Towers Watson (ticker: TW, exchange: NYSE Archipelago Exchange (.N))
News Release -
Financial Crisis Recasts Debate on Pensions Versus 401(k)sPressures mount on sponsors of both types of plans
WASHINGTON, Oct. 13 /PRNewswire-FirstCall/ -- The financial crisis starkly
highlights the relative pros and cons of defined benefit pensions and 401(k)
plans, according to experts at Watson Wyatt, a leading global consulting firm.
Broadly speaking, the predictable, mainly guaranteed income of pensions
(including so-called hybrid plans like cash balance plans) contrasts sharply
with the day-to-day fluctuation of 401(k) account values, which are wreaking
havoc on planned retirements.
"We are in uncharted territory. The 401(k) plan has been around for less
than 30 years, and we've not yet had a generation of workers retire on all or
mostly 401(k) assets," said Alan Glickstein, a senior retirement consultant at
Watson Wyatt. "What happens when market volatility makes 401(k) investment
returns and retirement income anything but predictable?"
With a 401(k) plan, employees invest assets as individuals. As they near
retirement, employees need to construct individual "glide paths" to reduce
risk in their 401(k) accounts and to provide some measure of predictable
income in retirement. Increasingly, employers are helping with this process,
as they are beginning to offer employees target-date retirement funds and, to
a far lesser degree, annuity options in their 401(k) plans.
With pensions, sponsoring companies invest assets as one large pool and
with a longer time horizon than individual employees. They can thus more
easily ride out market downturns. In addition, pension plan assets are
guaranteed by the sponsoring company and, in a second layer of security, by an
agency of the federal government for most benefits.
Individuals bear investment risk in 401(k) plans, while companies take on
the risk -- and the opportunity to provide more efficient benefits -- with
"The current environment underscores some latent employer risks with
401(k) plans," says Glickstein. "For example, they make it harder for
companies to predict who will retire and when. Employees who mostly rely on
401(k)s are also more likely to worry about their financial security,
creating an additional drain on morale and productivity during turbulent
On the pension side, employers are dealing with new funding rules that
became effective in 2008. Companies must fund their pensions based on the
value of plan assets relative to liabilities (the present value of projected
retirement payouts based on accrued benefits). Under old funding rules,
pension sponsors could smooth their asset values based on market returns over
a five-year period. Under new rules, companies can only average returns over a
two-year period, and the averaged assets cannot exceed current market value by
more than 10 percent.
The new rules are much closer to the so-called mark-to-market rules that
have been implemented in corporate accounting with respect to the balance
sheet. Assets are "marked" or valued at what the market will pay for them on a
given day, rather than smoothed over time.
"The federal bailout of the credit markets is an acknowledgment that in
extreme cases, the mark-to-market principle does not work," said Kevin Wagner,
a senior retirement consultant at Watson Wyatt. "This crisis should increase
pressure generally to revisit mark-to-market principles. Without some relief,
a sustained downturn in asset values will noticeably increase required
contributions to pension plans starting next year, when plan sponsors will
also be facing significant business pressure."
This pressure, especially with respect to accounting, will be offset to
some degree by the effects of higher corporate bond rates on pensions. As
high-quality corporate bond rates rise, which they have been doing, the
present value of future retirement payouts (or plan liabilities) goes down.
In addition to dealing with the workforce management risks mentioned
earlier, 401(k) sponsors should be stepping up the oversight and governance of
their plans, said Robyn Credico, national director of Watson Wyatt's defined
contribution practice. "We are in a very litigious environment, and the sharp
market downturn will only fuel matters."
Credico warns against hasty action: "Now is not the time to switch 401(k)
vendors or change investment choices unless absolutely necessary. The market
is too fluid."
About Watson Wyatt Worldwide
Watson Wyatt (NYSE, Nasdaq: WW) is the trusted business partner to the
world's leading organizations on people and financial issues. The firm's
global services include: managing the cost and effectiveness of employee
benefit programs; developing attraction, retention and reward strategies;
advising pension plan sponsors and other institutions on optimal investment
strategies; providing strategic and financial advice to insurance and
financial services companies; and delivering related technology, outsourcing
and data services. Watson Wyatt has 7,200 associates in 32 countries and is
located on the Web at http://www.watsonwyatt.com.
SOURCE Watson Wyatt Worldwide