Defined contribution plan sponsors have a tough job.
“Every day that goes by, DC is getting harder and harder to solve for,” said Lorie Latham, senior defined contribution strategist at T. Rowe Price during a session at Benefits Canada’s 2019 Defined Contribution Investment Forum in Toronto on Sept. 27.
Looking to lessons learned in the U.S.’s more mature DC market, she outlined three questions plan sponsors should focus on.
First, when plan sponsors consider for whom they’re solving DC problems, the simple answer of plan members isn’t enough, said Latham, noting each member population includes different demographics, so it’s important to avoid overemphasizing the needs of one specific group. For instance, the U.S. has a tendency to focus on baby boomers since they’re closest to retirement.
Research by T. Rowe Price found generation X makes up 43 per cent of the U.S.’s plan member population. “[For] gen X, DC plans is all that they know, since DB plans have been closing and freezing,” she said. “And so, what we’ve come to is, we’ve got to really pay attention and understand the importance of gen X as our DC plan population. And then we’ve got fast-following millennials who make up just about a quarter of the DC plan population in the U.S.”
As far as the biggest risk plan sponsors felt their members are facing, the research found longevity was by far the biggest concern, said Latham. “There is a shift in the U.S., and probably everywhere, to make sure that longevity risk is solved for. And if you tell me longevity risk is the one you’re most concerned with for your members, I’m going to ask you to think differently around how you . . . think about and assess equity.”
While equity as an asset class is often viewed as both aggressive and risky, it has to be part of the solution when DC plan sponsors consider longevity risk, she noted, especially in a scenario where downside, volatility and inflation risk are all taking a back seat to worries about longevity.
And when plan sponsors are asked if they’d rather see their members achieve the highest retirement income opportunity or the least possible downside risk, longevity takes precedence once again, said Latham. “We are experiencing what I would refer to as a structural pivot in the U.S. to really focus on solving for longevity. And it’s causing conversations to be very different and to be oriented towards, ‘How can we use all the levers in order to solve for longevity on behalf of our participants?'”
As well, plan sponsors have to consider the role they want to play in their members’ retirement journey, she said, noting they can’t act with care and prudence as a board or pension committee if they don’t have a clear answer to this question. “Do they want them to stay in retirement or do they want them to go?”
The U.S. is seeing a gradual trend towards DC members staying in their plans after retirement. “That may or may not be linked to those plan sponsors who’ve made a decision whether they want them to stay or go.”
The T. Rowe Price research also found about half of plans with assets over US$500 million indicated they want members to stay. “That can be driven by scale, buying power, the idea of folks being in that fiduciary safe haven, you’ve got a lot of expertise when you’ve culled down the options for them.”
On the other hand, while smaller DC plans are less likely to want members to stay after retirement, Latham noted they’re looking to larger plans to help guide them in the right direction.
But it’s troublesome when plan sponsors don’t have a clear opinion either way, she added, and this raises a number of problems, specifically around handling governance documents and the type of withdrawals they’re going to allow.
When a DC plan sponsor knows whether members will stay or go, they can choose better investment options, said Latham. For example, if members are staying in the plan, it changes the risk levels associated with equities, since their time horizon isn’t reduced by exiting the plan.
Retirement income options are also difficult to tackle if a plan sponsor doesn’t know if they want members to stay or go. “Whether it’s in-plan or out of plan, whether it’s guarantee or not, that core question of understanding what role you want to be in that journey with them is going to be able to drive a lot of key decisions.”
Read more coverage from the 2019 Defined Contribution Investment Forum.