Benefits September 22, 2022

Investors’ ESG Demands: Will More Plan Sponsors Be Forced to Act?

Studies about the concerns of Generation Z and Millennial investors indicate that they’re worried about retirement and care deeply about how they are investing.
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Art by Gizem Vural

On May 4, the Securities and exchange commission publicized two denials it made to companies that had requested the right to block a proxy vote that would require them to evaluate commitments in their retirement plans for investing based on environmental, social and governance principles.

According to two attorneys at the law firm Seyfarth, a shareholder requested that the board of a company review the company’s retirement plan investment options and assess how those options align with the company’s climate action goals. The shareholder said every investment on the plan menu, including the default, contained companies in businesses related to fossil fuels or deforestation. The shareholder also said there were limited numbers of funds to choose from that were screened for environmental and social impact, according to the attorneys.

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It’s unclear who is behind the request to the companies for a proxy vote that was upheld by the SEC. But the move does raise a question: Will retirement plans increasingly become a battleground for socially conscious investing efforts?

Recent studies about the concerns of Generation Z and Millennial investors indicate that they’re worried about retirement and care deeply about investing their money according to ESG principles. Given that these cohorts will eventually hold vast amounts of investable assets, much of it inherited from Baby Boomers, their attitudes are likely to have considerable influence. Meanwhile, anecdotal evidence suggests members of these generations are becoming more vocal about having the option to make ESG investments inside their retirement plans, with the tax advantages those plans offer.

In Nuveen’s 6th Annual Responsible Investing Survey, published in 2021, 96% of Millennial investors said it is important that their asset managers are knowledgeable about responsible investing. Additionally, 94% said they would be more comfortable working with an asset manager that had experience in responsible investing. Among all investors, not just Millennials, 63% agreed that their financial adviser could do much more to help them see the specific societal or environmental benefits of responsible investing.

Queries on the Rise

“I increasingly hear directly from individual investors who are trying to have more access to credible ESG funds within their retirement plans,” says Amy O’Brien, global head of responsible investing at Nuveen. “It’s related to their retirement savings plans and their employer’s behavior overall. Companies are starting to realize that their employees are scrutinizing their stated sustainability commitments and are connecting that to the availability of investment options.”  

O’Brien says plan sponsors should consider adding more options for values-based investing to their menus and understand what’s important to younger investors, who are coming out of college well-versed in the ideas behind sustainable investing.

 “Plan sponsors need to take a second look,” she says. “In the past, we’ve seen them add options, but in some cases if they did not commit to educating employees, they didn’t do the education, and then they didn’t see the fund flow they had hoped for. This is a way for companies to attract and retain younger workers.”

Similarly, Brendan McCarthy, head of retirement investing at Nuveen, says plan consultants have been reaching out to Nuveen looking for ESG options because sponsors, prompted by employee interest, are asking for them. “It’s a regular thing,” he says.  

In some cases, the option is already available but not widely known about among participants. To address the problem, companies can fold communications about ESG options in their plans into other sustainability communications, McCarthy says. One company he works with did this recently with its communication on Earth Day.   

Consistency in Word and Deed

“Millennials and Gen Z employees are particularly concerned about working for employers who act in line with their values,” says McCarthy. “If employees are raising this demand, it’s very important for companies to communicate back and let them know that the company appreciates and is considering their values.”

Lazaro Tiant, sustainability investment director in North America at Schroders, echoes that sentiment. “Plan participants in this group want to align their investments with their values, particularly those within companies that have made commitments to sustainability-related initiatives,” he says. “Companies that have set sustainability goals may continue to see a rise in demand from employees who want to see consistency between those commitments and their retirement options.”  Research published earlier this year by Schroders showed participation would likely increase if sustainable investments were offered. 

What the Data Say

Azish Filabi, professor and executive director at the American College of Financial Services Cary M. Maguire Center for Ethics in Financial Services, studies trust and ethics in financial services. Recent data she collected show that Millennials and Generation X, which comprises people age 26 to 55, are most concerned about their finances and worry that they won’t have enough money to last them in retirement. Data from Gen Z show low trust in financial services, with the younger generation having a bleaker outlook on their finances.   

She notes that when the younger generation begins to trust a company, one of the things they look for is that it supports the community. For Filabi, there’s a link to ESG themes: Values drive the decisions and engagement with financial services of the younger generation.

Making Values Actionable

Filabi says if companies want to reach these cohorts, authenticity matters. “Make sure your actions match your words,” she says. “If you are articulating certain kinds of values to live by, then you need to make sure you’re living by them.”

She adds that concepts related to ESG and stakeholder capitalism are not new, and companies need to have an opinion on them. “Reputation risk really matters in the ESG environment, and it could be of material value,” she says.

Similarly, many companies don’t actually know what their employees think about important issues, or if they perceive gaps between what a company says and does. Filabi says a five-question annual survey of employees’ views won’t cut it. “Do a deeper-dive analysis on what employee perspectives are on key topics,” she says.

Finally, keep in mind that investors are looking to make nuanced societal challenges more actionable. For the younger generation, this might mean support for the local community. And for many, it might mean making investment choices in line with values.

Who Is Calling the Shots on Plan Menus?

But how do you make your values actionable if the options in your plan just aren’t there?

Stefania Di Bartolomeo, founder and CEO of Physis Investment, an impact investment data platform, has observed that, in general, decisionmakers at investment companies and for 401(k)s “are part of the old generations, and do not see the need for ESG unless it is for regulatory compliance,” while Millennials are exercising their influence with their spending habits.

But it won’t be long before this starts to shift, says O’Brien.

The Boiling Pot

Pressure groups are targeting retirement plans for changes, and others, like the The Forum for Sustainable and Responsible Investment and the Intentional Endowments Network, have put together resources for more people to do so.

“I’d like to see more campaigns about generating end investor demand for plans,” says O’Brien. “That will demonstrate the interest in these options for decisionmakers and lead to outcomes. But often, it takes more, such as an internal ‘champion’ for employees who are asking for more options, or someone who really wants to see the company’s actions in line with its identity.”

She continues: “The reality is that a lot of sustainability and ESG investing has been done at a high level by sophisticated institutional investors. But now, gradually, I would say it’s being democratized. Average individual investors are learning about it and really demanding to have these options in their plans.”  

Dave Nadig, a financial futurist at VettaFi, a financial services firm, says companies should ensure that Gen Z and Millennials are represented on committees that advise the retirement plan. This can boost participation and helps companies understand what the cohorts want.

If a company is only now starting to pay attention to ESG, it’s about “15 years too late,” he says. “ESG is real. It’s ‘realer’ the younger your employee base. I don’t care what survey you look at. Boomers care. Gen X cares, Millennials care a lot, and it’s the only thing Gen Z cares about. If it’s not in their 401(k) plan, it’s just because they haven’t yelled loud enough.”

Administration September 1, 2022

Evaluating ARPA’s Impact, 1 Year Later

The law made it easier for some plans to continue operating by adding flexibility.
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Art by Carol Rollo

The American Rescue Plan Act of 2021 created funding relief for single-employer defined benefit pension funds by extending the amortization period for shortfalls and stabilizing the interest rates used to calculate their funded level.

Important Legislation

Impressions of ARPA’s impact since passage vary widely among sources contacted for this article. Some maintain that it provided a vital lifeline for sponsors. One such supporter is Harold Ashner, a partner with the Wagner Law Group in Washington, D.C., and the Pension Benefit Guaranty Corporation’s former assistant general counsel for legislation and regulations. “The funding relief was a lifesaver for employers facing unaffordable contributions that threatened the viability of the business, with a significant risk of a loss for PBGC,” he says. “Many of those employers will now be able to maintain their pension plans long-term.”

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By providing greater flexibility for the timing of minimum contributions and reducing the contributions’ volatility, the funding relief has reduced the pressure to close DB plans, Ashner says. “With the ability to apply the funding relief back to the 2019 plan year, there were many employers who found out that the minimum contributions they already made suddenly became excess contributions that could be used to offset significant current and upcoming contribution obligations,” he says.

Ashner also cites a benefit to the PBGC’s finances. While plans that ultimately fail despite the funding relief could present greater losses for the PBGC, he says, the PBGC will receive more variable-rate premium revenue to compensate for the increased exposure. Additionally, some plans that otherwise would have created losses for the PBGC will instead survive because of the funding relief, he says, citing the agency’s September 2021 projection that the relief’s net effect will be a $1.4 billion improvement in the PBGC’s financial position.

Nathan Hoellman, consultant and actuary with Cowden Associates in Pittsburgh, agrees that ARPA made it easier for some plans to continue operating. “For our cash-conscious sponsors, the ARPA legislation has been hugely helpful, often reducing contribution requirements to zero,” says Hoellman. Overall, ARPA’s impact on single-employer plans has been a “net positive,” he says, because it adds operational flexibility, but its effect will vary with the plan’s goals. For plans looking to terminate in the near term, the interest-rate relief could incentivize plans to delay that decision, which could have positive or negative effects, depending on market factors such as interest rates and market returns, Hoellman says.

At the same time, as funding rates and market interest rates near each other, settling liabilities results in a smaller loss with regard to funding, Hoellman explains. With higher funding interest rates, there is less incentive to settle liabilities via annuity purchases, lump sum windows or plan termination. Also, the lower required contributions that result from the amortization changes under ARPA make it easier for a plan to continue operating. “If terminating the plan is the ultimate goal, it may be delayed but not removed,” says Hoellman.

Limited Value

Brian Donohue, a Chicago-based partner with October Three, says that for a minority of plans, perhaps 10%, funding relief is meaningful and translates directly to them putting less money in their plans. The reason it’s a very small percentage is that most employers don’t base their funding decisions solely on the minimum required amount, says Donohue: “For most of those employers, what funding relief means is the rules are just less likely to impinge on what you’re trying to accomplish, which is nice—you have more room to pursue your strategy.”

For instance, a plan might be settling its liabilities through lump-sum payouts or pension risk transfer strategies. Plans need to have a funding level above 80% to implement those strategies, says Donohue, and ARPA makes it easier for them to maintain that 80% funded status so they can engage in settlement activity.

Donohue cites October Three’s research that found that 72% of plans with at least $400 million in assets were fully funded using the PBGC’s standards, which are more stringent than ARPA’s. PBGC’s premiums are based on funded status, and underfunding a plan and incurring the resulting higher premiums is “an expensive way for companies to borrow,” he cautions. “If companies have access to cash or credit at reasonable rates, it probably makes sense for them to go borrow that money and fund their pension shortfalls. So, what you’re left with is companies that don’t have any good options for cash or credit, and this is why they don’t fund their pension plans. That describes much of the 10% of plans that are at the minimum funding levels.”

Royce Kosoff, managing director with WTW’s retirement practice in Philadelphia, says ARPA is just one of many considerations for plan sponsors in managing their pensions. For most companies, the decisions on freezing plans were made well in advance of the legislation, with only 12% of Fortune 500 companies currently offering pension benefits to new salaried hires. The decision to maintain a plan in some form must consider multiple factors, he says, including the presence of legacy employee populations and the plan’s funded status.

ARPA’s provisions provided plan sponsors a high degree of flexibility, Kosoff explains. The new 15-year amortization rule applied for plan years beginning after December 31, 2021, but a sponsor could implement it for plan years beginning after December 31, 2018. The interest rate relief implementation’s date was also flexible. It applied to plan years beginning after December 31, 2019 but a sponsor could decide to not apply the changes to any plan year that began before January 1, 2022. This flexibility helped reduce immediate pension contributions, which was especially valuable in light of historically low interest rates. 

An analysis of companies in the WTW Pension 100 (the 100 largest sponsors of U.S. DB plans that use a calendar year end) found that those companies made pension contributions totaling $16 billion in 2021, while contributions from the same group of companies was expected to be $9.5 billion in 2022, based on information reported at the beginning of 2022.

For sponsors that had made earlier discretionary contributions and were in a better-funded position, ARPA’s primary benefit is the enhanced financial management and funding flexibility it has provided, especially during this year’s market downturn, says Kosoff. While it is difficult to separate the impacts from the interest rate stabilization and amortization changes, he says, both changes give sponsors more room to maneuver. 

“What we saw when the law got passed was plan sponsors reevaluating,” says Michael Clark, managing director with Agilis in Denver. “Do we need to restate anything? What are the implications for us? Will there be additional service provider costs?” Among plans with high funding levels, there was no need for them to do anything other than wait for the rules to become effective and then apply them, he says.

“But on the flip side, you had others that went back retroactively to 2020 and implemented the amortization change and the interest rate stabilization change to benefit from lower contributions in 2021, primarily,” says Clark. “I think what you saw last year was that most plan sponsors evaluated when the optimal time was for them to adopt these new provisions. They made those changes in 2021 and haven’t looked back.”

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