Solving a Very Real Problem

Five things to consider when evaluating retirement-income products

Just 3% of defined contribution (DC) sponsors say they very likely will add in-plan annuity or insurance products in 2011, according to an Aon Hewitt survey; yet, hope remains in the industry that this could change in the years ahead.
“The plan sponsor community is increasingly mindful of the challenges their employees face in retirement in a defined contribution world,” says Mark Smith, a Washington-based Partner at law firm Sutherland Asbill & Brennan LLP. “I hope we are at a point where plan sponsors will put more time and attention into what they can do in plans or around plans to deal with that.”

Despite lots of employer curiosity, adoption has been slow largely because of these products’ complexity, says adviser Martha Tejera, President of Tejera & Associates, LLC, in Bainbridge Island, Washington. “However, target-date funds seemed complicated at first too,” she says, “and these types of solutions have the ability to solve a very real problem.”

For employers considering in-plan options, think about these five factors:

Consider waiting for a safe harbor. Fiduciary worries have long played a major part in employers’ unwillingness to add annuities as an in-plan option. The regs have become somewhat clearer, but not clear enough for most sponsors.

“The Pension Protection Act (PPA) restricted the ‘safest available annuity’ standard to defined benefit plans and specified that a different standard would apply to annuities in defined contribution plans,” Smith says. The Labor Department subsequently published annuity guidelines for DC plans that did not persuade many employers to move forward. “There is, fairly, a fiduciary concern here,” he says. “To the extent that we are adding a feature to the plan that has a long tail to it—20, 30 years, maybe more—is that a different sort of decision than sponsors are used to making?”

A wide range of plan sponsors—corporate, public, and multiemployer—have a definite interest in offering in-plan options, says Jeffrey Snyder, a New York-based Consultant at Segal Advisors. “However, there is a hesitancy until a safe harbor is granted,” he says. That could happen sooner rather than later, believes Mark Foley, a Vice President at Prudential Retirement. He points out that the U.S. Department of Labor has identified retirement income as one of its regulatory priorities for 2011.

Evaluate the investment basics. “Under the safest-available-annuity rule for defined benefit plans, we have treated the annuity decision as different from everything else. For defined contribution plans, however, the PPA established that the annuity purchase decision is subject to normal fiduciary standards,” Smith says. “The foundation is a prudent decisionmaking process, governed by the same principles that sponsors are used to. There are additional elements to this decision, but the fact that it is a long-term decision is already within the scope of fiduciary practice.” The evaluation process for picking a retirement-income investment product with a guarantee differs less from typical plan investments than the process for choosing fixed annuities, Foley says.

Retirement-income product selections are comparable to other investment options, Tejera says, but have unique aspects. “They are subject to the standards of ERISA, so they have to have a sound due-diligence process, but it needs to be expanded,” she says. “The piece that is similar is the evaluation of the efficacy of the investment process. A lot of these products allow participants to continue to invest in the market. So, evaluate: How strong is the investment process? Are the investments appropriate? Can participants diversify? Is the glide path appropriate for participants? What is the performance of the underlying investment managers?”

Check out the guarantor and guarantee. Gauging counterparty strength means evaluating the product provider’s soundness, Tejera says. “Can they make good on that guarantee?” she asks. In addition, sponsors need to understand the guarantee’s nature, she adds, since they differ. “Some retirement-income products increase the odds of not outliving your assets but do not guarantee it,” she says, “and others say, ‘We guarantee you will get X% as long as you live.’” Different approaches can work better for different employee groups. Says Smith, “Think about, would this particular approach to lifetime income serve the interests of your particular plan participants, including whether you can present this to participants in a way that they really grasp?”

Scrutinize value for fees. Fee benchmarking for these products resembles that for other investments, Tejera says, as they can be evaluated against their peers. “Yet cost is not a stand-alone evaluation: It is cost versus benefit,” she explains. The value of a retirement-income product to participants can be quantified using actuarial methods, she says.

While an investment with a guarantee obviously will have a higher fee than a typical plan investment, Snyder says it could be worthwhile to a company’s employees. “Participants are looking for a quantification of what their account balance means to them on a periodic basis and some type of guarantee as they age,” he says. Specifics matter too: Do participants who get out of their annuity pay surrender charges? Do participants have flexibility in the form of payment, such as any remaining balance going to their heirs? Can participants get a rider with inflation protection?

Look at portability challenges. The portability issues dissuade a lot of sponsors from in-plan use, Tejera says. “There are limitations on the ability to move to another provider,” she says. “The fear is that 30 or 40 years from now, the insurer will not be able to make good on the guarantee, but I think that risk is manageable, because you are going to monitor the insurer all along.” Still, if a plan sponsor decides to change recordkeepers now, either the new recordkeeper has to support that product or the previous recordkeeper has to keep that slice of business and provide needed information about those accounts to the new one, she says. Today, sponsors who want an in-plan product typically have to go with whatever their recordkeeper offers, although she sees that shifting in the future, as it has with the opening up of other investment platforms. The SPARK Institute, an industry trade group, has produced data standards for sharing retirement-income information among providers. Great-West Retirement Services, which introduced its SecureFoundation guaranteed-income investment option in February 2010 for use in DC plans, says that offering was designed to increase portability at both the plan and participant levels.

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