Saturday, March 31, 2007

Another One Bites the Dust?

When Fidelity announced this last week that it was dropping its pension plan, it drew my attention.

Not so much because it was taking that step. By now, there have been enough pension fund freezes—or enough reports about how many pension fund freezes there will be—that the occasional announcement barely fazes me anymore. That Fidelity chose to do so while “riching up” their 401(k) plan (see “Fidelity Investments to End DB Plan”) was also pretty much standard fare for such moves.

But there was a significant difference in this particular announcement—a focus on concerns about paying for health care in retirement. In a Boston Globe report, a Fidelity spokesperson cited data that 71% of Fidelity workers didn’t know how they would pay for health-care expenses in retirement (kind of makes one wonder about the other 29%); and as part of this shift in strategy, Fidelity will be putting $3,000 into health-care reimbursement accounts for each worker—monies that won’t be taxable when withdrawn (ostensibly if used to pay health-care-related expenses).

There’s little question that health care looms large as a concern for most Americans. People routinely make job choices based on the availability and quality of an employer’s health-care program, and there is at least anecdotal evidence that, as workers have been asked to shoulder a larger share of the costs of those programs, they have paid for at least some of that with cutbacks in retirement savings. It’s now seen (or at least reported) as a “good” year when health-care costs increase at only twice the rate of inflation.

A Growing Concern

Moreover, there is a growing sense that the seemingly relentless upward trend in the costs of health care could well jeopardize an already financially precarious retirement lifestyle. A recent study by none other than Fidelity itself projects that an average 65-year-old couple will need $215,000 to cover retirement health-care costs (see “Fidelity Says Retirees Need $215,000 to Cover Health-Care Costs”). Workers have reason to worry; Medicare, the primary medical safety net for many retired Americans, is in more tenuous financial shape than Social Security—and corporate America has been shedding its retiree medical programs for longer and with more “vigor” than their more recent focus on setting aside those traditional pension plans.

It remains to be seen how Fidelity workers will respond to the change. With an average employee age of 35, it’s doubtful that they were emotionally much invested in the pension plan, IMHO. Moreover, a richer 401(k) match and the ability to roll their accumulated pension balances into a more “tangible” (as in one being capable of being touched) profit-sharing account will likely be appealing.

All in all, Fidelity has probably managed to transform a vague, uncertain, future benefit into something that can be appreciated in the here and now—and by putting an emphasis on retiree health-care costs front and center with their own workers, they also may have helped bring visibility to a critical retirement savings need—while there’s still time to do something about it.

- Nevin Adams

Saturday, March 24, 2007

When You Assume…

We live in an uncertain world, and when it comes to retirement planning, we are forced to make assumptions about an uncertain world some uncertain number of years in the future.

However, a recent white paper by JPMorgan Asset Management (JPMAM) calls to mind that old adage about what happens when one assumes (see Participant Behavior Matters in Target Fund Strategy).

First, retirement projection tools tend to overlook the reality that many, perhaps most, participants dip into their retirement savings from time to time: some for only awhile—JPMAM’s research found that 20% of participants borrow, on average, 15% of their account balance—and some forever. JPMAM’s data noted that a full 15% of those over the age of 59 ½ (the age when one avoids the 10% premature distribution penalty) withdraw, on average, a quarter of their account balance. The research, which looked at the behaviors of 1.3 million participants in some 350 plans recordkept by JPMorgan Retirement Plan Services, also found that the average participant withdraws over 20% of their account balance per year at, or soon after, retirement—not the even 4-5% drawdown implicit in most projections.

Additionally, most projections also tend to be optimistic about the rate of participant deferral. JPMAM found that, on average, participant deferral rates start at 6%—and stay there for a sustained period—increasing to 8% only by age 40, and not attaining 10% until age 55. More significantly, while most projections still contemplate annual pay increases, JPMAM found that, on average, people only get raises only every two of three years (and I’ll wager that, filtering out the occasionally distortive impact of averages, many aren’t seeing increases that often). Even more troubling—but a reality in an era of soaring health-care costs, rising fuel costs, and the economic squeeze being placed on the “Sandwich Generation”—is that, on average, 10% of participants lowered their rate of deferral—or stopped contributing altogether—each year!

Finally—though the JPMAM paper doesn’t touch on this—in this space, I have previously cast a doubtful eye on the rate-of-return assumptions often applied to participant investment patterns.

Optimistic Undercurrents

Now, there is an undercurrent of optimism associated with the Pension Protection Act—a confidence that its automatic enrollment safe harbor will usher more participants into the discipline of retirement saving; that the associated provisions on deferral acceleration will, over time, transform current savings rates to the requisite levels; that the application of professionally managed asset allocation funds as a default choice will impart a rational investment result to participant savings. Certainly these tools have the ability to modify some of the most egregious savings behaviors, and doubtless they will encourage some—perhaps a significant number—to come off the sidelines and begin a responsible preparation for retirement.

They’re not likely, however, to stem the premature drawdown of retirement savings, or to accelerate the pace or regularity of salary increases. In fact, it’s not beyond the realm of believability to envision how the adoption of these tools could, certainly in the short run, serve to reduce the rate of deferrals (participants auto-enrolled at the 3%, rather than the 6% rate they might have enrolled at if they had completed the form), and perhaps even decrease the rate of return (a more balanced portfolio might experience losses in the short-run that a stable-value-only portfolio might not).

What’s attendant upon us all in this emerging age of “automatic” solutions, IMHO, is to realize that they aren’t.

- Nevin Adams

Saturday, March 17, 2007

Mirror Image

For now we see through a glass, darkly. 1 Corinthians 13:12

When St. Paul wrote those words, he was trying to explain to the early Christians that we may not understand why things are the way they are today, because our perspective is clouded. That phrase, to see through a glass—a mirror—darkly, conveys a similar sense in today’s usage: a sense of an obscured or otherwise imperfect vision of reality.

For the very most part, those of us in the business of retirement plans look at the landscape and fret about things like the dismal rate of participation, tepid deferral rates, and inert asset allocations (see “IMHO: ‘Never, Ever’ Land” ). Heck, these days, you don’t have to be in the retirement plan business to wring your hands over the sorry state of retirement savings.

Equally discomfiting to me are the incessant recitations regarding how apparently oblivious retirement savers are about the looming financial disaster. And while “the industry” often comforts itself by noting that those who have taken the time to consider their situation are more confident than those who haven’t, I don’t get that either. Perhaps it is a veiled attempt to encourage participants to do some retirement/financial planning (“You’ll feel better if you do”), but from every objective statistic, it would seem to me that most, perhaps the vast majority of, participants should feel more concerned, not less, after contemplating their situation (one would hope concerned enough to do something about it).

Then we get reports like last week’s from the Fidelity Research Institute that suggest that a “typical” worker is on track to replace 58% of their pre-retirement income in retirement (see “Replacement Rate Assumptions Could Be Wishful Thinking”). From what I can discern, 58% is pretty good for typical (to their credit, Fidelity positioned it as a shortfall, not good news). I don’t know that the traditional replacement ratio bogey of 70% is valid (see “IMHO: An Inconvenient Truth”), but Fidelity’s findings would suggest that most aren’t so far off the mark that the gap couldn’t be closed with just a bit more effort/focus. That’s the good news.

The Fine Print

The “fine print” is where it all falls apart. Fidelity’s numbers aren’t drawn from actually looking at people’s balances/savings and comparing them with current compensation levels. Rather, for the most part, they are drawn from what participants report to them as expectations. Among those expectations of a typical household was an $18,000/year pension—from a traditional defined benefit plan. Now, traditional pensions are no longer typical, though they are more prevalent than one might glean from the news. Moreover, $18,000 pensions aren’t typical, either—certainly not outside the public sector (see “Saving While You Still Work”).

Basically, then, not only is 58% likely “short” of what will be required to provide a financially comfortable retirement, the “real” number is likely somewhat short—perhaps significantly short—of the reported 58%. In fact, much of the data in this and other surveys is drawn not from reality, but from participant perceptions of their reality. That may explain why we have expressions of participant “confidence” that seem misaligned with reality.

Ultimately, the concept of retirement security is so individualistic as to defy ready generalization. Our individual expectations are shaped by our past, our health, our careers, our families, our income, and certainly by our preparations for retirement—and the reality, when it comes, will likely be just as individualized. Still, we shouldn’t focus on the status of a typical saver, for there is no such thing. Nor should we rely on the sensibilities of a saver who may be saving what he or she can (or thinks they can), not what they should.

For now, we all see through a glass, darkly. But the time will come when what we’ll see—is all we’ll get.

- Nevin E. Adams

Saturday, March 10, 2007

Price Check

The good news is, Congress is beginning to take a hard look at 401(k) fees.

Unfortunately, that also happens to be the bad news.

They have a lot of company, of course. The Department of Labor has several initiatives currently under way, the Government Accountability Office (GAO) has called for more transparency, and a number of lawsuits have been filed alleging all sorts of fiduciary malfeasance on the subject (a complaint filed against Cigna last week seemed to suggest that having investment management fees netted against the returns in a mutual fund was some kind of conspiracy - see CIGNA Latest Target of 401(k) Fee Suit). In view of all that activity, last week’s hearing before the House Education and Labor Committee was relatively sanguine (see Congressional Committee Hears 401(k) Fee Disclosure Testimony).

Not that there weren’t points of contention (but not as many as one might have thought)—and even a couple of moments of tension between those offering testimony. All in all, those seemed to be rare, however—after all, we appear to be at a period where everyone agrees that we need to provide participants and plan sponsors with better information about the fees assessed against their retirement plan balances.

Comparison Points

Speaking on behalf of the American Benefits Council last week, Robert Chambers presented an intriguing analogy, noting that an automaker like Toyota no longer made cars—they assembled them, outsourcing the preparation of the various components. He made the point that consumers don’t know—or particularly care—what Toyota paid the individual subcontractors, they’re buying the total product. While it was a compelling image of how today’s 401(k) is put together, the analogy falls apart in two key aspects, IMHO. First, most of us buy our own vehicles, and not from a menu selected by our employer. Second, when I go to buy a car, I may not know (or care) how much the manufacturer paid its subcontractors—but I surely know how much I am expected to pay for that car.

Over the past thirty years, participants, and to a lesser extent, plan sponsors, have been lulled into a false sense of security about the fees they pay for these accounts. I don’t know how many actually believe these accounts are free, but I would imagine that a significant number of participants would be amazed at how much they are paying each year (that doesn’t mean those fees are necessarily unreasonable, by the way).

"Under" Currents

You can hear that same concern just below the surface of comments made by the defenders of the status quo—in between phrases about how “fragile” our current system is, and expressions of concern that participants might be so put-off by those revelations that they will eschew participation altogether. It’s not that I don’t understand what they are trying to say, but I wonder sometimes if they have any idea how that line of reasoning sounds. The implication is clear, even to those who aren’t yet convinced there is a problem: If people actually knew how much they were being charged….

The devil, of course, lies in the details—and concerns about how that information will be constructed and shared (and, trust me, it will be shared) were also just below the surface during the hearing last week. The concerns are twofold; that the mandated structure will be prohibitively difficult or costly to produce, or that the complexity of the information and/or the mandate will render a meaningful disclosure impossible (think prospectus). Indeed, IMHO, the scariest aspect of last week’s hearing was that Congress might feel compelled to roll up its sleeves and “help.”

I’m not altogether sure that the industry can be trusted to heal itself, but I do believe that a growing number are confident enough in the value provided—and their ability to explain it—to do the right thing, to place a visible price tag on those services. After all, if you don’t know how much you’re paying—it’s hard to appreciate how much it’s worth!

- Nevin E. Adams

Saturday, March 03, 2007

Option 'Null"

Not too long after my first daughter was born, my wife decided that we needed to have a vehicle with four doors. All other decisions about the car were mine—color, options, make, model, etc.—so long as it had four doors (anyone who has ever wrestled with a car seat, or with getting a child into and out of a car seat, will appreciate why).

In this particular case, even though I hate car shopping, I had done my homework—the service record of the make made it a cinch, the dealership was close, my wife and I saw eye-to-eye on color, and, for my money, there was only one model (in that make) whose four-door version looked sporty enough to satisfy my sense of a car I wouldn’t mind being seen driving. There was just one problem. This particular manufacturer had its model options arranged in three very specific packages. The model that had the features I wanted—for the price I wanted to pay—was the middle option. The one option I really wanted (and I REALLY wanted it) that wasn’t included in that middle option was a sun roof.

Model "Behaviors"

The dealer was able to give me the model I wanted with a sun roof—I would just have to wait some extraordinary period of time to take possession (this at a time when this car manufacturer was, in many cases, commanding a premium above sticker price due to limited availability) and pay more, of course. Oddly, it would wind up costing me almost as much for that modified mid-range model as if I just bought the higher-end version. As it turned out, that was more than I wanted to spend on that car. I didn’t want to wait that long for the modifications, nor did I want some of the “extras” on the higher-end model. Ultimately, I decided that, while I surely wanted the sun roof, I wasn’t willing to be “snookered” into buying the model the dealer surely wanted me to buy.

I’m sure that the manufacturer’s position on such matters was carefully developed, and I’m just as sure now as I was at the time that the desire for a sun roofed vehicle that could be driven off the lot had driven many a buyer to simply “upsize” their purchase. And while I was never really “happy” with that decision (the car worked out fine—the daughter who used to ride in that car seat now drives it), ultimately, I gained the satisfaction of having stood by my principles.

A Growing Concern

Much of the talk at the 401(k) Summit this past week was about fees: transparency, mandatory disclosures, lawsuits. In relatively short order, plan sponsors are going to be able to see how much they are paying for the services their plans receive. For some, that’s going to be a mere formality, of course; but for others—well, I suspect they’re going to feel that they are paying for things they don’t want, and perhaps aren’t getting.

It shouldn’t be all about how much you’re paying, of course. ERISA requires that the fees be reasonable, not dirt-cheap—and the determination of reasonable surely requires not only an awareness of what is being paid, but also an appreciation of the services provided relative to that remuneration. Bundled pricing has, in many respects, made it easier for many to buy (and sell) a retirement plan “package” without delving into those details. However, IMHO, it also has had a tendency to obscure the costs associated with individual components of the package. Like that sun roof, it isn’t that they think it is, or should be, free—but presented with the detailed invoice, they may not think the price is “reasonable.”

It’s not altogether sure to me that plan sponsors will relish the ability to probe those depths—but I don’t think it’s going to be an “option” in the near term, if it ever was.

- Nevin E. Adams