Goodbye Pension, Hello Opportunity: As More Employers Shift to DC Plans, Some Funds May Benefit
April 3, 2006
It used to be that after 40 years on the job, employees could count on two things: a gold watch and a good pension. But about 15 years ago, that began to change, as more and more employers abandoned pensions for defined contribution plans.
"Now it's more like maybe you get a gold-plated watch and hope you saved enough," said Jeff Feld, a principal at Alliance Pension Consultants in Northbrook, Ill.
"It's a big philosophical shift," he added.
It also may be a big market opportunity for mutual fund companies, as employers increasingly look for someone to administer new 401(k) plans.
In a recent survey of 201 chief financial officers, Baruch College of New York and Financial Executives International of Florham Park, N.J., found that 37% of companies with defined benefit or pension plans expect to either close their plans to new employees, convert them to direct contribution-style plans, cash them out or abandon them for some yet-to-be-determined alternative.
"[DC plan] providers will want to serve these companies, so there will be intense competition," said David L. Wray, president of the Profit Sharing/401(k)/Profit Council of America in Washington.
While the competition will be fierce, there will be few true contenders, analysts said. "It's not as if 500 companies will be approaching someone," Wray said. "It's a tough market out there, and a lot of 401(k) companies have exited the business. If you're not seriously in the 401(k) business now, it's very unlikely you will be able to get into it unless you have very, very deep pockets and good staying power."
Furthermore those companies that do still have pensions tend to be either very large, such as IBM, or very small, such as a local doctor or dentist's office. And "the large companies that have pensions, by and large already have defined contribution plans," Wray noted.
More likely than not, when employers with both DC and DB plans phase out the pensions, they tweak their DC plan to make it more attractive to employees by increasing their match, offering more investment options or requiring their provider to offer investment counseling for employees.
Fidelity Investments is one large company looking to court companies that are dumping DB plans in favor of DC plans by making the transition as seamless as possible.
"One thing we see happening is that people are adopting the DB model and applying it to DC plans," said Fidelity spokeswoman Jennifer Engle. Automatic enrollment and lifecycle funds are two features many recently converted DB plans are applying to their DC plans, she noted.
"For the [employer], the question becomes: Will their current provider remain their provider, or will the fact that they're now emphasizing their DC plan lead them to a process of reviewing who will provide the plan for them?" Wray said.
"Sponsors are hesitant to switch providers because of the cost and processes involved," noted Karen Remmele, an analyst with Boston-based Cerulli Associates. "Most would rather negotiate fees than switch a provider."
However, employers whose DB plan is based on annuities offered by an insurance company might want to consider switching to a mutual fund company rather than remaining with the insurer, Feld said.
Pension providers may offer a defined contribution plan with a similar cost structure to an annuity program that appears to be low cost. While up-front administrative costs appear low, these plans almost always end up costing contributors more. Furthermore, these fees are often not delineated in employees' statements, he added.
"I don't think a lot of DB money managers are suited to make the jump," Feld said.
Mutual fund companies, on the other hand, that offer 401(k) plans where costs are transparent to investors have a distinct advantage, he said.
In addition, open-architecture 401(k) plans, i.e. those that offer choices from outside investment firms along with those of the fund administrator, make a more attractive package, Wray said.
For fund companies looking to expand their retirement market reach in an otherwise mature marketplace, Wray said, that leaves small companies as a sort of last frontier.
The Federal government defines small businesses as those with fewer than 500 employees. By far, this is the largest segment of the American workforce, with about 11.6 million businesses and 40 million employees. Yet as of 2002, only 36% of small businesses with a single location offered employees any type of retirement plan, compared to 77% of companies with more than 500 employees, according to a 2005 report from the Small Business Administration of Washington.