Data & Research November 19, 2018

Setting Defaults and Auto-Escalations Too Low May Undermine their Power

In addition, a person invested in a stable value fund versus someone invested in a target-date fund could end up with a balance as much as 59% lower, BlackRock says.

Reported by

BlackRock took a look at various cases where a plan sponsor made changes to plan design to see what the outcomes were and found some unintended consequences.

In the first case study, a large consumer staples company with more than 100,000 participants and $5 billion in assets added auto-escalation as an opt-out for all new participants in annual increments of 1% up to a 6% cap. A look at the active participants, those who made proactive changes to their savings amounts, found that 43% were saving more than 6%. Thirty-three percent were saving between 4% and 6%, and 24% less than 6%.

BlackRock then looked at passive participants, those who merely accepted the defaults their employer set them into, and found that only 19% were saving more than 6%. Twenty-one percent were saving less than 6%, and 60% were saving between 4% and 6%.

In total, active participants’ deferral rates averaged 6.8%, and passive participants’ deferral rates averaged 4.9%.

For more stories like this, sign up for the PLANADVISERdash daily newsletter.

“Passive participants will typically remain at the plan sponsor’s default,” BlackRock says. “This tendency can be used to their advantage by setting defaults higher and increasing auto-escalation caps considerably—or even allowing them to reach IRS contribution caps. The example of the active group with their increased appetite for savings may also be considered an argument in favor of higher caps.”

BlackRock then looked at how saving 2% more a year over a 40-year career starting at age 25 would have on plan balances. For those saving 9%, the projected end balance would be $1,039,000. Those saving 11% would end up with $1,270,000, 22% more than the other group.

BlackRock concludes that setting defaults and auto-escalations too low may undermine the power of these plan design features.

In the second case study, a U.S. technology company decided 10 years ago to use a target-date fund (TDF) as the qualified default investment alternative for new hires, but not for legacy employees, who had been automatically enrolled into a stable value fund. Two years ago, the company added 10,000 employees through an acquisition, all of whom were reenrolled into a TDF. The result was that the company now had two very different participant populations with very different return profiles.

After 10 years, 42% of the legacy company employees were invested in a TDF, 25% in the stable value fund, and 32% in another fund. Sixty-one percent of the newly acquired employees were invested in a TDF, 10% in the stable value fund, and 29% in another fund.

Again, BlackRock projected the ending balance over a 40-year career starting at age 25 if a participant were invested in the stable value fund versus a TDF. The balance for the first choice would be $875,000—and $1,388,000 for the second, a 59% increase.

“The opportunity for the legacy company’s longest tenured employees may be significant,” BlackRock says. “Higher returns from a TDF compared to a stable value fund compounded over a career can result in a nest egg that’s 59% larger, or would potentially require a participant to save 7% more to make up the difference.”

In the third case study, a large U.S. health care company gave employees company stock as the company match and also offered company stock on the investment lineup. Senior managers and executives were required to hold a percentage of their assets in company stock.

BlackRock was surprised to find that those in the lowest quartile has 33% of their assets in company stock, whereas those in the highest quartile had only 15% in company stock.

“Non-investment savvy participants may tend to equate risk with the unknown and may, therefore, think that shares in the company they know firsthand are safer than an S&P 100 index fund filled with many companies they know little or nothing about,” BlackRock says. “Employees underestimate the risk of owning company stock.”

Using the S&P 500 Health Care Net Index as a proxy for the company stock, BlackRock found that in the event of a global stock market drop, the index would decline by 22.9%, whereas a TDF strategy would lose only 11.7% of its value.

BlackRock concludes that the three cases are an “argument for better data and deeper analysis.” The company recommends that retirement plan advisers and sponsors “review plan objectives. Conduct plan and participant analysis, and test plan changes.”

BlackRock’s white paper, “Best Intentions: The Unintended Consequences of Plan Design,” can be downloaded here.

Compliance November 16, 2018

PBGC Publishes Fiscal Year 2018 Funding Update

“The multiemployer insurance program deficit has narrowed, but it clearly won’t keep the program from running out of money,” says PBGC Director Tom Reeder.

Reported by

The Pension Benefit Guaranty Corporation (PBGC) Fiscal Year 2018 Annual Report shows improvement in the financial condition of the agency’s single employer insurance and multiemployer insurance programs.  

According to PBGC, the single employer program showed a positive net position of $2.4 billion as of September 30, 2018, emerging from a negative net position or “deficit” of $10.9 billion at the end of 2017 and continuing a trend of improving results. The multiemployer program showed a deficit of $53.9 billion, reduced from $65.0 billion at the end of 2017.

Never miss a story — sign up for PLANADVISER newsletters to keep up on the latest retirement plan adviser news.

“Despite this improvement, the multiemployer program unfortunately continues on the path toward insolvency, likely by the end of FY 2025,” the report says.

PBGC says the primary driver of the financial improvement in both programs was higher interest rate factors, which reduced the value of PBGC’s benefit liabilities. A strong economy and the absence of new large claims also contributed to the financial improvement, according to the report.

PBGC Director Tom Reeder says the continued improvement in the financial condition of the single employer insurance program is a welcome result.

“The multiemployer insurance program deficit has narrowed, but it clearly won’t keep the program from running out of money,” he warns. “PBGC continues to work with Congress and the multiemployer plan community to preserve the solvency of multiemployer plans and the multiemployer program.”

The PBGC report points out that the single and multiemployer programs differ significantly in the level of benefits guaranteed, the insurable event that triggers the guarantee, and the premiums paid by insured plans. By law, the two programs are operated and financed separately. Assets of one program may not be used to pay obligations of the other.

Greater single employer stability

According to PBGC, the single employer program had assets of $109.9 billion and liabilities of $107.5 billion as of September 30, 2018. The positive net position of $2.4 billion reflects an improvement of $13.4 billion during fiscal year 2018.

During the year, the agency paid $5.8 billion in benefits to more than 861,000 retirees, about the same as last year. Also during 2018, the agency became responsible for 58 single-employer plans that terminated without enough money to provide all promised benefits. These plans cover 28,000 current and future retirees.

As the report explains, PBGC works collaboratively with plan sponsors to negotiate agreements that protect pensions and premium payers. PBGC says it protected the pension benefits of about 52,000 people by working with eight companies to maintain their pension plans as the companies emerged from bankruptcy. Additionally, through the Early Warning Program, the agency negotiated over $550 million in financial protection, for about 100,000 people in plans put at risk by certain corporate events and transactions.

Multiemployer stress

According to PBGC, the multiemployer program had liabilities of $56.2 billion and assets of $2.3 billion as of September 30, 2018. This resulted in a deficit of $53.9 billion, down from $65.1 billion last year. The $11 billion decrease in the deficit stems mostly from higher interest rate factors used to measure the value of PBGC’s future payments to insolvent plans, the report says.

During FY 2018, the agency provided $153 million in financial assistance to 81 insolvent multiemployer plans, up from the previous year’s payments of $141 million to 72 plans. In the coming years, the demand for financial assistance from PBGC will increase rapidly as more and larger multiemployer plans run out of money and need help to provide benefits at the guarantee levels set by law, PBGC says.

“Absent a change in law, the assets and future income of PBGC’s multiemployer program are only a small fraction of the amounts PBGC will need to support the guaranteed benefits of participants in plans that are currently insolvent as well as those expected to become insolvent during the next decade,” Reeder says.

«