Bo Doesn't Know Retirement But Pension Actuaries Do!
By Ted Goldman
Retirement Section News, May 2021
A popular 1989 Nike commercial featured Bo Jackson, the first athlete in the modern era to play both professional baseball and football in the same year. Nike was promoting its cross-training shoes and captured its audience with the likeable Bo Jackson playing many different sports and interacting with well-known professionals in each sport. It was obviously an effective ad campaign, given over 30 years later, it still comes to mind. So, what’s the connection with pension actuaries and defined contribution plans? It’s time pension actuaries, the mathletes that we are, begin to cross-train and play some new sports, if you will. There is no better “sport” to focus on than defined contribution plans—as nobody knows retirement like pension actuaries.
The defined benefit plan, a trusty (and sturdy) component of the three-legged stool of retirement security has, over the last decades, been largely replaced with the much more wobbly defined contribution plan. Pension actuaries have incredible skills and insights about the delivery of retirement benefits, but the demand for this ever-important knowledge has declined along with the popularity of defined benefit plans. The challenge now is how to translate (or cross-train) this hard-earned knowledge into the new world of retirement security. The need for retirement experts is even more important today than it ever has been with an aging U.S. population sprinting into retirement.
There is an opportunity to translate these defined benefit skills into the defined contribution playground. One of the challenges of defined contribution plans is in its descriptive name—the contribution is defined, but no one knows how much benefit will be there at the end of the retirement rainbow. The defined contribution plan is essentially asking individuals to take on a task of planning for and managing his or her own retirement—a task that many are unequipped to successfully tackle. A natural place for pension actuaries to step in and add value.
The opportunity does not lie with asking pension actuaries to become personal retirement advisors; the opportunity is to apply pension actuarial principles to employer-sponsored defined contribution plans to help sponsors and participants understand how well the program is performing. While defined contribution plans currently require little or no actuarial expertise to design and administer, actuarial know-how can add tremendous value. Actuaries can help plan sponsors understand how a given plan is performing. How many employees are on a path to a secure retirement? Will employees be able to retire and allow the employer to attract, retain, and optimize the production of its workforce?
Defined contribution plans are evolving, but a gap remains from both the employer and participant perspective. Defined contribution plans take the steering wheel entirely out of the hands of the employer in terms of when individuals are targeted to be on financially steady ground in order to retire. Yes, there are tools for participants to help them determine how much to save, how to invest the assets, and how long wealth will last into retirement. What’s missing is any attempt to determine how the plan is performing in aggregate. A good analysis requires actuarial knowledge. Add an actuarial certification to the process and both employers and participants receive a better understanding of where they are with respect to retirement readiness and security.
A comprehensive defined contribution plan analysis can be performed on the plan population as a whole using readily available data. An annual evaluation of the defined contribution plan could have the following components:
- Projected defined contribution income at retirement—A projection of lifetime income generated by the defined contribution plan for each plan participant. This projection would be based on the current account balance, current salary, current employee contribution rate, and current employer match. Underlying actuarial assumptions would be needed regarding investment returns, future salary increases, retirement ages, and life expectancy.
- Total projected retirement income—The projected income developed above could be added to other expected income from Social Security, other employer-sponsored plans such as an ongoing or frozen defined benefit plan, and non-qualified retirement plan income. Most of this information is readily available through the employer’s own data or can be easily accessed or estimated.
- Population retirement readiness—An additional calculation would assess the overall retirement readiness of the employee population. This includes what percentage of the population will be able to comfortably retire based on the set of assumptions. Adequacy would be defined by the employer. It could be defined by converting a given retirement ratio (total retirement income divided by total compensation at retirement) into ranges such as unprepared, sustainable, or comfortable.
- Workforce insights—The final component of the analysis would include a finer breakout of the above results. The analysis could look at results by age group, salary ranges, or job descriptions. An employer could learn whether the workforce nearest to retirement will be prepared and able to retire or whether a much-needed skillset of the organization is under-saving for retirement. This information can drive targeted communications, plan design decisions, or recruiting and retention activity for the organization.
- Plan, economic, and business changes—The analysis will also highlight how the retiree readiness of a population is impacted by market forces or plan changes. This analysis will help employers understand whether the plan, over time, is becoming more or less effective. For example, if there is a change in the employer match or introduction of an automatic enrollment feature, the employer will be able to tell how the change is expected to impact overall retirement readiness. The analysis could also help understand the impact of an extreme market force such as a pandemic, if it resulted in changes in contribution rates, salary levels, or a suspension of the employer match.
- Retiree performance—The evaluation will also report on the actual outcomes (in aggregate and segments, no individual retirees would be identified) for the retiree population. It will show trends in retirement ratios at retirement.
- Plan effectiveness—The evaluation will also provide an overall rating of the effectiveness of the plan. The analysis will highlight how retirement readiness has changed over time. It will include a calculation of the shortfall (if any) of the overall population by determining the present value of the savings shortfall projected, an equivalent of the unfunded status of the employees, in aggregate. It will also report on the savings rate needed for individuals such that a targeted percentage of the population would be in the “comfortable” zone of retirement income. The historical trends of these calculations would be extremely valuable in helping employers design, manage, and communicate their plans.
- Actuarial certification—The report would be signed by a qualified actuary attesting that the assumptions and methods used in the analysis were based on actuarial principles and in accordance with actuarial standards of practice. This gives credibility to the analysis and demonstrates that the employer has the information to understand how well the program is performing.
The analysis described above is just a start. More sophisticated analyses and research could provide even greater benefits. This could be in the form of stochastic forecasts of certain variables such as future investment returns and future salary increases. Different assumptions could be applied to different segments of the population such as expected retirement ages or life expectancy. A potentially important and missing component is retirement income that individuals may own that are unrelated to the current employer or spousal income and benefits. The analysis could even be expanded to reflect other important retirement income sources and expenditures such as long-term care, debt, and home ownership. The opportunities are endless.
Pension actuaries definitely “know” retirement and the increasing reliance on defined contribution plans only hastens the urgency to find ways to translate our defined benefit skills. Providing a comprehensive, actuarially certified, retirement readiness report will be an important step forward and bring value to both defined contribution plan sponsors and participants.
Statements of fact and opinions expressed herein are those of the individual author and are not necessarily those of the Society of Actuaries, the editors, or the respective author’s employer.
Ted Goldman, FSA, EA, MAAA, FCA, is the director of Policy, Research, and Analysis at the Pension Benefit Guaranty Corporation. He can be contacted at firstname.lastname@example.org.