Testing Could Benefit Income Projections

Better disclosures can lead to better outcomes for retirees, according to Russell Investments, in weighing in on the proposed mandate for income illustrations on participant statements in response to the DOL’s invitation for comments. Bob Collie, chief research strategist at Americas institutional business at Russell, is one of the authors of the letter, as well as the author of a blog post on the same topic.

Russell has not done specific testing, but Collie told PLANADVISER they are advocates of market research. “Instead of just theorizing what is needed, let’s actually test it,” he said.

Some areas could benefit from market testing, Collie said, such as the usability and attractiveness of certain features of the proposed illustrations. Would monthly or annual amounts be more useful to participants? “While Social Security benefits are reported as a monthly amount, most individuals think of their income in annual amounts,” Russell said. “What form of wording (or possibly even quantitative illustration) is most effective at communicating the uncertainly of the market projections?”

Russell is strongly in favor of the income illustrations.  “There needs to be a disciplined savings program in place,” Collie said. Savings obviously creates an attractive level of retirement income. “Steps such as auto-enrollment have addressed some of the behavioral issues around how people make their savings decisions,” Collie said. “The reason the DOL is now emphasizing income reporting is that current practices don’t give individuals a clear picture of how close to – or how far from – their retirement goals they are. Better disclosure will lead to better decisions.”

A participant‘s current balance is clear and objective, Russell observed, and converting that balance into an annuity value requires few assumptions, which can be made with a relatively high degree of confidence.

The projected balance is more complex, Russell said. “This requires assumptions to be made about investment returns, assumptions which come with considerable uncertainty attached. Thus, even though we believe there is value in showing income values based on the projected balance (especially for a younger investor whose total wealth today is primarily in the form of earnings potential rather than current financial wealth) some care is needed in how this is done.”

The letter suggests the DOL consider making these assumptions more prominent. “Instead of putting assumptions and caveats in a footnote that may or may not be read, we‘d suggest the Department encourage providers to show both the projected retirement income and the key assumptions directly on the illustration.”

This way, participants would more clearly see the assumptions that underlie the numbers, and show a clearer path between a current balance and a future income stream. Russell feels that presenting projected outcomes in this way would help communicate the extent to which results are dependent upon the assumptions. As well, participants could make necessary adjustments to factors within their control such as their expected retirement date or their investment or savings behavior in light of these assumptions.

Because of the high degree of uncertainty in market returns, the disclosures should make it clear that actual investment returns are likely to differ significantly (over both the short term and the long term) from the assumptions and this could have a material impact on the final outcome.

Russell said the assumption of a 4% real return seems at the end of the range. “While history suggests that such a return has been achievable over many periods in the past – especially for growth-oriented investment strategies – lower interest rates may make these returns less likely in the future.”

Russell’s letter to the DOL is here.