DC Accounts Continue to Rebound from Credit Crisis
The average account balance of consistent participants in 401(k) plans saw a 6.8% annualized increase between year-end 2007 and year-end 2012, says a new study.
The increase reflects both employer and worker
contributions, according to joint research from the Employee Benefit Research
Institute (EBRI) and the Investment Company Institute (ICI), as well as
investment returns, withdrawals and loans. As the study points out, this
relatively strong yearly growth comes despite a 34.7% drop in the average
401(k) account balance experienced during the depths of the most recent
financial crisis, circa 2008.
The study, called “What Does Consistent Participation in
401(k) Plans Generate? Changes in 401(k) Account Balances, 2007–2012,” also
discovered that the average account balance of “consistent participants” was
67% higher than the average account balance among all participants in the
EBRI/ICI 401(k) database. Sarah Holden, ICI’s senior director of retirement and
investor research and coauthor of the study, says this result suggests that
contributing to a 401(k) plan consistently is likely to result in higher
account balances—even during periods of substantial market volatility.
This study also revealed that slightly more consistent
401(k) participants—i.e., those with accounts during each year in the sample
period—held target-date funds (TDFs) at year-end 2012 than did so at year-end
2007. According to Jack VanDerhei, EBRI research director and coauthor of the
study, almost one-third of those holding target-date assets invested all of
their 401(k) balances in TDFs.
“The data confirms the continuing important role of
target-date funds in 401(k) plans, revealing that a substantial core of
consistent 401(k) participants who held at least some target-date fund assets
in their account before the financial crisis, still did so at year-end 2012,”
he explains.
When analyzing the group of consistent 401(k) participants
at year-end 2012, the data showed that 4.5% had added a TDF allocation since
2007. At year-end 2007, 27.6% of 401(k) participants in the consistent sample
owned target-date funds. By year-end 2012, ownership in the consistent sample
had increased to 32.1%. More than two in five (43.7%) consistent 401(k)
participants in their 20s had target-date funds in their 401(k) accounts at
year-end 2012, compared with 28.4% of consistent 401(k) participants in their
60s.
Looking at the wider sample, ownership of TDFs in 2012 had
increased considerably to reach 41%, an increase of 15.9 percentage points
since 2007. Because TDFs are often used as a default investment option in
401(k) plans with automatic enrollment, some of their growth is related to the
spread of automatic enrollment in recent years, the study says.
On average, around three-fifths of 401(k) participants’
assets were invested in equities, either through equity funds, the equity
portion of target-date funds, the equity portion of non-target date balanced
funds, or company stock. Younger 401(k) participants tend to have higher
concentrations in equities than older 401(k) participants, according to the
study.
Trends in the consistent group’s account balances highlight
the accumulation effect of ongoing 401(k) participation, the study shows. At
year-end 2012, 15.5% of the consistent group had more than $200,000 in their
401(k) accounts at their current employers, while another 16.2% had between
$100,000 and $200,000. In contrast, in the broader EBRI/ICI 401(k) database,
just 8.5% of participants had accounts with more than $200,000, and 9.5% had
between $100,000 and $200,000.
While
it’s true that advisers are often hired to assist with defined contribution
(DC) retirement plans, knowledge of defined benefit (DB) issues can still be a
big value-add.
There are any number of ways for an adviser to use knowledge
of DB plan issues to demonstrate value to existing and prospective clients,
says Wayne Daniel, head of U.S. Pensions at MetLife. Obviously, DB plan
insights will be valuable for advisers actually serving DB plans, he says, whether
as a discretionary investment manager or in a more hands-off advisory capacity.
But even for those advisers with a heavy DC focus, it will almost certainly be
a positive to gain more knowledge about the difficulties facing pension plan
sponsors, he says.
“It’s pretty straightforward—the more knowledgeable about
innovation and the evolution of the wider retirement planning industry that the
adviser brings to the table, the more they can benefit their clients,” Daniel tells
PLANADVISER. “Even if the adviser is serving a DC client, or a client with both
DC and DB [plans], the knowledge can be a big differentiator.”
Daniel says this is especially true as the advisory
marketplace becomes increasingly competitive, due in part to merging business
models and new “robo-adviser” technologies. In such an environment it will be
increasingly important for advisers to be able to demonstrate that they are
keeping on top of the latest industry developments, Daniel adds, both on the DB
and DC sides of the industry.
Indeed, data
from Cerulli Associates suggests fewer than 1,500 of the more than 16,500 firms
in the registered independent adviser (RIA) channel manage 90% of the assets as
of the start of 2013. Schwab Advisor Services published similar findings in a recent
independent adviser outlook survey, which shows a strong majority (71%) of RIAs
believe there will be increased competition for new assets in the next five
years. Schwab says the number of RIAs believing their strongest competition will
come from other RIAs falls significantly looking beyond 2018, with greater
competition in the longterm expected mostly from the development of national
RIAs and online investment advisers.
And besides, there is significant overlap of concern between
DB and DC plans, Daniel explains. For example, the principles of
liability-driven investing (LDI) are clearly important for pension plans
looking to reduce funded status volatility and better align assets with
projected benefit payment schedules. But DC plan participants, too, are increasingly
demanding LDI approaches within their investment options (see “Is
LDI Feasible for DC Participants?”). Like pension plans, their attention is
shifting slowly from securing maximum investment returns to limiting volatility
and ensuring steady income will be available post-retirement.
“Pension
plan issues may not be something that is directly relevant for every particular
client an adviser serves—but advisers need to be able to demonstrate they
understand new products and strategies, and they need to explain why they are
relevant or not relevant,” Daniel adds. “Even if the client doesn’t have a DB
plan, you don’t want to be clueless if they start asking questions.”
One area in particular where advisers can demonstrate they
are keeping tabs on DB industry development is in the area of pension risk
transfer (PRT), Daniel explains. Plan
sponsors have a whole spectrum of options for offloading pension risk,
including the strategy of a pension “buy-in.”
While buy-ins are a relatively new pension risk transfer
strategy in the U.S.—with the first significant buy-in
deal coming in mid-2011—most plan sponsors have heard of so-called
pension “buyouts.” As Daniel explains, buyouts involve a plan sponsor
transferring all or part of the pension plan’s benefit liability directly onto
an insurer’s balance sheet. The insurer accepts all or part of the pension
plan’s assets as a premium payment for taking on the longevity, inflation and
investment risk associated with operating the pension plan.
Despite the naming convention, buy-in risk transfers are
actually similar to buyouts in many respects, Daniel says. “Exactly as for a
buyout, the pension plan makes a single premium payment to the insurer to enact
the buy-in, and the payment can either be 100% lump sum cash or it can be
assets in kind,” he explains. “And the single premium payment covers the future
benefit payments for either a selected group or all of the plan participants.
In turn, the insurer issues a group annuity contract to the plan. So far the
process is exactly the same as for a buy-in or a buyout.”
Where the buy-in differs is that, rather than taking over
the benefits payment schedule of the employer, the insurance company instead
makes a monthly bulk payment back to the pension plan to cover either current
or future cash flow needs, Daniel says. Cash payments to the employer represent
the monthly benefit amount covered under the buy-in contract.
“So one of the big differences, then, there is no direct
relationship between MetLife and the plan participant under the buy-in
arrangement,” he says. “The pension plan continues to make the pension
payments, and then the insurer makes payments to the pension plan to ensure the
necessary cash will be there to pay benefits that are claimed.”
Daniel says another and perhaps more informative name for
“buy-ins,” under which MetLife originally marketed this type of service, is
“pension cash-flow guarantee.” As this name implies, the benefit for plan
sponsors is ensuring the plan will have enough cash on hand at a given point to
meet projected benefits obligations.
“So
you see a pension buy-in is really part of the risk transfer spectrum,” Daniel
adds. “You can actually think of the full buyout—when all of the liabilities
and all of the assets are transferred to the insurer—as being on one end of the
spectrum, and then aggressive LDI is on the other end. Under this analogy the
buy-in concept would fit somewhere right in the middle.” LDI, or liability-driven investing,
is an asset allocation strategy that tries to match plan assets with
liabilities.
Daniel says MetLife has been a leader in bringing this type
of service to U.S. pension plan sponsors—adding that the firm secured what he
believes was the largest buy-in contract to-date in the U.S. earlier this year,
valued at $92 million. He says the firm is currently working to increase
acceptance of buy-in strategies among U.S. plan sponsors, and to give current
and potential clients a better sense of how buy-in strategies work.
One of the chief objectives, he says, is to help plan
sponsors (as well as the advisers guiding them) realize that different pension
risk transfer options can work together over time to smoothly de-risk a pension
plan.
“When the plan sponsor is beginning to think about a risk
transfer, this is generally coming only after the sponsor first reviewed the
liabilities within the plan and accurately projected the benefits schedules.
Perhaps they have already implemented an LDI portfolio,” Daniel explains. “Once
the assets are appropriately aligned, we start to see a reduction in the
volatility of the plan’s funded status. It then becomes easier for the plan to
start targeting for either a buy-in or a buy-out, whether for the whole plan or
for a section of the participants.”
He points to the UK market to demonstrate the idea. “In the
UK, employers moved to mark-to-market accounting faster and further than the
U.S. for the most part,” he explains. “And so, plans in the UK and their
corporate sponsors actually have for a while been forced to recognize the true
economic cost of holding the defined benefit promises that they’ve made. And
also in the UK, we saw a significant increase in the regulatory cost of
operating a defined benefit plan, such as increases in the pension protection
fund levies, and the regulator mandates fairly aggressive rates of improvement
in future longevity tables.”
All of this has more quickly added to the cost and pressure
for UK pension plans, he explains, which is why in the UK, plan sponsors saw a
need to de-risk earlier and there was recognition that for many plans
de-risking was going to have to happen in several stages.
“For those that were not fully funded or ready to move to
full buyout, a buy-in was a very appropriate solution,” he explains. “So
buy-ins became a fairly typical route from LDI to the full offloading of
pension liabilities. In fact, we’ve seen in some previous years that, in terms
of the total number and value of transactions in the UK de-risking market,
buy-ins have exceeded buyouts in recent years. It’s a major feature of that
market.”
Daniel says similar pressures are emerging in the U.S. as
significant increases in PBGC premiums take effect (see “PBGC
Premium Hikes Shake Up Buyout Landscape”). He says the pending adoption of
new Society of Actuaries mortality tables accounting for improved longevity
among U.S. retirees could cause projected liabilities to jump
as much as 8% for the typical pension plan immediately upon
implementation.
“It’s
clear the costs associated with managing the risks within pension plans are
going up, year in and year out, and plan sponsors are seeing that,” Daniel
continues. “Their advisers are pointing it out, and while we do expect to see
more buy-ins in the future in the U.S., I think that a lot of plan sponsors
will still go straight to buy-outs, more so than in the UK. We’re hoping to
change that.”