Saturday, April 28, 2007

The Deification of DB-ification

Last week, I stumbled across another of those “DC plans are becoming like DB plans” articles—you know, the “DB-ification” of 401(k)s?

This is all supposed to be a good thing, of course, because we know that defined benefit plans do a better job of providing adequate income in retirement than defined contribution plans (well, properly funded, and when workers accumulate adequate service credits, anyway). Moreover, the new Pension Protection Act-engendered trends toward auto-enrollment (nobody asks people to fill out a form to be covered by their DB plan) and asset allocation fund defaults (nobody asks participants to make the investments in the DB plan) are also widely touted as DB innovations that we have finally had the good sense to bring to the DC side of the world.

Don’t get me wrong—anything that turns employees into participants (and automatic enrollment surely does that) and helps them make better investment decisions (and, generally speaking, asset allocation solutions fulfill that need) has to be a good thing. But to suggest that these trends are essentially helping our DC programs mature into their more “responsible” DB counterparts represents, IMHO, a gross misinterpretation of what is going on.

The most obvious difference, of course, is that DB plans not only don’t ask employees to sign up or make investment decisions—they generally don’t ask participants to FUND them, either. In a DB plan, all the participant has to do is—well, they don’t have to do anything (other than continue to meet the eligibility requirements for the plan, and that’s generally been a natural outgrowth of keeping your job). Some might argue that that lack of involvement contributes to what continues to be a widely evidenced lack of appreciation for the benefit.

Another Difference

There is another big difference, of course, and it also has to do with how these plans are funded. Defined benefit plans are funded—at least, they are supposed to be—with an eye toward the benefit that will be paid out. As the name suggests, the benefit is defined—and the decisions that are made about how much to contribute to the plan and how those contributions will be invested are also done with that in mind.

Defined contribution plans, on the other hand—even the “new,” “automatic,” DB-ificated ones—have an entirely different focus. They are (still) about how much you can afford to put into them, not how much you need to get out of them. Oh, sure, the PPA’s safe harbor automatic enrollment includes a provision to increase those contributions on an annual basis—but starting at just 3%, and rising only to 6% of pay. That may well be all that many can afford to contribute—but is it any replacement for the kind of funding discipline that a true defined benefit focus represents? More importantly, will it be enough to provide the same kind of retirement security that the DB system promised?

Still, this notion of DB-ification keeps popping up. As though, through the graces of the PPA, we have managed to magically replace that missing leg on the three-legged stool of retirement security—when all we have really done is stick a piece of cardboard under one of the two remaining.

IMHO, we won’t really have a “DB-ification” of our defined contribution designs until we shift the focus—not just the funding.

- Nevin Adams

Saturday, April 21, 2007

A Different Kind of Investment

As the parent of a daughter away at college for the first time, the events in Blacksburg, Virginia, last week had a particularly horrific effect.

No, she’s not going to school at Virginia Tech, but what happened there could happen anywhere. Parents often worry that, despite years of raising them carefully, our kids will, nonetheless, wind up in the wrong place at the wrong time. Yet, so far as we know now, all those poor kids did was be in the right place – where they were supposed to be - at a very wrong time. In a matter of minutes, bright and promising futures were brought to a premature close for no better reason than their proximity to a madman.

Many will try to get back to “normal” this week – while for some, normal will never again seem possible. I’ve tried several times to pick up some other theme or idea to speak to in this week’s column – some normal topic, if you will – but all I can think of is those students that won’t be coming home to families. Families that, like mine, were anxiously waiting to have their family once again be complete.

People die unexpectedly every day, of course – and children much younger than the students at Virginia Tech unfortunately have their lives snuffed out in much less dramatic fashion. Still, those tragedies that grab our collective attention for a brief time can serve as a vital wake-up call to things that our busy lives all too frequently set aside for “another time.”

The admonitions that are part of our industry’s DNA – start early, do as much as you can, keep an eye on things – apply to many areas of life. As we make investments in our 401(k)s, we also invest in our friends and family – investments that generally produce a yield that would put to shame the most giddy hedge fund investor.

This week, if you don’t already, I’d encourage you to tell those you care for how you feel – tell them as often as you can; and keep an eye – or an ear - on them, particularly the ones you don’t see every day.

You never know how long you’ll have to do so, after all. And the only thing worse than losing a loved one – would be losing them without having told them how you feel.

Saturday, April 14, 2007

“Self-Fulfilling” Prophecies

The Employee Benefit Research Institute (EBRI) and Matthew Greenwald & Associates published the 17th Annual Retirement Confidence Index last week – and, for the very most part, it’s probably safe to say it didn’t tell us much we didn’t already know.

More than half (52%) expect to be comfortable, another third categorize their post-retirement income status as “adequate,” and 6% are looking forward to being “well-off” – at least in the first five years after retirement. Just 10% say they will be “struggling.”

While they are apparently less confident than they once were in terms of a traditional pension benefit, they remain largely complacent about their overall prospects for a comfortable retirement – more than a quarter are VERY confident, and another 43% are somewhat confident, in fact. Still, only 18% are much less confident about receiving that traditional pension. (Oddly, and perhaps proving that confidence is a relative term, “only” 29% of those who do not expect to receive a pension are less confident. Can one truly be less confident of receiving something that you don’t expect to receive?) And while 62% say that they expect to see that traditional pension someday, only 41% say they are currently covered by such a program.

The survey, well-regarded for its breadth and depth of analysis, also revealed that almost half of the workers who are saving for retirement (bear in mind that only about 60% are at present) have accumulated…less than $25,000. Seven in 10 of these workers have less than $10,000 saved (including more than a quarter of those older than 55). They also continue to misjudge the age at which they will be eligible for full Social Security benefits (it’s no longer 65, by the way), appear to overestimate the existence of long-term health coverage (they think they have it, though only 10% of the population does), and – at least based on current trends – seem to be more optimistic about the availability of employer-provided health care in retirement.

“Agree” Mien?

But what I found most intriguing about the RCS results from the perspective of advisers – was how survey participants responded to the notion of advice. There have been any number of surveys done in recent months about participants and the need for help in making investment decisions, and they consistently indicate a strong desire on the part of participants for help. Setting aside for a minute the fact that many of those surveys are underwritten by firms interested in providing that help, I’ve heard that exact message from both plan sponsors and advisers in the field (although, more recently, the call hasn’t been for help in making the decision, it has been an interest in having someone just take care of it).

However, in the RCS, fewer than two in 10 workers said they would be very likely to take advantage of investment advice at a modest cost (“modest cost” was not defined for them), and only about a third (35%) said they would be somewhat likely to do so (the rest broke nearly evenly between would not likely, and would definitely not take advantage). However, advisers might take some comfort in knowing that those who had used an adviser previously, those who were under the age of 55, and those with higher household incomes were more favorably disposed toward the service.

But even among those interested in investment advice, only about one in five (21%) said they would implement all of the recommendations – if they trusted the adviser. A full 11% said they wouldn’t implement any of the recommendations, and two-thirds said they would implement only the recommendations that were in line with their own thinking.

All of this would, unfortunately, seem to portend a rough road ahead for advisers who are trying to get across the importance of retirement savings. After all, if people are feeling this “confident” about their prospects, no wonder the nation’s savings rate continues to languish. And if participants are only interested in recommendations that match their own thinking – and their thinking is grounded in these feelings of relative optimism – how are they going to be able to ready themselves for what may be a very rough future reality? Ultimately, of course, it will take more than confidence to ensure retirement security: It will take awareness, planning, and action. The RCS should, IMHO, be a wake-up call for us all.

- Nevin Adams

Note: The good news in the RCS is that workers who are saving for retirement, who have taken the time to do a retirement needs calculation (and who have higher incomes) – tend to be more confident than others about their prospects.

For more about the Retirement Confidence Survey, see Workers’ Confidence in Traditional Benefits Slip

Saturday, April 07, 2007

The 80/20 Rule

Sooner or later in your career, you are exposed to the 80/20 rule or, as purists term it, the Pareto principle. Simply stated, it suggests that 80% of the consequences stem from 20% of the causes. You frequently hear how you get 80% of your revenues from 20% of your clients (and sometimes that 80% of your aggravation comes from that same minority).

Similarly, with all the furor of late focused on cost sensitivity, revenue-sharing, and the call for greater transparency, it’s easy to overlook the fact that most of that scrutiny and regulatory angst is being applied to 20% of the “problem” of retirement plan fees.

"Out of" Proportions

Traditional logic held that the fees on your “typical” retirement account ran like this: 70% for investment management, 20% for recordkeeping, and 10% for miscellaneous things like trust/custody, audit, etc. That apportionment wasn’t perfect, of course, but it was a rule of thumb that has been applied fairly liberally over the years. Investment fees were typically drawn from plan assets and, thus, participants have been bearing more than two-thirds of the costs of these programs for a very long time now.

Of course, over the past 20 years, we have seen a gradual shift where more and more of the remaining third is also paid from plan assets—and then redistributed to the same parties that used to get a check from the plan sponsor. Despite the occasional “study” from the Investment Company Institute to the contrary, 20 years ago, my sense is that mutual fund expenses were pretty much what they are now for the average 401(k) plan, at least for institutional class shares*.

So, while there is a growing sense that the participant is picking up a greater share of the plan costs, I’m reasonably sure that most are paying about what they used to, at least on a percentage basis. What’s different is those shareholder servicing fees that once upon a time simply rolled back into the pockets of the mutual fund complexes - now go to reimburse entities that actually perform those services for a retirement plan.

But while we agonize over how that 25-basis-point shareholder-servicing fee is parsed out between recordkeepers and advisers, the current debate barely acknowledges the fact that 70% or more of retirement plan fees paid by participants are the 50 to 100 basis points that come out of every participant dollar for “investment management.”

I’m not suggesting that investment management isn’t a skill to be highly prized and reasonably compensated. Nor am I suggesting that current investment management fees are disproportionate in every case to the value received. There may even be legitimate reasons why these funds grow from millions – to billions – of dollars in assets with no reduction in the expense ratios.

The 80/20 rule notwithstanding, IMHO, you won’t solve 100% of the problem by probing just 20% of the fees being taken from those participant accounts.

- Nevin Adams

* The misuse of retail class shares, and the liberal application of “R” shares, is a topic for another column.