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The P&I 1000: Defined contribution

Assets rise 10% on 3 booming quarters of gains in equities

Winfield Evens said increased DC contributions from companies abandoning their defined benefit plans also play a role in the growth of assets.

Increasing contributions, automatic features drive a portion of the increase

Defined contribution plans continue to grow faster than defined benefit plans in both the corporate and public sectors, according to Pensions & Investments' annual survey of the largest U.S. retirement funds.

DC assets in the top 1,000 plans surged to $4.1 trillion as of Sept. 30, 2018, up 10% year-over-year. DB assets, in contrast, grew a more modest 4.4% to $6.91 trillion.

Among the 200 largest retirement plans, the growth disparity between the two types of plans was even greater. DC plans among the top 200 swelled 10.7% to $2.47 trillion while the DB plans in the top 200 grew 4.4% to $5.46 trillion.

Industry observers attribute the faster growth rate of DC plans in large part to the strong stock market through the end of September. Defined contribution plans are heavily invested in equities, unlike defined benefit plans, particularly corporate plans, which tend to favor fixed income, they said.

"Your DC participant on average is invested more heavily in equity than a DB plan, so whatever the difference in those returns, that's going to be one of the differences in the overall growth of the pie," said James Veneruso, a senior vice president and defined contribution consultant in Callan LLC's fund sponsor consulting group in Summit, N.J.

The Russell 3000 index, for example, posted a one-year return of 17.6% through Sept. 30, while the Bloomberg Barclays U.S. Aggregate Bond index fell 1.2% during that period.

The different allocation preferences are reflected in P&I data, which show the top 1,000 defined contribution plans allocated 43.1% of assets to domestic stock, 21.6% to target-date funds, 6.7% stable value, 6.4% international stock, 4.9% fixed income, 12.8% cash and the rest to inflation protection, annuities and other. Defined benefit plans, in contrast, invested 24.8% in domestic stock, 16.4% in international stock, 6.1% in global equity and 26.2% in fixed income. Among the top 200 DB and DC plans, asset mixes were virtually the same as those of the top 1,000 plans.

Overall, defined contribution plans tended to invest heavily in passive indexed equity with the top 200 plans holding $539 billion in the asset class as of Sept. 30, up 14.5% year-over-year, according to P&I data. There was also a significant uptick in target-date funds, which grew 5.4% in the year to $270.8 billion. Custom target-date funds posted especially vigorous growth, climbing 8.8% to $201.4 billion.

Plan inflows

The other important driver of DC asset growth are contributions and other plan inflows, according to industry analysts.

The streamlining of investment options in DC plans, along with the rising use of auto enrollment and auto escalation, have had a positive impact on inflows, said Jason Shapiro, director of investments at Willis Towers Watson PLC in New York. Eligible employees who otherwise might not have participated in company DC plans because they were overwhelmed by the number of investment options now are more likely to participate and "stick around" in the plans, he added.

Many employers have either frozen or closed their defined benefit plans, moves that have reduced DB inflows and supported DC asset growth.

"Corporate clients have been freezing DB plans, so you wouldn't see as much in terms of new flows into those plans as a driver of growth," said Mr. Veneruso.

While the growth of DC plans outpaced traditional pension plans in both the corporate and public sectors, the growth differential was especially pronounced among corporate plans. Among DC plans in P&I's top 200 universe, corporate sponsors recorded $1.52 trillion in assets as of Sept. 30, up 11% year-over-year, according to P&I data. In contrast, corporate DB plans among the top 200 saw assets drop 2.9% to $1.21 trillion.

Today, 33% of employers have frozen their DB plans, up from 19% five years ago, according to a report from Alight Solutions.

When companies limit or freeze their DB plans, "they tend to increase their funding of the DC company match," said Winfield Evens, vice president in Alight's wealth practice in Charlotte, N.C.

"They'll take some portion of the money they were spending to fund the DB plan and redirect that toward the company match, so as a result, more dollars are flowing from the plan sponsor into the DC plan," he said.

DC plans are posting stronger growth than traditional pension plans even in the public sector, where few DB plans ever shut down, according to Bill Ryan, a partner and head of QDIA manager research and customs solutions at Aon in Chicago. "It's very rare for a public DB plan to close at all relative to corporate."

Among defined benefit plans in the top 200, government plans had $3.78 trillion in assets as of Sept. 30, up 5.2% year-over-year. In contrast, government DC plans among the top 200 saw assets climb a more robust 9.3% to $263.2 billion. Public DC assets have grown at a faster pace than public DB each of the past 20 years outside of 2012.

Choices affect inflows

Even though public plans are rarely terminated, some new hires ate given an opportunity to enroll in either a DB plan or a DC plan, a choice that can curb DB inflows.

"Instead of 100% of new hires going into the DB plan, it may be 90%, 80%, or something lower. That choice of retirement benefits by the participant can account for new or increased monies being contributed to a DC plan year-over-year," Mr. Ryan said.

Most public DB plans also contend with negative cash flows, meaning they're paying out more each year in benefits than they're collecting in contributions, said Keith Brainard, research director at the National Association of State Retirement Administrators in Georgetown, Texas.

The negative cash flow averages about 2.5% of the asset base. "If the public pension plans have no investment returns, they're going to lose about 2.5% of their asset base," he said.

Paradoxically, employer and employee contributions into DC plans fell 2.5% to $54.9 billion from $56.3 billion the year before, according to P&I data. Employer contributions dropped 4%, while employee contributions fell 1.8%.

Observers were mystified, saying the data might reflect timing issues. (The data only reflect plan sponsors that filled in that question on P&I's survey.)

"It could be that sponsors are changing their plan designs to encourage higher savings and that's taking some time to filter in," Mr. Shapiro said.

He and others also posited that changing employer match structures might be causing employees to contribute less. Some employers, for example, are "stretching out the match," or raising the bar for employees to snatch the full company contribution, according to Mr. Shapiro. Instead of offering employees a 100% match for the first 3% employees contribute, for instance, employers might offer a 50% match for the first 6% contributed.

"In aggregate terms, employees can still get the same match number but they would have to save more to get it," said Callan's Mr. Veneruso.

Participants might not want to reach for the higher bar and as a result, contributions may have fallen, observers surmised.