Longevity risk, long a concern of defined benefit plans, is increasingly of concern to defined contribution plan sponsors. Several recent industry discussion papers have zeroed-in on longevity risk as a key concern. Yet, while providers pitch annuity products as the ultimate solution, not all plan sponsors are willing to embrace them, experts say. Instead, as surveys of plan sponsors highlight, some are opting to wait for newer strategies or are setting their sights on more flexible options such as income-distribution strategies.
At the close of 2014 the actuarial liabilities of U.S. pension funds stood at approximately $6.6 trillion while Social Securitys stood at $24 trillion, according to the Society of Actuaries. But defined benefit plans have to worry only about the average longevity, said Bob Collie, chief research strategist at Russell Investments. In defined contribution you are on your own. With longevity already putting DB systems under strain, DC plans might soon have to reconsider their approach, experts believe.
The idea that plans should aid their participants in securing sufficient retirement income has been gaining ground among sponsors. Certainly there is a concern overall in the industry, said Joe DeSilva, general manager and senior v.p. of retirement services at ADP. One in three public defined contribution plan sponsors surveyed by the National Association of Government Defined ContributionAdministrators in 2015 already offer lifetime income products. Demand for them is high: 84% of employees surveyed by TIAA-CREF earlier this year believe it is important to them to have a guarantee of monthly income for the rest of their life.
Yet the pitch for annuitieswhether as standalone products or embedded within other investment vehicles (MMI, 3/27)has not been met with enthusiasm by all sponsors. According to AonHewitts forward-looking study for 2015, published early this year, the top concerns cited by sponsors were operational issues, fiduciary worries and poor participant utilization. Investors do not like the loss of liquidity and the loss of control, DeSilva said, pointing to the fact that to purchase an annuity investors must allocate a large portion of their account balance. Instead, many sponsors say they would like to wait and see the market develop newer and better products. There is a movement in the industry for new product, DeSilva said.
A lot of people in the industry are thinking hard to provide longevity pooling in some other way, Collie of Russell added.
In Aons study, 35% of the surveyed plan sponsors opted to include an option for participants to elect an automatic payment from the plan to an annuity over an extended period of time, versus 10% that facilitate the purchase an annuity outside the plan, 7% that have an in-plan annuity option, and only 1% that permit an in-plan deferred annuity purchase. The responding plan sponsors were not limited to choosing only one option in their plans. There are ways to address [longevity risk] without using annuities, Chris Lyon, a partner and head of defined contribution at Rocaton Investment Advisors, said. But it is important to explore all of your options.
Making distribution strategies work without an insurer to manage longevity risk can be tricky, however. For that reason some industry professionals recommend expanding investment lineups to include asset classes beyond stocks and bonds in pursuit of better growth prospects. If you are going to live 10-20 more years, you need more exposure to growth assets, said Edward Keon, a managing director and portfolio manager at Quantitative Management Associates (QMA), an asset management subsidiary of Prudential. Real assets like real estate are a good option.
A recent paper from QMA notes that market expectations, as expressed by futures contracts, are that low interest rates will remain a reality for the foreseeable future. Without healthy income from bondsthe safest component of a retirement portfolio401(k) investors might find themselves in a serious predicament if they end up living longer than they expected. The number of older people is growing, Keon said. So more and more people try to use financial assets to get income. But we have a limited supply of things to produce these returns.
Not all industry practitioners are convinced plan sponsors would be open to the idea of including riskier, and presumably more managerially expensive, assets in their plans, especially given the recent wave of lawsuits that have seen companies forced to agree to multimillion dollar settlements for allowing too-expensive options in their investment lineups (MMI, 11/6). There is a lot of industry interest in this but little interest from plan sponsors, Lyon said. And with the recent litigations, we must expect, at least temporarily, a delay [of such efforts.]
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