"Comparative Costs and Risks for Sponsors of Traditional Defined Benefit, Defined Contribution, and Hybrid Plans" 

GAOBO PANG, Towers Watson
Email: gaobo.pang@towerswatson.com
MARK J. WARSHAWSKY, Towers Watson
Email: mark.warshawsky@watsonwyatt.com

This stochastic simulation analysis quantifies the range of possible funding costs and volatilities for private sponsors of traditional defined benefit, defined contribution, and hybrid (cash balance) plans. Plan provisions of comparable benefit generosity are modeled, as are current funding requirements and practice. The model simulations include a comprehensive consideration of the uncertainties in asset and labor markets. The results show that costs and risks for sponsors vary significantly with plan type, funding strategy and participant demographics. Across the scenarios, the hybrid plan type exhibits good features of cost efficiency and risk reduction for the plan sponsor.

"Building Value and Reputation with Stakeholder Management: The Case of Washington State Investment Board" 

Rotman International Journal of Pension Management, Vol. 3, No. 1, 2010

THERESA J. WHITMARSH, Washington State Investment Board (WSIB)
Email: khaines@sib.wa.gov

The growing literature on pension governance identifies desirable governance characteristics, and links them to improved organizational performance. However, actual pension plan organization and governance are often a result of a series of historical events and cultural factors. Governance best practices that could feasibly be implemented in one country might be impractical in another. This article focuses on one specific element of governance: stakeholder management. We show that this element has played a critical role in moving Washington State Investment Board toward the optimal end of the governance scale within the legal and historical constraints within which public sector pension funds operate in the United States.

"The EBRI Retirement Readiness Rating:™ Retirement Income Preparation and Future Prospects" 

EBRI Issue Brief, No. 344, July 2010

JACK VANDERHEI, Employee Benefit Research Institute (EBRI), Temple University - Risk Management & Insurance & Actuarial Science
Email: vanderhei@ebri.org
CRAIG COPELAND, Employee Benefit Research Institute (EBRI)
Email: COPELAND@EBRI.ORG

The EBRI Retirement Readiness Rating™ was developed in 2003 using the EBRI Retirement Security Projection Model® (RSPM) to provide assessment of national retirement income prospects. The 2010 update uses the most recent data and considers retirement plan changes (e.g., automatic enrollment, auto escalation of contributions, and diversified default investments resulting from the Pension Protection Act of 2006) as well as updates for financial market performance and employee behavior (based on a database of 24 million 401(k) participants). This paper presents the results of the 2010 update. The baseline 2010 Retirement Readiness Rating™ finds that nearly one-half (47.2 percent) of the oldest cohort (Early Baby Boomers) are simulated to be “at risk” of not having sufficient retirement resources to pay for “basic” retirement expenditures and uninsured health care costs. The percentage “at risk” drops for the Late Boomers (to 43.7 percent) but then increases slightly for Generation Xers to 44.5 percent. Households in the lowest one-third when ranked by preretirement income are simulated to be “at risk” 70.3 percent of the time, while the middle-income group has an “at-risk” level of 41.6 percent. This figure drops to 23.3 percent for the highest-income group. These numbers are generally much more optimistic than those simulated for the same groups seven years earlier. In 2003, 59.2 percent of the Early Boomers were simulated to be “at risk,” as well as 54.7 percent of the Late Boomers and 57.4 percent of the Generation Xers. When the simulation results are classified by future eligibility in a defined contribution plan, the differences in the “at-risk” percentages are quite large. For example, Gen Xers with no future years of eligibility have an “at-risk” level of 60 percent, compared with only 20 percent for those with 20 or more years of future eligibility.

The model simulates a distribution of how long retirement money will cover the expenses for Early Boomers (assuming retirement at age 65). A household is considered to “run short of money” if their resources in retirement are not sufficient to meet minimum retirement expenditures plus uncovered expenses from nursing home and home health care expenses. While knowing the percentage of households that are “at risk” is obviously valuable, it does nothing to inform one of how much additional savings is required to achieve the desired probability of success. Therefore, this analysis also models how much additional savings would need to be contributed from 2010 until age 65 to achieve adequate retirement income 50, 70, and 90 percent of the time for each household. While this concept may be difficult to comprehend at first, it is important to understand that a retirement target based on averages (such as average life expectancy, average investment experience, and average health care expenditures in retirement) provides, in essence, a retirement planning target that has approximately a 50 percent “failure” rate. Adding the 70 and 90 percent probabilities allows more realistic modeling of a worker’s risk aversion.

"Target-Date Fund Use Over Time" 

EBRI Notes, Vol. 31, No. 7, July 2010

CRAIG COPELAND, Employee Benefit Research Institute (EBRI)
Email: COPELAND@EBRI.ORG

The use of target-date funds (TDFs) in 401(k) plans has increased rapidly in recent years. The percentage of all 401(k) plan participants using TDFs increased from 25 percent in 2007 to 31 percent in 2008. One of the reasons for this growth is that TDFs have been a popular choice for the default fund when 401(k) plans have an auto-enrollment feature. Consequently, use of these funds has been found to more likely occur among younger participants, participants with lower account balances, and participants with shorter tenure at their current job, as new workers are the most likely to be auto-enrolled in their employer’s 401(k) plan. This paper examines the persistence of use in TDFs among those who were using these funds in 2007. Therefore, the percentage of participants who remain in these plans is determined, as well as the percentage of participants who added TDFs among those not already using them in 2007. The analysis is focused on 401(k) participants who were in plans that offered TDFs in 2007 to see whether they remained in TDFs, moved out of TDFs, or moved into TDFs if they were not already using them.

The PDF for the above title, published in the July 2010 issue of EBRI Notes, also contains the fulltext of another July 2010 EBRI Notes article abstracted on SSRN: “The Early Retiree Reinsurance Program: $5 Billion Will Last About Two Years.”

"Policy Considerations for Hedging Risks in Mandatory Defined Contribution Pensions Through Better Default Options" 

PENSION FUND RISK MANAGEMENT: FINANCIAL AND ACTUARIAL MODELING, Gregoriou, Masala, Micocci, eds., Chapman & Hall, 2010

GREGORIO IMPAVIDO, International Monetary Fund (IMF), World Bank
Email: gimpavido@imf.org

The financial turmoil of 2008 highlighted the importance of default investment options in mandatory defined contribution pensions. Their design can improve the scope for intertemporal risk diversification for individuals and increase the likelihood of achieving adequate replacement rates during retirement. This topic is relevant to several countries in Latin America and Eastern Europe that have recently adopted the “multi-fund” design for investment choices and default options and the many more that are currently considering the adoption of similar products in the coming years. This chapter assesses the design and regulation of default investment choices in mandatory defined contribution pensions as they have been recently adopted in countries like Chile, Peru, Mexico and Hungary. It also suggests policies aimed at improving their risk diversification properties.

"Post-Firestone Skirmishes: Discretionary Clauses and Judicial Review of ERISA Plan Administrator Decisions" 

Boston Univ. School of Law Working Paper No. 10-20

MARIA O'BRIEN HYLTON, Boston University School of Law
Email: mhylton@bu.edu

Since the U.S. Supreme Court’s Firestone decision ERISA plans routinely include a clause granting discretion to the plan administrator. This language effectively insulates a plan from de novo review in virtually all benefit claims cases. Approximately 20 state insurance commissioners have come to believe that discretionary clauses enable biased decision making by insurance companies and insulate them from the consequences of their conflicted, self-interested determinations. These states have banned discretionary clauses. And, in spite of continued support for them in the Supreme Court, federal Courts of Appeal have upheld the bans in spite of preemption challenges. This paper reviews the development of discretionary clauses and situates them in the larger context of the on-going battle over the appropriate state role in the regulation of ERISA plans. It seems likely that the Supreme Court will soon have occasion to consider whether ERISA preempts discretionary clauses.

"Getting to the Top of Mind: How Reminders Increase Saving" 

NBER Working Paper No. w16205

DEAN S. KARLAN, Yale University - Economic Growth Center, Massachusetts Institute of Technology (MIT) - Abdul Latif Jameel Poverty Action Lab, Center for Global Development
Email: dean.karlan@yale.edu
MARGARET MCCONNELL, Harvard University
Email: mmcconne@hsph.harvard.edu
SENDHIL MULLAINATHAN, Harvard University - Department of Economics, National Bureau of Economic Research (NBER)
Email: mullain@fas.harvard.edu
JONATHAN ZINMAN, Dartmouth College, Innovations for Poverty Action, Jameel Poverty Action Lab
Email: jzinman@dartmouth.edu

We develop and test a simple model of limited attention in intertemporal choice. The model posits that individuals fully attend to consumption in all periods but fail to attend to some future lumpy expenditure opportunities. This asymmetry generates some predictions that overlap with models of present-bias. Our model also generates the unique predictions that reminders may increase saving, and that reminders will be more effective when they increase the salience of a specific expenditure. We find support for these predictions in three field experiments that randomly assign reminders to new savings account holders.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

"Health Cost Risk and Optimal Retirement Provision: A Simple Rule for Annuity Demand" 

Netspar Discussion Paper No. 05/2010-018

KIM PEIJNENBURG, Tilburg University, Netspar
Email: j.m.j.peijnenburg@uvt.nl
THEO NIJMAN, Tilburg University - Center and Faculty of Economics and Business Administration
Email: Nyman@uvt.nl
BAS J. M. WERKER, Tilburg University - Center for Economic Research (CentER)
Email: Werker@TilburgUniversity.nl

We analyze the effect of health cost risk on optimal annuity demand and consumption/savings decisions. Many retirees are exposed to sizeable out-of-pocket medical expenses, while annuities potentially impair the ability to get liquidity to cover these costs and smooth consumption. We find that if out-of-pocket medical expenses can already be sizeable early in retirement, full annuitization is not optimal. In the other case of low health cost risk early in retirement, individuals should take advantage of the mortality credit that annuities provide and save out of the annuity income to build a buffer for health cost shocks at later ages. When comparing to empirically observed levels of annuitization, we find that high health cost risk early in retirement may resolve the annuity puzzle. Moreover, we explain the observed pattern of annuitization as a function of initial wealth at retirement. For personal financial planning purposes, we develop a simple rule of thumb for annuity demand, based on expected health cost risk early in retirement, wealth at retirement, and minimum consumption levels. We show that the welfare costs from using the rule compared to the full life cycle model are small.