Mind the (Coverage) Gap

Since the Pension Protection Act of 2006 was passed, we have, as an industry, made great strides in improving the defined contribution system, for those with access to a plan.

Employees at companies that offer a plan are more likely to enroll, participate in an auto-escalation program and invest in a diversified, age-appropriate investment option.

However, what about the workers that are left out of the system? According to a recent Gallup poll, 70% of respondents between the ages of 30 to 55 are worried about retirement success. Within that 70%, approximately 52% have saved less than $10,000 and 36% have no savings at all. For those with no savings, 73% do not have a plan offered through their employer.[1]    

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Headlines frequently cite that more than half (half!) of all American workers do not have access to an employer-provided retirement plan.[2] Data from the Employee Benefit Research Institute (EBRI) suggests that the act of making a savings plan available—regardless of whether the employee participates—is the single most reliable indicator of retirement success.

Let’s define the magnitude of the problem. We believe that the frequently cited and aforementioned 50% statistic may be exaggerated. By excluding workers younger than 21 and older than 65, as well as part-time workers, the proportion of full-time private sector workers without access to a retirement plan at work falls from 51% to 39%.[3] Digging deeper, we see that one of the defining characteristics of this population is that they work for very small companies. For those without access to an employer-provided plan, 48% work for firms with fewer than 50 employees.[4]

This analysis is also a snapshot of a moment in time. According to EBRI, the private sector workforce comprises 91 million full-time, full-year employees between the ages of 21 to 64. Of this population, 35.6 million are not covered by a plan (i.e., 39% of 91 million)—17 million work for firms with fewer than 50 employees.[5]  

Dividing the population into four subsets provides a closer look. The subsets include those that: 

1. Had coverage at a prior employer, but do not today;

2. Do not have coverage today, but presumably will in the future;

3. Had coverage in the past, and presumably will again in the future;

4. Will never have access to an employer-provided plan.

Coincidentally, a reliable data set to explain the relative proportions of the four slices of this pie is not available. Surveys do not ask this sort of question nor do they broach the forward-looking aspect of “will have coverage in the future.” 

However, this analysis yields some valuable insights, especially when combined with another enormously important and widely misunderstood statistic about the American workforce—that we are, and have been for the better part of five decades, job-hoppers. In fact, the average job tenure of the private sector workforce has averaged around five years since the 1950s, even during the “Golden Age” of lifetime employment.[6]



[1] Gallup Economy and Personal Finance Poll, conducted April 3-6, 2014.

[2] Dow Jones MarketWatch, “Why 50% of Workers are Retirement Have-Nots,” July 23, 2013.

[3] Employee Benefit Research Institute, Issue Brief No. 378, “Employment-Based Retirement Plan Participation: Geographic Differences and Trends, 2011.”

[4] Ibid.

[5] Ibid.

[6] Employee Benefit Research Institute, “Myth Understandings,” May 9, 2014.       

If we imagine that pie again, but over a period of 10 years, two things happen: the pie gets bigger, and the relative size of the "never have coverage" slice gets smaller. As individuals transition from job to job within our dynamic economy, some leave large employers for very small employers, and experience an "episode of non-coverage." However, others leave small employers for larger ones, or alternatively, small employers grow larger and start offering a plan.

The first step towards solving a problem is admitting there is one, but it’s important to apply an objective perspective. A number of solutions have been proposed to address the uncovered worker - state level programs, the Obama Administration's myRA program[1], plus various Federal legislative proposals. These proposals have a laudable goal, one we share—expanding participation in retirement saving. However, each starts with different assumptions about the characteristics and demographics of the uncovered worker population, which can lead to unintended consequences.

Below, we propose guiding principles to consider as we begin to think about designing potential solutions:  

1. Improve non-employer-based solutions to connect episodes of non-coverage, linking multiple plans over an employee's career;

2. Adhere to the concepts behind higher savings levels (as opposed to low dollar caps) and connect to the concept of a percentage of pay and auto escalation;

3. Simplify investment decisions for the individual via a “quick path option” into qualified default investment alternatives (QDIAs), which would help the participant make better asset allocation decisions;

4. Maintain exposure to appropriately diversified market portfolios;

5. Insist that new designs operate and integrate seamlessly with existing designs - plans that can roll over to IRAs or a new employer’s plan. Removing obstacles is also important (e.g., signature guarantees) to mitigate disincentives for plan-to-plan rollovers.

Let’s put these principles in action: a young, aspiring chef takes her first job with a national chain restaurant and enrolls in the plan at 3% of pay and invests in a target-date fund with a high equity allocation. After a few years, she has the opportunity to work with an up-and-coming chef at a start-up restaurant: 20 tables, a small staff and no benefits. Thus, she enters into an episode of non-coverage. In a few years, if the restaurant fails, she may return to the national chain. If the restaurant succeeds, it may eventually add a plan. Either way, she has coverage again.

This vignette should inform how we can improve retirement plan coverage—the private sector workforce data suggest that our chef represents the experience of many employees. Programs designed exclusively for the "never have coverage" camp have certain characteristics—low savings rates, avoidance of market risk and a potential lack of interoperability with the rest of the existing retirement system.

Imagine, again, our chef moves to a state for her start-up role that offers a plan for small employers (e.g., something both California and Illinois are currently considering). She then accepts another start-up role in another state and now has multiple stranded accounts (her first 401(k), her California account and the new state's account). She is unable to consolidate them into a new employer's plan or an IRA. These constraints contribute to the risk of cash outs or lost accounts, as well as the cost of administering millions of small accounts trapped in a system not structured for rollovers. By following our guiding principles, our chef could roll each account into her new employer’s plan and build a significant balance. In our opinion, she would be dramatically less likely to cash out of her various plans.

Defined contribution is a foundation for U.S. retirement security—it is working, but there is room for improvement. We need to enhance our current programs and find coverage solutions that mind our coverage gap—primarily small businesses and the under-employed. Every American should have the opportunity to retire with confidence.

Authors:

Drew Carrington, senior vice president, head of Institutional Defined Contribution in the U.S. for North America Advisory Services for Franklin Templeton Investments   

Yaqub Ahmed, senior vice president and head of Investment-Only Division-U.S. for North America Advisory Services for Franklin Templeton Investments   

Michael Doshier, vice president of Retirement Marketing for Franklin Templeton Investments  

                                                                                          

This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the authors do not necessarily reflect the stance of Asset International or its affiliates.

Franklin Templeton Distributors, Inc., is a wholly owned subsidiary of Franklin Resources, Inc. [NYSE:BEN], a global investment management organization operating as Franklin Templeton Investments.


[1] myRA stands for “My Retirement Account”, a proposed retirement savings program backed by the U.S. Treasury, announced on January 28, 2014 by President Barack Obama.

Corporate Pension Funding Weakened in 2014

The financial health of private pension plans weakened in 2014, with funded ratios falling to levels resembling post-recession lows.

A year-end analysis from Towers Watson finds the aggregate pension funded status for Fortune 1000 companies fell to about 80% at the end of 2014, down 9% from a year earlier to give back much of the gains from 2013.

This represents a significant setback for pensions at the nation’s largest corporate employers, with a weakened funded status developing despite a year of relatively solid market gains. Towers Watson points to falling interest rates and the impact of new mortality tables as primary drivers of a lower pension funded status for 2014—two themes discussed often by the retirement planning industry during the year. The good news of added longevity aside, sponsors of large defined benefit (DB) plans have had to adopt revised longevity numbers from the Society of Actuaries (SOA), which caused substantially increased liabilities and lowered funded status for the typical U.S. pension plan.

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“For most plan sponsors, the discussion around the Society of Actuaries’ new study on the mortality of pension plan participants was the most significant pension event of the year,” notes Dave Suchsland, a senior retirement consultant at Towers Watson. “The study drew the attention of plan sponsors and auditors, resulting in many plan sponsors updating that key assumption.”

The Towers Watson analysis examined pension plan data for the 411 Fortune 1000 companies that sponsor U.S. tax-qualified pension plans and have a December fiscal-year-end date. Results indicate that the aggregate pension funded status is estimated to be 80% at the end of 2014, a decline from 89% at the end of 2013. Researchers also found that the pension deficit increased to $343 billion at the end of 2014, more than twice the deficit at the end of 2013.

“Despite a rising stock market in 2014, funding levels for employer-sponsored pension plans dropped back to what we experienced just after the financial crisis,” notes Alan Glickstein, a senior retirement consultant at Towers Watson. “A one-time strengthening of mortality assumptions alone is responsible for about 40% of the increased deficit.”

Glickstein says the analysis also found that plan sponsors that used liability-driven investing (LDI) strategies in 2014 had better results, as the declining discount rates were matched with very strong returns for long corporate and Treasury bonds. Overall, pension plan assets in the sample group increased by an estimated 3% in 2014, reflecting an underlying investment return of about 9%.

The analysis suggests investment returns varied significantly by asset class. Large-cap U.S. equities were up roughly 14%, while international equities declined by nearly 5%. The Towers Watson analysis estimates that companies contributed $30 billion to their pension plans in 2014—29% less than in 2013 and the lowest level of contributions since 2008. Contributions have declined steadily in recent years, Towers Watson says, partly due to legislated funding relief provided under the Moving Ahead for Progress in the 21st Century Act (MAP-21).

“We experienced another big year of pension de-risking in 2014, with significant lump-sum buyout and annuity purchase activity,” Suchsland says. “Given the change in funded status, we expect many plan sponsors will need to re-evaluate their retirement plan strategies in 2015. This year will most likely bring higher expense charges and, unless there is an uptick in interest rates or equity market performance, eventually additional contribution requirements.”

The full year-end 2014 results will not be publicly available until the spring, Towers Watson says.

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