Data & Research October 29, 2012

Participants Have Inaccurate View of TDFs

Many participants have an incorrect view about what they will get from a target-date fund (TDF).

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Although participants report being satisfied with their TDF default investment option, a large number assume the TDF will provide lifetime income, which is “overwhelmingly not the case,” Seth Masters, chief information officer at AllianceBernstein, told PLANADVISER.

Lifetime income is, by a wide margin, the top thing participants want in a retirement plan, Masters said during a recent AllianceBernstein retirement forum. The irony is that whenever participants are given the chance to add an annuity, however, research shows that virtually none of them do.

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Participants shy away from “traditional annuities” because they spur feelings of a loss of control, as well as the fear of insurance companies benefiting from a participant’s unpredictable lifespan. “The idea of losing that control is psychologically, unbelievably difficult for most people to agree to,” Masters said.

As a result, the lifetime income adoption rate is minimal if not made the default, Masters said, so the best solution is to marry the lifetime income solution with the TDF default.

Plan Sponsors Not Fully Utilizing TDFs 

Plan sponsors are also satisfied with TDFs, but AllianceBernstein’s third biannual survey of plan sponsors found only about half of plans have made TDFs their default option. “That was a real shocker to us,” Masters said.

Of the 50% of sponsors offering a TDF but not using it as the default, 83% have no default or are still using a stable value fund, an equity fund or a bond fund—none of which are qualified default investment alternatives (QDIAs)—as the default (see “Plan Sponsors Not Making Best Use of TDFs”). 

Masters thinks more plan sponsors have not adopted TDFs as their default for two reasons: The idea of QDIAs is relatively new so many plans do not fully appreciate the benefits, and some plan sponsors do not realize the behavioral benefit of making it the default, which leads to higher adoption rates.

AllianceBernstein research also found that the majority of midsize and large-plan sponsors are failing to leverage their assets to provide more specialized or customized TDFs. According to the company’s survey, 22% of large-plan sponsors ($250 million or more in assets) and 21% of midsize plan sponsors ($1 million to $249 million in assets) reported that they have adopted customized TDFs; and 36% of large-plan sponsors said they have not adopted customized TDFs because they were unaware of the benefits of improved structure.

Earlier this year, United Technologies Corporation (UTC) launched Lifetime Income Strategy, which is the default investment option designed by AllianceBernstein that combines the simplicity of a target-date fund (TDF) with the security of lifetime income. The Lifetime Income Strategy is an age-based default investment option through which each DC plan participant has access to a target-date portfolio built specifically for them (see “Default Investment Option Addresses Longevity Risk”).

“I think that the wave of the future in the large-plan market is custom TDF structure,” Masters said.

In the small and midsize markets, Masters said TDF customization will likely not catch on because customizing a TDF is less cost-effective for smaller plans. However, he said “there will be lifetime income options available really across the whole gamut of plan sizes.”

The Markets October 26, 2012

Considerations for Settling Pension Obligations

For today’s frozen defined benefit (DB) plans, the question is not if they will settle—it’s more about “how” or “when.”
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“We think 2012 is sort of the beginning of a tipping point [for the settlement market],” Jay Dinunzio, senior consultant at Dietrich & Associates, said during a webinar titled “The Next Big Thing in the Pension Market—Liability Settlements.”

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The “how” of a pension settlement—discharging all or a portion of an employer’s pension benefit obligation—is the decision to offer participants either a lump sum they elect to receive, or an annuity. The “when” has become complex because of factors including the low interest rate environment and many underfunded plans. In order to settle obligations, plan sponsors must also recognize the significant added costs associated with it, Dinunzio said.

The decision to settle is a deviation of “business as usual,” so plan sponsors must overcome the psychological hurdle of breaking out of their routine, he added.

This summer, General Motors Co. announced it would offer lump-sum payments to select retirees and monthly pension payments to others administered by The Prudential Insurance Company of America. The retirement plan actions resulted in an expected $26 billion reduction of G.M.’s U.S. salaried pension obligation, the largest insured annuity settlement in U.S history (see “GM Transfers Some Pension Risk”). Trailing behind it is Verizon Communications Inc., which announced in October it had signed a partial pension buyout deal to transfer approximately $7.5 billion of the Verizon Management Pension Plan obligations to Prudential (see “Verizon Signs Partial Pension Buyout Deal”).

 

 

When deciding between lump sum and annuity, Dinunzio said the following should be considered: 

For lump sums: 

  •  Large one-time payment
  •  Flexibility to invest
  •  Preference of non-retired participants
  •  Must be actively elected
  •  Interest rate basis fixed annually
  •  Attractive option for unhealthy people
  •  Distribution from plan trust
  •  Sponsor focused on bottom line
  •  Election process complexity

 

 For annuities: 

  •  Smaller monthly payments
  •  Guaranteed income for life
  •  Preference of current retirees
  •  Required default option if lump sum settlement (LSS) is not elected
  •  Interest rate basis varies daily
  •  Attractive option for healthy people
  •  Plan assets used to purchase group annuity contract
  •  Paternalistic sponsor

 

Most participants do not want a lump sum because they have budgeted around monthly income in the past, Dinunzio said. The risk remains, he added, that healthy people will all choose the annuity while unhealthy people will elect to have a lump sum.

Dinunzio concluded that several things are driving settlements: Aside from technical factors such as the Moving Ahead for Progress in the 21st Century Act (MAP-21), he said in general CEOs are becoming more informed and there is an increased corporate value to eliminating pension debt. “They want to move the obligation off their books,” he said.

 

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