Regulators have yet to issue guidance on how plan sponsors should handle annuities within their defined contribution plans, but that hasn’t stopped many of them from offering a lifetime income option to their retirement plan participants.
Prudential, one of the largest companies offering these types of plans, entered this marketplace six years ago when many companies were phasing out their defined benefit pension plans and that guaranteed stream of income was going away, said Srinivas Reddy, senior vice president of institutional income at Prudential.
The company has seen some momentum in the number of plan sponsors who have expressed interest in a lifetime income option for their retirement plans. “Early momentum was clearly slow. Two years ago, we had 300 plan sponsors,” Reddy said. Now that figure is about 7,000 plan sponsors, covering 60,000 individuals and $1 billion in assets.
“Every time you come out with something new, you are creating awareness. Even if you don’t want a guarantee, be aware of it and make decisions instead of having inertia make the decision for you,” Reddy said.
The problem for many plan sponsors is that the U.S. Department of Labor has not issued guidance about what their fiduciary responsibility will be regarding these types of plans being offered within a 401(k).
Reddy believes that if you look closely at other DOL regulations you could take those decisions and apply them to the annuity market. For instance, plan sponsors should make sure any fees associated with the annuity are reasonable and do everything in their power to make sure the company they choose to offer the plan is healthy.
Prudential began offering guarantees within its plans in 2007. In 2008, it redesigned its offerings.
“One of the things we realized is participants in retirement plans aren’t engaged on an ongoing basis. In 2008, we said, ‘why not build a solution that works in tandem with target-date funds.’ Ten years before the target date, the critical years leading up to retirement, the guarantee turns on automatically,” he said. There’s no need to take any other action.
The company reevaluates each participant’s plan every year on their birthday to look at the overall account value and how much they have contributed. The guaranteed lifetime income option takes the peak account value to determine how much a client will receive each year in steady income. That means participants will still receive the same steady stream of income even if their account balance is depleted. It also gives participants the chance to continue building up their lifetime income if their account balance continues to increase.
“I think that as much as a lot of plan sponsors have moved ahead and adopted this solution, there is a large base of plan sponsors waiting for guidance from regulators,” Reddy said. “Once that happens, in a few years, we will see more of these types of solutions go mainstream.”
Don Warwick, chief HR officer for Konica Business Solutions in New Jersey, began offering an annuity option within its retirement plan in January of this year. Konica’s plan is a bit different from Prudential’s standard plan in that it is only available to employees who are 50 years of age or older.
Warwick said he didn’t want to force younger employees to pay for this option when it wasn’t necessary, but the company did want to “keep adding choices.”
He added that “to make them pay something extra for a guarantee when they have that much time [until retirement] doesn’t make a lot of sense. If they are that concerned, our fixed income fund would be more than adequate for them.”
Konica could have begun offering the option to its 6,500 employees nationwide in September, but Warwick didn’t want people to choose that option in a panic because the market was down. He wanted to wait and offer the plan when the market had made back some of its earlier losses.
“It’s gotten a lot of interest. I wanted people to see it as a conscious decision in terms of retirement planning. To do it at a point where the market was relatively strong,” Warwick said.
He added that, “We’ve gotten a fair amount of interest from our employees and their spouses. We’re not pushing anything. We think it is a good thing for you to consider because everyone is in a different situation.”
Annuities within DC plans are still an emerging market, said Mark Fortier, head of product and partner strategy for AllianceBernstein Defined Contribution.
The industry as a whole is trying to achieve the same outcome, which is to get the defined contribution system to be what the defined benefit system was, where people gained retirement confidence, Fortier said. “We see the role of annuities, secure income, simply as a way to help participants save with certainty, so they can plan with certainty and retire with certainty.”
AllianceBernstein’s customers in this market tend to be larger ones that used to have defined benefit plans.
“The big issue for defined contribution plans is their fiduciary role. Plan sponsors unfortunately see the risk before they see the return,” Fortier said. “It’s not the right answer. To be fair to them, there is a heavy burden on fiduciaries in this country. Getting large employers to see the value is getting people to overcome risk.”
Like Prudential, AllianceBernstein offers its life cycle solution as part of its target-date funds. Historically, companies have tried to manage longevity risk through various investment strategies. Defined benefit plans got around that risk by pooling the risk away. Target-date funds have not been able to eliminate the risk of people living too long or retiring in a down market, he said.
What makes AllianceBernstein’s Lifetime Income Strategy so unique is that it offers a multi-insurer solution to promote price competitiveness and greater capacity, said Robin Diamonte, United Technologies Corporation’s chief investment officer.
“The Lifetime Income Strategy combines time-tested solutions into a single, simple to use retirement program designed to provide security and certainty, so that our participants can retire with confidence knowing they will have financial freedom and flexibility even when the unexpected occurs,” Diamonte said.
AllianceBernstein’s plan also includes lifetime income options in its plans’ default option.
“The sad reality is people do not value lifetime income protection because their fear isn’t living too long. Their fear is dying too soon,” Fortier said. “That’s why you put it in your default.” It is treated as another asset class that puts its annuity option into the default option.
The company has agreements with several insurance partners to provide the secure income aspect of the plan, including The Lincoln National Life Insurance Company, Nationwide Life Insurance Company and Prudential Retirement Insurance and Annuity Company. AllianceBernstein provides the asset allocation services, the open architecture platform and the participant service support necessary to manage the Lifetime Income Strategy.
“Many people come out and try to take shots at the DC system saying it failed and hasn’t accomplished its goal, but DC provides opportunity,” Fortier said. Many plan sponsors are worried about the risk associated with offering annuities within their plans or their fiduciary liability. “The risk they should be most worried about is not having their workforce prepared for retirement,” he said.
He added that annuities within DC plans have a different cost structure than a regular variable life annuity. “You eliminate the cost that makes them expensive on a retail basis,” he said.
The risk is pooled across everyone who has the annuity option and there are no sales expenses associated with the plan, since it is set up as a default option.
The early adopters of these types of plans, like UTC, will spur on the next level of plan sponsors until this type of plan is considered the normal market standard, he said.
“Be it right or wrong, a certain amount of sponsors have a herd mentality. Safety of the pack,” Fortier said.
Theresa Arena, retirement benefits manager for American Standard Brands, said she believes annuities in DC plans are a good idea, but “we have to be careful to make sure participants are well-educated about what an annuity is and how it can be of assistance to them, where retirement income streams are concerned. What happens sometimes is we put all our eggs in one basket. We have to be careful not to do that.”
Arena added that diversification is important but plan sponsors have to take into consideration their employees’ beliefs and value systems. Many people, who don’t earn a lot of money, may need to be able to tap into their retirement accounts for loans in the future. If all of it is tucked away in an annuity, they won’t have that option, she said.
And while American Standard doesn’t offer an annuity option yet, she said eventually it will be added to the menu. She is a big believer in only putting some of a retirement account into an annuity and leaving the rest in more traditional retirement vehicles.
“For me personally, I think of my retirement savings as an investment. There may be things I want to do with it later, like buy a small investment property or a small business, but I wouldn’t want to tie all of my money up into one retirement vehicle just for the safety of a stream of income,” Arena said.