By Mark Shemtob
As the private-sector retirement program landscape continues its march to a defined contribution (DC) world, actuaries might consider how their skills can be applied to improve retirement outcomes under DC programs. Our expertise can be of value to employers, plan participants, pooled plan providers (PPPs), insurance companies, investment organizations, and potentially other stakeholders. Below are several short summaries of the types of professional services that actuaries may be positioned to offer.
Consulting on Adding Insured Lifetime Income Options to Plans
The Setting Every Community Up for Retirement Enhancement (SECURE) Act includes a provision designed to increase the use of insured lifetime income products under DC plans. The goal is to make guaranteed lifetime income more accessible to retirees. Currently, the majority of DC plans offer only lump-sum payouts to retirees. Historically, employers have been reluctant to add other distribution methods to their plans because under a qualified retirement plan, the inclusion of additional options is a fiduciary liability concern. The SECURE Act aims to accomplish the goal of increasing access to insured lifetime income under plans by providing a safe harbor option for fiduciary relief to plan sponsors (employers or PPPs) should they modify their plans and offer these products.
A plan sponsor needs to first assess whether insured lifetime income products should be made available under the plan. There has been and will continue to be the option for retirees to purchase these products through Individual Retirement Account rollovers. Thus, depending on specific circumstances, adding these products to the plan may not be of sufficient value. If a determination is made that they are to be added, there is much to consider. There is a vast array of insured lifetime income products available in the market. Many plan sponsors may find navigating the process of selecting which to offer beyond their expertise. Among the choices are fixed income annuities. These provide a fixed lifetime income that can start either immediately or in the future. Then there are accumulation-oriented deferred annuities not inherently designed to pay a fixed lifetime income but that can be sold with a guaranteed benefit rider that provides an enhanced income in the event of poor market returns. The underlying investments, the guaranteed benefit rider features, and the fees can vary significantly from product to product. Insured lifetime income products are designed by actuaries. Thus an actuary with expertise in this area is well suited to help plan sponsors navigate the selection challenge, providing that he or she can provide independent analysis. In addition, actuaries who work in the DC space can better provide valuable knowledge to insurance companies regarding the design of products that plan sponsors and retirees are most receptive to using.
Consulting on Non-Insured Income Options
Though the SECURE Act opened the door to increasing the use of insured income options under DC plans through a safe harbor provision, it was silent on the topic of non-insured solutions. The reality is, however, that most retirees continue to find insured income options unattractive. This is generally as a result of perceived high fees, lack of liquidity, and low-interest concerns. Whether the provisions of the SECURE Act will make their use more common is yet unknown. Consequently, retirees and plan experts have expressed interest in having DC plans offer income options that are investment-based. Their rationale is that plans can obtain a larger variety of institutionally priced investments as well as expertise in designing a variety of income solutions.
There are many alternative investment-oriented income strategies that have been used over the years, the most common ones being the 4% rule (with adjustment for the current investment environment) and the required minimum distribution approach. Both of these can also be used with variations where the payouts are subject to periodic variations based on investment experience. But there are other investment-oriented approaches that might better serve the needs of some retirees. In addition, income approaches that combine insured and investment components might provide an attractive strategy for some retirees. Few if any plan sponsors are aware of the array of alternatives, nor are they capable of vetting which ones might best serve their employees’ needs. A consulting actuary can bring value to plan sponsors by educating them on optional approaches, along with the pros and cons of each from a risk/reward perspective. In addition, actuaries who work in the DC space can provide expertise to investment companies regarding the design of income strategies for plans.
Designing Lifetime Income Tools and Analytics
The SECURE Act requires that all DC plans include an annual lifetime income illustration based on accumulated benefits. The current Department of Labor (DOL) regulation governing this requirement provides only a bare-bones approach. Many experts have commented that retirees need a more comprehensive tool for projecting their potential retirement income in order to assess if they are saving enough for retirement. In addition, the DOL regulations require only an insured fixed lifetime income illustration, whereas most individuals do not purchase these products. Consequently, projections based on investment drawdown approaches would be of greater value, though they are not required.
In addition to tools designed to illustrate future retirement income, an actuarial analysis based on a range of assumptions can be used to measure the likelihood that the income projections will be achieved in recognition of unknown financial market experience and actual lifespan. This can be measured through scenario testing, stochastic analysis, or other approaches. Alternative income strategies can be analyzed using investment and/or insured approaches to creating income. Actuaries are well positioned to develop these tools.
Creating New Types of Retirement Programs
The final area where actuaries can bring value is in creating new plan designs. Alternative retirement plan structures are likely to emerge in the future, should Congress pass needed legislation that would allow greater flexibility. The need for new designs is driven by two well-known realities: Employers no longer will accept the financial risks accepted with sponsoring defined benefit plans, and the traditional DC plan design is focused on accumulating a retirement savings and not inherently providing lifetime retirement income. Hybrid approaches such as cash balance plans as well as variable annuity benefit plans are examples of plan designs that recognize employers’ desire to mitigate financial risk. However, both of these programs still provide some financial risk to the employer. In addition, cash balance plans are not inherently designed to provide retirement income. Many employers now desire a level of financial obligation that does not exceed an annual fixed contribution level. They no longer want to assume the financial uncertainty of investment or demographic experience. Though DC plans satisfy an employer’s need to mitigate financial risk, they do not inherently address the retirement income challenge. Of course, adding insured or investment-based solutions (as discussed above) is one approach and the one currently being pursued.
But more-efficient DC plan models can be created that do not rely on unpopular insured lifetime income products or investment solutions subject to erratic swings in income streams based on market volatility. These designs could also incorporate survival sharing (tontine annuity) approaches that can add the value of longevity pooling. Actuaries are qualified to design and monitor new plan structures.
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There are likely other areas where actuaries can bring their knowledge and skills to the defined contribution plan world. Those actuaries who are interested in working in this space may need some additional education in order to deliver quality consulting advice and to satisfy the obligation to take on assignments only where they are qualified.
MARK SHEMTOB, MAAA, FSA, MSPA, EA, is owner of Abar Retirement Plan Services LLC.