Investing December 14, 2020

Guaranteed Income, Private Equity Coming Soon to a TDF Near You

Legislation, regulations and market volatility will serve as catalysts for inclusion of income products and private equity in target-date funds, asset managers suggest.

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The strategic incorporation of lifetime income products and alternative investments in target-date funds (TDFs) could potentially help providers deliver superior long-term outcomes for plan participants and differentiate themselves in a market dominated by a handful of low-cost providers, according to the December issue of “Cerulli Edge—U.S. Asset and Wealth Management Edition.”

Momentum for including income products in TDFs has been building since 2014, when the IRS issued guidance providing that plan sponsors can include deferred income annuities in TDFs used as qualified default investment alternatives (QDIAs) in a manner that complies with plan qualification rules. A significant barrier to plan sponsor adoption of guaranteed income features was addressed by the Setting Every Community Up for Retirement Enhancement (SECURE) Act, which—along with a provision addressing the portability problem with annuity products—offered a fiduciary safe harbor for the selection of guaranteed income providers.

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According to Cerulli’s report, the majority (92%) of TDF managers said they expect managed payout options and annuity allocations will be incorporated into future TDF series. The market volatility of the first quarter of this year may also serve as a catalyst for guaranteed income adoption by defined contribution (DC) plans, as nearly two-thirds (63%) of TDF managers suggest this period of heightened market volatility will increase client demand for guaranteed investments.

Cerulli notes that market downturns can help illustrate annuities’ downside protection benefits.

Private Equity

Cerulli says it expects that in the coming months, plan sponsors and retirement plan providers will engage in more detailed exploratory discussions regarding the inclusion of private equity in multi-asset-class products such as TDFs. The Department of Labor (DOL) released an information letter earlier this year offering regulatory guidance related to the use of private equity funds within professionally managed strategies (e.g., TDFs, target-risk funds) that may serve as a DC plan’s QDIA.

Cerulli says it is perhaps most critical for providers to clearly demonstrate to plan fiduciaries how allocating to a certain private equity strategy within a professionally managed product can improve long-term outcomes for plan participants on a risk-adjusted, net-of-fees basis. However, private equity investments come with challenges that plan sponsors need to be made aware of.

“Private equity funds are typically characterized by infrequent pricing events, low liquidity, relatively high management fees and complex investment structures. Conversely, the DC market—litigious in nature—is notoriously fee-sensitive, and the product landscape is dominated by simple, transparent, low-cost investment vehicles,” says Cerulli Senior Analyst Shawn O’Brien. “It may take time for many plan fiduciaries to gain a sense of comfort with private equity investments, and, therefore, thorough educational and informational engagements may be a necessary precursor to adoption in a DC market where private market investments are rare.”

Compliance December 14, 2020

PBGC Programs in Very Different Positions

The single-employer program is improving, but Director Gordon Hartogensis says it’s clear legislative help is needed for the multiemployer program.

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The Pension Benefit Guaranty Corporation (PBGC) has released its Fiscal Year (FY) 2020 Annual Report, which notes, among other things, that the expected insolvency date of the agency’s multiemployer insurance program has been delayed from FY 2025 to sometime in FY 2026.

Meanwhile, the single-employer insurance program is improving, driven primarily by investment income and premium income.

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The multiemployer program remains severely underfunded, with liabilities of $66.9 billion but only $3.1 billion in assets as of September 30. This resulted in a deficit, or negative net position, of $63.7 billion, compared with $65.2 billion a year earlier. The decrease in the program’s deficit is primarily due to the enactment of the Bipartisan American Miners Act of 2019, which is expected to help the United Mine Workers of America 1974 Pension Plan avoid insolvency. This development resulted in a delay in the multiemployer program’s projected insolvency from sometime in FY 2025 to sometime in FY 2026.

During FY 2020, the agency provided $173 million in financial assistance to 95 multiemployer plans, up from the previous year’s payments of $160 million to 89 plans.

PBGC data shows that about 125 multiemployer plans are in so-called “critical and declining” financial status. Such plans report that they will become insolvent over the next two decades. Several very large union plans—including the United Mine Workers Pension Fund and the Central States Pension Fund—predict they will become insolvent within just the next few years.

The lack of a legislative solution belies what appears to be serious will on both sides of the political spectrum to address the multiemployer pension funding crisis. As is often the case with federal legislation, though there is professed agreement about the size and pressing nature of the problem, consensus about a solution remains elusive.

PBGC Director Gordon Hartogensis noted in a message accompanying the FY 2020 Annual Report that the agency continued to protect benefits for multiemployer plan participants. “In FY 2020, PBGC approved the first facilitated merger under the Multiemployer Pension Reform Act of 2014, providing financial assistance to help preserve the solvency of the merged plan and protecting retiree benefits in a way that will not impair PBGC’s ability to meet its existing financial assistance obligations to other multiemployer plans,” he said.

Single-Employer Program

The single-employer program had assets of $143.5 billion and liabilities of $128 billion as of September 30. The positive net position of $15.5 billion reflects an improvement of $6.8 billion during FY 2020. However, the program’s exposure increased to $176.2 billion in underfunding in pension plans sponsored by financially weak companies that could potentially become claims to PBGC.

During FY 2020, the agency paid $6.1 billion in benefits to more than 984,000 retirees in single-employer plans. PBGC also assumed responsibility for the benefit payments of an additional 56,405 workers and retirees in 69 single-employer plans that were trusteed during FY 2020.

“This year’s report illustrates that PBGC’s two insurance programs are in dramatically different financial positions,” Hartogensis said. “It remains clear that legislative reform is necessary to avert insolvency of the multiemployer program, and PBGC continues to provide technical support to policymakers, stakeholders and plan sponsors.”

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