ANNA RAPPAPORT CONSULTING STRATEGIES FOR A SECURE RETIREMENT SM US Pensions: Today’s Challenges,...

ANNA RAPPAPORT CONSULTING

STRATEGIES FOR A SECURE RETIREMENTSM

US Pensions: Today’s Challenges, Tomorrow’s Direction

Anna Rappaport, FSA, MAAASenior Fellow on Pensions & Retirement,

The Conference Board (US)

2009 Summit on the Future of Pensions: From Crisis to Sustainability

April 2009


Agenda

Today’s Challenges Tomorrow’s Direction

2


Today’s Challenges

Big picture Successes and failures DB/DC evolution DB and the Financial Crisis DC and the Financial Crisis

3


Big Picture

Social Security key Employer role

– Private large companies – big– Small companies – limited– Public sector – nearly everyone covered (mostly DB)

Retirement – later and more gradual Limits on individual action No consensus among stakeholders about right answers No integrated policy background

4


Successes and Failures: Different Perspectives

Successes Social Security benefits Retirees doing well – many

with DB income 401(k) plans

– Account balances

– Auto-enrollment and new defaults

Large plans well funded before the crisis

Public plans PPA strengthened system Benefits earned generally

paid

Failures Coverage gaps – small ERs,

part-time, job changers, etc. Inadequate savings 401(k) plans

– Account balances

– Using money too early Freezing of DB plans PPA punished previously well

funded plans in crisis Too many lump sums Inadequate response to

demographic change Social Security funding gap

5


DB/DC Evolution

Workers with pension coverage, by type of plan: 1983 to 2007

Year DB only DC only Both

1983 62% 12% 26%

1995 29% 56% 13%

2007 17% 63% 19%

Source: Center for Retirement Research, An Update on 401(k) plans: Insights from the 2007 SCF, March 2009

Notes:

• 55% of private sector full-time full-year wage and salaried employees have pension coverage

• DB plans widely used in public sector and for multi-employer plans (union – management sponsored)

6


Pensions in the economic crisis - DB

Large private DB plans– From 12/2007 to 12/2008: 100% to 75% funded– 2009 contributions – 2X 2008 or more– Pension Protection Act(PPA) challenges

Big funding increases Under 80% funded – limits on lump-sum payments Under 60% – law requires freeze + benefit limits

PPA intensified the problems– Limited relief granted– Further relief requested

If no relief – expect more freezes Public sector – not subject to PPA

7


Pensions in the economic crisis – DC

Little change in participation Some employers dropped/cut match – 3% dropped/8% cut

according to 12/2008 WorldatWork survey Creates challenges for more affluent near retirees and

already retired– Reduced 401(k) balances – average loss of 25%+ from

1/1/2008 to 1/20/2009 – accounts of $200,000+ and 56-65 year olds with 20+ years of service

– Many people need to work longer, but hard to do so – 4 out of 10 people retire earlier than planned

Shift to DC plans compounds issues for individuals

8


401(k) Plans in Perspective

Heavier reliance on default options Growth of auto-enrollment, life cycle funds in DC Advocates

– Big success/contribution to retirement security– % of participants taking hardship withdrawals under 2%

Voices of Critics – Too many people have been left out of the system– Too much risk and exposure to market swings– Lump sums at retirement– Leakage– Critical of investment options, expense disclosures– Tax benefits go largely to more affluent

9


Tomorrow’s Direction: New Approaches

Big Issues and Themes Concerns of Employers and Employees Defining the Future: Players and Proposals Mandatory or Voluntary? Risk: Sharing and Management Later and Flexible Retirement Dealing with Realities of Individual Action

10


Big Issues and Themes

Keep Social Security strong Coverage: Mandatory Tier II? Risk sharing – before and after retirement Risk management Governance and role of the employer Gradual retirement/faciliating work as part of retirement Payouts in DC plans

11


Concerns of Employers and Employees

Employers Helping employees realize the

benefit of the funds they have accumulated

Securing retirement for employees

Managing fiduciary liability Winning loyalty and

appreciation from employees Supporting talent

management policy Keeping administration simple

and cost effective

Employees Housing and asset losses Timing of retirement Dealing with confusion Managing money in

retirement Finding good advice Being able to deal with

emergencies Leaving money to heirs Making money last Not losing money

12


Defining the Future: Players and Proposals

U.S. Government ERIC (ERISA Industry Committee) – New Benefits Platform Projects focused on defining new models

– Society of Actuaries: Retirement 20/20– Retirement USA

Academics/think tanks– Auto-IRAs– New designs replacing current system on mandatory

basis

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Coverage: Mandatory Tier II?

Realities– Large private and public employers – very good

coverage and good benefits for long-term employees– Small employers – mostly out of the system

Social Security is universal program now

14


Proposals for Mandatory Coverage

Auto-IRA – require employers who do not offer plan to offer auto-enrollment payroll deduction IRA– Enhance with tax credit/government matching?– Employees can opt-out

Replace current system with mandatory account based system– 2.5% to 5% of pay– Benefits as income– Various management alternatives – government

(Federal Thrift Plan) or private– Or offer as an option

Increase Social Security minimum benefits

15


Risk sharing: before and after retirement

Risks include investment, longevity, health care, inflation, currency, business failure, fraud and more

Rethinking distribution of risk between plan sponsors, employees and public systems

Self-adjusting systems support pooling After retirement

– Growing use of lump sums in US

– Income based defaults not used in DC

Options for risk pooling – Potential risk poolers: social systems, employer DB plans,

independent pension entities, insurance and financial products, family

– Public systems, TIAA-CREF, examples of organizations that pool risk across employers

16


Risk management

Financial crisis reinforces importance Total enterprise risk perspective Investment management – matching of assets/liabilities Right investment structures Self-adjusting systems Large enough pools Different kinds of risk pools Good governance – focus on identifying best models Plan design

17


Redefinition of retirement

Will longer life mean longer work or longer retirement? The third age – new thinking about the life cycle People expect to retire later, but so far – few do About 50% work in retirement or have bridge jobs Virtually no formal phased retirement (private sector) 40% of people retire before they planned to

– Loss of job and poor health – major factors Many people say they want to work some in retirement

– Say vs. do conflict– Questions about availability of work– Big unknowns

Disability: key issue in thinking about this

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When people retire: Pre-retirees expect to retire later than retirees, 1 in 3 say it doesn’t apply

Age categoryRetirees (%)

(n=400)Pre-retirees (%)

(n=401)

Under age 55 31 1

55 to 61 30 16

62 to 64 16 12

65 to 69 13 27

70 or older 4 6

Will not retire 1 1

Doesn’t apply 3 32

Don’t know 2 6

Source: Society of Actuaries, 2007 Risks and Process of Retirement Survey

How old were you when you retired or began to retire from your primary occupation?/At what age do you expect to retire from your primary occupation?

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What people know and do

US savings rates are low People save much more when they have access to

employer plan Many gaps in knowledge about retirement

– Few think long term– Assets vs. expectations: out of step– Problems with math literacy, investment knowledge– Little focus on systematic risk management

Major method of managing risks– Reduce spending– Little focus on risk management products

Much changes during retirement, without pre-planning

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16%

22%

26%

62%

11%

60%

21%

21%

34%

58%

8%

58%

If your spouse were to pass away before you/if you were to pass away before your spouse, do you think it would leave you/your spouse financially…? (Among married retirees and pre-retirees)

Better off

About the same

Worse off

Source: Society of Actuaries, 2007 Risks and Process of Retirement Survey

Example: Few believe they will suffer financially by their spouse’s death

Retirees(2007 n=261)

Pre-retirees(2007 n=299)

You, if your spouse were to pass away first

Your spouse, if you were to pass away first

21


Employer roles in retirement income

Offer benefits and pay for them Offer programs for individual saving Provide plans that limit lump sums – can mandate income

for all of part of the benefit Serve as purchasing agent Offer access to pools Create expectations and provide information Advise and educate

Key questions – should employer offer benefits, facilitate them, or opt out? Should employer be primary source of security?

22


How and when benefits are paid

People say they want income but choose lump sums Distribution of benefits: lump sums vs. income

– DB: lifetime income common – DC: lump sums usual in US but growing concern as

these plans are primary Big issues:

– New defaults for DC plans– How to prevent leakage: how much early access should

be allowed and when?

23


Example of Proposal: ERIC New Benefits Platform

Includes DB, DC and short-term savings component Mandates coverage, but allows employers to offer own

plans, use purchasing cooperatives, or provide vouchers Provides standard benefit designs Mandates individuals without employer coverage to buy on

their own Levels playing field between those with and without

coverage Extends same tax benefits whether employer plan or

individual purchase Mandates Income payout for DB benefit

24


Developing Options: Retirement 20/20

Society of Actuaries project – focus on new models Multi-disciplinary Started with stakeholders: society at large, individuals,

employers and markets Looked at risks, needs and roles Key findings – ideas for the future

– Align roles with capabilities– Support new patterns of retirement– Importance of self-adjusting systems– Signals matter– Governance matters

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The Future – Some Dreams

Recognition of importance of organized retirement system Public will understand longevity including its variability Strong Social Security system Rational coherent policy structure

– Support employer role– Encourage range of plan designs

Encourage later retirement and facilitate work among third age persons

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More dreams

Self adjustment will facilitate risk pooling Sensible use of choice, with good default options Focus on life income Protect spouses and widows All stakeholders will recognize the importance of the post-

retirement period DC plans use distribution defaults that encourage income Culture will encourage more saving Adequate retirement funds to cover post-retirement inflation

and the cost of long term care Benefits available on disability retirement

27

[email protected]: 312-642-4720

Fax: 312-642-4330

ANNA RAPPAPORT CONSULTING

STRATEGIES FOR A SECURE RETIREMENTSM

[email protected]: 312-642-4720

Fax: 312-642-4330

28

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