Data & Research March 5, 2018

DC Plans Slowly Close Pension Performance Advantage

According to data from CEM Benchmarking, defined benefit pensions have outperformed defined contribution plans by less than half a percentage point over the last decade—described as a “huge improvement” for DC plan sponsors.

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Data collected by CEM Benchmarking from close to 2,000 defined benefit (DB) pension funds and over 1,600 defined contribution (DC) plans over the last 10 years suggests DB plans outperformed DC plans after fees by only 0.46%.

As researchers note, this is “a massive improvement” from the previous comparison reviewing the 1998 to 2005 time period, where the net return difference was 1.8%. According to the independent provider of cost and performance analysis for pension funds, DC plans, sovereign wealth funds and other large institutional investors, “this is simply great news for DC plan participants.”

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“Our first study was all doom and gloom,” observes Sandy Halim, lead author of the study at CEM Benchmarking. “The warning message was, in 25 years, DC account value would be 34% smaller than DB plans if they both started with the same dollar amount. Thankfully, our updated research shows that’s no longer the case since plan sponsors made substantial improvements to their plans during the past 11 years. This translates to a much smaller 12% difference in account balance over 25 years.”

The first source for the improved DC plan performance, Halim says, is a significantly improved asset mix. In 1998, company stock, stable value and cash represented 44% of all of DC plans’ holdings, whereas by 2016, these holdings had decreased to 25%.

“The assets have mainly moved to target-date funds and balanced funds,” Halim confirms. “In 1998, 15% of assets were in target-date funds and balanced funds, compared to 26% by 2016. Target-date funds, in particular, have exploded in popularity. In 2007, 46% of plans in our DC database offered a target-date fund, compared to 87% in 2016.”

And the asset mix is not the only plan design element to show massive improvements, CEM researchers find. There is clear evidence of much greater use of automatic enrollment, and greater use of a sensible default options as qualified default investment alternatives. Beyond this, Halim says, there were “many lessons learned from behavioral economics” in the early 2000’s that are now paying real dividends. Some of the most impressive gains include the following: 

  • Automatic enrollment in primary retirement plan now in place for 80% of all sponsors surveyed, up from 62% in 2007. Additionally, 70% of supplemental plans featured auto-enrollment in 2016, up from 51% in 2007.
  • Fully 95% of plans now have a default option, up from 79% in 2007.
  • As of 2016, 84% of sponsors have a target-date fund as their default option, up from 30% in 2007.
  • The biggest asset mix improvement has been realized within DC plans that no longer used a GIC/stable value/cash investment option as their default option. This represents just 1% of plans in 2016, down from 21% in 2007.

“Many plan sponsors took these lessons to heart and made plan design changes that resulted in higher participation and a better DC asset mix,” Halim adds.

Since the last study, average DB fund costs have increased from 0.40% to 0.60%, whereas DC plan costs have remained constant at 0.39%. This cost saving of 0.21% has also contributed to the lower net return difference, Halim says.

“DB plan costs have increased because DB plans are embracing more, higher cost, alternative assets (23% in 2016 for combined policy weight in real assets, private equity and hedge funds up from 14% in 2007),” the research shows. “DC plan costs have remained the same despite their improved asset mix, as they have also embraced low cost indexed options (58% of the indexable assets were in passive options in 2016, up from 40% in 1998).”

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Data & Research March 2, 2018

Auto Enroll and Opt-In Plans Need Different Efforts to Get Participants Engaged

A study from the TIAA Institute finds focusing on financial literacy and understanding of exponential growth boosts participation and savings in an opt-in DC plan plan, while efforts targeted at procrastination tendencies do so for automatic enrollment plans.

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A study from the TIAA Institute concludes that focusing on financial literacy and understanding of exponential growth is likely to be fruitful for getting defined contribution (DC) plan participants in an opt-in plan, while efforts targeted at procrastination tendencies are likely to be particularly important in automatic enrollment plans.

The study looked at employees of the U.S. Office of Personnel Management (OPM). Benefits-covered federal employees participate in an optional defined contribution (DC) plan, the Thrift Savings Plan (TSP). The Federal government implemented automatic enrollment for all benefits-covered employees hired after August 1, 2010. Under automatic enrollment, employees are enrolled in the TSP at a 3% deferral rate, while employees hired prior to August 2010 had to opt in to participate in the TSP.

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TIAA quantified present bias (PB), which is the tendency to exhibit patience when contemplating tradeoffs between future periods, but impatience when making tradeoffs between the present and the future; this is the central measure of procrastination tendencies. It also quantifies understanding of exponential growth by measuring exponential growth bias (EGB) and financial literacy.

According to the study report, defaults have been shown to have powerful effects on retirement saving behavior. Under auto-enrollment (AE) with a default contribution rate of 3%, the tendency to procrastinate is associated with higher tendencies to remain at the default contribution rate; however, procrastination tendencies do not predict such behavior in the opt-in regime in which the default contribution rate is effectively 0%. By contrast, the TIAA Institute found that lower financial understanding and misunderstanding of exponential growth increases the likelihood of remaining at the default rate under the opt-in regime, but these factors do not predict this behavior in the opt-out (auto-enrollment) regime.

Approximately 9% of pre-AE employees are at their default contribution rate of 0%, while 14.7% of post-AE employees are at their default contribution rate of 3%. The two groups of employees also differ on their contributions at higher levels. Approximately 19% of pre-AE employees contribute 5% of their salary—the amount to maximize the company match, while 31.1% of post-AE employees contribute 5%.

The institute also observed that whereas 13.3% of pre-AE employees are contributing the annual maximum statutory limit for deferrals, only 6% of post-AE employees are at this cap. Employees hired before AE have annual TSP contributions of $8,460 on average, while the younger cohort hired after AE average $5,223. The institute does note that because automatic enrollment is determined by hire date, and its data comes from a single cross-section, people hired before automatic enrollment are also longer-tenured and generally older. Therefore, some of the differences may be due to systematic differences in tenure and/or age between the two groups.

According to the study report, TSP annual contributions are increasing in age, possibly due to increases in salaries; notwithstanding, the pre-AE cohort consistently contributes more than the post-AE cohort at any given age.

The results show no evidence that PB is a predictor of remaining at the default when the default contribution rate is 0%, but strong evidence that PB is a predictor of remaining at the default when the default contribution rate is 3%. While procrastination tendency does not predict remaining at the default contribution rate for employees hired under the opt-in regime, EGB and financial literacy do predict this behavior.

An Insights report and the full research report may be downloaded from here.

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