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Contribution level is the key contributor to benefit adequacy alongside investment returns – the more you pay, the more you get out (all things being equal). And if there are no contributions, there are no benefits!
However, adequacy almost always loses when it is up against the issue of affordability and other financial priorities for both employers and employees. This outcome has been demonstrated in many DC schemes around the world where we often see significantly less than 100% participation and less than 100% take up of already reduced employer contributions.
So, what can be done to persuade workers and their employers of the obvious benefits of saving more for their retirement? How can we convince already challenged organizations that this is a vital objective for their plan and their organization in the first place?
In terms of employee contributions, plan sponsors and fiduciaries need an understanding of current saving patterns before trying to influence behavior. A combination of administration and HR records will provide sufficient information to assess members’ participation rates and contribution patterns. This data will confirm whether the plan is meeting the sponsor’s objectives in terms of participation and contribution. If it does not, the sponsor will need to consider what action can be taken to influence a change in behavior.
Communication and education are of course effective tools for influencing behavior. A UK client was concerned about low participation rates in its DC plan. It launched a communications campaign designed to be accessible to as many employees as possible and with a specific target participation rate at the end of the campaign. Participation rates were measured on a regular basis throughout the campaign which told the sponsor whether they were on target or not. It was hugely successful.
Similarly measurable would be a campaign to increase access to higher company contributions. The essential requirement is that sponsors become engaged through ongoing monitoring and discussions with employees to look beyond aggregate plan level statistics. For example, a large sponsor in the US had been plagued with less than competitive participation rates, despite various communication campaigns to address the issue. After finally raising the issue with employees directly, the sponsor learned that the access channels in place for employees to enroll (voice response and internet) were less than user friendly and employees were simply giving up in frustration before enrolling.
Of course, for all of the employees who respond to overtures to increase participation, there will be many who simply do not engage. This has been recognized by governments around the world, including Australia and more recently the UK, where public policy has been used to drive up participation and savings rates.
Automatic enrollment of employees into a pension scheme will be a duty on all UK employers commencing in 2012. The duties will be staged over a period of time, starting with the larger employers, so that by 2016 all employers should be compliant. However, the government has stopped short of compulsion, allowing individuals a short window in which to opt out, and no-one is pretending that the level of required contributions (eventually 8% in total on earnings between £5,700 and £38,000) will result in adequate benefits. However, this is the first step on the road to encouraging more people to save for retirement. We also believe that the UK government will monitor closely the number of members that do opt-out.
In the US, automatic enrollment is an optional plan feature that sponsors concerned about participation – and able to bear the accompanying increase in employer costs – can choose to employ. Following the implied endorsement of auto-enrollment provided by the Pension Protection Act, sponsors have increasingly opted to implement the feature. Today the majority of the largest plan sponsors have effectively used auto-enrollment to address participation issues. The lesson has been learned that employees will accept a push into contributing, as evidenced by the low opt-out rates.
Now the question is how far sponsors are willing to go. The move from DB to DC has left many US workers with an appreciably smaller retirement benefit than their now-frozen DB plans would have provided. Automatic enrollment increased the number of participants but, generally, the rate of contributions is not enough to make up the lost ground, as shown by the low average account balances cited in survey data. Typically, if sponsors have embraced auto-escalation – that is, the automatic increasing of employee contributions over time – they have done so only to the level of contribution necessary to maximize the match. Policy considerations to address the issue include requiring automatic enrollment but legislation is not on the table to do so – and currently there is little appetite among employers for a mandatory approach to contributions.
Benefit adequacy could also be furthered by increased contributions from employers. While DB plans were historically designed with the goal of providing a sufficient level of retirement income, the level of DC plan benefits has been a function of competitiveness. The transition from DB to DC has only marginally affected the level of DC benefits, with sponsors typically focused on softening the blow for older workers through transition benefits. Yet longer-term expectations of employer costs for new hires in the new all-DC retirement environment typically reflect savings for the employer, even if modest.
The impact of inadequate retirement savings will not be felt immediately, as the effect of the move to DC works its way through the next generation of workers. But the opportunity to improve the outcome exists today, through increased engagement of workers and greater commitment from plan sponsors.
There is no doubt that contributions are a key success factor if benefit adequacy is a prime objective. Measuring actual contribution and participation rates, and re-evaluating them in light of management actions to increase contribution and participation rates, is a great first step.
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CALL TO ACTION
1. Assess contribution and participation rate experience
2. Consider ways to encourage further contributions and/or further participation into the plans (communication, education and auto-enrollment are some options)
3. R e-evaluate contribution and participation rate experience in light of the management actions proposed