It has been just about eight months since Josh Cohen, formerly at Russell Investments, took on the role of head of institutional defined contribution (DC) plan business for PGIM, the investment management wing of Prudential Financial.
Describing the move from Russell to PGIM, Cohen says the job is actually pretty similar, despite the somewhat different focuses of the large financial services organizations.
“Working with plan sponsors and their consultants, and bringing thought leadership and strategic advice has remained very familiar and similar across the organizations,” he explained. “I think that speaks to the similar ways that companies in this space are trying to get ahead and be strategic about client service and growth.”
At PGIM, Cohen now gets “even more unique insights to work with,” given that he can look across all the different segments of Prudential Financial. For starters, being associated with a top-10 recordkeeper with several million participants gives him a new view into how participants behave and what drives their behavior. A big part of the new gig, as Cohen put it, is to “grab insights from all across the organization and then help to build those into real solutions.”
“I think it’s becoming increasingly clear to everyone in the DC plan industry that the DC plan solutions of tomorrow are going to cross over the traditional lines of investments, design, administration and guaranteed income solutions,” Cohen suggest.
A decade out from PPA, much more work is needed
Asked to step back and describe the DC plan industry’s development over the last decade, Cohen pointed out academic research still shows only 57% of plans are automatically enrolling new hires, and most commonly they still use a default rate of 3%.
“We talk so much about how important automatic enrollment is, and how important it is to set people up with 6% or even 10% deferrals to get them on the right track,” Cohen pointed out. “And so it can be eye opening to pause and look at the academic research and see that the Pension Protection Act has brought about some tremendous strides, but to realize we’re still quite far away from having a totally rationalized DC plan environment in the U.S.”
As readers will likely know, historically it has been the larger end of the DC plan market where the best practices have taken hold earlier. But there has been a historical legacy even in this market segment of using lower match rates of 2% or 3%, driven in part by past regulations, but also by the notion that, as Cohen framed it, “We need to start folks off lower so we don’t scare them away.”
“Today, there is a greater recognition that we need to take into account the fact that employees are thirsting for guidance from their employer, and they won’t run away from higher default rates,” Cohen said. “At PGIM, something we are doing is pushing this idea of ‘individual retirement income liability’ within plan designs. It’s not just about deferring 6% or 10% for the sake of deferring 6% or 10%. Even a simple analysis shows these are the levels at which most individuals are going to have to save, at the very least, to have any chance at all of meeting their own retirement income liability through DC plans.”
Cohen agreed there is not one specific deferral rate to point to that is the right rate for everyone, but that being said, the proper rate for a given individual is very likely higher than 3%.
“Even if you factor in a 2% or 3% employer match, it’s just not going to be enough to get folks to meet their liability,” Cohen warned. “Through our research, we estimate that 57% of employees are somewhat or very stressed about their financial situation, but only 30% admit to being distracted at work about their finances. This is a problem for employers and employees alike. You can see it in the workplace around you that financial hardship and distractions really do have an impact on employers and on their bottom line.”
Previous Prudential research shows, for each individual who cannot retire at the traditional age of 65, the cost averages an extra $50,000 a year, representing the difference between the salary and benefits of an older worker and hiring a younger person. The annual cost across a workforce is an additional 1.0% to 1.5% a year. Considering a company with 3,000 employees and workforce costs of $200 million, a one-year delay in the average retirement age would cost the firm between $2 million and $3 million.
“Helping to solve this problem is a big initiative for us,” Cohen said. “We see very clearly the need to find new ways to get employers to think about the big picture of workforce management, vis-à-vis, the retirement and benefits programming. I think it is really important for DC plan sponsors not just to worry about features such as the default rate or the default investment. It also has to be about outcomes, because a more retirement ready work force is not just good for the participants, but also for the company.”
Litigation threat has delayed progress
Cohen went on to describe another factor at play here that has complicated the effort to broadly improve DC plans in the United States.
“On the litigation threat, we are stressing that minimizing any and all perceived fiduciary concerns should not be the sole basis of the decisions being made within DC plans,” Cohen said. “This may seem counterintuitive, but doing so could potentially put participants at risk of failing to meet their goals, arguably creating more legal risk by violating one’s fiduciary duty in thinking more of the sponsors’ risks than the participants’ best interest.”
Cohen asked readers to consider that, since 2006, there have been over 120 class action lawsuits filed related to fees, and while many have settled, very few judgements have actually been issued against sponsors.
“Even so, litigation risk often does deter plan sponsors’ willingness to implement innovative investment or administration solutions for their DC plans,” Cohen noted. “This includes adding diversified asset classes or having a thoughtful mix of active and passive funds, for which PGIM advocates strongly. In fact, where plan sponsors have selected an entirely passively-managed menu, our surveys show as many as a quarter did so because they are easier for a fiduciary to monitor and nearly the same number did so to alleviate threat of litigation.”
This is problematic because the fiduciary obligation in fact require sponsors to do what is in the best interest for participants, and not simply offer basic, passive investment options that are easier to oversee. In other words, fees are critical to consider, but the Employee Retirement Income Security Act (ERISA) requires that costs be “reasonable,” and not necessarily the lowest. Also, documentation of deliberation and decisionmaking by the retirement plan committee or the dedicated investment committee is crucial.
Promoting the language of ‘individual retirement income liability’
Turning to his expectations for progress—or not—on these and other challenging issues, Cohen suggested a broad new perspective is needed, one that focuses more on the notion of “individual retirement income liability.”
“As all of these issues play out, ultimately we must keep in mind that DC plan participants will need ongoing help in managing a variety of risks, notably market, inflation, and longevity risks,” Cohen said. “Longevity risk, the risk of outliving one’s money, is linked to all risks retirement savers experience and thus, the most critical to manage.”
Individual participants in DC plans will always face the structural disadvantage of not being able to pool their mortality risks. In addition, growing life expectancies due to healthier lifestyles and advancements in medicine require that investment earnings keep pace. Further, demographers have often underestimated life expectancy. For example, an American born in 1940 was expected to live on average until 63; current life expectancy for that 1940 cohort is now known to be well over 75.
“These mortality improvements, while positive from a lifestyle perspective, leave participants in a difficult position to manage through these risks on their own,” Cohen warned. “Insurance-related solutions can be of significant help to bolster private savings and Social Security. These products have the ability to better pool mortality risk, reduce market volatility, and protect against inflation, but of course they come with unique complexities that need to be carefully considered.”
Cohen believes sponsors should be aggressive and truly help participants solve these challenges, even with expectations that some participants may intend to leave the plan upon retirement.
“Doing so will require addressing a variety of questions,” Cohen said. “Will the retirement income solutions be offered in-plan or out-of-plan? Should it be guaranteed or not? If in-plan, is the product offered on a standalone basis or part of an existing investment option like a target-date fund? If income is guaranteed, is the rate the guarantee is based on fixed or variable? Is it portable?”
For insurance-related products, fiduciary and cost concerns continue to weigh on sponsors, but increased protection from regulators around insurer selection will likely lead to greater adoption.
“While we understand the process can be overwhelming, sponsors and their advisers should determine the appropriateness of various solutions, particularly given the growing role of DC plans in retirement savings,” Cohen concluded. “The reality is that there is likely not a single one-size-fits-all solution, and retirees will need access to a variety of products and services that meet their specific objectives and situation. A good first step sponsors can take is communicating to participants in terms of projected future retirement income, away from the focus on account balances.”