Opinions December 14, 2022

Retirement Trends to Watch in 2023

As larger numbers of Americans near retirement age, a renewed focus on retirement income is expected. 

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As 2022 nears its close, many of us in the retirement income industry are planning for an eventful 2023.

SECURE 2.0, a proposed package of retirement security legislation that would add enhancements to its sibling bill — the Setting Every Community Up for Retirement Enhancement Act of 2019 — enjoys wide bipartisan support; as such, many industry observers predict it may pass, just as its sibling did, attached to a year-end spending bill.

This legislative focus on enhancing retirement income access for more Americans could not come at a more critical juncture: Facing equity markets plagued by volatility, an interest-rate environment increasing rapidly from all-time lows and what some perceive as runaway inflation, today’s soon-to-be retiree faces unprecedented challenge in securing protected income that will last as long as they may.

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We all should be concerned about the challenges this population faces, since 2024 is the year for Peak65: the year in which, according to the Alliance for Lifetime Income, the largest number of Americans ever will turn 65, a traditional retirement age.

Some retirement industry trends responsive to the above that have been developing through 2022, and that we can expect to continue into 2023, include:

  1. Lower retirement savings rates than the prior year, driven by households coping with surprise high inflation. According to a study recently published by Allianz Life, 54% of Americans report either reducing or fully discontinuing retirement saving because of the impact of suddenly spiking inflation on their daily household expenses. This suggests lower industry inflows than in years prior. Industry observers hope for a taming of inflation in 2023 that allows Americans to resume their normal savings habits, and for provisions within SECURE 2.0 to enable more access to qualified savings plans for Americans now lacking this access.
  2. Increased plan sponsor interest in retirement income solutions, due to the desire to keep participants in plan through retirement. Retirement income industry optimists had entered 2020 with the expectation that SECURE’s passage would quickly pave the way for consideration of Guaranteed Retirement Income Contracts (in-plan annuities). Then in March 2020 came COVID-19, and so ensued a several-years-long disruption to normal as we knew it. As we have emerged into our new normal, SECURE’s impact is just now being felt by sponsors and their advisers. Interest in evaluating income derived from plan is rising within the plan fiduciary community. This trend is driven not only by SECURE’s passage, but by administrative economics. According to PIMCO’s 2022 US DC Consulting Survey, 76% of plan sponsors advised by surveyed consultants now prefer to keep assets in plan through retirement, a material trend reversal from just a few years ago. In order to successfully retain assets through, not merely to, retirement, plans must accommodate income-producing products and services for retired participants.
  3. Even more new products to enter the market. The pace of product development in the DC insured solution space has been frenetic since SECURE’s passage. Expect this trend to continue. Recordkeepers, middleware providers, other service providers and insurance companies have been making material advancements towards benefit portability, increasing their confidence in being able to deliver plan-and-consumer-friendly products and services to this community. Many providers intend to launch their second (in some cases, even third!) post-SECURE income product iteration in 2023 as industry participants test the market for which product and service types might ultimately prove most appealing with sponsors and participants.
  4. The launch of tools, services and curricula enabling fiduciaries to compare income solutions. American Century has recently launched an annuity comparative tool in Beta version that can be used by advisers/consultants who have access to outside data sources to supply inputs. Broadridge Fi360, which has launched a consortium of retirement income providers to establish an industry-agreed comparative framework, is another likely candidate to launch a comparative tool. It is expected that NAPA will soon launch a retirement income certificate program for plan fiduciaries. Don Trone’s Center for Board Certified Fiduciaries has already launched an annuity-oriented certification program for plan fiduciaries. These trends are very important for advisers and consultants to watch, in part because this author has heard from several fiduciary advocates that in the not-too-distant future, they intend to communicate their perspective that non-consideration of income solutions could be viewed as constituting a fiduciary breach. As a protective measure against this possibility, this author recommends that in 2023, plan fiduciaries consider two actions:
    1. Consider documenting having made a prudent decision to either explore retirement income this year or to postpone such an evaluation to the year following, and document why this decision was made.
    2. Consider documenting the method by which SECURE-mandated lifetime income illustrations are made on participant statements. Will the safe harbor method be used? If not, how does the plan prefer to illustrate this calculation? If yes, will the plan provide access to a marketplace where the form of immediate annuity that underlies the calculation in the safe harbor is made available to participants? If not, how does the plan want to address questions already coming in from participants responding to 2022 statements regarding how they lock in this number that is illustrated on their statement at least once annually?
  5. Increasing demand for plan-derived income to be driven by near-retiree plan participants. Driven not only by asset-to-income translation appearing on their (typically Q2) statement, participant interest in lifetime income is growing. A recent Schroders survey reveals that when asked what they seek in a retirement income option, the most popular reply from DC participants is lifetime income, desired by 52% of those surveyed. Partial annuitization (or partial account investment into a deferred annuity with lifetime withdrawal benefits), especially for use in guaranteeing coverage of basic expenses in retirement, frequently polls as an appealing investment approach amongst participants.

For all the reasons cited above, 2023 can be expected to be a year in which plan sponsors, advisers/consultants and participants experience a renewed focus on retirement income. With more product, service and educational resources becoming available in our space, retirement income prevalence in DC is expected to increase materially over the next several years. All members of our community would be well-advised to get up to speed on this market soon, as it is advancing rapidly, and none of us benefits from being left behind by the after-effects of a tsunami.

Michelle Richter is the executive director of the Institutional Retirement Income Council.

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 author do not necessarily reflect the stance of Institutional Shareholder Services Inc. (ISS) or its affiliates.

Data and Research December 14, 2022

Corporate Pension Plan Funding Remains Up in 2022, Despite November Drop

The funding status of corporate pensions in the U.S. was down narrowly in November, as liability growth outweighed investment gains.

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For the month of November, pension funding statuses declined by 1.4 percentage points from 105.5% to 104.1%, while assets increased by 5.1% and liabilities increased by 6.5%, according to Insight Investment. During the month, the average discount rate fell by 55 basis points to 5.05% in November from 5.61% in October. The change in rates is primarily due to the change in the risk-free rate, while spreads decreased considerably during the month.

“Year-to-date funded status has still improved by more than 7%, driven primarily by pension discount rates having risen by ~200 bps over the year,” said Sweta Vaidya, head of solution design at Insight Investment. “The Fed has indicated that it will begin slowing down on rate hikes, but that we may expect rates and inflation to persist higher for longer than originally anticipated.”

LGIM America’s Pension Solutions Monitor, which estimates the health of a typical U.S. corporate defined benefit pension plan, estimates that pension funding ratios decreased from 100.7% to 100.2% through November.

Equity markets had a strong month, with global equities and the S&P 500 rising 7.8% and 5.6%, respectively. Plan discount rates were estimated to have decreased roughly 62 basis points over the month, while the Treasury component decreased 43 basis points and the credit component tightened 19 basis points.

Overall, plans with a traditional “60/40” asset allocation increased 6.1%, and liabilities rose by 6.7%.

According to October Three’s November monthly pension update, pension finances were mixed in November, as lower interest rates offset the impact of higher stock prices.

According to October Three’s data, interest rates, which have risen steadily all year, fell in November, pushing up bond returns. Treasury yields fell 0.4% last month, and corporate bond yields declined 0.5%. As a result, bonds gained 4% to 7% in November but remain down 13% to 24% for the year, with long-duration and corporate bonds performing worst. October Three expects most pension sponsors will use effective discount rates in the 5.0% to 5.2% range to measure pension liabilities at the end of 2022.

Corporate bond yields fell 0.5% during November but remain up 2.3% this year. As a result, pension liabilities rose 5% to 8% last month but are still down 16% to 27% for the year.

Stocks advanced strongly and broadly during November. A diversified stock portfolio gained 7% last month but is still down more than 15% in 2022. With one month to go, 2022 is looking like a surprisingly positive year for pension finances, particularly in view of double-digit stock market declines.

November legislation provided additional relief for pension, expanding upon a pension funding relief law signed in March 2021.

“The new laws substantially relax funding requirements over the next several years, providing welcome breathing room for beleaguered pension sponsors. However, the surge in interest rates this year, if sustained, will reduce or eliminate the impact of funding relief,” wrote Brian Donohue, a partner at October Three.

During the month, the Milliman 100 Pension Funding Index funded ratio declined from 113.3% in October to 111.2%. The drop was due to the monthly discount rate decreasing to 5.16% from 5.71%. As a result, the PFI projected benefit obligation rose to $1.342 trillion, representing a loss of $76 billion for the month, even as investment gains of 4.63% caused the market value of assets to rise by $59 billion.

“November’s discount rate decrease was the largest monthly drop of the year and only the second monthly decline we’ve seen in 2022,” said Zorast Wadia of Milliman, co-author of the PFI. “This caused the plans’ funded status to drop, despite November’s stellar investment returns, which were the largest monthly gain of the year.”

Wilshire’s U.S. Corporate Funded Status for the month of November found that the aggregate funded ratio for U.S. corporate pension plans was unchanged from October, ending the month at 99.1%.

The month’s activity in funded ratios resulted primarily from a 6.3% increase in liability values, offset by a 6.4% increase in asset values. The aggregate funded ratio is estimated to have increased by 2.9% year-to-date and 5.5% over the previous 12 months.

According to the WTW Pension Finance Watch, the equity portion of the benchmark portfolio returned 6.3% in November, with the international equity asset class having the largest growth. Yields on long high-quality corporate bond indices decreased an average of 56 basis points, and the yield reductions were followed by decreases in long Treasury rates. The yields on 10- and 30-year Treasury bonds decreased 42 basis points over the month.

The WTW Pension Index tracks the performance of a hypothetical pension plan invested in a portfolio with 60% invested in equity and 40% in fixed income. This portfolio recorded a 5.1% return for the month.

Pension obligations move in the opposite direction of the interest rates used for their valuation. The liability implicit in the index increased by 7.2% from the discount rate change and the accumulation of interest. These factors contributed to an overall decrease of 1.9% in the WTW Pension Index, which closes the month at 103.4%.

“Everything continues to be about interest rates,” proclaims Agilis’s U.S. pension briefing for November, “funded status at the end of the month will be close to where it started, despite the big changes in discount rates and investment returns.”

Agilis highlights that the Treasury yield curve continues to be inverted, a potential indicator of a looming recession. The lower discount rate meant higher liabilities for pensions offsetting market gains; leaving pension plan funded ratios at, or slightly lower on the month.

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Pension plan sponsors are still better off today than they were at the start of the year which could have a meaningful effect on year-end balance sheets into the end of 2022.

 

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