Pressure has fallen on the defined contribution strategy as retirement plan sponsors have shifted the defined benefit plan away from being the primary retirement option offered to employees, according to a recent research paper.
Nearly 74% of participating plan sponsors now offer more than one retirement income benefit to at least some segment of their employees, according to SEI Investments Company, which surveyed 231 executives from DC plan sponsors in the U.S. at the end of 2015. While nearly 64% of respondents say they still offer employees a DB plan, nearly 30% offer supplemental savings plans in addition to the DC plan.
Meanwhile, almost 74% of DB plans are now closed to new hires while many sponsors have stopped accruals for participants, the firm says.
“We conducted a similar survey in 2014,” explains Wilkinson, the director of marketing at SEI Institutional Group, adding that, “there has been a 5% increase in the last two years that points to the DC plan as the primary vehicle.”
This, Wilkinson said in an interview with Money Management Executive, has resulted in what many in the industry have described as the, “DB-izing of the DC plan.” Sponsors, he adds, have now focused their efforts in building DC plans to look more like DB, “in terms of how they’ve been constructed from an investment standpoint, so that they’re capable of being that retirement income source.”
Wilkinson and his colleague Joel Lieb, the DC director at SEI’s Institutional Group, agree that plan sponsors should be begin to consider a re-design of the DC to better suit the needs of their clients.
How did SEI conclude that DC Plans need to be redesigned?
Wilkinson: When we set out to actually do this research we were really looking into a few high level questions. That was, the level of confidence that DC sponsors have that their participants are going to be able to retire, come retirement age. Adding onto that is whether or not the plan sponsors felt that would actually be a problem, and if so, are they actually doing something about it?
The survey told that story, which was they’re not very confident that their participants are going to be able to retire with the needed amount of income by the retirement age, which we posed at 62 to 65. It might be 65 to 67, but we were starting at 62, and 84% said they’re not very confident that that’s the case.
The second question, around whether or not it would be a problem, was interesting as well as 88% of plan sponsors said their businesses would be impacted in some way if their employees could not stop working at retirement age. This was something we hadn’t really seen asked a lot as the common perception was most plan sponsors viewed the DC plan as the participant’s responsibility and whether or not they could retire at retirement age was really the participant’s problem. This indicated that the significant majority of plan sponsors are saying this would have an impact on business. The third part was that 57% of the plan sponsors acknowledged that DC plans were not initially built to be the primary retirement vehicle and therefore need to be redesigned.
The reality of that is DB plans were the primary retirement vehicle when DC plans started, Social Security was strong and the reality was DC plans were built to be supplemental. The survey told us that they are definitely viewing the DC plan as the primary retirement vehicle moving forward. Nearly 62% said the DC plan will be the primary retirement income source for their employees.
Has SEI looked at this before?
Wilkinson: We conducted a similar survey in 2014 and the answer to this question was 57% that said the DC plan will be the primary. So there has been a 5% increase in the last two years pointing to the DC plan as the primary vehicle.
Why has there been a shift to DC?
Wilkinson: One of the big things is the elimination of DB plans as a retirement benefit. The survey showed that 74% of DB plans are closed to new hires. Then 38% of them have frozen accruals in those plans, so the existing participants are no longer accruing benefits in those DB plans. When that happens there is usually an emphasis to transition those employees over to the DC plan so plan sponsors, when they freeze accruals to the DB plan, will do things like increase the match with the DC plan for a certain period as they go through the transition.
The fact that 38% have gone down the route of freezing accruals, those are plans that will most likely eventually terminate. Moving away from DB is one of the key drivers in the realization that all that is left at this point is the DC plan. There are little expectations that Social Security is going to be the primary income source — only 12% — and then about 11% felt personal savings or some sort of IRA would be the primary. So it is the DC plan.
In what ways can the DC plan be improved to meet that gap left by the removal of the DB?
Wilkinson: The term that’s being used a lot now is the ‘DB-izing of the DC,’ — the concept of constructing DC plans to look more like DB plans in terms of how they’re constructed from an investment standpoint, so that they’re capable of being that retirement income source. There are a lot of things that plan sponsors should be considering and I think the first step is the realization that this plan needs to be the primary retirement income source, and it’s not currently designed to do that. The next step is what needs to happen is to get into the idea of redesigning DC plans to look more like DBs from a management standpoint.
It’s really more around the idea of unbundling asset management from record keeping, using more sophisticated investments in the plan, managing the investments and building asset allocation that’s designed to meet a goal and not to just save as much as you can. On the DB side, that would also be the liability. So DB plans were really built from an asset allocation standpoint to work towards meeting a liability, and DC plans need to start to think along that same path.
What are some of the key inefficiencies surrounding the DC plan that need to be addressed?
Lieb: While we have acknowledged the DC plan is the primary retirement vehicle, the responses don’t reflect that. They weren’t built originally to be primary and when we asked the question about how they think the shortfall can be made up, most respondents said their employees need to save more. When we asked questions about the resources devoted to the investment oversight process for DC, around 85% said they have less than six internal resources. Around 54% have less than three.
The challenge with plans is acknowledging that DCs are primary, yet their actions so far haven’t really followed that line of thinking. We even asked questions in the survey about their plans over the next year, and we gave them topics. Here are some that you would think would be ranked higher, but weren’t:
• Consolidating the number of funds in a core lineup
• Adding exposure to non-traditional assets
• Incorporating custom multi manager funds
• Increasing company match
• Revising target date funds to be more customizable for the workforce
• Conducting reenrollments
How do you suggest plan sponsors now look at the DC plan as a retirement option?
Lieb: We’re trying to have plan sponsors look at the DC plan differently, meaning, if you’re truly saying that this is now your primary retirement vehicle going forward, one of the things that you need to do is make sure that your employees are taking full advantage of this retirement vehicle to move them down the path to retirement. As you’re seeing now in the acknowledgement in the survey responses, companies understand that even though the DC has been an employee issue, it ultimately could end up becoming an employer issue if they have to deal with employees that are trying to fund their retirement by working longer.
You really can’t be disengaged anymore in DC, and we all acknowledge that there truly is a limit to the employer as far as what they can do — because again it’s DC versus DB — but that shouldn’t stop a plan sponsor from trying to move their plan in the appropriate direction. Where we see this as another challenge for plan sponsors is there is still a disconnect between how investments affect the participant experience and vice versa — how the participant experience effects the overall returns — and that gets into the liability of the shortfall that most plans are acknowledging is there, but if you’re acknowledging it, what are you doing to measure what that exposure is and how are you trying to address that?
What we try to tell plans is you have to take the participant data and the investment data and come up with analysis of the two to determine what truly is your exposure and liability. And we do that around this whole concept of goals-based investing, which is; what’s your goal for your DC plan? If your goal is to have the ability for your employees to retire at age 62 with 80% of their final salary at retirement, then we ask how are you measuring your plan against that goal? So they need to look at where their participants are today relative to that goal and the things that they can do to move them down that path.
What are some ways managers can get more engaged?
Lieb: They should consider things like; if they don’t have auto-enrollment, should they implement that? Or if they have auto-enrollment should they increase it? Are they using auto-escalation? If not, maybe they should do that. If they’re using it and it’s not a high-enough increase over a certain period of time, maybe they should look at that? We’ve also seen people look at company matches. Maybe they want to stretch that to get people to invest more, or even increase it if they think that would get people more engaged. Those are participant activities you can do.
Then the other thing you should do at the same time is look at your lineup. Ask things like, is my lineup appropriate for the way that my participants like to invest and would they be better off if they were more focused in the QDIA as opposed to in the core menu making of their own decisions?
When you take all of this into consideration, you’ll find that it paints a pretty good landscape of what your plan looks like and what you can do organizationally to move in the appropriate direction.