William Arnone, from Ernst & Young’s Human Capital, noted, while presenting his report “Educating Pension Plan Participants” at the 2004 Pension Research Council (PRC) Symposium at the Wharton School in Philadelphia, Pennsylvania, that part of the problem lies with how the generation known as “Baby Boomers” handles their retirement planning. “We have not learned the lessons, we have not changed the behavior and someone is going to pay the price,” Arnone said, himself a member of the generation born between 1946 and 1964.
Whimsically, Arnone suggests a relabeling to “drop the word ‘Baby’ from the title, we are now ‘Boomers,’ we have to grow up,” which may have an impact on inducing more responsible fiscal behavior on the part of “Boomers.” However, he suggests that the heart of the issue lies in how companies are educating their participants, the types of programs provided by employers, and the impact education programs have had on changing participant behavior.
Part of the solution lies in Arnone’s “redefinition” of employer-sponsored participant education. Simplistically described as “a program that helps employees develop skills to make informed decisions and take action to improve their financial well being,” Arnone said that definition works, assuming it is based on:
- helping individuals not just as plan participants, but as employees of the firm;
- providing participants with skill development;
- enabling individuals to make decisions;
- providing a basis for accurate information about decisions;
- being action orientation attempting to affect behavior;
- seeking a long-term result of improving financial well-being.
Such programs are relatively rare, Arnone says, noting that “no more than 20% of large employers (1,000 employees or more) have a sustained, on-going employee financial education program.” Employers will say they have a program in place, but their definition of program is “minimal,” which Arnone went on to say means “our 401(k) plan provider issues a quarterly newsletter, therefore we have a financial education program.”
Arnone found the impact of education programs on participant behavior has been minimal, as evidenced by five patterns of employee behavior:
- Non-participation in plans
- Low rates of plan contributions
- Questionable investment allocations
- Distribution upon termination.
The average participation rate in large 401(k) plans is approximately 70%, Arnone said citing data from a Fidelity Investments study, with indications of a current downward trend in participation rates (See 401(k) Participation Levels Drop to 68% in 2002 ). Arnone found a “key determinant of impact” to be the frequency of employee education programs. Where low-frequency education programs can increase employee participant rates by an average of 13%, citing Douglas Bernheim’s report “Financial Literacy, Education and Retirement Saving,” Arnone said high-frequency education increases this rate by an average of 25%.
To further increase participation in employer-sponsors plans, Arnone also found the quality of communication greatly influences participant behavior. Citing research done by Olivia Mitchell and Sylvester Schieber in “Rates and Contribution Levels in 401(k) Plans,” Arnone said that while providing generic material in addition to forms and statements increased the probability of participation by 15%, using customized information increased participation probability by an additional 21%.Customized information could also have an impact on contribution rates. Citing data provided by Hewitt Associates, Arnone says the contribution rate of plan participants is only 7.8%, yet tailored plan information can resulting in an increase to the annual plan contribution rate of 2%.
"Many plan participants appear to be engaged in questionable investment behavior ranging from problematic asset allocation and failure to rebalance funds periodically, to specific fund selections that indicate nondiversification of retirement assets," Arnone said. Of particular concern to Arnone is the lack of investment options selected by participants and an overconcentration in employer stock. Citing data provided by Fidelity, Arnone found 25% of participants have only one option in their 401(k) plan. Further, over 8 million 401(k) plan participants have more than 20% of their retirement assets in company stock.
Participant loans and lump sum distributions also have the potential to be devastating to participant wealth accumulation. Arnone said that many participants take lump-sum distributions from their plans at retirement, rather than deferring distributions or rolling them over to Individual Retirement Accounts (IRA), a process that results in widespread "leakage" of retirement funds. This Arnone attributes to lack of education about viable options for post-retirement investing and savings, a lack of understanding that also translates into high rates of loan withdrawals by plan participants. In fact, Arnone said, approximately 20% of plan participants have outstanding loans at any one point in time, and "few participants understand the true cost of loans and their negative impact on long-term retirement funding."
Arnone cited a lack of "meaningful systematic evaluations" of employee financial education programs. Those employers that do evaluate their education programs tend to limit such evaluation to participant evaluation forms completed immediately after the education session, which Arnone dubs "feel good evaluations."
"An employee attends a workshop for three hours on company time, leaves the workshop, gets the respondent questionnaire 'How Do You Rate the Workshop?" Given that employees have only to measure education programs against being at work, Arnone believes the current method of evaluation does not get to the heart of the information delivered, rather compares being at work with not being at work.
In fact, Arnone said plan sponsors "do not appear to be satisfied with their current employee financial education programs," citing data from the January 2004 survey by investment education provider ICC Plan Solutions showing only 11.9% of plan sponsors were satisfied with current programs and 73.8% said participants need help with basic investing knowledge (See Many Participants Clueless About Contribution Rate ).
To provide a solution to the problem of low impact participant education models, Arnone says "a successful program needs a baseline of data from which to measure progress." This program use more data on employee benefit plan activities to identify patterns that have the potential for serious long-term effects on long-term retirement planning. Further, the data would need to be supplemented with assessments of different employee population segments to provide a more targeted approach to employee education.
"This type of quantitative evaluation of actual behavioral change by an independent third party may serve as the model for future program evaluations," Arnone concluded.