Execs struggle with auto-escalation issue

Defined contribution plan executives are wrestling with ways to improve participants' savings through automatic escalation.

The struggle is between two philosophies: the opt-in approach, which requires participants to make a commitment to automatically raise their savings rate annually; and the opt-out approach, which includes participants in auto escalation unless they tell plan administrators to remove them from the program.

Most defined contribution plan experts say the opt-out approach is the best way to improve retirement savings when combined with auto enrollment.

Although opt-out is gaining, some surveys show opt-in either dominates or still represents a large percentage of auto-escalation policies in DC plans.

“In conversations I've had with record keepers, they say a very high percentage of participants stick with auto escalation on an opt-out basis and a relatively low percentage of participants take up auto-escalation if they have to opt in,” said Lew Minsky, the Jupiter, Fla.-based executive director of the Defined Contribution Institutional Investment Association, who supports the opt-out strategy.

A recent study by Principal Financial Group, Des Moines, Iowa, found that when participants were given a choice to opt-in for auto escalation, only 6% did so. T. Rowe Price Retirement Services, Baltimore, reported that 10.5% of participants in client plans offering automatic escalation via opt-in programs chose to participate.

Among those with opt-out auto escalation, 86% of participants stayed with annual increases, Principal said. At T. Rowe Price, 69% continued with the program.

“We say let inertia work for you,” said Francisco Negron, head of client services at T. Rowe, which encourages opt-out programs in conjunction with auto enrollment.

Among clients that offer auto enrollment, Mr. Negron said the opt-out auto-escalation approach rose to 33.6% last year vs. 22.4% in 2009. However, opt-in plans still outnumber the opt-out plans by a 2-to-1 margin.

DC plan executives are slow to accept opt-out methods for fear employers will appear excessively paternalistic, Mr. Negron said. In addition, they worry about cost and that participants will drop out of the auto-escalation program, he said.

Annual surveys of DC plan executives by Callan Associates Inc. show the opt-out approach is becoming more popular, said Lori Lucas, Chicago-based defined contribution practice leader and executive vice president. Callan found last year that 63.2% of plans offering auto enrollment used an opt-out program, up from 48.7% in 2010, the first year Callan asked about auto escalation strategy.

Ms. Lucas said plans typically start by offering auto enrollment and, if they offer auto escalation, they start with the opt-in approach. “They look at the results and they are not satisfied,” she said, so the next move could be raising the deferral rate for auto enrollment or raising the contribution cap. “Opt-out is the last thing they think of,” she said.

Among corporate plans with auto enrollment, 2012 data from the annual Plan Sponsor Council of America survey show 39.8% offered opt-out auto escalation, up from 36% four years earlier.

“I don't understand why it isn't more widely promoted and available,” said Robert Benish, PSCA executive director and interim president. “We have been promoting it and encouraging people to adopt it.”

Usage is increasing faster among 403(b) plans, although their bar is lower. PSCA found 20.7% of 403(b) plans offered opt-out auto escalation last year, up from 8.3% in 2009. (Both PSCA surveys are sponsored by Principal Financial Group.)

“It is frustrating,” said Mr. Benish, noting more than two-thirds of 403(b) plans surveyed each year from 2009 to 2013 didn't offer any form of auto escalation.

T. Rowe's Mr. Negron said convincing plan executives and participants to embrace the opt-out approach requires a sales pitch that combines finance and psychology. “We tell them "here is the opportunity that you are not capitalizing on,'” he said. “We tell them they need to look at the whole package” of auto enrollment and auto escalation.

“It's all about framing the discussion,” he added. “It's about the long-term impact.”

One T. Rowe Price client that adopted an opt-out strategy is Hershey Entertainment & Resorts Co., Hershey, Pa. At the beginning of 2014, plan officials launched auto enrollment with a 3% deferral rate and an opt-out auto escalation program for members of its $45.1 million plan covering non-union employees. The annual auto escalation is 1%. There's a cap of 6% of salary that combines the auto-enrollment deferral and auto-escalation increases.

Hershey Entertainment also raised its match to 50 cents on the dollar for the first 6% of pay from the previous 50 cents on the dollar for the first 5% of pay.

Hershey Entertainment chose the opt-out approach “because we wanted to get past inertia,” said Kimberly Mann, director of compensation and benefits. “People have good intentions but they don't always act. We wanted to overcome the hurdle. We wanted to do something mandatory so employees didn't have to think about it.”

Hershey Entertainment has allowed participants to voluntarily enroll in auto escalation since 2005. Currently, participants contributing more than 6% annually can opt in for auto escalation up to 50% of salary, she said. The opt-in program “is not widely used,” she added.

Among DC plans for which Vanguard Group Inc., Malvern, Pa., is a record keeper, 67% offered opt-out auto escalation and auto enrollment last year, a percentage that has held relatively steady since 2007.

“We were early to link the concepts of auto enrollment and auto increase,” said Jean Young, senior research analyst for Vanguard's Center for Retirement Research.

In recent years, clients of Fidelity Investments offering auto enrollment essentially have been evenly split between opt-out vs. opt-in auto escalation. For the second quarter of this year, 46.6% had an opt-out feature while 49.7% had opt-in. Only 3.7% didn't offer auto escalation. n