Sunday, July 24, 2005

Starting “Blocks”

It’s hard not to be impressed by the newfound enthusiasm for automatic enrollment features. After all, one of the greatest challenges to a reliance on participant-directed savings is - a lack of participant savings. Most surveys (including our own Defined Contribution Survey) indicate that only about 75% of those eligible to participate choose to do so at any level, but some of those – perhaps most of them – are not signing up because they either forget to or because they are simply stymied by the forms, the process, or the daunting list of investment choices. Automatic enrollment purports to help overcome those obstacles.

And so it seems to, based on any number of studies. The most recent was by the Employee Benefit Research Institute (EBRI) and the Investment Company Institute. That report notes that, without automatic enrollment, 401(k) participation depends “strongly on age and income,” ranging from a low of 37% among young, lowest-income workers who are eligible to a high of 90% among the older, highest-income eligible workers. The study also found that the default rate of deferral, and the default investment fund(s), had a significant impact as well. The bottom line: Those who were disinclined to save on their own ended up being better prepared for retirement if the decision to save were made “for” them by automatic enrollment.

The fact is, we’ve made these programs too complicated for the average 401(k) participant. It’s ironic, having spent the past 30 years expanding the menu and beating them over the head with the intricacies of modern portfolio theory, only now to tout the “wisdom” of doing it for them.

However, automatic enrollment and lifestyle funds are not a panacea for all that ails our retirement savings system. Indeed, there appear to be some unintended consequences associated even with those programs. The EBRI/ICI study noted, for instance, that “the impact of automatic enrollment on higher-income groups is less dramatic and, in some cases, is reversed because workers in this group tend to have higher 401(k) participation rates.” In other words, since default contribution rates tend to be lower than higher-income workers choose on their own, automatic enrollment might actually put them at a disadvantage. Moreover, those same workers tend to invest in more aggressive investments than is typically the case through automatic enrollment – and thus, those same programs can tend to work against that group of workers.

The real challenge with automatic programs is also what makes them “work.” The original premise behind these programs was to get participants into the plan, at which point they would become engaged in the process once they had “skin in the game.” Except it doesn’t seem to work that way. Rather, those very same workers who couldn’t/wouldn’t fill out the form don’t seem to ever make any changes with their accounts. In that regard, of course, they are very much like the majority of plan participants (even the ones who did make the conscious effort to join the plan), but with a decided difference. They are saving at the default deferral rate, generally 2% or 3%, rather than the rate that typically draws most “active” participants, the rate at which their contributions are fully matched, which is often twice the default deferral rate.

More troubling still – there is at least one published study that indicates that, over time, the establishment of a default deferral rate seems to lower the overall rate of deferrals in the plan. Mostly, this seems to be a result of an increase in the number of workers who simply leave their choices in the hands of the default option. But it is hardly beyond the realm of reason to imagine a scenario where workers take the establishment of a default rate as being the “right” answer for them as well.

All in all, we need to remember that the results of automatic deferrals, however encouraging at the outset, should not be left unattended. An “automatic” deferral is a start, perhaps even a good start. It should not, however, be the end of the matter.

- Nevin Adams

1 comment:

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