IBM sent shockwaves through the retirement industry recently when it was revealed that the tech and computing giant is halting its 5% 401(k) match in favor of a 5% contribution to a new, portable, immediate-vesting pension called a “Retirement Benefit Account.”
Joining us to discuss this move and its wider implications within the retirement industry is someone who knows the defined benefit market very well in Brian McDonnell, Head of the Global Pension Practice at Cambridge Associates. There he oversees the firm’s work with more than 150 plan sponsors, and also works directly with clients as their OCIO.
He’ll explain why the move happened, whether (and why) other plan sponsors might be considering it, and key trends he sees impacting the defined benefit space in the coming year.
Click to read the audio transcript here.
SEE ALSO:
- IBM Replacing 401(k) Match with 5% ‘Retirement Benefit Account’ Contribution
- IBM 401(k) Replacement Elicits Questions from Retirement Leaders
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Transcript
Brian Anderson: [00:00:00] This is 401k specialist editor in chief Brian Anderson and this is the 401k specialist podcast. Tech and computing giant IBM sent shockwaves through the retirement industry recently when it was revealed that the company is halting its 5 percent 401k matching contribution in favor of a 5 percent contribution to a new portable immediate vesting pension called a retirement benefit account.
IBM is guaranteeing a 6 percent return for these new retirement benefit accounts for the first two years. After that, it reverts to 3 percent and then the 10 year treasury yield. Immediately, people started wondering if this will signal a big corporate swing of the pendulum away from defined contribution plans back toward pension plans.
Here to discuss this today, we are happy to have Brian McDonnell, head of the Global Pension Practice at Cambridge Associates, a company with 50 years of experience in building and managing sophisticated pension portfolios. In his role, Brian oversees the firm’s work with more than 150 plan sponsors globally.
And he also works [00:01:00] directly with clients as their OCIO. Welcome to the 401k specialist podcast, Brian. Thanks for having me. All right. So first off, can you give us a little bit of a deeper background about what IBM did and why they did it? It seems like it kind of caught a lot of people by surprise.
Brian McDonnell: Yeah, I think that’s definitely right. You know, first of all, to be clear, I don’t have any inside info. I just what I’ve read. But I think the history ultimately of the IBM pension plan is not all that dissimilar from other blue chip companies in America. They started cutting back on how generous the benefit was in the 1990s.
Then closed the plan to new participants when the Pension Protection Act was passed in 2006 and completely froze the plan a few years later. From there, a defined contribution plan became the primary retirement benefit that was offered. Now what they’ve announced going forward is they’re no longer going to be making those employer contributions to the 401k plan.
And it’s more of a restart, but not really a restart of what was before. [00:02:00] Presumably the old traditional final average pay plan. It’s going to be, I think a cash balance plan or what’s sometimes referred to as a hybrid plan. The reason sometimes people in the industry call these cash balance plans, hybrid plans is because they sort of retain some elements of a defined contribution plan in that each participant has a individual account balance.
And as you mentioned, it is a little bit more portable. But also they have some of the features of a defined benefit plan in the sense that all the assets are aggregated together. So it can benefit from scale can benefit from investment strategies that might not be available in a traditional 401k.
It’s employer directed in terms of picking those investment strategies, and there’s also some degree of predictability or, floor on return as opposed to a traditional 401k, which just sees the market returns either to the good or the bad.
Brian Anderson: Okay. Well, in light of what IBM has [00:03:00] done do you think other large plan sponsors with frozen defined benefit plans are now considering this strategy? Or was IBM in more of a unique position to be able to do this?
Brian McDonnell: So they’re definitely not unique. They do appear to have a better funded status than the average plan in America right now amongst corporate DBs. But I think almost all plan sponsors have really seen material improvements in their, uh, in their funded status over the past few years.
I think to some degree, having an existing frozen plan that they could reactivate essentially might be a little bit of an administrative advantage, but I don’t think that needs to be a hurdle. I do think a lot of companies are starting to have these conversations about what the next step of retirement readiness for their employees is.
So probably the most important and biggest factor in my mind that makes this something that just about everyone can consider. It has less to do with the idiosyncratic circumstances of any specific company. But I just think [00:04:00] more broadly, as I reflect on what we can do with the fine benefit plans, uh, the tools we have as an investment advisory industry are just very different today than the tools that were available To plan sponsors back when most of them made the decision to either soft freeze or hard freeze their plans in that 05 to, or sorry, 06 to 010 to 2010 range plan sponsors are just able to deploy much more sophisticated liability hedging strategies right now.
So if that lets them dial in the amount of funded status risk that they’re taking, while also preserving assets that can be invested in growth to offset contributions. And in those growth assets, there’s other less correlated assets, particularly in private markets that we can use to provide good returns with less mark to market volatility.
Along the way than the traditional stocks and bonds that we used to see in defined benefit plans.
Brian Anderson: Okay, so you’ve touched on a [00:05:00] couple of these already, I think, but, um, what would you say are some of the other main types of driving factors or characteristics that might cause 401k plan sponsors to consider a switch back towards pension plans?
Brian McDonnell: Yeah, you know, I think there’s a number of factors that are at play first. The labor market remains tight, right? And wage pressure continues. So I think it’s completely natural that companies might be looking at their total rewards package to see if there are better benefits that they can provide.
And I think at the end of the day, as they step back, I also think looking at their experience, plan sponsors aren’t necessarily finding that their 401ks is. cost them less over sort of any reasonable time period than that defined benefit plan might’ve cost them. It was a more predictable cost. The CFO could wake up on January 1st and have a pretty good sense for what their 401k would cost them.
But there is a reason that DB plans were once a default. It’s actually a very efficient way [00:06:00] to provide a good retirement benefit for your employees. There’s that time arbitrage element for companies. It allows them to take advantage of a long time horizon to fund a return benefit and also access other asset classes besides stocks and bonds.
So I think that’s a big part of it. To be frank, stocks and bonds are still the predominant exposures in 401k plans today. So as you look around, we’re really coming off 2022, which is one of the worst years for a simple stock bond portfolio in a generation. And up until about a month ago, the Barclays Ag, you know, one of the widest measures of fixed income performance was on track for its third calendar year in a row of negative returns of 2023.
That would have been the first time that had ever happened. I think that’s called a lot of people to really think about the question of whether fixed income as a traditional tool that 401k investors would use to de risk their portfolios as they near retirement, um, [00:07:00] is still working as they would have expected.
So there’s definitely interest in a retirement plan that can invest in other investment strategies. The last thing I might say is, to some degree, the first generation of workers who relied solely on a 401k are nearing retirement. So how do they do accumulate right?
There’s been a lot of discussion about annuities and 401k plans and some movement, but it’s far from the industry standard now. So, even for folks who have built a sufficient retirement balance in a 401k, there’s no. Turnkey transition to take that, um, balance into that monthly guaranteed check and retirement, as you might’ve seen with a defined benefit plan.
Brian Anderson: Right.
Okay. Good point. Can you tell us a little bit about the impact of a high interest rate environment on the overfunded plans and how this kind of plays into it?
Brian McDonnell: Yeah. So, you know, clearly the main driver that has put this even back on the table is higher funded status that most plans have now, so while asset returns have certainly helped, the quick [00:08:00] multistandard deviation move in discount rates for corporate plan sponsors has been the biggest driver of the funded status gains that have pushed people over 100 percent funded from much lower levels. Not all that long ago. I think absent that higher fixed income level. Most corporate defined benefit plan sponsors would still have to really stay narrowly focused on how do they shrink their large funded status gap without writing big checks off their balance sheet, that would have remained their primary objective.
I do think, at least for the time being, higher interest rates give plan sponsors more flexibility in what investment strategies they can use to provide a Somewhat stable mid single digit return on assets in a way that frankly, fixed income hasn’t played a role in a mid single digit return on asset portfolio in a long time.
That’s, of course, nominal returns. So I do think we also have to be careful that in an inflationary world we think also whether that [00:09:00] sort of investment return is sufficient to provide a meaningful. Inflation adjusted retirement benefit to someone in the current environment.
Brian Anderson: All right. And, beyond this IBM development, what other kinds of trends are you currently seeing in the defined benefits space as we’re heading into 2024?
Brian McDonnell: You know, I think, a lot of plans are official, working on officially increasing their liability hedging to take advantage of higher rates, lock in those funded status gains. I also think that there’s continued plan Review of options outside of simple stocks and bonds. What are other uncorrelated asset classes in a world where the S and P is close to a high again?
, I think people are willing to take on some illiquidity, particularly as they think about maybe a more barbelled approach. If they’re also increasing their fixed income holdings, they might be taking another look at what is their ability to take on which. Illiquidity and access some of these other investment classes that provide still a [00:10:00] premium return, but an uncorrelated return outside of traditional stocks and bonds.
Brian Anderson: All right. Well any final thoughts on how the IBM move in particular might impact the retirement industry at large for the foreseeable future? Seems like pensions have been getting a lot of attention this year with the United Auto Workers seeking a return to defined benefit plans in their recent contract negotiations, which of course the automakers didn’t go for.
Brian McDonnell: Yeah, sure. And I think the increased attention is frankly welcome, right? We’re all. We’re all out here trying to find ways to increase quality of life for employees in retirement and increase the stability for them. I think a really important part of that is making sure these retirement plans are affordable for plan sponsors and also predictable enough in terms of the volatility of their costs.
They’ve got to be affordable, and they’ve got to be to some degree predictable in order for them to be sustainable and for plan sponsors to stand behind them and continue to offer them, [00:11:00] because that’s the only way we can we can really offer that attractive benefit collectively for employees when they retire I think the plans that we work with, whether they are 401k or traditional pensions are finding that there really are lots of asset classes and investment strategies out there that can balance these Dual goals of affordability through premium investment returns and also predictable volatility in a way that I don’t think has always been true.
Right? It’s, you know you do have to real take on some complexity, though. And, it’s just not as turnkey or simple to implement as it might have been back in the day when the IBM plan started, for example, many decades ago. But that’s not a reason to pursue it in my view.
Brian Anderson: This has been a really enlightening. I’ve learned a lot, Brian McDonald, head of global pension practice at Cambridge associates. Thanks for joining us today and sharing your insights on the 401k specialist podcast.
Brian McDonnell: All right. Thanks for having me.
[00:12:00]
Veteran financial services industry journalist Brian Anderson joined 401(k) Specialist as Managing Editor in January 2019. He has led editorial content for a variety of well-known properties including Insurance Forums, Life Insurance Selling, National Underwriter Life & Health, and Senior Market Advisor. He has always maintained a focus on providing readers with timely, useful information intended to help them build their business.
