The cash balance moment

We have written before on how the $20 billion club sets industry trends. To see what lies ahead for pension plans, one must only look back at what these massive plan sponsors have already done. Whether it is annuity purchases, lump sum programs, or dynamic asset allocation policies, this group tends to lead the way.

A seismic shift happening behind the scenes

A trend continuing to gain popularity in the industry, in perhaps a more covert way, is related to plan design—namely, cash balance plans. In an industry that has been dominated for years with headlines for plan freezes and buyouts (signs for a declining DB market), these “hybrid” plans are on the rise. Their ease of understanding, portability, and potential for reduced risk appeal to sponsors and participants alike. Their share of the DB market (based on number of plans) has grown from being only 3% in 2000 to around 30% in 2015¹, a mind-blowing shift. We have noted this shift before, and the momentum has not let up.

Did the $20 billion club start this trend too?

As with other major DB trends, members of the $20 billion club were leaders, rather than followers in the cash balance surge. Several in their ranks were among those earliest adopters. Bank of America (a former member of the Club) adopted one of the first cash balance designs in the mid- 1980s.

In the 1990s, several others followed with their own hybrid arrangements, including AT&T, IBM, Boeing, Honeywell, HP, and Dow Chemical.² These were not new plans—many were originally established over a half century ago—but instead many were converted from traditional, final average pay-type arrangements.

Later, more of these massive sponsors joined on to the new designs, with FedEx, United Technologies, Northrop Grumman, GM, and Verizon all using hybrid plan (usually cash balance) features in at least one of their major DB plans. These later shifts coincided with the swell in cash balance sponsorship by small businesses.³ Their interest crediting rates vary widely, from using fixed rates to some variation of Treasury rates, to even some adopting a recently popular option of using actual portfolio returns for interest credits. They all maintain hypothetical account balances with a full lump sum option (which usually has a very high take rate) found in nearly all hybrid designs.

Different from traditional DB plans

Due to their benefit structure and high lump sum take rates, Cash balance plans do not fit neatly into the mold of traditional DB plans. LDI, a popular risk management strategy among DB plans, is not a slam dunk solution for cash balance plans, but sponsors should not dismiss it altogether. New designs that use interest crediting rates tied to actual investment performance are legal and offer much to sponsors hoping to share risks with their participants. With new trends come new challenges, and for cash balance plan sponsors this means assessing the risks they are exposed to and carefully determining how to best manage them.

Please note: Content for the Fiduciary Matters blog is being provided by guest authors while Bob Collie is on sabbatical.

¹According to publicly available 5500 filings
²According to publicly available 5500 filings
³We should note that while the shift to cash balance designs began among the very large sponsors, the surge in the number of cash balance plans is driven by the very small plans. In fact, the median size of all cash balance plans is now fewer than 10 participants. These much smaller companies often adopt this design as a means to maximize their tax-deferred retirement contribution.