“We firmly believe the defined benefit plan economics are
shifting and will afford employers the opportunity for lower funding costs,
thereby positioning defined benefit plans to once again become one of the most
cost effective methods of providing adequate retirement income to your
employees,” authors of the white paper by Pentegra Retirement Services
wrote.
The paper says the factors and economics that caused
significant increases in required contributions to defined benefit plans are
showing signs of slowing and reversing themselves. The impact of the Pension
Protection Act of 2006 (PPA) is passed, as the provisions of this law have been
fully phased in.
The authors point out that historically low interest rates,
which cause plan liabilities to increase every time they drop, appear to have
nearly hit bottom and are poised to begin rising as soon as the Federal Reserve
suspends the accommodative support of growth through an expansionary monetary
policy. Other underlying macroeconomic trends such as the 30-year bull market
in bonds, the decade-long stagnation in the equity markets and the lack of
viable options to extend duration for pension investment managers all exhibit
signs of changing for the better.
The paper also notes that the financial crisis that began in
2008 caused sponsors of retirement programs to begin to rethink their
strategies, as it became clear that relying solely on defined contribution
plans provided inadequate retirement benefits and resulted in participants
being unprepared for retirement.
“What we have all needed was a change in the influences
impacting employer costs and those changes are under way,” the authors
conclude.
The white paper, “The Future of Defined Benefit Plans Will
Change Dramatically – For the Better,” is here.
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Quantifying
key retirement risks is the first step advisers can take to help their plan
sponsors address them with participants, according to a report.
Some plan sponsors may think they have no way to know or
influence how much money participants will save for retirement, making it
“impossible” to achieve objectives and quantify risk, but this is not true, Rod
Bare, defined contribution consultant for Russell Investments, told PLANADVISER.
Bare is the author of the report “Quantifying Key Risks in Retirement,” written
on behalf of the Institutional Retirement Income Council (IRIC).
Even basic assumptions about savings trends can help
tremendously to improve a plan, Bare said. Plan sponsors must keep in mind that
helping participants is not necessarily about investments; it is about finding
ways for participants to save, and implementing tools – such as automatic escalation – that
can help them achieve this goal. “Finding ways to boost contributions is
equally, if not more impactful, [than investment selection],” he said.
Here are the six most common risks, according to Bare, and
how plan sponsors can tackle them:
Sequential Risk
Sequential risk highlights the importance of the sequence of
investment returns, especially for a retiree making regular withdrawals to
cover expenses.
Poor returns early in retirement are much more harmful to
one’s retirement prospects than poor returns later in retirement, the report
said. A participant heavily invested in equities at retirement is exposed to
excessive sequential risk.
Plan sponsors can mitigate participants’ sequential risk by
encouraging them to invest more conservatively during the years close to
retirement. This can be through education, asset-allocation solutions like
target-date funds (TDFs) or guaranteed retirement income products.
(Cont...)
Inflation Risk
Price increases can hurt retirees’ standard of living. In
order to maintain their standard of living in retirement, plan sponsors can
offer participants the option to take automated systematic withdrawals with a
cost-of-living adjustment (COLA) or to purchase an annuity with a COLA, the
report said.
This does not necessarily mitigate inflation risk because
the retiree’s purchasing power is based on expected inflation rather than
actual inflation. As a result, some insurance carriers offer annuities with the
benefit linked to the Consumer Price Index, but the report pointed out that the
tradeoff is lower initial annual income.
Longevity Risk
The risk of living beyond one’s life expectancy can put
stress on a retirement portfolio. To tackle this problem, the report suggests
plan sponsors offer participants an immediate or deferred life annuity in the
plan. Variable annuities with a guaranteed lifetime withdrawal benefit rider
can also address longevity.
Interest Rate Risk
Interest rate risk is the possibility of low bond returns
and high annuity prices. Low interest rates depress the coupons paid out by
bonds, and if interest rates rise, the market value of the bonds will decline.
Low interest rates usually lead to an increase in annuity prices, the report
said.
Plan sponsors should give participants the option to invest
in a short-term bond portfolio in order to avoid locking in low interest rates
for the long term. For purchasing an annuity, dollar-cost-averaging into an
annuity –
or holding long-duration bonds that
closely track annuity prices – can
mitigate interest rate risk, according to the report.
(Cont...)
Health Care Risk
Participants may have high, unexpected health care risks in
retirement because of a chronic illness that can lead to long-term care needs.
Plan sponsors must educate participants on the cost of nursing homes and other
long-term care expenses, Bare said.
“It’s a cost that’s larger than most people realize,” he
stressed.
To counter this risk, plan sponsors can offer access to
institutionally priced long-term care insurance, along with education. Employee
health and wellness programs are becoming more important to companies, the
report said.
Behavioral Risk
Behavioral risk is the possibility of human biases getting in
the way of good retirement decisions. An example is a participant who spends
too much early in retirement, which puts pressure on the portfolio to perform
well.
According to the report, this may be the most difficult risk
for plan sponsors to help participants overcome. One solution is to offer them
a default investment option that helps protect them from themselves by
combining liquid assets and retirement income-oriented insurance products.
Plan sponsors can also focus communication around the amount
of guaranteed lifetime retirement income they are accruing instead of around
the volatility of their account value. In addition, participant advice is
important in order to help them make important decisions.
Participants need help mitigating longevity risk, as well as
the discipline to withdraw at an appropriate rate, Bare said. “Assuming you can
keep from having your own mind sort of betray you [as] you build up a nest egg,
then you have another set of behavioral biases about what to do with that nest egg,”
he added.