Benefits October 4, 2013

The Link Between Health Care Benefits and Retirement

October 4, 2013 (PLANSPONSOR.com) – Decisions about employer-provided benefits, such as health care coverage, can affect retirement planning.
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“Questions about whether a person has enough saved to retire on or whether they will outlive these savings definitely tie into their benefits coverage. If you have an unplanned event occur, you will need to protect your retirement savings and have access to short-term savings. It’s not a question of whether such an event will occur, but when,” Heather Lavallee, president of employee benefits distribution, ING U.S., in Minneapolis, told PLANSPONSOR. For example, she pointed to research that one in two men and one in three women will have to deal with cancer at some point in their lives.

“If participants don’t have money for this increased spending on health care costs, then they are going to have to tap into either their savings or their 401(k) retirement account,” she said.

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Lavallee pointed to the parallel example of employees now having an expectation that employers will provide retirement savings vehicles such as 401(k) plans, but probably not the pension systems offered in previous years, for which plan sponsors took care of retirement savings and investment decisions. The rise of the health insurance exchanges is similar, in that employees will have to be more proactive in making decisions for themselves. “Employees have a greater sense of the types of coverage. This information also makes them aware of the impact of a broader financial decision,” she said.

“The PPACA [Patient Protection and Affordable Care Act] has brought health care to the forefront of people’s minds. We are also seeing the rise of private exchanges, which kind of parallels defined contribution [DC] plans in terms of offering employees choices. As with DC plans, the exchanges definitely require more decisionmaking by employees,” Lavallee added.

Along with these choices, there is also the leveraging of technology to consider, Lavallee said. “With retirement plans, things started out with offering many choices for employees to invest in, but have been moving to more-targeted choices—ones that are more suited to the needs to the individual. Similarly, with health care, tools such as decision support allow employees to ask questions that winnow down the choices to the ones that best fit their needs.” In some ways, she said, it also mirrors the experience of shopping online, with preferences and subcategories of products.

Employers can take steps to help educate their employees about this holistic view and the impact that one decision can have upon another, said Lavallee. In terms of a delivery system for communicating information to employees, several things need to be done.

“First, you need to look at the industry. For example, someone in retail may benefit more from meeting one-on-one with an adviser before coming to a decision. Second, you need to look at the geography of the employees. Workers in the northern part of the country may lean toward online materials, while those in the southern U.S. may prefer a combination of online and print materials, as well as one-on-one meetings. Finally, you need to look at the employee demographics. For instance, younger employees may not look at anything they can’t view on their smartphone.”

Lavallee added, “Employers need to keep in mind that, in addition to the differences in how they want information delivered, employees’ needs are all a little bit different. Research shows that many people spend more time choosing their smartphone coverage plans than their health coverage plans.” Therefore, employers need to make sure the information is delivered in a way that is both appropriate for the employee—online, paper, etc.—and that it is designed to be understandable enough to catch their attention.

Lavallee noted that employers working with employees to assess their needs is definitely helpful. “Learning how to be a better-educated consumer when it comes to health coverage can definitely make employees more aware of health care expenses,” she said. This in turn can allow them to be prepared with information when it comes to planning strategies for retirement.

Opinions October 4, 2013

Exploring Target-Date Fund Transparency

October 4, 2013 (PLANSPONSOR.com) - Since the Department of Labor release of additional guidance for target-date fund screening and monitoring in February of this year, a more stringent regulatory framework has emphasized the importance of transparency and due diligence of target-date funds.
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This has had a significant impact on plan sponsors, advisers, and consultants in their roles as fiduciaries. In particular, the new standards have come with increased pressure to ensure management fees are reasonable in light of the services actually being provided by an investment manager. While it may seem daunting at times, plan sponsors should recognize the role they play in the target-date due diligence process, and quickly get up to speed from an evaluation standpoint as a named fiduciary of a plan.

An important consideration when assessing whether a target-date fund fee is reasonable, is whether or not a target-date fund is actively or passively managed. In theory, it is not difficult to distinguish between active managers and passive managers. An active manager will typically make investment decisions based on current fundamentals and valuations, as well as maintain the flexibility to adapt and manage risks based on evolving market conditions. In contrast, a passive manager will simply link portfolio construction to a benchmark, essentially mirroring a market index, and rebalance back to a preset allocation glide path.

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In practice, however, it can be difficult to determine exactly how active a manager really is. The challenge is often compounded in the defined contribution industry because many target-date funds are constructed as a fund-of-funds. Often, when displaying a target-date fund’s composition, the investment manager may simply list the underlying mutual funds or exchange-traded funds (ETFs), rather than provide a detailed list of individual holdings within the constituent funds. Without a more detailed description of the securities that make up these underlying funds, it is difficult, if not impossible, to know how active an actively managed target-date fund is.

How can an actively managed target-date fund become a passive fund? The answer is over-diversification. Specifically, a target-date product could come to resemble a market index because lack of coordination between portfolio managers may result in holding too many individual securities. This would make it difficult for plan participants that invest in the target-date fund to experience returns that are materially different from the benchmark. Over-diversification should be on a plan fiduciary’s radar because it may result in paying active management fees for what ultimately is passive investment positioning and risk management.

Fortunately, tools are available to help plan fiduciaries measure the extent to which lifecycle funds are actively managed. This, in turn, can assist in determining whether participants are really getting what they pay for when they choose to invest in target-date products.

One tool plan fiduciaries can use to analyze the equity portions of target-date funds is active share. The concept of active share was developed by two professors in Yale’s School of Management, and was presented in a study originally published in 2006, and again in 2009. Active share measures the percentage of a fund’s weight-adjusted portfolio that differs from the benchmark. Readings fall within a possible range of 0% to 100%. Very simply, the higher the active share, the higher the level of differentiation between the portfolio and its benchmark.

In addition to quantifying the extent to which a portfolio’s holdings differ from a benchmark, the fact that active share information is current is another distinct advantage. Other tools often use backward-looking data, and may be less useful to fiduciaries that need to focus on determining how effective they believe a product will be at helping plan participants achieve their financial goals going forward.

While a high active share number is not a guarantee of future excess returns, the premise of active share remains relevant for target-date portfolios. Specifically, we should not expect an active manager to add value unless the manager has the flexibility to look different than the benchmark. It is also necessary to keep in mind that it is not a catch-all, but rather one of many tools that can and should be used by fiduciaries such as plan sponsors when performing their target-date due diligence. A timely measure, given the challenges posed by today’s low yield environment on the Treasury-heavy U.S. bond market, is the sector exposures and maturity structure of the fixed income holdings relative to an overall bond market index. In addition, several other metrics may be considered, including historical performance draw down and recovery in turbulent markets, and up/down capture ratios.

Ultimately, participant objectives should always be the driving force behind the selection and monitoring of lifecycle funds. In order to view target-date fund selection and monitoring through a fiduciary lens, target-date funds need to have the transparency necessary to allow plan sponsors to evaluate such issues as fee flexibility, risk management, and the ability of the funds to meet participant goals and objectives.

More information about target-date fund transparency can be found in our recent whitepaper, issued with Strategic Insight, an Asset International company, at www.manning-napier.com/raisethebar.

 

Jeffrey S. Coons, PhD, CFA, president and co-director of research at Manning & Napier  

This summary is for informational purposes only and does not constitute an offer.  

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