investor Solutions, New York, the formation of these hybrid plans has been on hold until lawmakers and regulators resolve the issues.

"You won't see any more (cash balance) plans until you get a resolution to the problems," said Mr. Fine, adding that there may be some resolution of the cash balance debate in 2005.

"The debate (over them) is coming to the foreground," Mr. Fine said.

"For some time now, companies have been moving away from defined benefit plans and toward 401(k) plans or cash balance plans as the work force becomes more mobile," said W. Allen Reed, chief executive officer of General Motors Asset Management, New York, which manages $89 billion.

"Only time will tell how effective these alternative plans will be in providing long-term retirement security.

"Cash balance plans offer an alternative to companies looking to continue to provide retirement benefits while still remaining competitive and addressing the needs of a more mobile work force," said Mr. Reed.

"Given the less favorable accounting treatment and more stringent funding requirements for defined benefit plans, it is likely that we will see more companies offering these alternatives in the coming years."

The Financial Accounting Standard Board's impending rule change on mark-to-market accounting — which would force companies to carry their defined benefit plans' stock and bond investments at their daily market value on their balance sheets — concerns William F. Quinn, chief executive officer of AMR Investment Services Inc., Fort Worth, Texas. AMR Investment oversees the $7 billion American Airlines Inc. defined benefit plan.

"It would be a big negative with the volatility of earnings that it would cause," he said. "It would make (companies) rethink if they should have defined benefit plans."

But the picture for defined benefit plans isn't all bleak. Some big plan sponsors think that the underfunding that has plagued many large defined benefit plans will improve in 2005.

"The recent funding crisis for many plan sponsors was triggered by poor asset returns and historically low interest rates," said GM's Mr. Reed.

"If asset returns continue to perform in line with historical norms, and interest rates return to more normal levels, the funding pressures should ease."

John Myers, president and chief executive officer of GE Asset Management, Stamford, Conn., which manages $66 billion in pension assets for General Electric Co., Stamford, also thinks funding pressures will ease in 2005.

"Defined benefit plans should be able to meet their expected returns as long as they're reasonable," he said.

Mr. Myers said that the median assumed rate of return for large defined benefit plans was 8%BD;%, which he thinks is reasonable. Equity returns on a global basis will be better than 8%BD;% over the long term, he said.

Not that defined contribution plans don't have their own problems. Plan sponsors will closely scrutinize the fees they and their participants pay in 2005. Helping plan participants pick the investments that will best serve their retirement needs will have many plan sponsors trying a variety of methods to educate and help participants make better choices in 2005.

Lori Lucas, director of participant research at Hewitt Associates, Lincolnshire, Ill., said defined contribution plan sponsors will be looking for ways to reduce fees, sparked by the scandals that have shed a light on fees that plan sponsors and their participants are paying.

"I would be very surprised if fees didn't become more transparent in 2005," said Ron Peyton, president of Callan Associates, San Francisco.

Plan sponsors "will see that costs are allocated appropriately" in 2005, Mr. Peyton added.

Also, more large companies will choose one administrator for their defined benefit and defined contribution plans in 2005, according to Stephen Deschenes, executive vice president of Fidelity Institutional Retirement Services, Boston.

"Total retirement outsourcing with the administration of defined benefit and defined contribution plans combined will occur more in 2005" because companies are looking to consolidate the administration of the plans, said Mr. Deschenes.

Mr. Deschenes acknowledged that Fidelity offers total retirement outsourcing and wants to expand the business.

The rates of return on defined contribution plans vary along with the account holder's investment choices, and DC plan sponsors will continue their efforts to help participants make better choices and get better results in 2005.

David Wray, president of the Profit Sharing/401(k) Council of America, Chicago, thinks 2005 will be the beginning for more DC plan sponsors to provide automatic solutions to plan participants. "Professionally managed options in (401(k)) plans will be the biggest voluntary change to the system" in 2005, he said. He said offering risk-based and lifestyle funds will help plan participants better manage their accounts.

(correction appended)