Some 401(k) Plans Are Adding an Annuity Option

NYTimes.com
By FRAN HAWTHORNE
Published: September 15, 2010

BURDENED with a reputation for being inflexible and expensive, annuities have never been popular in retirement plans. But insurance companies and Wall Street investment firms have produced a new crop of products that fiddle with the standard structure.
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Minh Uong/The New York Times

Their idea is that these products can promise employees the security of a traditional pension, while freeing employers from the task of paying for it. However, they are still having trouble breaking through the A-barrier.

Image via WikipediaOnly 2 percent of 401(k) plans include some sort of annuity or insurance option as an investment choice alongside standard stock and bond funds, according to Hewitt Associates, a benefits consulting firm in Lincolnshire, Ill. An additional 3 percent are “very likely” and 17 percent are “somewhat likely” to add the category this year, Hewitt says.

Promoters hope that hearings this week, sponsored by the Treasury and Labor Departments, will lead to federal regulations that clarify some of the administrative concerns.

“Most people would want, as they approach age 50, to have some sense of what level of income they would have at retirement,” said Thomas J. Fontaine, global head of defined contributions at the investment management firm AllianceBernstein, one of more than a half-dozen insurance companies and money managers devising these products. “And they will want to know that they will have that income for life.”

The products work in two basic ways. The most common varieties are tied to target-date funds — premixed funds that base their investment strategy on the date the employee hopes to retire, automatically changing the mix as the date draws nearer.

In the AllianceBernstein model, an increasing portion of the target-date assets are shifted to a special guaranteed fund starting at age 50, with 100 percent in that fund by five years before the retirement date. Although the product isn’t complete, Mr. Fontaine said he expected it to guarantee a 5 percent rate of return for life, for a fee of about 1 percent of the assets.

Prudential Retirement has a product that combines a group variable annuity with a target-date fund, basically insuring against market downturns, also for a 1 percent fee. It guarantees that each year for the first 20 years of retirement, an investor can withdraw an amount equal to 5 percent of the assets that were in the target-date fund at its highest year, even if the market crashed the year before retirement. After 20 years, Prudential starts paying that 5 percent.

Image via WikipediaMetLife’s Personal Pension Builder takes a wholly different approach, akin to a deferred fixed annuity. Each time someone makes a 401(k) contribution, all or part of the money essentially buys a mini-annuity (also known as a laddered annuity), getting the prevailing interest rate at that time. Thus, a person who contributed every two weeks would be purchasing 26 mini-annuities that year.

What all these products have in common is that employees use their 401(k) assets to buy a guaranteed, steady payout for the rest of their lives after they retire. The cost is usually around 1 percent of the assets guaranteed, on top of the regular 401(k) fees.
For many people, the added security is worth the price.

“We insure everything — disability, our car, our house — but we don’t insure the risk that we could outlive our assets,” said Pamela Hess, Hewitt’s director of retirement research. She recommended that people use this kind of guarantee for around half of their 401(k) assets.
There are other concerns, however. Because so many parts are movable — including the interest rate, the retirement date and the amount of the contribution — companies worry about the administrative difficulties. It is not as simple as having one small-company stock fund for the whole work force.

Like a standard annuity, some of the new products depend on a single insurance company’s staying in business long enough to keep paying out the guarantees, maybe for decades.
“How do you fix this if it’s not the right provider?” Ms. Hess asked.
Jody Strakosch, MetLife’s director of retirement products in the United States, has a ready reply for that sort of criticism: “MetLife has been meeting our financial obligations for 140 years.”

And John Kalamarides, the senior vice president of retirement strategies and solutions at Prudential, said new “safe harbor” rules from Washington could relieve some employers’ fiduciary concerns in selecting insurance companies.
On the plus side, the target-date-related products are more flexible than annuities. Investors can pull out their money at any time, although that means they will have paid the extra fee for nothing.

The firms pitching these products say demand is growing. In a survey of 1,300 companies last fall, MetLife found that 44 percent of employees “would like my employer to offer an annuity option” in their 401(k) or similar retirement plan. A MetLife spokeswoman acknowledged that the statement could refer to rolling over the 401(k) into an annuity at retirement, as well as having an investment option.

Stephen P. Utkus, who runs the Center for Retirement Research at the Vanguard Group — which does not sell any of these new products — said that trying to buy security with a 401(k) investment was a mistake. The best approach, he says, is simply to build a bigger nest egg.
“Our clients view having a portfolio of assets itself as a form of security,” he said.

A version of this article appeared in print on September 16, 2010, on page F2 of the New York edition.

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Pros and Cons of Cashing Out Your 401(k) to Start a Business

BlogHerImage via CrunchBase

September 09, 2010 11:36 am by paulag01 in Money
The combination of a bad lending environment, the economy, and the uptick in people starting businesses have made tapping retirement funds a very tempting business financing option.  Is it right for you?
If you listen to any of the financial experts, the message "never touch your 401(k)" gets repeated over and over.  …  Yet it is happening more frequently than you think, it is legal (if certain tax code provisions are followed), and it doesn't have to be the all-or-nothing doomsday scenario.
A recent article in Inc. Magazine details "How to Finance a Business with your 401(k)".  Here's how it works.  Essentially you establish a C corporation for your new business that has been created but has not issued stock.  The new corporation adopts a retirement plan.  You roll over your 401(k) to the new corporation's plan. The new corporation issues all of its stock and transfers it to the new profit-sharing plan in exchange for the cash.  Voila, instant cash flow.
The process of using a rollover as business start-up is often referred to as "ROBS." You can read more about this in Tapping Retirement Money for Your Business? Be Careful.  It is particularly appealing for franchise opportunities:

But an article published in Franchise Times cited compelling figures from franchise-data firm FranData that showed more than 4,000 businesses started using ROBS funding last year. More than 60 percent of those businesses were franchises.

Back in 2008, the IRS did express its displeasure about the ROBS plans in a retirement-plan newsletter, so Uncle Sam may not be as enthusiastic about this approach as some entrepreneurs.
So is it right for you or not?
The Franchise King had this to say about using your 401(k) to fund your franchise business.  Bottom line?  Get educated, make an educated decision ... for you.
Here are some pros and cons to consider:

Pros

• Relatively quick and easy access to potentially large sums of cash without having to qualify for a loan.
• You leverage your own cash to build something of value, essentially becoming your own venture capitalist (needless to say, this is only a positive if the business thrives).
• Up to 100 percent of your retirement funds can be used, but you can diversify and use only a portion to fund your business venture leaving the rest of your retirement assets intact.

Cons

• You put your future retirement and financial security at risk should the business fail.
• Must hire a tax attorney or CPA to handle the formation of the corporation and retirement plan.
• These provisions may be under scrutiny (or that is the picture some paint) by the IRS.

Paula Gregorowicz, owner of The Paula G. Company, offers life and career coaching for women to help you figure out what you want to do with your life and career and cultivate the confidence to be the person you most want to be so you succeed on your own terms. Learn more about The Life Alchemy Success Formula™ and Get the free eCourse "5 Steps to Move from Fear to Freedom & Experience Greater Confidence" at her website.

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Creating value in the age of distributed capitalism

As mass consumption gives way to the wants of individuals, a historic transition in capitalism is unfolding.

McKinsey Quarterly - Strategy - Strategic Thinking
SEPTEMBER 2010 • Shoshana Zuboff



Capitalism is a book of many chapters—and we are beginning a new one. Every century or so, fundamental changes in the nature of consumption create new demand patterns that existing enterprises can’t meet. When a majority of people want things that remain priced at a premium under the old institutional regime—a condition I call the “premium puzzle”—the ground becomes extremely fertile for wholly new classes of competitors that can fulfill the new demands at an affordable price. A premium puzzle existed in the auto industry before Henry Ford and the Model T and in the music industry before Steve Jobs and the iPod.

The consumption shift in Ford’s time was from the elite to the masses; today, we are moving from an era of mass consumption to one focused on the individual. Sharp increases in higher education, standards of living, social complexity, and longevity over the past century gave rise to a new desire for individual self-determination: having control over what matters, having one’s voice heard, and having social connections on one’s own terms. The leading edge of consumption is now moving from products and services to tools and relationships enabled by interactive technologies. Amazon.com, Apple, eBay, and YouTube are familiar examples of companies solving today’s premium puzzle. Lesser-known companies like CellBazaar (in emerging-market mobile commerce), TutorVista (in tutoring), and Livemocha (in language education) also abound.

It would be easy to construe these as isolated cases of innovation and industry change, but I believe they represent much more: a mutation in capitalism itself. … Innovations improve the framework in which enterprises produce and deliver goods and services. Mutations create new frameworks; they are not simply new technologies, though they do leverage technologies to do new things. Historically, mutations have superseded innovations when fundamental shifts in what people want require a new approach to enterprise: new purposes, new methods, new outcomes.

In the same way that mass production moved the locus of industry from small shops to huge factories, today’s mutations have the potential to shift us away from business models based on economies of scale, asset intensification, concentration, and central control. That’s not to say factories are going away; their role in supplying quality, low-cost goods, including the technologies underpinning the shift to more individualized consumption, is secure. Yet even mass production is becoming less homogenous (consider the ability to order custom sneakers from Nike). And for many goods and services, new business frameworks are emerging: federations of enterprises—from a variety of sectors—that share collaborative values and goals are increasingly capable of distributing valued assets directly to individuals, enabling them to determine exactly what they will consume, as well as when and how. This shift not only changes the basis of competition for companies but also blurs—and even removes—the boundaries between entire industries, along with those that have existed between producers and consumers. The music and newspaper industries ignored this shift, to their great detriment. I believe all businesses will have to find ways to adapt to this new world if they want to grow.
The economist Joseph Schumpeter cautioned his readers not to expect new forms of economic development to announce themselves with a grand flourish. “The ‘new thing,’” he wrote, “need not be Bessemer steel or the explosion motor. It can be the Deerfoot sausage.”¹ My hope is that this article will help executives see the links between today’s “Deerfoot sausages,” recognize the magnitude of the economic transition these mutations portend, and begin setting—or at least contemplating—a new course in this changing world.

It won’t be easy. But enterprises that can leverage technology and real-world social connections to solve their piece of the premium puzzle—creating individualized ways to consume goods and services at a radically reduced cost—will prosper as they realize wholly new sources of value that remain invisible to companies still bound by conventional business models.

Mutation and distributed capitalism

The last chapter of capitalism unfolded in the early 20th century and was epitomized by Henry Ford and his Model T. …The Model T embodied a mutation we now call mass production. It solved the premium puzzle of its time, reducing the price of an automobile by 60 percent or more, and thrived in the emerging environment of mass consumption.

Ford’s Model T not only changed the entire framework of production but also set the stage for another automotive pioneer, Alfred Sloan, to establish the modern, professionally managed, multidivisional company as the basis for wealth creation in the 20th century. In the end, the Model T’s power had nothing to do with cars per se. Mass production could be applied to anything—and it was. It provided the gateway to a new era because it revealed a parallel universe of economic value hidden in mass-market consumers and accessible to companies that could create affordable versions of previously unattainable goods such as cars. That potential for wealth creation remained invisible to those who clung to the 19th-century framework of small-factory, proprietary capitalism.

The mass-production business model has come under assault during the past decade, perhaps most successfully by the combination of Apple’s iPod and its music service, iTunes. The iPod is … also a gateway product, one of the first to achieve both scale and commercial success while expressing a new mutation. The iPod and iTunes reinvented music consumption by starting with the listener’s individual space, which I call “I-space.” Apple rescued musical assets from a faltering business model…. It supported users in reconfiguring their music as they saw fit. … But I would argue that the real breakthrough had nothing to do with music per se. The true source of value, which had been invisible to the music industry, resided in Apple’s ability to reinvent the consumption experience from the viewpoint of the individual, at a fraction of the old cost.

The iPod—and its successors, the iPhone and the iPad—are part of the first wave of what I call “distributed capitalism,” which encompasses the myriad ways in which production and consumption increasingly depend on distributed assets, distributed information, and distributed social and management systems.² Distributed capitalism could not thrive without the technologies associated with the Internet, mobile computing, wireless broadband, and related developments in digitization and software applications. But just using these technologies does not ensure success.

Winning mutations—those that create value by offering consumers individualized goods and services at a radically reduced cost—express a convergence of technological capabilities and the values associated with individual self-determination. The iPod and scores of other successful mutations have infiltrated the economy sufficiently to provide preferred alternatives to established sources of goods and services across many industries. Taken together, they have begun expressing a distinctly new “genetic code” that encompasses five essential functions:

Inversion

The old logic of wealth creation worked from the perspective of the organization and its requirements—for efficiency, cost reductions, revenues, growth, earnings per share (EPS), and returns on investment (ROI)—and pointed inward. The new logic starts with the individual end user. … This inverted thinking makes it possible to identify the assets that represent real value for each individual. Cash flow and profitability are derived from those assets.

Rescue

Once valuable assets have been identified, they must be rescued from old, costly industry structures. … Rescuing assets means digitizing them whenever possible for easy and affordable distribution to users in I-space.

Bypass

… By leveraging digital technologies and new social arrangements, these mutations are bypassing existing institutional structures … and connecting individuals directly to the assets they seek. Just as a coronary bypass ignores a damaged blood vessel and takes blood to its destination another way, so mutations like iTunes or distance learning simply bypass the unnecessary costs, outdated assumptions, and value-destroying practices of legacy systems.

Reconfiguration

Once individuals have the assets they want, they must be able to reconfigure those assets according to their own values, interests, convenience, and pleasure. A teenager, for instance, may use her iPod Touch … to assemble an entire personalized “radio station” while at the same time learning Mandarin Chinese … through an online classroom based thousands of miles from her home.

Support

… The new sources of economic value can be discovered and realized in I-space only when consumption strengthens the sense of personal control, delivers opportunities for voicing ideas, and enables freely chosen social connections. The emerging logic of distributed capitalism rewards enterprises that realign their practices with the interests of the end consumer and punishes enterprises that try to impose their own internal requirements or, worse yet, maximize their own benefit at the expense of the individual end user.

…[Early] mutations address individual needs that are invisible from the perspective of a typical company and target the kinds of trapped assets that are both valuable to individuals and easily digitized (to learn more about how mutations vary in the degree to which they incorporate these five functions, see the interactive exhibit, “A taxomony of mutations” ).

A taxonomy of mutations
Mutations in capitalism vary in the degree to which they have developed each of the five functions essential to the new "genetic code."
Launch Interactive

The next test for distributed capitalism

Can distributed capitalism go further? What happens when it confronts … arenas where face-to-face experience is essential? This is when distributed capitalism, … will begin to mature as it takes aim at core economic functions with a second wave of more complex mutations that combine virtual and real-world assets.

Early mutations in health care

The premium puzzle has become the defining characteristic of most individuals’ health care experiences: the health care one can afford is rarely the health care one wants. … But it is sure to intensify elsewhere as aging populations make it harder for governments to finance today’s systems.

In the vacuum created by these frustrations, many people concluded that they must first try to help themselves and their families before turning to professionals. Mutations such as WebMD arose, aimed at capturing, interpreting, and distributing information once held closely within the medical enclave. Such sites are now credible ways to acess information that doctors just won’t provide at a price people can afford—and sometimes at any price.

Another group of mutations has emerged in the areas of home-based diagnosis, monitoring, and testing. … Distribution has even gone mobile with cell phones that monitor blood glucose levels and heart rates, connect you to hot lines, signal the calorie count of your cheeseburger, or register the energy you burn as you walk your dog.

Radical mutation in elder care: A case study

One of the most intractable premium puzzles in the health care system today is elder care. The average annual cost of nursing-home care in the United States approaches $80,000. Only a small percentage of US residents can afford these prices, while state and federal funding is shrinking. Further, nursing homes tend to be for-profit businesses in which cost imperatives lead to understaffing and low wages. Dismal data on bedsores, medical errors, and elder abuse suggest that elder care as generally practiced is a euphemism for human warehousing on the cheap.

A Maine-based start-up called Elder Power (EP) has taken direct aim at the elder care premium puzzle. It showcases new capabilities and strategies that integrate digital and face-to-face support, and its initial success provides important guidance on solving today’s premium puzzle in the physical world. …The average monthly cost in Maine exceeds that in the United States as a whole … In contrast, EP has enabled seniors to remain at home at an average monthly cost of $702–$378 for technology and $324 for personalized support. EP enables seniors to be secure, socially enriched, and personally empowered for 3 percent of the average cost of conventional home care in Maine, 10 percent of the average cost of a nursing home, and 18 percent of the average cost of assisted living.

Before explaining how this is possible, I want to offer two caveats. First, the reason I have such detailed information about EP is that my husband and collaborator, Jim Maxmin, is one of its architects. Jim holds shares in the company, which is a for-profit community network whose profits are entirely reinvested in the network to support its neediest participants. Second, EP is a tiny experiment, with (as of March 2010) 56 members. This group does not, however, represent an easy-to-serve population: many have mild to severe Alzheimer’s disease.
EP has a significant technology component. Each elder person’s home is equipped with a “digital spine,” with members opting for various technology levels, from the basic tools (emergency alert, a stationary webcam, a videophone, and a computer interface) to more elaborate systems that include multiple webcams, sensors, and around-the-clock monitoring. A Web site provides access to a community calendar, local services, a story and poetry corner, video clips, advice, e-mail, and an EP Facebook page. There is also a Web-based Elder Power TV network, which features local events such as plays and church services. The technology reassures families that the elder person is well and the network is there to help.
As is crucial to second-wave mutations, the EP model extends beyond the digital realm. EP is a social network that includes members; their families, friends, and neighbors; volunteers; paid staff; and professionals. Each member has a personal advocate within the network who helps coordinate the use of EP’s services. In addition, EP expects members to take an active role in their own well-being and to help others in the network. A partially disabled housebound member, for example, oversees the daily monitoring.

Financial surpluses generated by the EP model help to offset the expenses of volunteers and to reward them with meal vouchers, gasoline, film tickets, and the like. This combination of paid and unpaid support services means that one registered nurse employed by EP can serve more than 60 remote seniors. EP estimates it would take 40 to 50 volunteers to support 1,000 seniors.

Strategies for radical mutation

Elder Power exemplifies four new strategies for pulling off radical mutations in arenas where real-world—not just digital—assets are integral to the individual experience. First, it’s a federation, by which I mean a branded constellation of enterprises drawn from many industry sectors that revolves around the individual—such as a local utility that gives EP members top priority in the monitoring and emergency maintenance of home electrical and heating systems. Second, EP identifies, uses, and remunerates underutilized community and network resources (services, spaces, people, capabilities, and goods) that are “hidden in plain sight,” such as the local high-school cafeteria, where elders dine weekly after the regular lunch period ends, or an extra bedroom in a member’s home that can be used for another elder to recuperate after a hospital stay.

Third, EP leverages available resources by distributing work: one volunteer or member might make two daily phone calls. Another might transport a group of seniors to lunch once a week. A third might coordinate the evening meal for three seniors in her neighborhood. Finally, EP relies on what I call “I-metrics,” which realign business practices with the experience, values, and priorities of the people an enterprise serves. For EP, I-metrics reflect subjective evaluations such as “I feel safe and happy at home,” “I feel needed,” or “I can get down to the back meadow to see the spring flowers.”

Elder Power is far from the only place where the importance (and sometimes the difficulty) of implementing these strategies is revealing itself. Consider federation: since Apple understood that its iPod users wanted to be connected to one another, … it broadened the scope of its offerings, creating new partnerships and business models at each turn as the stand-alone iPod morphed into the iPhone. The choice to host applications on the iPhone further accelerated this process, reimagining the iPhone as a portal to an ever-widening “protofederation” of support providers.

But creating effective federations is challenging. … [Apple and Facebook] began by regarding applications as simply hosted transactions … but are evolving toward a recognition that applications are a seamless extension of their end users’ experience. And both are confronting the following challenge: how much control will they, as the coordinators of their respective federations, exercise, compared with other member enterprises and with end users? …These kinds of relationships are the early building blocks of federated support networks.

Embracing distributed capitalism

While Elder Power is operating on a tiny scale, its way of solving the premium puzzle in elder care offers a vivid demonstration of what I believe will be core features of the 21st-century economy: creating new social and enterprise frameworks that operate on behalf of individual end users, enabling them with the tools, platforms, and relationships to live their lives as they choose. The range of individual support underlying many of today’s mutations is wide.
What should executives do to ensure that their organizations will grow in this new world? For starters, it’s critical to question the old logic and vocabulary of competitive strategy. …[Mutations] do not arise within industries; they arise as reconfigurations of assets defined by the unmet needs of individual end users. Mutations take root in individual space, and they quickly blur the boundaries of industries, sectors, and enterprises—ultimately making those boundaries obsolete. Is Amazon.com, for instance, in the retail, the logistics, or the Web-services industry? The question no longer makes sense.

One way for executives to shake up their strategic thinking is to start with the radical question of how a mutation could destroy the boundaries of their industries.

As mutations move into the physical world, it’s easy to imagine a similar blurring of boundaries: … In short, mutations that upend industries can come from anywhere, and conventional forms of market analysis and competitive strategy will miss those mutations.

One way for executives to shake up their strategic thinking is to start with the radical question of how a mutation could destroy the boundaries of their industries. In my mind, that danger increases under the following circumstances:

1. The products or services you offer are affordable to few but desired by many.
2. Trust between you and your customer has fractured. The average person’s trust in business has been in steep decline for the past 30 years, and the distance between what today’s businesses can deliver and what individuals want is only growing. This problem makes all consumer-facing industries—especially financial services, health care, insurance, autos, airlines, utilities, media, education, and pharmaceuticals—particularly vulnerable.
3. Your business model is concentrated, with a high level of fixed costs, a large percentage of which could be distributed, delegated to collaborators, or shifted to the virtual world. Here, too, most existing industries are deeply vulnerable.
4. Your organizational structures, systems, and activities can be replaced by flexible, responsive, low-cost networks. A neighborhood watch, citizen journalists, online peer support, and peer-to-peer reviews and information sharing are all examples.
5. There are hidden assets, outside institutional boundaries, that are underutilized but could replace your fixed costs, add capacity, or add new capabilities.
6. You don’t have all the tangible or intangible assets required to meet your customers’ needs.
7. Your end users have needs and desires that you haven’t imagined and have no way to learn about. Unless you make a strategic commitment to explore I-space, you’ll learn about this vulnerability only when your end users migrate elsewhere. This has already been the experience of executives in industries such as recorded music, newspapers, broadcast news, and travel.

Despite the drama and significance of historic transitions in capitalism, they do not announce themselves. The pattern of change is one of overlapping and interwoven fields of transition rather than clean, unidirectional breaks. For those of us living through these transitions, they can be confusing and frustrating; resources invested in innovation serve only to fix what was, bringing us no closer to the future. But these times are also rich with unique opportunities for companies able to decipher the emerging pattern of mutation and to convert that understanding into new business models that support the complex needs of the 21st-century individual.

About the Author

Shoshana Zuboff, the former Charles Edward Wilson Professor of Business Administration at the Harvard Business School, is the author of In the Age of the Smart Machine: The Future of Work and Power (Basic Books, 1989), among other books.

Notes

¹ Joseph Schumpeter, “The creative response in economic history,” Journal of Economic History, 1947, Volume 7, Number 2, pp. 149–59.
² Distributed capitalism—and the shift away from business models based on economies of scale, asset intensification, concentration, and central control—was first described in my 2002 book, The Support Economy: Why Corporations Are Failing Individuals and the Next Episode of Capitalism, which I wrote with Jim Maxmin.

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Vanguard - Cash balance plans can hold hidden risks for plan sponsors

Vanguard

Vanguard | 08/31/2010

Legislative and accounting changes that require faster funding and balance-sheet pension cost disclosure—not to mention a 2008 market that devastated funding ratios—have given rise to a new respect for risk and volatility on the part of defined-benefit (DB) plan sponsors.

Plan sponsors who move to a cash balance plan from a traditional defined benefit (DB) plan may not always realize they are trading interest rate risk for investment risk, Vanguard’s chief actuary maintains.

“Generally, cash balance plan sponsors have the same goals and desires as any other plan,” said R. Evan Inglis, a principal in Vanguard Strategic Retirement Consulting and the chief actuary supporting Vanguard’s clients. “They are looking into ways that they can reduce risk. But reducing investment risk is actually easier with a traditional plan.”

That’s because while cash balance plans are technically DB plans since they provide a guaranteed level of benefit payable to a participant, the benefit is expressed as a lump-sum amount.  However, a traditional pension plan expresses its benefit as an annuity, payable over the participant’s lifetime.

As a result, it is more difficult to invest in assets that match the liability of the cash balance plan than it is to invest in assets that match the liability of a traditional pension plan, Mr. Inglis said. A traditional plan’s liability acts as a long-term bond, which means long bonds can be used to hedge the risk inherent in pension funding levels, he said. This can be a powerful risk-management tool because pension liabilities and bonds both change in value the same way when interest rates change. Investing in long-term bonds minimizes risk, but also allows for potentially a relatively high return.

On the other hand, the liability for a typical cash balance plan is not very sensitive to interest rates, Mr. Inglis said. The liability itself is more stable and predictable, especially because final average pay and early retirement provisions add volatility to a traditional plan. However, because there are no specific assets that will match the liability, the funded status of a cash balance plan is difficult to control, he said.

The original concept for cash balance plans was to credit a relatively low rate of interest to participant accounts and invest in a balanced portfolio that would generate investment earnings higher than the interest crediting rate, he said. That is likely (but not certain) to work fine over a very long time frame, but doesn’t allow for substantially eliminating uncertainty and volatility, Mr. Inglis said.  The reason is that most cash balance plans invest in a traditional balanced portfolio and cannot take advantage of liability-driven strategies that effectively reduce risk, he said.

Cash balance plan features
There are different ways, however, that cash balance plans can be structured, affecting the level of risk and ability to minimize risk.
Most cash balance plans credit a market rate of interest, which changes each year. The most common interest crediting rate is the 30-year Treasury rate. … For a cash balance plan that credits the 30-year Treasury rate to participant accounts, however, investing in 30-year Treasuries doesn’t match the liability, Mr. Inglis said. Each year when the interest crediting rate changes, there would be a gain or loss on the 30-year Treasury assets that’s not matched to the accounts, he said.
Other common interest crediting rates are the 10-year or 1-year Treasury rates. Plans that use the 1-year Treasury rate to credit interest on participant accounts can match the liability pretty well by investing in 1-year Treasuries, Mr. Inglis said. Doing so, however, sacrifices quite a bit of return relative to a traditional portfolio made up of 60% stocks and 40% bonds, he said.
Cash balance plans that use a fixed rate of interest for participant accounts are interest rate sensitive and allow for somewhat easier risk mitigation at higher rates of return, he said. Other plans have interest rate floors. “For example they may credit the 10-year Treasury rate with a minimum of 5%,” Mr. Inglis said. “When you do that you’ve introduced some interest rate sensitivity.” It’s hard, however, to actually invest in anything that matches the liability, he said. There may be some complex derivative strategies that match such a structure, Mr. Inglis said.  But it’s unlikely that most sponsors of cash balance plans are interested in such complicated approaches….
Accepting the efficient frontier

Image via Wikipedia

Beyond such strategies, however, there is little cash balance plan sponsors can do but accept that managing a cash balance plan means taking on investment risk they wouldn’t have to face managing a traditional DB plan.

“There’s just really no reasonable strategy you could adopt to minimize that risk other than to invest in cash or short bonds,” Mr. Inglis said. “That’s kind of the traditional efficient frontier approach.”
It’s a distinction that often goes unnoticed by many plan sponsors, he said.
“Plan sponsors with a traditional pension plan think: ‘Well, there’s a lot of volatility in this plan. We want to get rid of that and replace it with this cash balance plan because it is less risky, less volatile,’” he said. That’s true, however, only if both a cash balance and traditional DB plan invest in the same mix of stocks and bonds, Mr. Inglis said. Sponsors of traditional DB plans are more and more moving to a strategy when it can match its liability with long bonds.
It’s understandable that some employers have moved to cash balance plans. Many employees seem to understand the account balance concept offered in cash balance plans and appreciate the value of an account balance more than the value of a promised annuity. Also, younger participants may appreciate that the value of their benefit increases faster than in a traditional pension plan where much of the value accrues after age 45.
However, the potential to reduce risk and make costs predictable has to be considered alongside potential advantages.

Getting Tensions Right

How CEOs can turn conflict, dissent, and disagreement into a powerful tool for driving performance.

strategy+business magazine
by Ken Favaro and Saj-nicole Joni

Illustration by Lars Leetaru
Chief executives most often work in a pressure-cooker atmosphere where two kinds of tension are present. The first kind is the natural tension that exists among top teams, in which talented, driven people who have to work together are also competing with one another for results, power, and stature. The other kind is performance tension: the stress caused by three pairs of important objectives that, in many companies, come into conflict on a daily basis. These are profitability versus growth, the short term versus the long term, and the success of the organization as a whole versus that of its individual parts. …[The] most successful chief executives are the ones who get these tensions right. …Their mind-set is that having the “right fights” — embracing the right tensions and making them work for you — is the most effective way for companies and teams to move forward. As Brian Pitman, the former chief executive of Lloyds TSB, liked to put it: “You need real disagreement first to get true agreement later.”
The dynamics that exist within boardrooms and top teams vary widely, but most fall somewhere on what we call the relationship spectrum. At one end of this spectrum are the boards and teams that could be characterized as dysfunctional in a friendly way. The inclination to avoid conflict and to be in agreement is so strong that important issues never really get resolved. Consensus in these groups really means the absence of apparent disagreement rather than the presence of a shared commitment to decisions and actions. …
At the other end of the spectrum are the teams that are dysfunctional in an unfriendly way. This is where personal agendas, excessive pride, and turf battles over lesser issues get in the way of the real work that could improve a company’s performance and potential. … [People] are fighting against one another rather than for the company’s good.
The place to be is in between, as a productively tense team. Here there is enough like-mindedness on foundational matters (mission, goals, the facts, and so on) to allow the group to have the right fights in the right way over what matters most to the company’s current and future performance. …
Too little tension puts a company to sleep; too much bad tension diverts precious energy into the friction it creates. In our experience, creating a productively tense dynamic is essential to having a high-performance company. Therefore, instead of trying to eradicate tensions, leaders must choose to cultivate them productively.

Embracing the Right Tensions

… The three performance tensions — growth versus profitability, short term versus long term, and whole versus parts — provide fundamental energy that can be harnessed to deliver superior, sustainable results. The ability of the board, CEO, and executive team to navigate these tensions largely determines their company’s ability to both create wealth and serve society.
If the CEO, the top team, and the board aren’t spending the majority of their time on issues that address at least one of these three tensions, they are wasting their time on matters that are relatively unimportant. … Three examples — one for each tension — illustrate our point:
1. Profitability versus Growth. John Sunderland, the former CEO of Cadbury Schweppes, often responded with a parable when an executive argued that the business could increase either margins or sales, but not both. Sunderland would remind the executive of a time when people lived in mud huts and struggled to get both light and heat: Put a hole in the side of your hut, and you let the daylight in, but also the cold; block the opening, and you stayed warm, but sat in the dark. The invention of glass made it possible to have both light and heat. He would then ask, “Where is the glass?” … He found that it created more energy and raised the quality of thinking and debate.
2. Short Term versus Long Term. Norman Bobins was the chief executive of LaSalle Bank (now a subsidiary of ABN AMRO) in the 1990s and early 2000s, when it was one of the most successful middle-market banks in the United States. He tells this story …: “One of my managers came forward and proposed a [US]$180 million profit plan. I had in my head that $200 million should be possible. The manager’s response when I challenged him was, ‘Just tell me what you want and I’ll deliver it.’ I said to him, ‘You don’t get it. It’s not what I want; it’s how I want it achieved.’ The quality of earnings is as important as how much earnings are produced. ….”
Bobins’s approach was a masterful example of using the tension between short term and long term to improve the quality of management. He neither let the manager off the hook nor left him alone to sort out the tension for himself.
3. Whole versus Parts. Soon after Matthew Barrett became chief executive of Barclays PLC in 1999, he purposely introduced tension into a meeting of his executive committee (Exco), which included the executives who led different parts of Barclays. Barrett had become frustrated with how everyone put his or her part of the bank first. …“I took the Exco out for an away-day. Over dinner the night before, I said, ‘I’ve got some good news: I’m disbanding Exco.’ … I said, … ‘You either persuade yourselves that your first job is the co-management of the group and your second job is managing your piece, or I’m disbanding Exco.’ I wanted to create a sense of ownership for the [group’s most important] issues wherever they sat in the organization. It really turned things around. ….”
Barrett created a right fight over one of the most important tensions that exists in any large, complex company: how to make the whole more than just the sum of the parts. He used tension deliberately, aiming it squarely at improving the team’s effectiveness in driving the bank’s performance.
These CEOs have in common a focus not just on the right tensions, but also on using them in the right way: to move things forward, to energize, to spark new thinking, to wake people up! This is how they transformed their companies into great performers.
No business can escape the three performance tensions that pull it in different directions. Any top team or board that tries to ignore them is fooling itself and taking productive tension out of the company.

Test the Tensions within Your Board and Top Team

• How much time in your boardroom and with your top team is going toward the right tensions?
• How well are performance tensions being addressed by your strategy?
• How well do dissent, different views, and competing ideas surface, get discussed, and get productively decided?
• How good is your board’s or team’s alignment? Is it strong enough and focused enough to support right fights fought right?

Making Tensions Work for You

When CEOs, top teams, and boards are operating too close to either extreme of the relationship spectrum, at least one of three situations is nearly always present: The right tensions may be sitting under, rather than on, the surface. They may be recognized, but are not being resolved in the right way. Or there may be insufficient alignment around the foundations of high performance, such as vision, mission, goals, and facts.
… As we saw with Sunderland, Bobins, and Barrett, a productively tense dynamic at the top of a company keeps the most important tensions on the surface at all times for all to see. … This helps the entire company stay focused and prevents less-important matters from taking over the agenda.
But although keeping the right tensions on the surface at all times is the first step, it’s not the whole story. Right fights fought badly usually produce terrible results, leading to volatility, unpredictability, and the loss of energy and momentum. The idea is to pick the right fights, put them on the table, and then fight them in the right way.
For example, when Rolf Classon took over as CEO at a large health-care company, he unexpectedly found himself facing a very tough call. The company was far down the path of considering an acquisition that would make it a dominant player in its market. … Classon discovered that there were real doubters among the team members, including people whose opinions he respected.
Classon called together the team and told them he was uncertain about the acquisition. … He wanted to know what the team thought and to have them dig deeper into the substance of the reservations that many felt but hadn’t vocalized — questions for which there were no clear-cut right or wrong answers.
When the team members realized that Classon was engaging them in a new kind of inquiry — based on his belief that the relationships at the top had sufficient trust and respect to tolerate and even embrace dissent — a lot of new thinking came forward. … They decided to pass. Six months later, a much better acquisition opportunity came along, and the team had the resources, the time, and the mutual trust to act. The resulting acquisition took the company to another level.
In orchestrating this right fight, Classon had one important thing going for him: a strong foundation of alignment on which to build success. Another CEO, Douglas Conant, had no such foundation when he took the chief executive role at Campbell Soup Company in 2001. … Without a common view of what the organization was trying to accomplish, the leadership had become consumed with conflicting priorities and infighting, blaming one another for the financial mess they were in. The once revered American brand had lost its way and become the poorest-performing major food company in the world.
Conant faced each of the three performance tensions — in spades. But he was in no position to tackle them right away. He first had to build a foundation of alignment. So in his first 90 days, he worked with the leadership team to create a values statement, an “employees matter” promise, and a mission statement that defined Campbell’s purpose as “nourishing people’s lives everywhere, every day.” Fixing the company’s performance was important, but the mission had to come first.
At the same time, Conant knew he had to re-energize the organization and make it more innovative — and efficient. He started at the top, rearranging the hierarchy into a matrix to provide team members with broader lines of sight to facts (avoiding silos), and requiring them to “own” more than one perspective. …
Conant was candid about Campbell’s problems, telling his team that the company couldn’t “talk its way out of a situation it had behaved its way into.” He promised consistent, well-measured improvement, year over year. Slowly but surely, his focus on the future began to work. Pricing came into line. Product quality improved. The innovation pipeline became full again.
By the end of 2008, Campbell’s was ranked in the top 10 percent of food companies in financial performance and in the top quartile of Fortune 500 companies in employee morale.
By starting with building sufficient alignment on vision, mission, goals, and facts, and then structuring a way forward that made the lines of tension visible and safe, Conant stopped all the fighting about things that didn’t really matter and turned his team’s attention to fighting really well about the few critical things that did.

Becoming Productively Tense

Many boards and top teams have too little good tension in them; … Many others have too much bad tension in them; … Both dynamics are dysfunctional and ultimately undermine a company’s ability to realize its full potential.
The sweet spot is the dynamic of being productively tense — where the fights are primarily about the right performance tensions, where the fights are conducted in the right way, and where there is sufficient alignment to make dissent and disagreement work in favor of better decision making, faster learning, and more effective solutions.
Every CEO must master the management of tensions, raising and lowering them. This is one of the most important tools a top leader can use to realize a company’s and team’s true potential. Chances are, there is at least one thing your team is fighting about that’s not worth the effort, and one thing the team has let pass that needs to be addressed now.
Reprint No. 10301

Author Profiles:

• Ken Favaro is a senior partner with Booz & Company based in New York. He leads the firm’s work in enterprise strategy and finance.
• Saj-nicole Joni is a business strategist and confidential advisor to CEOs and their top executives around the globe. She is the founder and CEO of Cambridge International Group.
• Examples in this article were drawn from The Right Fight: How Great Leaders Use Healthy Conflict to Drive Performance, Innovation, and Value, by Saj-nicole Joni and Damon Beyer (HarperBusiness, 2010), and The Three Tensions: Winning the Struggle to Perform without Compromise, by Dominic Dodd and Ken Favaro (Jossey-Bass, 2007).

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