Is the Retirement System ‘Fragile’?
It’s not all about “the Benjamins,” but a recent analysis of the nation’s private retirement system certainly puts a lot of emphasis on the accumulation of aggregate assets in retirement plans.
No Surprises
There were some findings that seemed to surprise the authors that didn’t strike me as all that remarkable. Apparently (I hope you’re sitting down for this one) larger plans pay lower fees (expressed as basis points) than smaller plans. They are also more likely to invest in collective investment trusts (which tend to have lower fees, though that isn’t necessarily the case).
What I did find surprising was Morningstar’s assessment that those smaller plans pay, on average, “just” 88 basis points (compared to the 41 basis points estimated for larger plans)—indeed, I found both numbers pretty reassuring. On the other hand, “averages” can often obscure reality, and the authors also found that smaller plans also feature a much wider range of fees between plans—with roughly a third of those plans costing participants more than 100 basis points in total.
And make no mistake: Those higher fees are—literally—a “toll” on
retirement. The Morningstar report says that two workers who save the
same amount and invested the same way might well result in an individual
who worked for a smaller employer (and who participated in a smaller
plan) having 10% less in retirement savings. That’s a hefty price to
pay—but then this is hardly the only area in life where larger
purchasers are able to obtain a volume discount.
ESG ‘Risk’
There was also little surprise in the finding that “Plan sponsors appear to have shied away from considering environmental, social and governance (ESG) information and analysis, in part because of regulatory uncertainty.” Oddly, Morningstar’s analysis—here they leverage their own ratings system to ascertain funds that might be considered to be exposed to ESG “risk”[ii]—produces a number that, while well short of what Morningstar would apparently deem prudent,[iii] still notes that “as many as 48% of retirement plans with at least 100 participants already offer investment strategies that use ESG analysis to evaluate investments”—though that belies the results of most industry surveys (including PSCA’s 64th Annual Survey of 401(k) and Profit Sharing Plans). On the other hand, the report acknowledges that this includes funds with a “broad definition” of ESG—funds that presumably take those type factors into account without touting that as an explicit emphasis (and perhaps without the awareness and focus of plan fiduciaries). Regardless, and undoubtedly for the reasons cited by the report, there’s little question that plan sponsors outside of the public and non-profit sectors have indeed shied away from ESG. At least for the moment.
Assets Oriented
There was, however, some interesting new ground in the apparent “churn” in the system. The report states that more than 380,000 plans closed during the period from 2011 to 2020—a result it attributes largely to employers going out of business. While that is certain a point of vulnerability for those previously covered by those plans (not to mention the presumed loss of employment), the solution for that lies beyond the retirement system per se.
As we have noted consistently, the report expresses concerns about coverage and the access to workplace savings, but ultimately differentiates its focus from traditional retirement system analysis by focusing on the size and flow of the system, as measured by assets. Indeed, and as noted above, the report seems particularly obsessed on the subject of assets—not on an individual level, or on obtaining a measure of retirement income adequacy, but on the premise that more assets mean the ability for plans in the system to negotiate for lower fees (and, on a related note, to opt for investment types, notably CITs, that have lower expenses). But while the emphasis was intriguingly unique, it’s also the basis upon which these authors affix the “fragile” label to the system, as if “the system”—as measured by assets—must constantly grow in order to be considered healthy.
Now, there were some jaw-dropping numbers behind this premise—the report claims that there have been outflows of more than $400 billion a year since 2015, at least as reported by plans in their annual filings. However, at a time when 10,000 Boomers are said to be heading off into retirement every day, one might well expect a lot of them to be taking their retirement savings with them.
‘Out’ Flows?
The concerns expressed in Morningstar’s analysis seems to assume that much of the outflow is pre-retirement “leakage”—though they seem equally concerned about rollovers. Why? Well, once again they write that, “More assets in the defined-contribution system would help more sponsors gain the leverage to demand lower fees from asset managers and drive down costs for end investors.” While true enough, it seems an odd anchoring.
Indeed, in commenting on their assumptions, the authors comment that while they believe their estimates are “conservative,” and that “any errors understate the massive detectable flow of money out of DC plans,” they also admit that it is “…clear from Internal Revenue Service data that most flows out of plans are for rollovers rather than cash-outs…,” though they concede you can’t draw a distinction there between cash-outs and rollovers with the Form 5500 data.
Indeed, while 30,000-foot assessments of the retirement savings landscape are not unique, in looking nearly exclusively at the total pool of assets in that system and its implications, Morningstar’s report makes no attempt to correlate those assets to the needs of the individuals covered by the system.
‘Pool’ Rules?
That asset-focused prism leaves it to claim that the entire system “relies on a few thousand employers to cover most people saving for retirement,” as though that’s a unique vulnerability. But the defined contribution retirement system is not one gigantic pool that must satisfy all obligations. Sure, it would be great if more employers, specifically more small employers, saw fit to offer a plan—but the fact that they don’t doesn’t put “the system” at risk.
But those who do have these programs, and take advantage of them, face no jeopardy as a result (although they may well wind up being taxed at higher rates in the future). The U.S. DC system doesn’t “rely” on new employers to offer plans to compensate for those that are no longer doing so—though arguably the coverage gap, and the lack of ready access that results, are an issue of general concern.
All in all, the report offers an interesting assessment of “the system”—more thoughtful and comprehensive than most, though the obsession with total assets seems a bit myopic, and as one might expect a lot of assumptions, perhaps of necessity in a report as broad as this.
In sum, while its conclusions are perhaps a bit “fragile” upon which to build a firm assessment, there’s plenty there to warrant discussion—and action. But is the system "Fragile" - only for those who aren't part of it.
- Nevin E. Adams, JD
[i] While much of the report focuses on DC plans, the Morningstar researchers also intriguingly acknowledge that more than 33 million people are or will receive benefits from defined benefit plans as of 2019, and that DB plans accounted for more than 30% of distributions paid to participants in 2019 and they do not appear to have peaked. It even notes that approximately 8.8 million people who are no longer working are still entitled to future benefits and 11.7 million people who are still working will eventually receive benefits. Looks like those “dead” pension plans still have a lot of life in them!
[ii] The percent of assets that are in the various categories of ESG risk assigned by the Morningstar® Sustainability Rating™ for funds, sometimes called the globe rating.
[iii] In fact, the report comments, “…sponsors have left the U.S. defined-contribution system in the aggregate tilted toward investments with more ESG risk—which is the degree to which companies fail to manage ESG risks, potentially imperiling their long-term economic value. Plan sponsors may wish to reexamine their investment choices using an ESG lens.”
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