The Markets April 24, 2014

More Reasons for De-Risking DB Plans

Employers are finding more reasons to de-risk their defined benefit (DB) retirement plans, says a new analysis from Buck Consultants.
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The analysis, “Employers Finding More Reasons to De-Risk Retirement Plans,” observes how improvements in the funding status of DB plans are prompting DB plan sponsors and fiduciaries to take steps that will reduce future volatility in plan costs. To achieve this reduction, liabilities are being moved out of the plan and sponsors are aligning investment allocations more closely with plan liabilities.

“For nearly six years, defined benefit plan sponsors have been nervously watching their funding ratios in the wake of the financial crisis. Now that they are closing back in on being fully funded again, many want to take steps so this never happens to them again,” say Jerry Levy and Marjorie Martin, authors of the analysis.

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The reasons most often cited as the underlying rationale for de-risking efforts include:

  • Funded status improvements. These may have triggered an increase in fixed-income allocation or the development of a hedging portfolio based on glide path strategies. When it comes to investment strategies, experts recommend that plan committees review the thinking behind why a glide path was set up, since significant downturn events are still not entirely out of the realm of possibility.
  • Current certainty versus the unknown. Even if the plan is in a position to pay lump sums or purchase annuities, it may be tempting to wait for interest rates to go higher and push those costs down. However, for plans that have moved heavily into fixed income, there may be no advantage to waiting. In terms of investment strategies, the analysis suggests adding a dual trigger to the glide path based on interest rate levels to ease into a hedging portfolio over time.
  • Premiums for the Pension Benefit Guaranty Corporation (PBGC) increasing. DB plan sponsors with underfunded plans pay additional risk premiums, which have increased since 2013. The analysis points out that a dynamic asset allocation approach will not reduce the premium cost immediately, but that an increase in funded status will reduce the PBGC premium costs over time.
  • Avoiding one-time accounting charges. Lump-sum cashouts may trigger one-time settlement charges sooner rather than later, so if a plan pursues a cashout strategy, this needs to be kept in mind.

The analysis also mentions guidance offered by the Department of Labor, derived from testimony and recommendations from its 2013 ERISA Advisory Council, which could have applications for de-risking strategies. A summary of this guidance can be found here.

Levy and Martin conclude that DB plan sponsors need to carefully weigh the options they have to de-risk their plans. A copy of the Buck Consultants analysis can be downloaded here.

Products April 24, 2014

Automatic Features Aid in Employee Participation, Outcomes

Automatic features help increase employee participation in defined contribution (DC) plans and can significantly improve participant outcomes, says a new paper from BMO Retirement Services.
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The paper, “BMO Defined Contribution IQ: Automatic Features,” is the first in a nine-part, bi-monthly education series titled “Defined Contribution IQ (DC IQ),” which was developed for retirement plan sponsors and their consultants. The reports will examine issues related to retirement plans, including plan design, participant utilization and operational efficiency.

The “Automatic Features” paper examines the use of automatic features within a DC plan. It notes that plan features such as automatic enrollment and automatic escalation typically increase employee participation and are likely to improve retirement readiness. However, the paper contends that plan sponsors have not traditionally received guidance on how to implement these features effectively. The paper identifies questions that plan sponsors need to address such as:

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  • When should employees be automatically enrolled?;
  • Which default investment option should be used?; and
  • What annual automatic escalation rate should be adopted?

“For increased transparency and ease of understanding, we believe access to a retirement plan should be treated like any other employment benefit,” says Todd Perala, author of the series of papers and director of Strategic Initiatives, Retirement and Trust Services for BMO Global Asset Management, based in Chicago. “We recommend that during the annual benefits enrollment, plan sponsors simply inform employees that unless they opt out, they will be automatically enrolled in the 401(k) plan at the beginning of the new benefits year.”

The paper also highlights that a deferral rate as high as 6% for automatic enrollees does not increase the number of participants opting out. For this reason, Perala suggests automatically enrolling participants at the maximum matching level. In the paper, Perala also recommends automatically escalating deferral rates by 1% to 2% annually, ideally timed with yearly salary increases to limit reductions in take-home pay.

In addition, Perala suggests a carefully chosen target-date fund may be the most suitable qualified default investment alternative. While traditionally, principal-safe investments were considered an ideal choice, he notes, these investments rarely generate the growth needed to provide for a financially secure retirement.

“While a target-date fund may have the potential for loss of principal, it also has the ability to generate the earnings over time that will be needed to support a more lengthy retirement period,” says Perala. “Among the universe of target-date funds, most of which use a fund-of-funds approach, we recommend plan sponsors select a fund family whose managers actively monitor the underlying investments. This ensures that no individual stock comes to represent an overly significant percentage of the fund’s total holdings.”

The paper can be downloaded here. More information about the nine-part series can be found here.

BMO Retirement Services is a part of BMO Global Asset Management and a provider of retirement services such as defined contribution recordkeeping and defined contribution investment-only services.

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