Speaking at the 2015 PLANSPONSOR National Conference in Chicago, two longtime industry executives dissected the top trends impacting retirement plan administration and employee benefits generally.
From the oft-cited decline of the corporate pension system to the boom in financial wellness programs in the defined contribution (DC) context, plan sponsors and their service providers are in the midst of great change, noted Sean McLaughlin, senior vice president for client relations and business development at Prudential Retirement. Greg Wilson, managing director and head of platform solution group for North America at Goldman Sachs Asset Management, echoed that sentiment and suggested plan sponsors today must confront a remarkably dynamic set of opportunities and challenges.
Presented below, in no particular order, are the top 10 trends Wilson and McLaughlin confront in their daily work with retirement plans and the sponsors whom run them.
1. The decline of pensions and the rise of DC plans
Still a trend impacting the retirement space today, McLaughlin suggested the decline of pensions has been playing out for decades. He pointed to the year 1975 as an important milestone—the year following the passage of the Employee Retirement Income Security Act (ERISA).
“At that point there were approximately 33 million participants in private defined benefit (DB) pension plans,” he noted. “It’s a statistic that surprises a lot of people, but the number of DB participants actually didn’t plateau until 1980, when it reached about 41 million, which is about where we still are today, though a decline has started in earnest.”
Granted, the overall U.S. population has grown substantially since 1975, so while the rote number of participants has remained level, the covered portion of the U.S. population has dropped off steadily with that population growth. Private employers have moved away from DB plans for a variety of reasons, not least of which is substantially increased longevity amongst participants.
On the DC side, there were about 10 million people contributing to such accounts in 1975, McLaughlin said. Today, it’s grown to more than 90 million.
“So from this perspective DC plans are already way past where pension plans were at their peak, in terms of participation, and they’re still growing,” he said. “We all know what’s behind this. It’s the risks inherent in retirement income guarantees and defined benefits. In DC the same risks are present, but they’re borne by participants rather than plan sponsors. There’s very little chance this trend will reverse course.”2. Money market fund reform
Wilson pointed to money market reform as another important ongoing trend for plan sponsors and service providers to be aware of.
“In many ways, new regulations mean cash has become complicated,” Wilson suggested.
The regulations he’s referring to are the Securities and Exchange Commission’s (SEC) money market fund reforms, which take effect in October 2016. Many investment experts have opined the changes will require retirement plan sponsors to review the money market funds in their lineups and possibly replace their funds. The changes will affect nearly two-thirds of plans, as 63.5% have money market funds in their lineup, according to the 2014 PLANSPONSOR Defined Contribution Survey.
Wilson noted the rule amendments require investment managers to establish a floating net asset value (NAV) for institutional prime money market funds. The rule also allows non-government money market funds to use liquidity fees and redemption gates.
“What’s the practical implication of this? Plan sponsors will likely have to switch to government money market funds, due to the growth of things like liquidity fees and redemption gates in the prime money market funds,” Wilson said. “Today you see many plan sponsors using prime money market funds, but it’s going to change under the new rules.”
3. Reducing Risk in DB Pensions
“What do General Motors, Verizon and Bristol-Myers Squibb have in common?” McLaughlin asked. “They have all completed substantial pension buyout transactions in the last handful of years.”
McLaughlin pointed to recent polling data showing 45% of human resources and finance executives said their companies have the intention to transfer or have transferred pension debt to an insurer.
“Why so much interest in pension risk transfers? The main reason is that companies sponsoring pensions simply aren’t in the business of managing liabilities and assets,” McLaughlin explained. “The core business is something else—whether that's manufacturing or technology or whatever. And asset managers are way better at managing pension assets and liabilities, frankly. The second issue is persistently low interest rates during a time of strong markets, which helps makes risk transfers attractive.”
Beyond these factors, new mortality tables from the Society of Actuaries are anticipated to increase pension liabilities by as much as 6% to 9% on average for a given DB plan sponsor. Looking across the top 100 corporate pension plans by assets, this small-seeming increase in new liabilities translates to a whopping $140 billion of additional funding required.
“Plans will have to start funding this new shortfall, and it’s at the same time Pension Benefit Guaranty Corporation premiums have jumped 30% or more in just the last year, and they’ll only continue to go up in the future. It’s all just putting more pressure on sponsors to run for the door.”
4. Fundamental fixed-income changes
“It won’t be news to anyone in the audience that, while fixed income has generally been on a positive bull run for the last 40 years, offering a great counterbalance to equity investments, right now the environment is really tough for finding yield,” Wilson observed.
Add to this the Herculean task of trying to identify the timing of a rate hike from the Federal Reserve, and you’ve got a truly challenging environment for fixed-income portfolios.
“In the face of all this, we’re working with sponsors to rethink fixed income,” Wilson noted. “We see many more sponsors looking at things like unconstrained bond funds. Or perhaps they’re looking to add a ‘core-plus’ fund that can look beyond government bonds and mortgage backed securities into other, higher yield areas. We’re also seeing a great and growing interest in ‘white-labeled’ fixed-income options, through which the sponsor seeks both higher yield and better diversification.”
5. Longevity challenge or longevity bonus?
Retirement plans are complicated beasts, but that doesn’t mean the challenges they face are intractable.
“One of the main challenges we face is a simple one,” McLaughlin observed. “People are living longer, and that makes it harder to generate steady income and dependable income for their entire retirement. People today are expected to live to 80 years for men and 88 for women, but they’re not preparing for that type of lifespan.”
McLaughlin said studies consistently show more than half of people underestimate their own life expectancy.
“We all have a tendency to believe we’re not the special ones who will live as long as the actuaries predict, but the reality is that that many of us will live longer than we expect to, maybe even a lot longer,” he noted. “So the question becomes, is this a longevity bonus or a longevity challenge?”
6. Multi-manager product growth
Wilson next pointed to the growth of multi-manager investment products as a key trend reshaping the way plans do business.
“In brief, the emergence of more customizable qualified default investment alternatives (QDIAs) is having a profound impact on the way people are thinking of their default investment,” he said. “Following a series of tips and guidance from the Department of Labor, we have seen huge drops in the numbers of sponsors using the proprietary target-date fund series of their recordkeeper, for example, and this will only heat up in the years ahead, both up and down market.”
Some benefits of the multi-manager approach include gaining access to best-of-breed managers across the different asset classes built into an asset-allocation solution, as well as the ability to make changes to certain pieces of an asset-allocation solution without having to change out the entire fund.
7. Client experience as key differentiator
“Client experience is the sum of what the participant takes away from their interactions with the plan and its service providers,” McLaughlin explained. “It combines the emotional side of things with the objective side of things.”
McLaughlin suggested that, more and more, the retirement industry is seeing “the experience of saving and investing itself as the product. It’s not how financial services firms traditionally think, but it’s a huge factor in today’s market competition.”
This means ease of doing business has become a key determinant of client experience, as has proactive service and anticipating client needs and being responsive.
“Second, it’s the people—the people being effective, not just nice or friendly,” McLaughlin said. “Third, it’s the feeling of commitment and partnership. Something remarkable we see in the retirement space is that when a service provider makes a mistake, they can actually use this as an opportunity to grow customer loyalty by effectively solving the issue and proving they are a reliable partner, even when there are speedbumps. Of course, it’s not always easy to recover from a mistake—and if you string problems together the advocacy tanks.”
8. Fee compression continues
“The ongoing review of administrative fees and other plan expenses keeps growing in importance, and this isn’t like to stop,” Wilson noted. “We’ve all seen the Tibble vs. Edison ruling—it’s just the latest example of the increased scrutiny of fees.”
Wilson pointed to statistics showing a third of all plans reduced fees in some way last year—and almost 20% changed how they pay fees.
“Fee compression and scrutiny is not just occurring on the mutual fund side—it is also impacting collective investment trusts and all the other investment vehicles in DC plans. Revenue sharing is going down and fee levelization is going up.”
9. Financial wellness rapidly expanding
McLaughlin said he defines financial wellness a little differently than others.
“Financial wellness to me is being protected against risks that are difficult to predict and may have significant negative consequences,” he explains. “Part of this is what we normally think of as financial wellness—teaching the employees to do better budgeting and to prioritize savings—but it’s also about managing the big risks participants face before retirement.”
According to McLaughlin, these are loss of income due to premature death of a spouse, loss of income due to illness or injury, and unanticipated out-of-pocket costs for health events.
“Beyond providing more basic financial education for people, the retirement market is growing in interest for protection products in these areas,” he said.
10. Use of alternatives continues to grow
Wilson concluded the session by noting alternative investments are increasing in use, and the tenants of the alternatives conversation are changing.
“Sponsors are learning that alternatives are not a group of really aggressive or risky investments,” he said. “It’s all about diversification and finding ways to mitigate volatility. For investment managers hoping to grow in the space, it’s critical to work with plans on the role of alternatives—sponsors and participants. Again, people think of them as risky, but really alternatives are striving to diversify and solidify returns. They offer risk mitigation and can help protect during equity drawdowns. We’re not at a tipping point yet but in the next 24 months alternatives will continue to gain more of the DC universe assets.”