The Markets July 18, 2014

Equity Overweighting Likely as 401(k)s See Record Balances

Savings in defined contribution (DC) retirement plan accounts recordkept by Fidelity grew 12.9% in the last year, to an average balance of $91,000.
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The average balance is up from $80,600 at the end of the second quarter 2013, Fidelity says. The figure includes all employees participating in workplace retirement plans served by Fidelity, regardless of career stage. For those employees who have been active in a workplace 401(k) retirement plan for 10 years or longer, average balances rose 15% per year over the past decade to reach $246,200, according to a quarterly Fidelity analysis.

Jeanne Thompson, vice president of thought leadership for Fidelity Investments, says the growth has caused a significant amount of unintentional style drift within retirement portfolios.

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“I actually went back into the data and looked at the average percent equity our participants are holding, and right now it’s up at 73% of assets, which includes equity assets held in professionally managed options like target-date funds,” Thompson tells PLANADVISER. “Going back to 2010, they were only holding 64% in equity. This suggests to me that it’s likely many people are overweight on equities without realizing it.”

Thompson says the more distressing fact she pulled from the data is this: Of the approximately 63% of workplace retirement investors that Fidelity classifies as “do-it-yourself” investors—i.e., those who create and manage their own portfolios rather than buy into a managed account or target-date option—many have not checked on their accounts even once in the last two years.

“They haven’t gone in to do a fund exchange or reset their asset allocation or do anything,” Thompson says. “With the markets rising pretty steadily over the last two years, again many are overweight in equities without realizing it. Those people doing it on their own, they need to take responsibility for rebalancing and taking charge of their investments, or they could suffer more than they have to should the market experience a correction. We are strongly recommending that folks go in and make sure they’re only taking on as much risk as they are comfortable with in case the markets fall.”

Individual retirement account (IRA) investors experienced similar growth in the last 12 months, Fidelity says. The average balance of Fidelity IRAs now stands at a record high $92,600, also nearly a 15% increase over the average balance from a year ago.

Thompson points to strong stock market gains as the principal factor underlying the record-setting balance growth. Indeed, the analysis shows as much as 77% of the one-year 401(k) average balance increase was due to the equity markets. Just 23% of the growth, in turn, was based on combined employee and employer contributions.

Fidelity 401(k) Infographic

 

But Thompson is quick to point out that this is out of the ordinary.

“Looking at contributions over the last 10 year period, the data tells a much different story,” she explains. “We see that since 2004, 55% of the net account growth was due to the markets, and 45% was due to contributions. We don’t necessarily have the data needed to look back farther, but it’s certainly possible that over a longer term the impact of contributions will be equal to or even outweigh the impact of investment returns.”

Thompson says this fact “really highlights the role the markets have played in the last year, but over the long term, it’s much more equal between the markets and contributions.” Therefore it’s critical for plan sponsors and advisers to remind participants that it’s not just the investment decisions or the asset allocations underlying growth and successful outcomes, she continues.

“Long-term success is just as much about maintaining high contribution levels as well,” she adds. “If you look at periods like 2008 and 2009, when the markets were not doing well, it was zero-return environment at best for many investors. Any growth in account balances during that time was driven by contributions.”

Interestingly, Thompson says, Fidelity’s data shows employee contribution levels do not respond significantly to market crashes or surges. Contributions by employees to 401(k)s accounts averaged $6,050 over the past year, with an average of $3,540 being contributed in the form of employer matches. Both figures are rising, Thompson says, albeit slowly.

“That is actually encouraging to us,” she says. “Employees seem to maintain their contributions regardless of what the markets are doing, and again that’s critical for long-term success. As the markets are going down, as a long-term investor you can buy in at a lower price and then later on reap the benefits of dollar cost averaging and compounding. If you’re only going to contribute when the market is high, you’re chasing performance. Especially with retirement being a 40 year proposition, potentially. You need to maintain some equity allocation and you need to keep contributing even in the down markets.”

The Markets July 18, 2014

Options for Pension Risk Transfer Expanding

A pension plan transaction recently announced by British Telecom, offers a glimpse of a coming pension risk transfer option for U.S. defined benefit plan sponsors.
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On July 7, the British Telecom (BT) pension plan trustee announced longevity insurance and reinsurance arrangements have been entered into to provide long-term protection and income to the plan in the event that members live longer than currently expected. To facilitate the transaction and maximize the plan’s access to the global insurance and reinsurance market, the trustee has set up a wholly owned insurance company and transferred longevity risk to this insurer, which has in turn reinsured this longevity risk with The Prudential Insurance Company of America.

Amy Kessler, a senior vice president and head of Longevity Reinsurance within Prudential Retirement’s Pension Risk Transfer business, tells PLANADVISER that since the BT transaction, more U.S. clients with foreign subsidiaries that are struggling with de-risking their UK, Canadian or Dutch pension plans are inquiring about their options abroad.

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Kessler notes defined benefit plan sponsors have liability risk because they do not know how long people will live, and they have asset risk because they do not know how the market will perform. In the 2000s, more plan sponsors started turning to liability-driven investing (LDI) strategies, in which they add long-duration bonds and other fixed-income investments, to try to match liabilities to assets. While U.S. plan sponsors were turning to LDI, those in the UK were moving on to pension risk buy-ins or buy-outs. Beginning in 2011, U.S. plan sponsors began following the UK’s lead.

The transaction BT announced is different and newer, however. Kessler explains that in the UK, many pension plans that began using LDI years ago now have 70% to 80% of their portfolios invested in fixed-income with longer durations to match liabilities, and because they are so heavily invested in fixed income, they are no longer expected to “outrun” life expectancies. If life expectancies continue to increase, the pension plans will have to come up with cash to continue paying annuitants. Rather than retain that risk, the largest plans in the UK are buying longevity insurance to lock in a future cash flow that will help pay benefits after annuitants reach their life expectancy. “That gives the pension funds a fixed and known future liability cash flow,” Kessler says. There have been many such transactions in the UK, and Prudential expects the first longevity insurance deal in Canada in the not-too-distant future, she adds.

However, this solution has not yet migrated to the United States. Kessler says this is in part because of the asset mix of U.S. defined benefit plan portfolios, and the U.S. market has just begun to adopt up-to-date longevity expectations. A key deterrent has been the mortality tables used by U.S. plans, but new mortality tables look more like what insurance companies use. In addition, once U.S. defined benefit plans get to 70% to 80% of assets in longer duration fixed-income investments, longevity insurance will be a viable solution for longevity risk. “It’s a turning point in the U.S. market—a time for plan sponsors to take a look at the new solution as well as revisit the other two,” Kessler says.

Kessler explains that a buy-out covers all asset and liability risk associated with the annuitants for whom the buy-out transaction is made. An annuity is purchased by the plan to settle certain pension liabilities. It is a full settlement, so the portion of liabilities annuitized leaves the plan sponsor’s balance sheet and goes on the balance sheet of the insurance company. Kessler says this is a holistic, bundled solution similar to what GM and Verizon entered into with Prudential. “From that moment forward, Prudential pays participants directly,” she explains. She adds that a buy-out is a solution available in the U.S., UK, Canada and the Netherlands.

A buy-in is similar in that it is an insurance product that covers all asset and liability risk for annuitants covered, but the key difference, Kessler explains, is a buy-in is a contract between the insurance company and the pension plan, which is held in the plan, rather than a settlement of the liability. The first U.S. pension risk transfer transaction was a buy-in Hickory Springs Manufacturing in Hickory, North Carolina, entered into with Prudential. Prudential knows the amount of the payout obligation the plan has each month and matches that liability. Prudential is responsible for all of asset and liability risk, and pays the benefits into the pension plan, while the plan cuts the checks to annuitants. Kessler says buy-ins are the most frequently used pension risk transfer transactions in the UK. Buy-in solutions are also available in Canada.

Prudential recommends defined benefit plan sponsors start working with actuarial consultants to prepare their data and to look at the different solutions available side-by-side to see which is best. “One of the things we think is very exciting about all the innovation that has happened in pension risk transfer space in the UK, is we can bring all those ideas to the U.S. market,” Kessler says, adding that plan sponsors should engage in dialogue with insurers about the goals for their plans and the resources available.

According to Kessler, “For the first time in a long time, U.S. pensions have a healthy funded status, and a lot of plans are in striking position to reduce risk or transfer risk. It’s a good time to think about getting risk off the table.”

She notes that in the past there have been various windows of opportunity where plans were well-funded, but at some point there’s economic difficulty again. “There’s a sense of urgency to de-risk today, to strike when the iron’s hot, because there’s likely, at some point, to be a turn in the business cycle.”

More information about pension risk transfer from Prudential is at http://pensionrisk.prudential.com.

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