Recent trends in U.S. private pensions are undeniable. Over the last 25 years, defined benefit plans — once the centerpiece of the retirement portfolio — have lost considerable ground to defined contribution plans, which have become the primary vehicle for saving for retirement. Some analysts claim that traditional defined benefit plans are a dying breed (if not already dead). Detractors typically contend that defined benefit plans are too complicated, too risky for plan sponsors and underappreciated by employees.
Watson Wyatt set out to learn how employees felt about their defined benefit and defined contribution plans and how these plans affect employees' workforce decisions. Watson Wyatt's Retirement Attitude Survey found that most workers value both types of plans very highly. And workers who strongly value their retirement plan are more likely to want to continue working for their current employer than workers who don't. As such, the design and features of a retirement program can have very meaningful effects on workers' behavior, which can deliver favorable economic returns to the organization.
Business Case for Employer-Sponsored Retirement Plans
In addition to serving as a tax-advantaged means of accumulating retirement income, retirement plans can enhance productivity. Pensions strongly influence workers' behavior, giving younger workers a compelling reason to continue working for their employer and encouraging older workers to retire on a timely basis. Empirical evidence indicates that pensions influence the type of worker a firm attracts and can help an employer attract workers who exhibit desirable behavior patterns. While the productivity effects have been associated mostly with defined benefit plans, recent research has shown that 401(k) plans exhibit similar effects in shaping workers' behavior (Ippolito, 1997).
Lower employee turnover reduces costs and improves productivity, and thus can significantly increase shareholder value. To measure the influence of both types of retirement plans on employee behavior, we examined how a plan's value to employees affects their desire to stay with their employer. The Retirement Attitude Survey asked respondents to indicate the importance of their defined benefit and defined contribution plans in two ways. First, we asked employees whether and to what extent the retirement plan was an important reason for taking their job. Second, we asked them whether and to what degree the retirement plan gives them an important reason to stay with their employer. We combined both responses into a single summary variable of plan importance.
Separate from their feelings about their plans, we asked employees to indicate their likelihood of staying with their current employer until retirement and their likelihood of leaving their employer within the next two years. We again created a summary indicator by combining employee responses to measure the overall likelihood that an employee will stay with his or her employer.
Responding workers who consider their defined benefit plan highly important are over three times more likely to express a strong desire to stay at their current organization than other workers (Table 1). Employees who consider their defined contribution plan very important are 2.5 times more likely to intend to stay with their current employer. In fact, for both plan types, more than half of respondents who value their retirement plans highly also indicate a high likelihood of staying with their current employer. For employees who assign low importance to their defined benefit plan, roughly equal numbers say the plan would (36.3 percent) or would not (37.1 percent) influence their decision to remain with their current employer. The situation is much the same for workers who assign a low value to their defined contribution plan.
What does this mean for shareholder returns? Responding employees who consider their defined benefit plan very important tend to work for companies whose total returns to shareholders (TRS) averaged 26.7 percent from 1999 to 2003 (Table 1). This compares very favorably with 21.8 percent TRS over the same period at companies whose employees value the plan the least. At the median, TRS during the most recent five-year period was more than 12 percentage points higher at firms whose workers strongly value their defined benefit plan than at firms whose workers are less enthusiastic about their plans.
The differences in five-year TRS between employees who value their defined contribution plan the most and those who value it the least are more modest. There is very little difference between the two groups on average five-year TRS, but there is more than a six-percentage-point difference in median shareholder returns.
Higher plan satisfaction is also strongly associated with an employee's intention to remain with his or her current employer (Table 2). For defined benefit plans, employees' overall satisfaction was determined by combining employee ratings of eight features: value of benefits as future income, information about current value, information about projected value, form of benefit payout, benefit availability age, years of service before vesting, ability to access funds before retirement and how the plan compares with competitors' plans.
For defined contribution plans, overall plan satisfaction also was determined by employees' satisfaction with eight features: match rate, type of matching funds, contribution limits, investment options, information about balances, education programs, plan administration and how the plan compares with competitors' plans.
Employees who are most satisfied with their defined benefit plan are more than three times more likely than other employees to plan on remaining with their employer until retirement. An equivalent relationship emerges for employees who are highly satisfied with their defined contribution plans. However, employees who are much less satisfied with their defined benefit and defined contribution plans are equally likely to plan on staying with their employer or not.
A popular pension plan translates very favorably into higher shareholder returns. Average five-year TRS is over 10 percentage points higher at companies whose employees are highly satisfied with their retirement plans — either type of plan. In fact, in comparing median satisfaction, five-year TRS is –3.6 percent at companies whose employees are least satisfied with their defined benefit plan compared with 18.9 percent at companies whose employees are most satisfied. A very similar relationship holds true for defined contribution plans as well — a link between higher employee satisfaction with the 401(k) plan and significantly higher shareholder returns.
Although plan importance and satisfaction strongly influence employees' desire to stay with their current employer, age also affects their degree of commitment. As workers mature and settle into their careers, their desire to stay with their current employer generally becomes stronger. While we have left the details out of this condensed analysis, our results confirm that workers 45 and older are more likely to plan on remaining with their current employer regardless of their feelings about their retirement plans. Yet, commitment is higher still for older employees who are satisfied with their plans and consider them valuable than for older workers who value their plans less.
Employers typically experience significantly higher rates of turnover among younger segments of their workforce. For many employers, reducing turnover among these ranks is critical to their overall success. Employees younger than 35 who value their plans most highly and are very satisfied with them are more likely to remain with their current employer than other young employees (Tables 3 and 4). This is particularly true for defined benefit plans. Of those who are happy with their defined benefit plan and consider it very important, one-half say they firmly expect to stay with their employer. On the defined contribution side, those who value their plans and consider them very important also indicate a greater likelihood of sticking around, but the difference is less pronounced than it is for defined benefit plans. Not surprisingly, younger workers who don't consider their plans important and are not particularly satisfied with them appear much less committed to their employer. In fact, more than one-half of younger workers who neither value their plans highly nor express high satisfaction indicate a low probability of staying with their employer.
Importance of Retirement Plans
As noted above, our measure of plan importance is based on employees' responses to two questions: (1) How did the plan affect your decision to work for your current employer? (2) How does the plan affect your desire to continue working for your employer? The answer to the first question measures the retirement plan's effect on attraction; the answer to the second question indicates the plan's effect on retention.
Table 5 shows the effectiveness of retirement plans at attracting and retaining younger and older employees. In general, retirement plans do a much better job of retaining workers than attracting workers. Roughly twice as many respondents say their plan strongly affects their decision to remain with their current employer than say the plan convinced them to sign on in the first place. Older employees are significantly more likely than younger employees to have been attracted to their firm by the retirement plan. Older respondents are also more likely to consider their retirement plan an important reason to continue working for their employer. This is not surprising, given that older workers are generally much more focused on retirement issues than younger workers.
Across plan types, defined benefit and defined contribution plans are generally equally effective in attracting and retaining employees within each age group. These results are surprising, since 401(k) plans are generally considered to be more attractive than defined benefit plans, especially to younger workers. In fact, defined benefit plans are just as important in convincing younger workers to take a job as 401(k) plans (14.6 percent versus 14.5 percent). Defined benefit plans have slightly greater attraction value to older workers than 401(k) plans (25.5 percent versus 20.0 percent).
In terms of retention, defined benefit plans are more likely to convince older workers to remain with their employer than 401(k) plans (52.8 percent versus 44.1 percent). Defined benefit and 401(k) plans exert very similar effects on younger employees. As you may recall from Table 3, however, younger workers who rate their defined benefit plan as highly important are nearly twice as committed to their organization as comparable employees with a defined contribution plan. So while younger employees seem to value their defined benefit and 401(k) plans fairly equally, defined benefit plans appear more effective in boosting employee commitment among young workers than 401(k) plans, at least for younger employees who strongly value their plan.
The tables above show only modest differences in the extent to which plan type affects employee commitment. However, these results do not account for the different mix of retirement programs that employers offer. Table 6 shows employees' perceptions about the attraction and retention power of their retirement plans for workers whose employers offer (1) a defined benefit and defined contribution plan, (2) only a defined benefit plan or (3) only a defined contribution plan.
In general, retirement plans have the strongest attraction and retention power at defined-benefit- only firms. Employees at these firms are twice as likely to cite their retirement plan as an important factor in choosing their employer than workers at firms that offer only a defined contribution plan. In fact, employees at firms that offer only a defined benefit plan are significantly more likely than employees covered by both a defined contribution and a defined benefit plan to rate their retirement plan as a highly important reason for joining the company.
Employees at defined-benefit-only firms also tend to credit their retirement plan with the greatest retention effect. Fifty-three percent of respondents at defined-benefit-only firms who highly value their plans say their retirement plan gives them a very important reason to stay with their current employer. This is comparable to the retention effect we identified among older workers (Table 5). In companies that offer both a defined benefit and a defined contribution plan, both plans appear to improve employee retention. Workers at defined-contribution- only firms, on the other hand, are significantly less likely to cite their retirement plan as a reason to stay on the job than workers whose employers offer a defined benefit plan. This further supports the assertion that defined benefit plans engender employee loyalty and commitment.
Satisfaction with Retirement Plans
Employers have long sought to enhance organizational performance by improving employee satisfaction. The idea that a satisfied employee is a better employee seems intuitive. And, as shown above, designing a retirement plan that strongly appeals to employees can create significant value for an organization.
Which plan characteristics elicit the most favorable ratings from employees? The Retirement Attitude Survey asked employees to indicate their degree of satisfaction with a number of retirement plan features. Table 7 shows the responses, indicating the percentage of employees who are highly satisfied with various features of their defined benefit plans, including plan generosity, vesting, eligibility, age when benefits become available and plan communications. Overall, about one-half of the respondents say they are highly satisfied with their defined benefit plan. Responding employees indicate the highest satisfaction with their plan's vesting requirements, benefit availability age, plan generosity and form of benefit payout in retirement. Employees report being least satisfied with limited access to their money before retirement. To a lesser extent, employees also are less satisfied with plan communications and with how their plan compares to plans at other organizations.
Worker satisfaction is relatively consistent across the various plan types and mix of retirement programs. Most notable is that responding employees seem to be just as enthusiastic about their hybrid pension plans as they are about their traditional defined benefit plans. These survey findings do not confirm the popular media's portrayal of employees being passionately unhappy with their hybrid pensions. This could be the result of increased communication around recent hybrid plan conversions, raising awareness of and appreciation for these plans. Similarly, employees at defined-benefit-only firms are just as satisfied with their plan as those who are also covered by a defined contribution plan.
The survey asked employees to indicate their satisfaction with defined contribution plan features such as value and type of matching contributions, available investment options, permissible employee contributions and educational materials (Table 8). Roughly two-thirds of all responding employees are satisfied with their 401(k) plan, which is about 10 percentage points higher than employee satisfaction with a defined benefit plan. Employees appear most satisfied with communication of their account balances, contribution limits and available investment options. Workers are least satisfied with their employer's investment education programs and how their plan compares to plans offered by other organizations. However, employees at defined-contribution-only firms tend to be slightly less satisfied with their plan than the average respondent. This difference is perceptible with each plan design feature.
Most employees appreciate their retirement plans and value them highly. In fact, it appears that an attractive plan plays a very significant role in both attracting and retaining employees. Although employee attraction and retention are always important, they are likely to become increasingly hot issues as the baby boom generation starts retiring.
Defined benefit plans appear to exert a stronger influence on employees' decisions to remain with their employer, but respondents overall express greater satisfaction with their defined contribution plans. This could be because benefits in defined contribution plans are often communicated more clearly, accrue at younger ages and seem more tangible than those in defined benefit plans. As employees get older, defined benefit plans seem to acquire greater appeal, perhaps because the benefits become more valuable with age and the payout begins to feel less distant. While no one would deny that defined benefit plans face many challenges today, these plans clearly remain a valuable and important part of the U.S. private pension system, continuing to provide value to both employees and employers across changing workforce environments.
This article is the second in a series analyzing employees' attitudes toward their employer-sponsored retirement plans. In the March 2005 Insider, we analyzed the effect of employer-sponsored pension programs within the context of retirement security. The final article will investigate the ways in which plan generosity and plan communications affect employees' perceptions of the value of their plans.
About the Survey
The Watson Wyatt Retirement Attitude Survey was completed by roughly 8,000 employees from a national panel in summer 2003. Every employee in the sample was matched to his or her actual plan design information using the Watson Wyatt COMPARISON™ database. All respondents are covered by a defined benefit plan or a defined contribution plan or both. Tw o-thirds of employees have both a defined benefit plan and a defined contribution plan, while 27 percent have only a defined contribution plan. The remaining workers have only a defined benefit plan. The final sample includes employees from 982 firms.