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It’s been the biggest news in the retirement community over the last week or so: documents got out, showing changes that IBM is making to its retirement programs for its employees.
While we’ve not spoken to representatives from the company, we have our views on these changes. What did IBM do and why do we think they did it? What alternatives might they have considered? And finally, just as many companies did when IBM was among the first major employers to shift to an all defined contribution retirement program in 2008 (announced in early 2006), will many companies be following IBM’s lead again?
IBM froze participation in its defined benefit plan as of the end of 2004 and froze all benefit accruals for pre-2005 hires as of the end of 2007 – such accruals had been in the form of cash balance benefits since the end of 1999. Today, the plan is overfunded for minimum funding purposes and likely has enough assets for IBM to terminate the plan as many expected the company would. Instead, the company has moved in the other direction.
The 6% of pay maximum employer contribution (dollar for dollar match up to 6% for some employees and a 1% nondiscretionary contribution plus a dollar for dollar match up to 5% for others) is being eliminated. In its place, IBM is giving a one-time 1% pay increase and an ongoing 5% pay credit in a cash balance (a type of defined benefit plan) account. Those pay credits will accumulate interest credits at 6% for the first 3 years, the greater of the rate on 10-year Treasuries or 3% for the next 7 years, and the rate on 10-year Treasuries thereafter.
Why now? And why these changes?
A number of reports have shown that a hypothetical typical defined benefit plan has its highest funded status since roughly 2001. Based on our analysis of publicly available information, IBM’s pension plan is at or close to that point as well. While IBM might choose not to, it likely can apply that surplus to pay for some of those future cash balance accruals. Said differently, the plan has accumulated surplus assets and we think they are looking to unlock the value of that surplus.
In thinking about why IBM is making the specific changes that they are, we might consider them from the company perspective, the employee perspective, or both.
The potential cash flow savings for IBM, at least in the short run, appear clear. The element that has not received much press or online commentary is how these changes could help employees.
Not every employee has the financial wherewithal to contribute enough to a 401(k) every year to get the full matching contribution. For those employees, getting an accrual to replace the match even in years when they do not contribute fully on their own, is a clear win. It provides a core benefit that they may choose to supplement with their own savings. Who are these employees that sometimes cut back their own contributions? In the specific case of IBM, we don’t know although they report that 97% of their eligible employees participate in their 401(k) plan. In the broad workforce, however, significant data suggests that they tend to be the same groups that IBM targets with its Diversity and Inclusion initiative – “Be Equal.” The other employee winners are likely those who want their retirement program to provide them with guaranteed lifetime income. The new cash balance plan will do that on an actuarially equivalent basis. Our estimates are that defined contribution annuity solutions might cost those same employees 10-15% more.
If our suspicions are correct about why IBM is making this change, we have to wonder what other options they might have considered. While the cash balance design they are implementing is providing a mix of fixed interest crediting rates and rates tied to Treasury instruments, we also know that many employers are looking at Market-Based Cash Balance plans. Key advantages of these newer designs are that assets and liabilities tend to move in lockstep and that participants like the idea of getting a rate of return tied to an actual bucket of investments.
Another change IBM might have considered was to split the money they are allocating to be partially cash balance and partially 401(k). After all, it’s quite unusual for a company to make a switch from 100% DC to 100% DB, but that is where they have gone.
Does all of this mean a rebirth of pensions is coming? It’s difficult to tell. Certainly, IBM is a large, well-known employer. And many observers would say that it was IBM’s shift to a DC-only model was the start of a fairly large exodus away from them. If there is any organization that could make this change to start a trend back, IBM might be the one.
We think that IBM may very well have set the stage for the next step in the evolution of the private sector retirement system in the U.S. We encourage employers to take stock of what IBM did, not necessarily jumping on to that bandwagon, but evaluating whether those kinds of changes might be advantageous to their companies and their work forces. In this increasingly competitive market for employees and the heightened focus of the younger generations on savings for retirement, taking steps to modernize a retirement program could provide a competitive advantage.
About the Author: John Lowell brings over 30 years of extensive experience as an actuary in the benefits and compensation sector. Renowned as a thought leader in the industry, John excels in delivering distinctive solutions to the intricate challenges encountered by organizations.