Towers Watson Finds DB Plans Outperformed DC Plans

February 3, 2010 (PLANSPONSOR.com) - Rates of return for defined benefit (DB) pension plans outpaced those for defined contribution (DC) plans, including 401(k) plans, in 2007 and 2008, according to a new analysis by Towers Watson.

A Towers Watson news release said DB plans outperformed 401(k) plans by roughly 1 percentage point in 2008, although both types of plans lost value, and 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, according to the news release.

According to the analysis, DB plans had median investment returns of -25.27% in 2008, while DC plans had median returns of -26.20%. The 2008 results are based on a survey of 79 employers that sponsor one DB plan and one 401(k) plan. Towers Watson said these results will be updated and expanded as additional data becomes available.

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, according to Towers Watson. 

"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," explained Mark Ruloff, senior consultant at Towers Watson, in the news release. "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."

Sylvia Pozezanac, senior consultant at Towers Watson, said the findings of the analysis are not surprising as "[m]any 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" - resulting in a larger proportion of fixed income instruments and other assets as opposed to equities, which fared better than stocks in the recent market downturn.