Guaranteed Minimum Benefits For Defined Contribution Plans?

In a decreasingly paternal private work culture, it's not surprising that employers are shifting the risks involved in providing guaranteed retirement payments back on employees themselves.

Employers by 2008 had moved all but 31% of the 50% of workers covered by any plan from Defined Benefit to Defined Contribution arrangements, in which workers depend largely on their own savings with or without employers’ contributions. By comparison in 1980, 83% of these workers were enjoying the retirement prospect of a steady amount every month. Employers should be swimming in savings from not socking away money for employees to retire on. Yet employer costs for retirement plans for new employees, from 1998 to 2008, dropped only 10%.

Researchers found that DC participants, who control the amount and direction of their retirement contributions (within the fund choices provided), were shaken by the erratic behavior of equity markets post credit-crisis and lost confidence that their savings would survive or sustain them in retirement. Consequently, they didn't retire when planned. Some 36% of DC participants are opting not to retire at 65, a three-fold rise over the 11% who stayed on working in 1991, according to data compiled by the Employee Benefit Research Institute (EBRI). The vast majority are doing so because of financial concerns, EBRI reports in ‘The 2011 Retirement Confidence Survey: Confidence Drops to Record Lows, Reflecting 'the New Normal.’ Since these older, presumably higher paid workers are continuing to draw on health care and other employer-supplied worker benefits, plan sponsors need solutions to help DC participants improve their savings and retire.

Prudential Financial's Retirement business unit proposes that plan sponsors incorporate a guaranteed minimum withdrawal benefit, or GMWB, into Defined Contribution plans. The guarantee component is aimed at providing a level of income of which retirees can be assured. Prudential quotes its own consumer survey showing two-thirds of respondents said a guaranteed lifetime income – with the option to opt-out – would be ‘appealing.’ 

“GMWBs ... may reduce the level of assets required for plan participants to achieve the same level of retirement income,” Prudential also concludes in a white paper it commissioned, entitled ‘What Employers Lose In The Shift: From Defined Benefit To Defined Contribution Plans ... And How To Get It Back.’ Plan sponsors gain as well, Prudential says, by “pooling the longevity risk of defined contribution participants...allowing them to help manage workforce planning challenges which will be even greater in the future.”

Participants in the plan activate for a fee the GMWB option some five to ten years before retirement, which generates their income base. The base will grow with regular contributions, annual ‘step-ups’ and market appreciation, which will “determine the participant's guaranteed level of future retirement income,” says Pru.  Retired participants receive a percentage of the base, such as 5%, for life.

However, not all plan providers favor this approach. Steve Utkus, head of Vanguard's Center for Retirement Research, recently listed drawbacks to such plans during a presentation to the U.S. Dept of Labor and Dept of the Treasury. Such ‘annuity’ products, says Utkus, can be “complex structures that are difficult for many sponsors and consultants to understand.”

A GMWB contract “cannot be transferred to another insurer if the employer decides the insurer is no longer appropriate from a fiduciary perspective.” Since most plan participants leave a plan upon retirement and roll over assets, Vanguard is concerned that “participants will have paid for guarantees and then leave the contract, forfeiting the value.” Utkus allows that, “if participants roll over to an IRA, some insurers offer equivalent IRA contracts that can retain the guarantee.” However, he adds, “they often come with higher fees.”   

More than 60 million Americans are currently covered by DC plans with assets now totaling $4 trillion, according to Vanguard's annual DC data. ‘How America Saves: 2011’ is based on its recordkeeping data from 2010, which found that “average participant account balances have now recovered” and “at yearend 2010 reached their highest level since 1999,” according to R. Gregory Barton, MD, Vanguard's managing director of the Institutional Investor Group.

Whether they find peace in contract guarantees may rely on a lot of fine print and complex clauses. But this market size would seem super fertile territory for a provider willing to simplify the language and tighten up the guarantees.