401(k)s Increasingly Adopt Pension-Like Features
May 29, 2006
WASHINGTON - The days of defined benefits may be ending, but their tactics live on in an increasing number of defined contribution plans, from enrolling employees automatically, to picking their portfolios and even investing in annuities.
For years, experts have warned that although companies offered their employees the tools to prepare for retirement, few chose to use them, making for a generation of workers with uncertain futures.
Correcting that is simple, James Cornell, senior vice president for Fidelity Investments's FIRSCo Plan Sponsor Strategy, told those gathered at the Investment Company Institute's General Membership Meeting. "We just had it backwards," Cornell said. "We use the power of inertia to our advantage."
BlueCross BlueShield of South Carolina did just that, according to Barbara A. Kelly, vice president for human resources. Until recently, low participation plagued the insurer's 401(k) plan. The program, started in 1983, suffered when the company stopped offering to match employee's pre-tax savings. In 1989, the staff doubled, and by the mid 1990s, poor participation among rank-and-file workers caused the company's plan to continuously fail non-discrimination requirements set forth by the Internal Revenue Service.
Attempting to correct that, the so-called "South Carolina Blues" implemented automatic enrollment in 2000. Employees who did not actively opt out, had 2% of their salaries shuttled into the company's plan.
But because employees never adjusted their contributions, most of those savings sat in money market funds, and because of low balances with little growth, the maximum possible contribution was capped at $8,100 per year. "In 2003, we hit rock bottom," Kelly said.
That's when the company increased the automatic enrollment to 6%, reinstated a company match and moved the default investment from money market funds to lifecycle accounts. In 2005, employee contribution rates automatically increased 1%. Only 169 employees, or 2.4% of the staff, opted out.
Between 2003 and 2005, participation surged 37% to 94% of the company's 12,800 employees. "We help with life after work for our employees by making deferral decisions for them," Kelly said.
But it's not just inertia that keeps American workers from saving. Intimidation and ignorance also contribute, said Warren Cormier, president and founder of the Boston Research Group.
Cormier's group surveyed a group of plan participants who were "very satisfied" with their plans. But when asked how they would rate each feature, though, education fared the worst. "The lowest level of satisfaction is the ability of the educational program to help them make decisions and learn the principles of investing," he said.
As a result, Cornell predicts that "auto features are going to become plan standard design."
Despite initial concerns that automatic enrollment might roil employees uninterested in participating, neither Cornell nor Kelly recalled any serious complaints about the process. Notifying employees upfront that they can opt out at any time protects companies from any legal liability.
Choosing which fund an employee's savings are channeled to, however, is a little trickier. "We went to outside counsel for an opinion," Cornell told the crowd. "They said we're doing it in the best interest of our employees as a fiduciary." Attorneys produced a letter that FIRSCo makes available to plan sponsors and their employees.
BlueCross BlueShield of South Carolina has never received a complaint, according to Kelly. In fact, sometimes employees even thank her, she said. Employees there also must initial a document, acknowledging that they have been placed in a lifecycle plan, and they always have the option to change their allocations.
Because workers of different ages and incomes may have different needs or feelings toward investing, providers that want to compete should consider offering plans tailored to individual tastes, said Barry Schub of New York Life Investment Management. "Our belief is crafting a plan with the participant that is better than the default," he said.
In general, investors can be organized into a few large categories: those who want to manage their own retirement account holdings but also want feedback on their choices, those who don't know how to assemble a portfolio but who want to watch its progress, and those who only have a retirement account because they have a job, but are otherwise nave when it comes to the markets.
"You have to have to learn the pattern through their behavior and tailor the message to those patterns," Schub said. That means different educational and marketing materials for each group. In the past, tailored programs might have been cost prohibitive, but electronic document delivery and on-demand-publishing erode such barriers, he said.
Not all workers are confident that the investment decisions they make now will serve them well in the future, especially given the rising costs of health care and inflation, said Tom Johnson, senior vice president for Boston-based MassMutual Financial.
Even if a participant saves $500,000 through a 401(k), they may not be able to gauge if, ultimately, that will be enough. "Investors want predictabilities and guarantees," Schub said. Adding annuities to a qualified plan can provide just that, he said.
Annuities turn off many advisers, because, once a client agrees to buy them, there are no real fees for advisers to collect. But annuity providers, struggling to maintain their business as employers are bailing out of the defined benefit space, are focused on ways to push their products through defined contribution sales channels.
One way to do that is to allow the earnings in a qualified plan to be reinvested into an annuity. For the individual participant, buying into such annuity offers a guaranteed steady income to complement whatever amount they draw down from their 401(k) holdings. "It's a baseline guarantee of a lot more money for a longer period of time," Johnson said.
Each of these innovations can help build what Johnson called "an individual pension plan."
"The participant wins, the employer wins, and we win," Cornell said.
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