Defined Benefit Plans Outperformed 401(k) Plans During 2007 and 2008, Towers Watson Analysis Finds

NEW YORK, February 3, 2010 — Rates of return for defined benefit (DB) pension plans outpaced those for defined contribution (DC) plans, including employee-directed 401(k) plans, in 2007 and also in 2008, when the economic crisis began to unfold, according to a new analysis by Towers Watson (NYSE, NASDAQ: TW), a leading global professional services company.

The Towers Watson analysis found that DB plans outperformed 401(k) plans by roughly 1 percentage point in 2008, although both types of plans lost value. Additionally, while most DB plans incurred losses for 2008, some actually reported small positive returns. By contrast, all DC plans in the study had losses of at least 10%, and a few had losses greater than 40%, more than any DB plan in the study. The 2008 results are based on a survey of 79 employers that sponsor one DB plan and one 401(k) plan. These results will be updated and expanded as additional data become available.

According to the analysis, DB plans had median investment returns of -25.27% in 2008, while DC plans had median returns of -26.20%. A broader analysis of more than 2,000 plan sponsors shows that DB plans had a median return average of 7.71% while DC plans had a median return of 6.78% in 2007. This finding is consistent with earlier analyses, which show that DB plans have consistently outperformed DC plans by an average of about 1 percentage point per year during both bull and bear stock markets. 

“Participants in 401(k) plans were less likely than DB plan sponsors to rebalance their asset portfolios while stock values ran up, leaving them more vulnerable to market declines,” said Mark Ruloff, senior consultant at Towers Watson. “Many DB sponsors had been reducing their exposure to equities and already shifted toward more conservative investment strategies in 2007, which helped to mitigate their losses.”

The analysis also found that, between 1995 and 2007, larger retirement plans — both DB and DC — realized investment returns higher than those of smaller plans. During this period, the largest sixth of the analyzed DB plans outperformed the smallest sixth by approximately 3 percentage points, compared with a difference of approximately 0.7 percentage points between the median investment returns of the largest and smallest 401(k) plans.

“Size influences the performance of DB plans more than it affects DC plans because larger pension plans can afford to spend more on professionals to manage assets and use more sophisticated strategies,” said Mark Warshawsky, senior retirement researcher at Towers Watson. “On the other hand, 401(k) plan participants often do not optimize their investment strategies. Even with more investment education and better default investment options for 401(k) plan participants, DC plans do not replicate all the advantages of DB plans and are unlikely to outperform DB plans, which generally have extended investment horizons and economies of scale.”

“It is not surprising that DB plans have outperformed DC plans in the most recent bear market,” said Sylvia Pozezanac, senior consultant at Towers Watson. “Many DB plans, especially the larger ones, have adopted strategies where assets are invested in a way that their movement would more mirror those of pension liabilities and have diversified into alternative investments. This often results in a larger proportion of fixed income instruments and other assets as opposed to equities. Bonds and alternatives fared better than stocks in the recent market downturn."

About the analysis

The analysis, the latest in an ongoing series by Towers Watson, is based on Form 5500 financial and pension disclosure data released by the U.S. Department of Labor. Only companies that sponsor one DB plan and one 401(k) plan, each with at least 100 participants, are included in the data for 2007 and earlier reported here. Results for 2008 are based on a separate Towers Watson survey of plan sponsors about their Form 5500 information. A more detailed discussion of this analysis can be found here.

About Towers Watson

Towers Watson (NYSE, NASDAQ: TW) is a leading global professional services company that helps organizations improve performance through effective people, risk and financial management. The company offers solutions in the areas of employee benefits, talent management, rewards, and risk and capital management. Towers Watson has 14,000 associates around the world and is located on the web at www.towerswatson.com.