A Season for Change

“Our job is to be two steps ahead of our clients,” says Managing Director Jim Lyday of Pensionmark in Nashville, Tennessee. “And, in many ways, on retirement income products, advisers have been two steps behind them.” He says he thinks many plan advisers have not taken the time to learn about, and understand, these multifaceted products. “Now, advisers need to step up their game in this area, to help their clients do what’s right for their participants,” he says.

A new fiduciary safe harbor for selection of a lifetime-income provider, in Section 204 of the Setting Every Community Up for Retirement Enhancement (SECURE) Act, could prompt that shift. “It clears up much of the perceived or real concerns that sponsors have had about adopting a lifetime-income product in their plan.”

Managing Principal Erik Daley of Multnomah Group in Portland, Oregon, says advisers have a chance to provide real value in helping sponsors understand these options. “We have some clients that already have a retirement-income solution in their plan, and we have other clients—almost all of them—that are considering it or exploring it,” he says. “If we look at what we’re supposed to do as advisers, we take really complicated things and explain them simply, and get sponsors to the point where they feel they can make a good decision for their plan. And this is a massively complex issue.”

Simplifying Provider Due Diligence

In a change from the previous safe harbor (see sidebar), the SECURE Act safe harbor clarifies that a plan fiduciary need not do independent due diligence on a provider’s ability to fulfill the financial obligations of a lifetime-income contract. Instead, it provides a list of specific written representations that a fiduciary must get from the insurer to satisfy the safe harbor requirements, such as confirmation that the insurer is licensed to offer guaranteed retirement-income contracts and that at least every five years it undergoes a financial examination by the insurance commissioner of the state where it is domiciled.

“The good news about this statutory safe harbor is that it simplifies the process of selecting the provider,” says Bruce Ashton, Los Angeles-based senior counsel at law firm Faegre Drinker Biddle & Reath LLP. “It says, ‘If you get this list of information, you have met the terms of the safe harbor, and you’re good to go.’”

Asked how he would explain the upshot to sponsors, he says, “I would say, ‘Now, you’re not going to be responsible if the insurance company gets into financial trouble in the future and can’t pay off on this contract.’ I think that will make it easier for advisers to recommend that a plan client add a lifetime-income option.”

The new safe harbor “offers a ton more clarity,” says Tom Roberts, a principal at Groom Law Group, Chartered, in Washington, D.C. “Under the old safe harbor, a fiduciary was left to wrestle with how to analyze an annuity provider’s financial capabilities. Under the new safe harbor, as long as the plan fiduciary receives the written representations from the provider that are required, then, at that point, the plan fiduciary is freed of its burden of having to independently investigate the finances of the insurance company.”

It is important to explain the SECURE Act safe harbor’s parameters to sponsors, Ashton says, because it does not release fiduciaries from all risk associated with selecting a retirement-income option. “Something people probably don’t understand about this is that it’s a safe harbor for the selection of the provider, not the selection of the product,” he says. “So the safe harbor applies only to choosing the insurance company; it doesn’t apply to choosing the product itself. Plan fiduciaries still have to engage in a thorough investigation of the products to decide, ‘OK, which lifetime-income solution do we want to offer to our participants?’ So they need to look closely at things such as the costs and features of the products.”

Consider Benefits and Costs

Helping plan sponsors get comfortable with the benefits and costs of these products takes time, sources say. It is a multistep evolution in thinking. The sponsor must:

• Decide to address decumulation issues. It starts with a broader, ongoing discussion that advisers should have with their clients about the needs of employees nearing retirement age, suggests Barbara Delaney, founder and principal at StoneStreet Renaissance (SS/RBA), in Pearl River, New York. “We need to change the dialogue, to be more comprehensive, and include health care in retirement, a drawdown strategy; people need to understand their expenses in retirement,” she says. “It all ties in to, what do people need when they transition to retirement? I’m bringing it up at every committee meeting, and I’m telling my clients, ‘You need to look at this more broadly.’”

Plan sponsors have begun to recognize the need to help employees nearing retirement with their transition, Delaney says. “I have some very stubborn plan sponsors who still say, ‘It’s not my problem.’ I tell them, ‘It’s going to be your problem soon. We’re starting to see people stay on the job instead of retiring, because they don’t know how to transition to retirement.’”

The issue of adding a retirement-income option relates to where a particular plan is in the retirement-plan lifecycle, Daley has found. Decumulation needs typically get addressed after a plan progresses to the point where most of its participants are on track to save enough for retirement, he says. Plans like that are seeing some participants retire with high-six-figure or low-seven-figure balances, he says. “Now the worry for these sponsors is, they did all that, and it’s heartbreaking for a human resources [HR] director to see a pre-retiree who desperately needs help but a broker sells him a retirement-income solution that’s clearly not in the participant’s best interests,” he says. “We are seeing more sponsors say, ‘We don’t want our plan to be a place where we grow big account balances so that brokers can make a big commission off of a rollover.’”

• See the value of guaranteed income. Once a sponsor decides it is worthwhile to address decumulation needs, then the issue becomes seeing value for retired participants in guaranteed income. It helps to talk with sponsors about how the value of an income guarantee relates to the risks that retiring participants face in trying to make their account balance last, Ashton says. “They have a pot of income, and they’re asking, ‘Now what do I do?’” he says. “These retirement-income contracts remove most of the risk from that issue.”

Ashton understands that some sponsors have perceived lifetime-income products as expensive. “But I think the issue of being ‘expensive’ needs to be put in the context of, ‘What are your participants getting for that fee?’” he says. “Participants are receiving a guarantee that they’ll be getting retirement income for life. When you put it in that context, I think the cost seems reasonable.”

To educate a sponsor about the value in guaranteed retirement income, Daley suggests that an adviser make the concept of longevity risk more understandable. “One of the problems with a DC [defined contribution] plan is that there is no collectivization of longevity risk, like there is in a DB [defined benefit] plan,” he says. “So, if individuals are responsible for managing their own longevity risk, the issue is, how can they do that, and what products are available to do that?” Most plans offer no assistance, he says, and that is a problem.

It can help to show sponsors an illustration of the volatility a participant’s payout can experience in retirement because of market swings, Daley says. It could show a hypothetical retiree with a 60% equity/40% fixed-income portfolio who takes 4% out of his account annually. Using data from previous market cycles, a simulation can project the volatility in the retired participant’s expected withdrawals each year. “It can project, what would the volatility of that 4% amount be expected to be over the years, and with what frequency would you expect to have a bad outcome?” he says.

Helping sponsors see value in a retirement-income guarantee is not a one-time, brief conversation, Daley says. “You’re having what are really pension and actuarial conversations with a DC plan committee that really hasn’t thought of its plan in that way,” he continues. “If you do it correctly, it’s a year-plus-long process for a committee to get there.”

• Identify the sponsor’s goals and participants’ needs. Retirement-income products’ fees differ substantially because the products’ underlying features differ substantially, Roberts says. “Some carry more of a guarantee than others. Some are much more liquid than others. Some are much more forgiving in terms of a participant’s ability to transfer out of the product,” he says. “With a myriad product offerings come a myriad different fee levels. It’s up to the plan fiduciary to decide, ‘Within this universe, which product and features make the most sense for our plan, given our participant demographics?’”

Lyday recommends looking at the big picture before identifying which specific product features a sponsor wants. “You need to ask sponsors, ‘What are your goals in offering a retirement-income product?’ If their goal is to just protect against longevity risk, they can offer a longevity rider[—i.e., a type of insurance that kicks in only at a later, predetermined age—]which is less expensive than a guaranteed-income product,” he says. “If they want a product that annuitizes a participant’s balance and provides lifetime income, that’s a whole other set of products. It’s critical to work with clients to answer the questions: ‘What are you looking to accomplish?’ and ‘What are your participants’ needs?’ Then you find products that match those needs and goals.”

• Get comfortable with fee reasonableness. Currently, retirement-income products are offered mostly on a proprietary basis on the provider’s recordkeeping platform and usually at fees closer to retail than institutional levels, Delaney has found. “Can you find it at an institutional price, versus a retail price? That’s very difficult,” she says. “We’ve done such a great job of getting everything institutionally priced for our sponsors and participants. Now we need to offer in-plan annuities at institutional prices, with no commissions. Are we there yet? No. But I think we will be there in the next few years.”

It is likely that the perceived value-for-fees formula of retirement-income products will improve over the next few years, Lyday says. Amid fee compression for their traditional products and services, he says, both recordkeepers and asset managers are looking for a new way to earn fees—ideally in the “sticky” way that lifetime income products do because they are long-term products. He predicts there will be new entrants, as well as upgrades in existing products, that will offer better features for the same price. One example would be a guaranteed minimum “floor” benefit and the ability for participants to ramp up their contributions and, once retired, receive a larger monthly benefit. “You’ll not necessarily see a dramatic drop in fees, but, over time, you’ll see both better product features and lower costs,” he says.

Art by Philip Lindeman