DC East speakers discuss leakage, retirement and the markets

The idea of retirement plan leakage was prominent at Pensions & Investments' East Coast Defined Contribution Conference March 10-12 in Miami, leading one keynote speaker to outline a list of ways to increase the savings of plan participants.

“Leakage is enormously important,” said David Laibson, the Robert I. Goldman Professor of Economics at Harvard University, Cambridge, Mass., and the conference's opening keynote speaker. “One out of two dollars is leaked before retirement … Participants need to ramp up savings because leakage is probably here to stay.”

Mr. Laibson told the DC East audience — the largest ever for a P&I DC conference — that the savings system works in theory, factoring in appropriate employee contributions, employer matches, Social Security and retirement drawdown. However, “the problem is the savings system is not working,” and the reason is leakage, which has proven not to be a product of the recession, Mr. Laibson said.

Total leakage increased to more than $80 billion in 2007 from $60 billion in 2004, but the leakage rate only grew 2.5% during the recession years, from 2007 to 2009. However, once the recession ended, that leakage rate increased 24.9%, or more than $110 billion, in 2010, the most recent data.

James Delaplane, Washington-based principal, government relations, at Vanguard Group, speaker for the conference's final keynote address, said leakage is “coming up the policy ladder” in exploring where it is coming from – loans, hardships or cashing out when leaving a job.

Mr. Laibson discussed several steps plan executives can make to increase savings from participants, including increasing the default savings and auto escalation rates — “6% is the new 3%,” he said. Another idea picked up by several speakers and panel discussions throughout the conference was the idea of increasing the match threshold, for example, to 10% from 6%, but while lowering the match rate to produce a cost neutral scenario for employers.

“It will give a better message to save more,” he said.

Leakage and inadequate retirement income in general are not the only reasons savings habits have to improve, Mr. Laibson said. The new 401(k) landscape covers much more than just retirement these days; it also covers down payments, education, medical bills and rainy day money, so participants need more money in their accounts, Mr. Laibson said. He said the net national savings rate since the 1950s is “on a tear to zero.”

Marina Edwards, senior consultant, benefits advisory and compliance at Towers Watson & Co., Chicago, agreed with Mr. Laibson that increasing the default rate is a “great start” and even suggested bumping it up to 8%. She added that “retirement confidence is at an all-time low” and that plan executives have to factor in more and more that employees are delaying retirement.

Ms. Edwards said recent survey results showed 48% of companies have a small contingent of employees working longer and 15% have a large amount of employees delaying retirement.

Because retirement at age 60 or 65 is no longer something companies can assume their employees will want or be able to afford, speakers on the panel “Retirement: is it still relevant?” said employers need to move to a more holistic approach.

“We cannot limit ourselves to looking at the investment menu,” said Fredrik Axsater, managing director and global head of defined contribution for State Street Global Advisors, Boston. “We need to look beyond investment returns to reach an overall objective of having enough for retirement.”

Edward Waldvogel, vice president of pension investments for Cincinnati-based The Kroger Co., said retirement is “getting to be an irrelevant term” due to people's fear of ever being able to stop working.

Mr. Axsater suggested that there is a need to refocus on retirement as a new stage of life that people need to plan for. He added if employees are working longer, companies need to address that in the design of their defined contribution plans by including longer target-date funds.

Mr. Waldvogel stressed that it is important to tell plan participants to pick target-date funds that match their plans for when they will retire, not just for the year that is closest to when they turn 60 or 65.

A panel discussion on target-date fund best practices talked about the need to look at more custom approaches and allocating by risk to obtain more exposure to other asset classes. Dan Zelazny, director of retirement, subadvisory group, at AQR Capital Management LLC, Greenwich, Conn., said the five largest target-date funds, by capital, have an average even split of equity and fixed income even though equities make up 91% of the risk, mostly domestic. He said the way to solve that problem is to maximize market beta and broaden to areas such as international and emerging markets equity and debt, TIPS, real estate investment trusts and commodities.

Allocating by risk will lead to a higher Sharpe ratio for the portfolio, he said. Mr. Zelazny also added there are fewer reasons for not using alternative investment options, and that by embedding them in target-date funds it takes away the risk of participants overallocating to the asset classes.

Tim Walsh, managing director, institutional product at TIAA-CREF New York, said in a panel discussion on guaranteed income at retirement that annuity income products will also become more prevalent as a carve-out in target-date funds.

But the panel focused on the need for plan executives to use the same due diligence and third-party expertise for selecting income products as when selecting a mutual fund. Mr. Walsh emphasized how sophisticated the products are.

The two key areas to keep an eye on are the government and inflation, Mr. Walsh said. He said he would be surprised if the government mandated an option in plans, but to deal with the threat of inflation, it is “absolutely crucial” to leverage a guaranteed product with some kind of inflation protection.

While much of the conference focused on uncertainty over the state of retirement savings and the need to select the right investment options to assist participants, one of the keynote speakers brought some optimism to the event.

Ed Yardeni, president of Yardeni Research Inc., Old Brookville, N.Y., and a morning keynote speaker, said he was optimistic that a broad, secular bull market will continue, arguing against bearish sentiments in the current environment. “The bull market of the last four years is the Rodney Dangerfield of bull markets — it just gets absolutely no respect,” Mr. Yardeni said.

He acknowledged the ongoing concerns that have persisted over the years, including Greece's debt problems and U.S. fiscal debates, but said the eurozone recession will bottom out in the second half of 2013 and U.S. growth does not show signs of a double-dip recession.

The U.S. real GDP is still at a “stall speed” at 2.5%, but he argued the growth is really around 3% when government spending is taken out of the equation. “It may all end badly, but it won't end badly today,” Mr. Yardeni said.

Among a slew of graphs, Mr. Yardeni highlighted the close correlation between world exports and Standard & Poor's 500 companies' revenue. “The world economy is what counts for the S&P” and while the global economy has slowed, it will continue to grow, Mr. Yardeni said.

He predicted the S&P will have a nominal return of 5% to 7% in both 2013 and 2014 with aggregate earnings of $110 and $118 per share, respectively.

The S&P 400, 500 and 600 all currently have a record high for 52-week forward estimates from analysts, Mr. Yardeni said. Now, he added, investors have to get corporations back to the idea of paying out dividends and not stock buyback programs.

Mr. Yardeni said what worries him the most, outside of aging demographics, is income inequality, but he thinks the government will continue to "pick the pockets" of the wealthy to keep it at peace.

Meanwhile, Vanguard's Mr. Delaplane updated attendees on what is happening in Washington in regard to retirement system and regulation changes. While he said there is not much on Congress' agenda, fiscal battles could result in changes to the retirement system to fund agenda items not directly related to retirement. The changes would not be based on merit, but whether it generates more revenue for the government.

New Mr. Delaplane warned attendees they can expect more brinksmanship in Washington and that the majority parties in the House and Senate are unlikely to change in 2014. He said the retirement industry should ignore the rhetoric and that the markets have already tuned out Washington drama for the most part. One area to monitor is whether Phyllis Borzi, assistant secretary of labor for the Employee Benefits Security Administration, will receive the same level of support from the new labor secretary, he added.

There will likely be more revenue-driven changes to the retirement system, but it is doubtful it will be across the board and will probably focus on the high earners, Mr. Delaplane said. The most likely change is a return to the Roth concept, such as requiring after-tax contributions instead of pretax contributions, he added.

Other possible proposals could include ending tax-preferred savings in IRA and 401(k) plans once account balances reach $2 million, a return to raising Pension Benefit Guaranty Corp. premiums and limiting tax-deferred contributions to retirement accounts to the lesser of $20,000 a year or 20% of income.

One area that is more likely to see regulation changes is money market funds, Mr. Delaplane said. He expects a proposal from the Securities and Exchange Commission in the second quarter of this year as the likelihood of new regulations is increasing on floating net asset value, requiring the funds to have a buffer to absorb daily fluctuations and requiring a holdback on redemptions.

“It's more likely that segment is affected by some new regulations,” Mr. Delaplane said.

Other areas of policy interest without much traction, include coverage expansion, rollover dynamics and how to reform multiemployer DB plans. The Department of Labor is also starting to look at retirement income products, but Mr. Delaplane said any final regulations are still years away.

Executive Editor Amy Resnick also contributed to this story.