General Recession Average 87% for. Average 72% for large plans. Defined. Defined Benefit. Benefit Design. (88%) Hybrid Plans.

Transcription

1 NAGDCA 2015 Annual Conference The Bad, the Good, & the Ugly Presented by: Cathie Eitelberg Senior Vice President National Director Public Sector Market Then & Now Public Pension Evolution Public Pension Environment Transition Public Plan Redesign Future Behavioral Economics Influencing Generational Behavior What is the number? Millennials Measuring Success Agenda Page 1774 Continental Navy 1774 Continental Army Social States Security 1857 NYC Fire MA Teachers Establish Plans Enacted 1945 Expansion of Plans Social Security 85 Statewide Extended Plans Exist 1974 ERISA Enacted 1990 Go-Go General Recession Funded by the sale of prizes Pay Go Pay Go Funded Pay Go Pay Go Pay Go Pay Go Pay Go/Funding Begins Public Plans Exempted High Levels of Funding Average 87% for large plans Average 72% for large plans Disability benefit percentage of sales proceeds by rank Disability benefit percentag e of pay by rank Lump sum disability benefit Cash Balance Defined contributi on Prohibited state and local government participation Defined Benefit/ Defined Contribution Defined Benefit Defined Benefit Regulated by State Laws/Local Statues Defined Benefit Defined Benefit (88%) Hybrid Plans Defined Benefit Design Reform Congress expropriates Forerunner Evolved into Evolved into assets to pay of current a retirement a Defined Slow Growth down civil war plan plan Benefit Plan debt Public plans designed outside of Social Security Conversion to Defined Benefit Plan Began Coverage grows to 75% of State/Local Workers Restricted to fixed income investments Legal Lists Expanded regulation through taxcode Expanded investments to stocks. High market return Slow recovery from market downturn Changing Investment Strategy LEGEND Funding Benefit Design Key Facts 1

2 Public Pension Environment Accountants and Actuaries No fault Exhaustion Theory Flawed math Investigative Ideology Discount rates Policy Pundits Easy Target Bond Rating Agencies Suspenders after the belt failed Policy Makers Distressed entities Uneven recovery Fear of bailouts Tax Expenditures Economic Realities Public Pension Environment A defining characteristic of public sector employment is retirement plan coverage Nationally 1 99% of full time state and local government employees have access to an employment based retirement plan 92% have access to a DB plan However, access to an employment based retirement plan does not guarantee retirement income adequacy Access to a defined benefit plan and social security significantly reduces the required level of individual savings Retention of retirement savings through job changes increases ability to reach adequacy Distribution options and continued investment earnings in retirement add to stability 1 Source: National Compensation Survey: Employee Benefits in the US, March 2013, BLS, US DOL, Bulletin 2776 (9/2013) Public Pension Environment For state and local government workers: 1 20% of public sector works experienced a change in the last year to their expected retirement age 76% expect to retire at a later age than originally planned Desired/expected retirement ages are: 61/64 for general employees 60/63 for teachers 58/60 for public safety employees Can t afford to retire financially Cost of living higher than expected Health care costs Expect Social Security to be reduced Pension and/or Social Security age changed Change in employment situation 10% 12% 15% 18% 21% 30% Retirement Confidence Survey of the State and Local Government Workforce, August 2014; TIAA CREF/Center for State & Local Government Excellence 2

3 Then & Now Public Pension Evolution Public Pension Environment Transition Public Plan Redesign Future Behavioral Economics Influencing Generational Behavior What is the number? Millennials Measuring Success Agenda Page Balance Risk and Cost RISK COST Lessons Learned Funding Deficits Lead to Expanded Risk Sharing Plan Redesign Apprehensive Participants Reform Outcomes Retention of Reduced Defined Benefit Plans Mixed Improvement in Funding Implementation of Alternative Designs Path Forward Focus on Security Doesn t Matter What You Call If You Don t Fund It Funding Metrics and Transparency Rebuilding Participant Confidence 3

4 Trends in Public Retirement Plan Redesign Continuum of Public Retirement Plan Redesign Defined Benefit Combined Plans Cash Balance Defined Contribution Retention of defined benefit plan with Oregon Nebraska 1/1/2003 Alaska 7/1/2006 changes for new hires: Combined DB/DC plan Employees contribution: 4.8% All new employees Raise retirement eligibility Tier II: Employer contribution: 7.5% Employer contribution: 3.5% plus 3.75% to Delay Retirement Eligibility DB 1.5% of pay plan employer funded Investment return guarantee: retiree health fund Raise contributions DC 6% employee funded At least 5% annual return Employee contribution: 8% Lower multiplier Utah 7/1/2011 Potential for additional Board approved amount Michigan 3/1/1997 Reduced or suspended COLA All new hires Total credited return not to exceed 8% State Employees: Eliminate rehired retirees and spiking Employee Choice of: Kentucky 1/1/2014 Employer contribution: Some states/localities have reduced Tier II: Employee contributions: 4% up to 7% COLA for existing retirees DB 1.5% of pay plan Nonhazardous 5% Employee contribution: Some states/localities are considering 10% cap on employer contributions Hazardous 8% up to 3% changes for future accruals for current DC funded by excess employer contributions All 1% retiree health Oklahoma 11/1/2015 active employees OR Employer contributions: State Employees: DC 10% employer contributions Nonhazardous 4% New hire non safety employees Rhode Island 7/1/2011 Hazardous 7.5% Employer contribution minimum 3% Combined DC/DB Investment return guarantee: Employee minimum contribution 3% All participants At least 4% annual return Employers can match up to 7% of employee contributions DB 1% of pay plan Potential for additional amount based on 5 year DC returns (up to 75% of returns over 4%) Employer can reduce match to minimum 3% at anytime Eliminates COLA until 80% funded No cap on credited returns Investment: Employee self directed City of Atlanta Kansas All workers in hybrid 7/1/2012 Cash balance plan for new hires on/after Virginia 7/1/2015 New hires in hybrid 7/1/2014 There are many choices for redesign. Impact of Changes State and Local Pension Costs: Pre Crisis, Post Crisis, and Post Reform This study examines the long term effects of pension reforms on employer costs and on state budgets for a sample of 32 plans in 15 states. The results show: For most plans, the reforms fully offset or more than offset the impact of the financial crisis on the sponsors costs. For the sample as a whole, pension costs as a share of state local budgets are projected to eventually fall below pre crisis levels. A few caveats: the projections assume that the reforms stick, that plan sponsors consistently make their required payments, and that they earn expected returns. Source: State and Local Pension Costs: Pre Crisis, Post Crisis, and Post Reform, Boston College, Center for Retirement Research March 2013 Impact of Changes Pension Costs as Percent of State Local Budgets, Sample Average, Pre Crisis through Post Reform 8% 6.5% 6% 5.3% 4% 4.1% 3.3% 2% 0% Pre Crisis (2007) Post Crisis (2011) Post Reform Partial Impact (2028) Post Reform Full Impact (2046) Source: State and Local Pension Costs: Pre Crisis, Post Crisis, and Post Reform, Boston College, Center for Retirement Research February

5 Agenda Page Then & Now Public Pension Evolution Public Pension Environment Transition Public Plan Redesign Future Behavioral Economics Influencing Generational Behavior What is the number? Millennials Measuring Success Helping Participants Understand Income Adequacy OVERALL RETIREMENT INCOME CONFIDENCE AMONG STATE AND LOCAL GOVERNMENT EMPLOYEES, Overall, how confident are you that you will have enough money to live comfortably throughout your retirement years? All State and Local Employees K 12 Teachers Police/Firefighters Very confident 18% 21% 15% 22% 28% 29% Somewhat confident Not too confident Not at all confident Source: Retirement Confidence Survey of the State and Local Government Workforce (2014). TIAA CREF Institute and the Center for State and Local Government Excellence; Retirement Confidence Survey of the State and Local Government Workforce (2012). TIAA CREF Institute and the Center for State and Local Government Excellence: Understanding Income Adequacy What is the Number Reaching Replacement? A 25 year employee with a: Defined benefit plan with a 1.5% formula Social Security Leaving individual Savings to What is the percentage of salary in personal savings to attain 90% replacement? 25 year old needs to save 3% of salary 40 year old needs to save 12% of salary Replaces 38% Replaces 30% Replaces 22% 15 5

6 Encouraging People to Save How do we help a 30 year old view what their life will be like at age 70? Participants who saw their CURRENT selves contributed 4.4% toward retirement Participants who saw their FUTURE selves contributed 6.2% toward retirement Source of Data: Increasing Saving Behavior Through Age Progressed Renderings of the Future Self, Hal E. Hershfield, et al, Journal of Marketing Research Vol. XLVIII, S23 S37, November Construct a bridge between life today and in retirement! 2. Focus as much on consumption as asset accumulation Save 9% of pay Save 6% of pay Save 2% of pay Eat steak and lobster; live the good life! Eat hamburger. Eat processed bologna for the rest of your life. Travel to exotic locations; live the good life! Travel to a nearby resort. Vacation at your local community center. Generational Behavior: Enter the Millennials who are they? Born Median age is 23 years Oldest : 1/3 of all adults 2025: 75% of workforce Outnumber the Baby Boomers 6

7 Characteristics Compared to Earlier Generations More Educated More Ethnically Diverse More Liberal More Open to Innovation More Upbeat About the Ability to Affect Change More Focused on Communal Outcomes Less Religious Less Trusting Less Committed Selfies School Debt Digital Natives How to Influence Millennial Behavior Establish Personal Relevance Trigger Emotional Reactions Define Clear Choices and Convey Value Ask a Small Related Request Channel to the Best Resource Establish personal relevance through peer comparisons Engage formal and informal leaders who are admired and liked Trigger emotional responses tied to: Shared values Community Comparisons Define clear choices about trade offs between financial options and quality of life Convey value in making smart choices: live well care for others Ask employees to complete a small task related to a larger goal: save more tomorrow visit the website pay back the loan quickly Channel employees to the best resource available: retirement calculators pre retirement counselors financial advisors Independence Involvement Treat Them Like Consumers NOT Investors Then & Now Public Pension Evolution Public Pension Environment Transition Public Plan Redesign Future Behavioral Economics Influencing Generational Behavior What is the number? Millennials Measuring Success Agenda Page 7

8 The Bad, the Good, and the Ugly Behavioral Economics in DC Plans Presented by Greg Jenkins, CFA Invesco FOR US INSTITUTIONAL INVESTOR USE ONLY NOT FOR USE WITH THE PUBLIC NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE Invesco Distributors, Inc. 22 Behavioral economics in DC plans How does it affect participant investment elections? Definition: a study of investor market behavior that derives from psychological principles of decision making Communications and plan design are also closely related Two examples Misuse of Target Date / Target Risk Funds The 100% Stable Value election For Illustrative Purposes Only 23 Misuse of target date funds How does it affect participant investment elections? AonHewitt survey 1 many DC participants are combining target date and target risk options with other funds on the menu: Misuse of managed options can harm participants The Good: Participants with balances in TDF or target risk is 68% The Bad: Average allocation is 69% Why is that so bad? The Ugly: Participant may select 70% 2030 target date fund, 30% large cap equity fund (avg fund is ~72% equities) Total equity exposure may be as high as 80%, portfolio more concentrated, may not be rebalanced For Illustrative Purposes Only 1 AonHewitt 2014 Universe Benchmarks, Data as of Dec, 31,

9 Invesco language research Background Invesco Consulting financial language research Invesco teamed up with word specialists Maslansky + Partners Studies began in 2007 and are ongoing 26 focus groups conducted 7,200 participants surveyed New Word Order is based on our firm's ongoing research with Maslansky + Partners. Invesco Distributors, Inc. is not affiliated with Maslansky + Partners. 25 Invesco financial language research General findings Use positive, plausible messages Research shows that language is critical and can affect participant behavior Avoid industry jargon, use plain English Personalize the message connect it to participant goals To explain something new, relate it to something known 26 Misuse of target date funds Invesco language research When asked if they wanted to invest their entire portfolio in a target date fund, the answer was overwhelmingly no When the question was explained further, the results changed dramatically New Word Order is based on our firm's ongoing research with Maslansky + Partners. Invesco Distributors, Inc. is not affiliated with Maslansky + Partners. 27 9

10 Misuse of Target Date Funds Academic research Benartzi and Thaler 1 Diversification Bias; people don t like to put all of their eggs in one basket, prefer to pick multiple options 1/n Rule; a common shortcut is to divide contributions equally Participants have deep rooted biases toward diversification Read and Lowenstein 2 Kids Halloween candy study Demonstrated the same diversification biases Asset allocation/diversification does not guarantee a profit or eliminate the risk of loss. 1 Heuristics and Biases in Retirement Savings Behavior, Schlomo Benartzi and Richard Thaler, Diversification Bias, Daniel Read and George Lowenstein, The 100% stable value election Academic research The Good: Vanguard surveys show participant concentrated balances are becoming less prevalent: Extreme concentrations : 22% 2014: 13% Participants with zero equity : 9% 2014: 5% Studies have shown that the 1/n rule holds until the number of options gets too large Iyengar and Kamenica found that adding 10 options to a menu increases fixed income and money market allocation 2 Another shortcut observed is participants picking an option that they are the most comfortable with (e.g., stable value) Researchers found that even small differences in framing made a huge difference in results 1 How America Saves 2015, Vanguard 2 Choice Proliferation, Sheena Iyengar and Emir Kamenica, 2008 & Conclusions The DC industry has underestimated the importance of behavioral economics Communications, language and plan design are closely linked to behavioral finance Plan Sponsors need to take steps to help participants use the investment menu correctly Study data from recordkeeper and identify any problem areas Make sure that terms like target date fund are not taken for granted and fully explained Consider plan design or enrollment design changes to help participants not harm themselves Researchers found that even small differences in framing made a huge difference in results 30 10

11 The opinions expressed are those of the author and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals. Asset allocation/diversification does not guarantee a profit or eliminate the risk of loss. A target date fund identifies a specific time at which investors are expected to begin making withdrawals, e.g., Now, 2020, The principal value of the fund is not guaranteed at any time, including at the target date. This material is for illustrative, informational and educational purposes only. If the illustrations herein are used outside of the designated audience, it is the respective user's responsibility to ensure that such material complies with all applicable regulations and is filed with the appropriate regulatory bodies if so required. We make no guarantee that participation in this program or utilization of any of its content will result in increased business. It does not constitute a recommendation of the suitability of any investment strategy for a particular investor. This is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in an investment- making decision. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Invesco Distributors, Inc. FOR US INSTITUTIONAL INVESTOR USE ONLY NOT FOR USE WITH THE PUBLIC NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE 31,, What is behavioral economics? Core premise of economic theory is that people choose by optimizing or making rational decisions The flaw is that the optimization problems people confront are often too hard for them to solve, and people have biases that impact their decisions Behavioral economics brings psychology and other social sciences into economics Source: Misbehaving by Richard Thaler 11

12 Behaviors that result in lack of savings and poor investment decisions Inertia Loss aversion Present bias Source: Misbehaving by Richard Thaler No Single Solution Plan design details must be based on circumstances DB plan benefits Social Security Affordability Collective bargaining Politics Demographics Account Balances Active (Contributing Participants) Ages Average $80,700 Median $40,600 12

13 50% with years in plan defer less than $100/pay Typical Ohio DC Participant 13

14 14

15 Form Design: Opt in/out Form Design: Opt in/out Unless I check this circle, I will also be enrolled in the SMarT plan to automatically increase my deferrals each January by $10 per pay period (unless you choose a different amount). Other: $ per pay Dahling, you look beautiful just as you are put that money to work in your Ohio DC account instead. 15

16 Professor Penny Outcomes Ohio DC Employer Survey 16

17 Employers Participating in Auto Enrollment SVO GRO Fixed Annuity $ SVO GRO Fixed Annuity % of Total Assets 17

18 Target Date Funds $ Target Date Funds % of Total Assets 35.3% Active participants solely invested in LifePath funds 18

19 Percentage of Total Assets SVO TDF SMarT Participation (auto escalation) Automatic Enrollment Since Inception 19

20 Obstacles to Success Employer lack of knowledge or commitment Lack of automatic features Auto Enrollment Fear of paternalism Multiple plans Auto Escalation Status quo bias Lack of retirement champions Uninteresting plan literature Lack of re enrollment 20