What’s Your Succession Strategy for Managing Your DB Plan?

Executive summary:

While the retirement of several high-profile CIOs has generated ample news, and headlines, there’s been very little press coverage about OCIO as a potential solution. We find this perplexing.
We believe that for most organizations, OCIO is a scalable and cost-effective solution that warrants serious consideration.
Managing a DB plan is very different from managing a DC plan, as it requires a specific skill set. This is where we believe investment outsourcing can help.

June 2023 update

Since this article was published last August, we’ve received remarkable engagement from clients and prospects alike. And in the months that have passed, headlines about the retirements of several high-profile chief investment officers (CIOs) have generated waves across the DB space, sounding the alarm on what we see as a growing problem: the aging—and therefore shrinking—talent pool of CIOs.

But here’s the rub: Despite the alarm bells going off in the industry, there continues to be very little mention in the press of OCIO as a potential option for corporations. In other words, while there’s a profound awareness among plan sponsors that CIOs are exiting the business, there’s a surprising lack of press coverage about investment outsourcing as a solution. To be frank, this is perplexing, especially since OCIO is now a fully mature solution. In this day and age, shouldn’t a comprehensive talent management process consider OCIO as an option?

And that’s ultimately why we’re publishing this article again, and why we’ll continue beating the drum on this topic for as long as it takes—because we firmly believe that for most organizations, OCIO is a scalable and cost-effective solution that deserves serious consideration. To those reading, my only ask is this: After finishing this article, might it be prudent to finally explore what OCIO could do for your organization's investment program?

Let's be blunt: Defined benefit—or DB—plans are fast becoming legacy functions for many corporate plan sponsors. Because of the specialized knowledge required that is frequently far from the organization's core mission, creating an ongoing staffing plan can be a challenge. This is especially true in a world where there aren't a ton of recent college grads targeting a career in the DB management space. With all that in mind, how do you manage succession risk for your DB plan?

I know this issue intimately because I used to manage the small team at Pacific Gas and Electric (one of the largest DB plans in the U.S. at the time) that was responsible for trust investments. When I was there, the treasurer would come to me once a year and ask me to line out my succession plan. What he was really asking was, "Who's going to manage this thing if you get hit by the red truck?"

It was an often uncomfortable question because the resulting list of candidates who were ready now was typically pretty short. At the same time, I understood that it had to be asked. It would have been irresponsible for the organization to not have a succession plan in place, especially considering that many DB plans have a significant impact not just on the plan participants, but on the overall organizational bottom line as well.

Succession planning is a critical part of management at all well-run organizations, whether or not red-truck accidents are involved. Turnover has always been a known challenge. Add onto that the Great Resignation, staffing challenges, and low unemployment, and your best practice for DB succession planning is, well, to be planful.

Why is DB succession planning particularly difficult?

Making contingency plans to replace any senior role takes thought and effort, but for most DB plans, it is especially challenging. Here's why:

The DB staff is just too small. If you have a staff of only 2.5 people, the chances that the second-in-command is ready to take over running the function are logically slim. And building out a meaningful career ladder on a small team working in a legacy function—well, that's going to be tough, too.
There's a big DB learning curve. Investing is complicated. Institutional investing is doubly so. Add to that the need to become a journeyman DB plan actuary and pension accountant, and it's understandable that it takes years for even the brightest candidates to get fully up to speed. Honestly, it takes years just to understand all the acronyms.
Your best and brightest successors may have already left. If you're lucky enough to have that rising star sitting in the next chair down, they're likely exploring other career opportunities. Or they may have already left because they wanted to leverage their experience in a related role in an organization where that knowledge was closer to the firm's mission. That's why I left my PG&E role, in case you were wondering.
Recruiting externally in the DB space is tough. More experienced candidates may be expensive. To get the good ones at any level, you may have to compete with higher-paying opportunities. And with so many plans moving toward frozen status, DB plan management may not be the most intuitive career choice for candidates early in their work lives.
You'll even have to compete with your own organization. If your HR department helps you find a real hotshot MBA, will they prioritize managing the pension plan, especially if that plan is moving toward frozen? Again, the job is important but often viewed as less than mission-critical, given that most asset owners are not investment firms.

Managing a DB and DC plan is different. The skill set is different, too.

Why wouldn't you just move your DB plan management under your defined contribution (DC) plan? If, like most organizations, you've shifted all or mostly from DB to DC, then you likely already know how different managing the two types of plans can be. For me, the biggest difference is the impact on the overall corporate bottom line. DB plan management is really about managing the plan's funded status. A DC plan is, by definition, always 100% funded. There is no balance-sheet dimension. There is no funding-gap impact on corporate profits. This, of course, removes a massive level of stress. But it also removes the financial management challenges that may energize some DB-management succession candidates.

Listen: A well-run DC plan is worth its weight in gold in attracting and retaining human resources in today's labor market. But DC plans tend to be team-managed by HR and investments. HR typically handles recordkeeping. HR gets the phone calls from disgruntled participants. And if those disgruntled participants are complaining about investment choices, that consideration can influence asset management decision-making. In other words, the investment challenges can just be narrower in DC plans, where asset allocation—outside of selecting a target date fund glide path—is left to participants.

Why OCIO strikes me personally as a logical option

Let's get right to the punchline: If you're thinking about your org's DB succession plan—if you're thinking about that red truck—then you should think about some level of outsourcing. Let me tell you why, based on my own experience.

When I was at PG&E, I was an island—I was an investor in the middle of an ocean of utility professionals. If the topic was utilities, I was a novice. But if the topic was DB plan pension investing, I could easily be the smartest guy in most rooms. It was personally great … but I would argue risky for the organization. There was just no redundancy.

At Russell Investments, I'm side-by-side with about 1,400 people dedicated to improving people's financial security—often via DB plans. If I leave, there are 1,399-ish other people standing by who can provide answers as well as I can. There is simply a much larger pool of expertise. Not only do I have a drastically larger team of resources, but the beneficiaries of my clients' plans do also as well.

Hiring a team, via OCIO, rather than hiring an individual, reduces risks of institutional knowledge loss. It manages the risk of all that knowledge disappearing if the red-truck event occurs. This is not a sales pitch. It's just a fact. Asset owner succession planning risk is diminished because firms with robust capabilities—like Russell—have intentional redundancy, business risk management, and business continuity teams. They manage other related continuity risks as well—such as cybersecurity—with robust, vigilant purpose-built efforts.

Four additional OCIO benefits for succession planning

Specialized expertise across all required categories. When I was running a DB function at PG&E, my small team never managed to become experts in all the areas needing expertise. With OCIO, my clients have access to customized advice to increase returns, reduce risk and manage costs. But there are all the little subcategories that demand consideration as well: manager strategies, overlays, private markets, ESG, and on and on.
Economies of scale. OCIO can not only help with succession risk but can also provide an opportunity to piggyback on a drastically higher level of investment scale. Providers like Russell are almost always able to reduce costs for the OCIO client because it is what we do. Our economy of scale results from the aggregate power of managing many plans, not just one. So you may be able to achieve your objectives more reliably, with improved risk management and succession-risk mitigation, all for less money.
It's not an all-or-nothing decision. Be sure you understand the shades of gray between insourcing and outsourcing—it's not an all-or-nothing thing. The best OCIO providers will meet clients where they are. Some clients see the greatest risk in manager contracting, so they may outsource that to firms like us, but decide to keep actual manager selection decisions in-house. One way you could approach outsourcing would be to look at your greatest, lay-awake-at-night risks and just outsource those. Regarding succession specifically, one CIO we work with who is near the end of their career has begun to prepare the firm for their departure by just outsourcing risk management. This way, the firm can test the OCIO waters with this one assignment, and then potentially move further along the outsourcing spectrum.
Outsourcing can create valuable optionality. Let's look at two succession scenarios. In option one, you implement changes to a new internal staff resource—either through an external recruiting and onboarding process or through promoting a junior member to the senior DB management role. In option two, you outsource to an OCIO provider. Now let's imagine, for whatever reason, you're unhappy with the results. Is it easier to reverse internal staff issues through firing and restructuring and re-recruiting and restaffing? Or is it easier to move to another OCIO provider?

Be careful who you outsource to

Is there a different kind of succession-planning risk with OCIO providers? Yes. It's known as key-person risk. The risk is about the key person—the person at the OCIO provider who most impacts the success of your plan. If that person leaves, how much might that negatively impact your plan? How much of your relationship is locked up with one special person?

To alleviate key-person risk, make sure you work with a provider that does not have star manager issues. Ask about years of tenure for portfolio managers and client executives. Make sure the OCIO provider takes a team approach to clients. A wise buyer should ask about client satisfaction and tenure.

The bottom line

What's your DB management succession plan? Senior financial leaders should seriously evaluate OCIO as a succession planning alternative. But before you flip the switch, get educated on OCIO. An educated investor is the best kind.

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