Professional Documents
Culture Documents
October 2013
The Future of
Retirement Plans
October 2013
WWW.BRANDES.COM/INSTITUTE
BRANDESINSTITUTE@BRANDES.COM
Executive Summary
Collectively, Americans are woefully unprepared
financially for retirement. This retirement
problem actually reflects a collection of diverse
issues. This paper identifies the most important
ones: longevity; access; contributions; portability;
behavioral mistakes; funded status; expenses; and
regulation. Our research focuses on solutions for
both plan sponsors and participants.
The Retirement Rule, Benefits = (Contributions
+ Investment Earnings) Expenses, provides a
good framework to evaluate the problems and
assess potential solutions to the pensions crisis.
It also clearly identifies where the move from
defined benefit (DB) to defined contribution (DC)
plans alters the balance of risk and cost from plan
sponsor to participant.
Three generations of American workers have
experienced an amazing transformation of
the employee benefit landscape with changes
that initially provided greater wealth, but
subsequently led to capped or reclaimed benefit
promises. With relatively little public awareness,
but with significant consequences, within the last
few years DC plans have been transformed for
many from supplemental savings to the primary
source of retirement income. Plan sponsors have
experimented with hybrid DB plans (such as
cash balance plans and adjustable benefit plans),
but todays landscape remains dominated by a
shift away from DB to DC with significant impact
for participant benefits.
Various factors are likely to hurt DC participants
financially, including lower contributions, lower
investment returns and potentially their own
poor investment decisions. In the meantime, DB
plan sponsors are still dealing with underfunding
problems. The simple (but not necessarily easy)
solutions include: increase contributions; retire
later; and increase investment returns. The real
solution for the pension community is to find
ways to enable participants to build adequate
retirement income and to do so in a structure
that works effectively for cost- and risk-conscious
plan sponsors.
To help get to and through retirement workers
must participate in and make contributions to
To achieve success, in our view the retirement plan of the future needs these features:
Contribution levels should be high, in the range of 15% of salary each year.
The plan design should use behavioral techniques to encourage participation and raise
contribution rates.
Assets should be professionally managed.
Collectively,
Americans are
woefully unprepared
financially for
retirement. This
retirement problem
actually reflects a
collection of diverse
issues.
PAGE 3
Can the solution be as simple as just setting aside more for retirement savings? Unfortunately not.
But contribution rates are a good place to start in understanding the scope of the problem. To accumulate
enough money to replace their salary at retirement, people need savings (including any company match)
equivalent to 15% to 20% of their salary every year over their entire career while averaging investment
returns of around 4% annually above inflation on these investments, according to Bob Maynard, CIO
of the Idaho Public Employees Retirement System. And these numbers assume at least 20% of that
retirement income target comes from Social Security payments.
The National Conference on Public Employee Retirement Systems (NCPERS) is in the same camp. In its
report, The Secure Choice Pension, it estimates that a worker 35 years from retirement needs to save
around 12% of salary to replace 80% of income in retirement. This is consistent with Brandes Institute
models that estimate that 15% annual contributions may come close to replacing final salary.
Stacking these objectives against the reality of many workers savings and investments, especially those
reliant on DC plans, reveals a wide gap. Government estimates from the Social Security Bulletin (volume
71, no. 2, 2011) measured the median annual contribution by participants in DC plans in 2006 at around
5.5%. Wealthier savers tended to save more, but not nearly enough. For the highest decile of earners,
the median annual contribution rate was 7%, dropping to a meager 3% for the lowest decile of earners.
Either out of necessity or choice, participants struggle to set aside enough to help their future selves a
couple of decades down the road.
Exhibit 1: The Savings Shortfall: Around 10% a Year in Contribution Levels, as of 2006
Median annual contribution rate for DC plans
Estimated annual contribution to replace final salary
16%
14%
12%
10%
8%
6%
4%
2%
0%
Source: Social Security Bulletin as of 2011, EBRI, NCPERS Secure Choice Pension, Brandes Institute estimates
At the contribution rates in Exhibit 1, a participant might achieve 30% replacement of final salary, instead
of 82% if contributions had been made at the recommended rate.
According to the Employee Benefit Research Institute (EBRI), the average U.S. worker likely will need
$900,000 upon retirement to maintain his or her lifestyle, but, The average balance in all 50 million U.S.
401(k) accounts is just over $60,000. Even people within 10 years of retirement have saved an average of
only $78,000, and more than a third of them have less than $25,000.3
In addition, 43% of workers between the ages of 45 and 54 said they werent currently saving for
retirement at all. Collectively, the difference between what U.S. workers have saved for retirement vs.
what they should have at this point in their lives is $6.6 trillion.4
3
PAGE 4
90%
80%
43% of workers
between the ages of
45 and 54 said they
werent currently
saving for retirement
at all. Collectively, the
difference between
what U.S. workers have
saved for retirement vs.
what they should have
at this point in their
lives is $6.6 trillion.4
70%
60%
50%
40%
30%
20%
10%
0%
Source: Social Security Bulletin as of 2011, NCPERS Secure Choice Pension, Brandes Institute estimates. Illustration of percentage of final salary replaced
assumes real investment returns of 4% over a working lifetime. It also assumes a 25-year old retiring at 65, inflation and contribution increasing at 3%
annually, costs at 1% annually. This hypothetical example is for illustrative purposes only. It does not represent the performance of any specific product.
Actual results will vary.
Over the 40 years to yearend 2012, U.S. stocks had gained 9.8% annualized and long-term government
bonds gained 8.9% annualized. But since the start of 2000, U.S. stocks gained less than 2.0% annualized
through yearend 2012, as measured by Ibbotson data. The continuation of the bond bull market has
Exhibit 3: The Assets Shortfall
What the average near-retirement worker* has saved
What the average worker may need for retirement
$1,000,000
$900,000
$800,000
$700,000
$600,000
$500,000
$400,000
$300,000
$200,000
$100,000
$0
Source: EBRI, Social Security Bulletin, NCPERS Secure Choice Pension, Brandes Institute estimates.
*near-retirement defined as within 10 years of retirement age.
led to 10-year U.S. Government bonds yielding less than 3.0% (both at yearend 2012 and into the third
quarter of 2013). As a result, many workers (and many plan sponsors) may have turned sour on equities
due to poor returns, while bond yields are still close to historic lows.5
4
The Retirement Crisis and a Plan to Solve it, a proposal by Senator Tom Harkin, July 2012
PAGE 5
U.S. stock returns represented by data from Ibbotson Associates via Morningstar. Long-term U.S. Government bonds represented
by data from Ibbotson Associates via FactSet through yearend 2005 and the Barclays U.S. Treasury 20+ Year Index from 2006 to
yearend 2012. Historical 10-year U.S. Government bonds yields were drawn from Prof. Robert Shillers website: http://www.econ.yale.
edu/~shiller/data.htm. According to the Shiller data, the 10-year U.S. Government bond yield reached its all-time low (based on
monthly data back to January 1871) in July 2012 when it fell to 1.53%. Outside of this decade, the last time U.S. Government bonds
were at a comparable level was January 1941 when they fell to 1.95%. The yield in August 2013 was 2.57%. The 40-year returns for
stocks and bonds referenced above are for Jan. 1973 to Dec. 2012. Past performance is not a guarantee of future results. One cannot
invest directly in an index.
5
PAGE 6
All of the above factors contribute to the problem. Every topic on this list has generated articles and
arguments regarding dangers and the implications for individuals, employers and even society as a
whole. The problem is complex, and there is no easy solution.
The retirement
problems in the
United States must
include solutions for
both DB and DC plans
and for any other plan
design variations
that evolve.
In this paper, we touch on all of these, but our focus is on finding the solutions that have the broadest
impact on the primary goal: ensuring that adequate retirement benefits are at least within reach for
most workers and retirees. This includes finding approaches that work effectively for both plan sponsors
and participants.
6
7
Benefits
Contribution
Investment Earnings
Expenses
DB plan
Typically,
Annual pension
Primarily sponsor6
Plan return
Sponsor control
DC plan
Lump sum
Participant return
PAGE 7
Benefits
Contribution
Investment
Earnings
Expenses
Financial Risk
DB
DB
DB
DB
Longevity Risk
DB
n/a
n/a
n/a
Behavioral Risk
n/a
n/a
DB
n/a
Benefits
Contribution
Investment
Earnings
Expenses
Financial Risk
DC
n/a
DC
DC
Longevity Risk
DC
n/a
n/a
n/a
Behavioral Risk
DC
DC
DC
n/a
D C plan participants are typically required to make an annual minimum withdrawal, called a Required Minimum Distribution (RMD),
soon after reaching age 70. The RMD is calculated based on the participants age and the account value. But participants who
purchase a deferred income annuity (sometimes called longevity insurance) with a lump-sum premium and hold the contract within
their DC plan (to preserve the tax-deferred status of the premium paid) could still be subject to RMDs even though the contract may
not begin to pay income until they reach age 80 or 85. Participants who do not have additional resources within the DC plan to make
the annual minimum withdrawals would be subject to surrender charges for withdrawing money prematurely from the annuity contract
to satisfy the RMD. The Department of Labor has proposed modifications to required minimum distributions with regard to deferred
income annuities but no changes have taken effect.
PAGE 8
Annual studies by Dalbar show consistently that the average mutual fund investor achieves results well
below the overall market, largely because of following the crowdbuying high and selling low. Their
most recent study, for the 20 years through 2012, shows a shortfall of 4% annually over the past two
decades. Thats actually on the low end of the range seen historically in the Dalbar studies.
In 1940, private
pensions covered 4
million people or about
15% of the active U.S.
workforce. By 1960,
those numbers had
grown to 23 million or
about half of all private
sector employees.9
To be fair, DB plan sponsors are not exempt from the behavioral errors of chasing short-term
performance. Research by Goyal and Wahil in 2008 covering a 10-year period to 2003, showed that plan
sponsors tended to fire managers after they underperformed, and subsequently those fired managers
tended to outperform their successors. Nevertheless, the impact of this factor appears modest compared
to the potential damage individual investors can inflict upon themselves when making their own DC
investment decisions if the Dalbar study is representative of their results.
So there is fairly significant evidence that DC plans fall short of DB plans from a participant perspective.
But this is not new news. Our focus is on evaluating DC, DB and other competing plans to see which,
if any, can provide a solution to the various issues outlined earlier.
In order to provide the right context, we need to start with the past: how did the American retirement
industry get to this state of affairs?
Seburn, Patrick W. Evolution of Employer-Provided Defined Benefit Pensions. Monthly Labor Review. Dec. 1991
PAGE 9
In 1985, the
Department of Labor
reported there were
114,000 DB plans in
the United States.
PAGE 10
PAGE 11
According to the
Federal Reserves Flow
of Funds Accounts,
there were assets of
$4.3 trillion in DC plans
as of March 2013, with
another $5.8 trillion in
IRAs. This compares to
$2.6 trillion in private
sector DB plans, and
another $5.0 trillion in
public sector DB plans.
So of the $17.6 trillion
total, DB plans are
now the minority with a
43% share of the total.
10
Walsh, Mary Williams. Xerox Reaches Settlement With Retirees on Pension Suit. The New York Times. Nov. 15, 2003.
PAGE 12
Section 4 Summary: Various factors are likely to hurt DC participants financially, including lower
contributions, lower investment returns and potentially their own poor investment decisions. In the
meantime, DB plan sponsors are still dealing with underfunding problems. The simple (but not necessarily
easy) solutions include: increase contributions; retire later; and increase investment returns. The real solution
for the pension community is to find ways to enable participants to build adequate retirement income and to
do so in a structure that works effectively for cost- and risk-conscious plan sponsors.
This shift from DB to DC plans combined with the low-return market environment has a major impact
on Benefits, especially for DC participants. Contributions have gone down (as participants have generally
not used even the modest maximum limits allowed). Investment earnings from equities have been poor
in recent years and the record low level of bond yields pose the risk of negative future returns (both
nominal and real) from bonds. With C and I down, the money available for Benefits that are supported
by C+I-E are likewise down. By getting out of the DB Business, plan sponsors no longer make up the
difference. Participants have taken on the responsibility of picking up this tab, even if many havent
realized it yet.
Even for those who contribute actively to DC plans, the longevity and behavioral risks associated with
DC plans (see Exhibit 2) potentially leave another gap between adequate replacement income levels and
the likely outcome for most retirees.
The discussion on fixing the pension crisis appears ever more complex. But we believe the key drivers
that can remedy many of the failings are quite simple. Using the Retirement Rule, we can move forward
from the historical context and see that any serious solution must include two elements:
Save more: increase C
Earn better returns: increase I
(While reducing Expenses would also help, its impact is likely to be small relative to the other two, so we
have excluded it as a meaningful solution).
Note that a solution for the participant is not the same as a solution for the plan sponsor. For a DB
plan sponsor, the preferred solution for many is to close or terminate the plan, or to pay to transfer the
liabilities to an insurance company. This may solve the problem for the sponsor. However, even if this
solution preserves the already-earned benefits for the participant, it leaves a gap to be filled in respect of
pension benefits based on future earnings.
On the sponsor side of the equation, there is also the well-publicized and debated issue of underfunding.
With stagnating asset values and low bond yields, funding gaps have increased in recent years. This is
meaningfully impacting private sector DB plans which use a high quality corporate bond yield as the
liability discount rate.11 Record low yields have reduced the level of funding, and contributed to the
desire to get the pension liabilities off the balance sheet. Changes in bond yields, especially from recent
low levels, can have a significant impact on private sector plan funding ratios. Estimates by consultants
Mercer on the aggregate pension funding ratio of the companies in the S&P 1500 show the ratio climbed
from 74% at the end of 2012 to 86% by May 2013.
Public sector DB plans have more flexibility in selecting their liability discount rate, and tend to use less
conservative assumptions than their private sector peers. Underfunding is a major problem for some,
but not all, large public DB plans. For example, a June 2013 report from Moodys estimated that while
the fifty states are in aggregate 74% funded on published data, when adjusted to take into account market
11
A ccording to guidance at the IFRS Foundation/IASB website (ifrs.org), the organizations Interpretation Committee did not specify a
credit rating, noting that the discount rate should be determined by reference to market yields at the end of the reporting period
on high quality corporate bonds. While acknowledging that the general interpretation of this rule is understood not to be bonds with
a credit rating below AA, The Interpretations Committee discussed this issue in several meetings and noted that issuing additional
guidance on or changing the requirements for the determination of the discount rate would be too broad for it to address in an efficient manner. For more information: http://www.ifrs.org/Current-Projects/IASB-Projects/Employee-Benefits-Discount-Rate/Pages/
Project-summary.aspx
PAGE 13
risks (for example by changing the liability discount rate to that used by private sector plans), the funding
ratio drops below 50%. Moodys numbers show a wide range between best and worst states in terms of
funding ratio and overall pension burden (Nebraska, Wisconsin and Idaho top the Moodys rankings as
having the lowest pension burden). There is debate in the industry over the validity of these assumptions
and methodologies but this is beyond the scope of this paper.
The reality is that a
pension plan is
deferred compensation.
As part of the overall
compensation package
for employees, it
can be an important
element in recruiting,
retaining and
motivating employees.
Its financial impact is
often underestimated
by workers.
The take-away from our perspective is that both private and public sector DB plans will be dealing with
underfunding issues for the foreseeable future, and this will continue to undermine the rationale for
sponsors to maintain their traditional DB plans.
For a DC plan sponsor, there is no problem as the whole premise of the DC industry is that the risks
and consequences of inadequate contributions, poor investment earnings and longevity are all largely
handed to the participants.
Can plan sponsors solve their own pension crisis simply by this financial pass the parcel technique of
dumping the problem into the laps of their employees (and ultimately on society as a whole which could
need to support a growing number of destitute retirees)? We dont think so. The reality is that a pension
plan is deferred compensation. As part of the overall compensation package for employees, it can be
an important element in recruiting, retaining and motivating employees. Its financial impact is often
underestimated by workers. Employer-sponsored DC pension arrangements may be seen as increasingly
unattractive in coming years as todays retirees run out of assets. Then the competitive power of an
effective pension plan may be an even more visible and valuable management tool for the plan sponsor.
The real solution for the pension community is to find ways to enable participants to build adequate
retirement income and to do so in a structure that works effectively for cost- and risk-conscious
plan sponsors.
Exhibit 6: 40-Year Real Returns for 65% Equity, 35% Bond Portfolio (1926-2012)
8%
Annualized 40 Year Rolling Real Returns
7%
6%
5%
4%
3%
2%
1%
0%
Dec-65
Oct-73
Aug-81
Jun-89
Apr-97
Feb-05
Dec-12
Source: U.S. stock returns represented by data from Ibbotson Associates via Morningstar. Long-term U.S. Government bonds represented by data from
Ibbotson Associates via FactSet through yearend 2005 and the Barclays U.S. Treasury 20+ Year Index from 2006 to yearend 2012. Performance is for the
period Jan. 1926 to Dec. 2012. Past performance is not a guarantee of future results. One cannot invest directly in an index. Rolling periods represent a
series of overlapping, smaller time periods within a single, longer-term time period. For example, over the illustrated 87-year period, there are 48, 40-year
rolling periods, with the first one running from 1926 through 1965, the next from 1927 through 1966, and so on. There are 78, 10-year rolling periods with
the first one running from 1926 through 1935, the next running from 1927 through 1936, and so on.
is straightforward: people commit in advance to allocating a portion of their future salary increases
toward retirement savings. The authors essentially enabled apathy as a positive force by automatically
increasing contributions faster than pay rises unless an enrolled participant opts out of the Save More
Tomorrow arrangement.
...The Canadian
industry has pioneered
the path towards
variable benefits in
North America, moving
away from the pure
defined benefit model,
and sharing some of
the pre-retirement
investment risk with
the participant.
Behavioral methods have also proved successful in raising overall contribution rates elsewhere. We look
at lessons from some other countries in the next section. In sum, given that Investment returns are
substantially tied to the fate of the markets, the only major variable in the Retirement Rule that is under
our control is Contributions. For any long-term solution, for Benefits to be adequate, Contributions
must rise.
Canadas basic old age pension is complemented by the Old Age Security (OAS), which is paid out
to low-income retirees. With the social safety net, the need for replacement income in retirement is
materially lower than in the United States. Canadian pension expert Zev Frishman (member of the
Brandes Institute Advisory Board and EVP of Open Access Ltd.) estimates based on statements made
by leading Canadian actuaries that the replacement need for final salary for many if not most Canadians
may be around 50% compared to the 80% typically assumed in the United States.
Effectively, this reduces the strain on the Benefits element of our Retirement Rule, Benefits =
(Contributions + Investment Earnings) Expenses, B=(C+I)-E.
The need for high Contributions is therefore less than for the United States. In fact, because of the
means tested component of government pensions, those who contribute higher amounts towards their
retirement may actually be worse off, with claw-backs in benefits that offset the additional savings.
As a result, some of the pension failings that are common to both Canada and the United States are
less impactful in Canada. This includes the fall in funded status of DB plans and the problems for those
employees who dont have access to an adequate DB or DC plan.
PAGE 17
Many Canadian
DB plans allow a
commuted benefit to
be transferred to a
qualified DC plan when
an employee leaves.
PAGE 19
Applying these principles will often have uncomfortable implications for plan members. They will often
show that if members want to have a particular standard of living in retirement, then they will be making
insufficient contributions to their pension plan, following a recklessly conservative investment strategy,
planning to retire too early, or some combination of these. Practitioners have told us that revealing this
reality to members might put them off contributing to a pension in the first place. We would argue that it is
much better to be realistic about the future than to hide your head in the sand.
The NCPERS Secure
Choice Plan explicitly
uses the cash balance
plan as its model,
but given the legislative
negotiations of
state-by-state
implementation, the
final versions may vary
in some respects.
The Harkin Plan sets
out a legislative outline
on broad principles,
leaving the private
sector to implement
within that outline.
Common Factors:
Design
PAGE 21
Benefits
Both proposals
allow employees to
make additional
contributions, but these
will be subject to the
same behavioral factors
that already impact
401(k) contributions.
While the broad concepts are similar, there are important differences in the proposals. The Harkin plan
envisages a mandatory nationwide approach, covering all eligible workers (i.e. those offered inadequate
or no pension plans). The NCPERS proposal aims to leverage the existing state-level public pension
fund infrastructure to offer similarly managed pension funds to employers and their workers. Exhibit
7 illustrates some key differences between the two proposals. Note that the NCPERS Secure Choice
Pension is explained in detail in its proposal, while the Harkin/USA approach is only outlined in its
proposal, with detail expected when Sen. Harkin introduces a legislative proposal later in 2013.
EXHIBIT 7: Comparison of Harkin Plan and NCPERS/Secure Choice
Managed by
Supervised by
Employer fiduciary liability
Once started, pension guaranteed
at that level as minimum
Number of plans
Subsidizes low income workers
Employers not offering an adequate
pension plan must participate
Harkin/USA
NCPERS/Secure Choice
Private sector
Public sector
(in parallel with existing funds)
Federal
State
None
No
Yes
Yes
No
Mandatory, through
payroll deduction
Voluntary
The concept of filling the retirement gap with this type of broadly available hybrid plan proposal is a
sound one in our view. Given the early stage of these proposals, it is not clear which would be a better
solution, and we would expect the proposals to be modified as the political process unfolds. The two
approaches are not mutually exclusive, and could co-exist well in a competitive market. Tax policy will
also be a major factor in determining eventual success, especially any decisions on the maximum level
of deductible contributions.
When we look through the prism of the Retirement Rule (B=(C+I)-E), the strengths and weaknesses of
these proposals are much clearer.
Both Harkin/USA and NCPERS/Secure Choice use the common attributes with a DB-type plan structure
to provide improvements in Investment returns (through professional management) and Expenses
(through economies of scale). Critically, both proposals include portability, which is a real weakness of
traditional DB plans in todays world of rapid job changes.
The NCPERS/Secure Choice proposal provides for the professional investment management of assets
alongside existing State pension systems. It is implied (but not explicit) that the asset allocation policies of
PAGE 22
In the NCPERS/Secure
Choice proposal,
expenses are expected
to be kept in line
with the state plans
with which they
combine investment
and administrative
expenses. For the
Harkin/USA proposal,
the expense control
mechanism is market
disclosure.
the Secure Choice funds would be similarly longterm focused as are those State funds. While Secure
Choice is already moving toward implementation
in some states, the Harkin/USA proposal still has
to go through the political process. While its goal is
bi-partisan approval, some aspects of the proposal
may be contentious.
The Harkin/USA proposal would turn the asset
management role over to private sector firms
under the guidance of independent trustees.
These independent boards are central to longterm success. If they function effectively, the USA
funds would be run with the necessary long-term
investment goals and allocation policies that are
required to meet adequate real return targets. If
the boards are ineffective or their independence is
subsumed to the influence of the plan providers,
then long-term success will be elusive.
In the NCPERS/Secure Choice proposal,
expenses are expected to be kept in line with the
state plans with which they combine investment
and administrative expenses. For the Harkin/
USA proposal, the expense control mechanism is
market disclosure. Competition between private
sector plan managers should help keep expenses
down, especially if as expected, transparency in
fee comparisons are mandated in the proposed
legislation. However, the possibility of an
oligopoly of a few large and dominant investment
firms may offset this.
But the bigger issue once again is Contributions.
As we have seen, this is a key determinant of the
long-term success for any pension plan. While
the Harkin/USA proposal includes a mandatory
employer contribution, it does not specify the
rate. The NCPERS/Secure Choice proposals
illustrations use contribution rates of 5% and 3%,
which may be realistic but even the 5% level does
not move the dial enough to be the primary
source of pension benefits. That illustration
suggests that a 25-year old working for forty years
would be able to replace only 29% of final salary
with the Secure Choice benefit. Social Security
could provide a similar amount, but the balance
needs to be filled by additional personal savings.
PAGE 23
in any DC plans into one of these plans. While the participant still has investment risk, the behavioral
impact of investment choices could be removed, the expense level may be lower, and longevity risk for
the participant (a big problem for DC plan participants) could be reduced or possibly eliminated.
Summary of Section 8: Hybrid plans may emerge as viable, long-term solutions. To achieve success, these
plans must:
Structure management of investments and operational costs to provide adequate long-term
returns, and contain expenses
Provide pooling of longevity risk
Allow portability in an era when changing jobs is the norm
Use behavioral techniques to encourage participation and raise contribution rates
Enable participants to understand in simple terms how well prepared they are for eventual
retirement
The newer hybrid plans require various legislative changes and regulatory approvals. We support moves that
make these plans easier to implement as they offer features that address current challenges for participants
and plan sponsors, alike.
We have argued that any solution must deal with the Retirement Rule elements: I, E and particularly C.
But as a practical matter, the structure of any broad solution must be:
appropriate and practical for both public and private sectors
supported and encouraged by government (federal, state and local)
reinforced as opposed to hindered by behavioral biases (both of participants and sponsors)
In general, recommendations by political and industry experts all aim to boost contributions and
investment returns, while containing costs. But as the saying goes, The devil is in the details.
Our assessment of the two national-level hybrid proposals in Section 7 is that they have a good chance
of success as long as the contribution levels are high enough to allow the math of the Retirement Rule
to work.
But as explained in Section 3, these are not the only approaches that use hybrid structures. Cash balance
and adjustable plans in the United States and Shared Risk plans in Canada all offer a route for plan
sponsors to maintain key pooling elements of the traditional DB plan while shifting some or all of the
investment risk to participants and hence reducing the risk to sponsors.
It may be that the broadening category of hybrid approaches will provide an effective long-term solution
for the industry. We suggest five criteria that need to be incorporated in such a solution.
Specifically, how well do the plans:
1. Structure management of investments and operational costs to provide adequate long-term
returns and contain expenses
2. Provide pooling of longevity risk
3. Allow portability in an era when changing jobs is the norm
4. Use behavioral techniques to encourage participation and raise contribution rates
5. Enable participants to understand in simple terms how well prepared they are for
eventual retirement
PAGE 24
Traditional DB plans didnt meet all these criteria (for example #3), but as previously noted, traditional
DB is increasingly unavailable as a retirement option. DC plans generally struggle with numbers 1 and
2, and need to do better with numbers 4 and 5.
Hybrid plans, including the two national-level proposals, are structured to score well on the first three
criteria. Depending on how they are implemented, they also have the potential to satisfy the last two
criteria as well. It is likely that implementation will bring greater awareness of the hybrid concept, and
may even redefine the DB vs. DC debate into a real three-way contest.
The national-level proposals clearly state that they aim to supplement existing DB and DC plans,
not replace them. However cash balance plans are already rapidly stepping into the gaps vacated by
traditional DB plans, and adjustable plans also may gain popularity. It seems inevitable that over the
long-term, traditional DB plans will play a declining role in retirement planning at least for private sector
employees. It is by no means inevitable in our view that DC plans will take over as the only or even the
dominant alternative.
But we are still at an early stage in this contest. Except for cash balance plans, the hybrid approaches
are still not widely used, and require more development work as well as various legislative changes and
regulatory approvals before they are cleared to be significant challengers to the dominance of traditional
DB and DC. Exhibit 8 summarizes their status.
In a free market (assuming no regulatory bias or impediments), long-term success should go to the
structures that provide the best outcomes for both participants and plan sponsors. Hybrid plans appear
to be well-designed in this context. As detailed earlier in this paper, most of todays DC plans need
significant improvement to meet the needs of participants for adequate retirement benefits. Design
improvements are feasible: pooling longevity risk through annuity features, improved participation and
contribution rates, and avoidance of behavioral investment errors. But they are not inevitable, nor is the
dominance of DC in retirement saving.
EXHIBIT 8: Hybrid Plan Approaches in North America
Status
Jurisdiction
Legal approval
needed?
Harkin/USA
Outline proposal
Federal
Yes
All
NCPERS, Secure
Choice
Detailed proposal
States
Yes
Partial
Established
Federal
Approved
Partial
Canadian SRPP
Newly introduced
Canada provinces
Yes
Partial
Adjustable
Newly introduced
Federal
Yes
Partial
Double DB
Detailed proposal
Federal
Yes
Partial
Plan type
Cash balance
Note: descriptions of these plans can be found in earlier sections as follows: Harkin/USA and NCPERS Secure Choice, Section 7; Cash Balance, Section 3;
Canadian SRPP, Section 6; Adjustable and Double DB, Section 3.
Source: Brandes Institute
PAGE 25
We believe adaptations
of hybrid plans will
emerge as competitors
to existing DC plans
and alternatives to DB
if the latter continue
to be phased out by
plan sponsors.
Summary of Section 9: In theory, DB and DC plans that are well designed, well-funded and properly
invested can deliver adequate retirement benefits. In reality, some DB plans and most DC plans do not meet
these objectives. We believe adaptations of hybrid plans will emerge as competitors to existing DC plans and
alternatives to DB if the latter continue to be phased out by plan sponsors. Regardless of plan structure, we
believe the following six recommendations are needed to give participants the opportunity to reach their
retirement goals:
Contribution levels should be higher, in the range of 15% of salary each year.
Assets should be professionally managed.
Plan assets should be portable across employers.
Longevity risk should be minimized by pooling individual participants assets with others.
Retirement age should be deferred where feasible, increasing both savings and benefits.
Cost control and disclosure must be emphasized, not only for DC plans, but for any new hybrid
design that aims to compete successfully for retirement savings.
The retirement train is pulling into the station; it is our collective responsibility to get passengers off the
tracks and onto the platform.
The Brandes Institute Advisory Board includes nine external members with extensive experience in
the retirement and fund management industry worldwide. All have been involved in this research and
we are grateful for their input and opinions. A list of Board members is available at www.brandes.com/
Institute/Pages/BIBoardAndStaff.aspx and we thank all of them for their detailed and thorough work in
providing guidance and reviews for this paper. However, the views expressed in this section are those of
the Brandes Institute and should not be taken as personal or professional views of any specific Advisory
Board member.
In conclusion, we reiterate that regardless of plan structure, we believe that the most effective way to
address the pension crisis must include a determined focus on the Retirement Rule (B=(C+I)-E). Here,
we summarize our central arguments and offer recommendations related to:
1. Contribution Levels
4. Longevity Risk
2. Professional Management
5. Retirement Age
3. Portability
6. Expenses
For existing DB and DC plans, neither rates a top grade in all six of these areas. DB plans fail on
portability in the United States. With increasing numbers of DB plans closing, the DB plan structure is
no longer widely available as a contribution mechanism. And while DC plans score well for portability,
they generally fall short to some degree on most of the other criteria.
Nevertheless, we believe that in theory, either DB or DC plans, IF well-designed, well-funded, and wellinvested, can deliver adequate retirement benefits. In reality, some DB plans and most DC plans do not
meet those conditions.
So can hybrid plans fill the gap? At present the only approved and viable contender among
hybrid plans is the cash balance structure, as other hybrids are still at a very early stage in the
introduction/approval process. Nevertheless, we believe that adaptations on this theme may prove
to be real competitors to DC plans, as traditional DB plans continue to decline in availability over
the long term. The impact will likely be felt first in the private sector given the rapid erosion of
traditional DB plans in that sector, but ultimately may gain wider acceptance with public plans
as well.
PAGE 26
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The Barclays U.S. Treasury 20+ Year Index is an unmanaged index consisting of U.S. dollar-denominated, U.S. Treasury-issued securities. The Index represents public obligations of the U.S. Treasury with a remaining maturity of at least 20 years. The index is a total return index which reflects the price changes
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