Bank of America Merrill Lynch

The evolution of plan design

An interview with Tom Kuuskvere, director, Plan Design Consulting, Bank of America Merrill Lynch

Workplace Insights talked with Tom Kuuskvere to learn about trends he is seeing in plan design and creative strategies using plan design that some companies have implemented to help meet their goals.

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Tom Kuuskvere

Workplace Insights (WI): What are some of the key trends you are seeing in plan design?
Tom Kuuskvere (TK): Automatic enrollment continues to be the most frequent theme that comes across my desk. The introduction of the Pension Protection Act of 2006 (PPA) really opened the flood gates by explicitly allowing automatic programs. Initial implementation by plan sponsors often followed the examples included in the PPA, such as automatically enrolling new hires at a 3% deferral rate. Today, more than 10 years after the PPA, we’re seeing many plan sponsors evolving their auto programs based on what they’ve learned from earlier tentative implementation decisions.

WI: What are some of the implications of those tentative decisions?
TK: While some clients are exploring implementing automatic programs for the first time, much of what we are doing today is helping clients who previously implemented auto enrollment using a conservative design and are now dealing with the implications of that design. For example, plans that implemented automatic enrollment at a 3% deferral rate have a large number of participants that have remained at 3%, a rate that likely won’t be enough to provide the income they will need in retirement. A 3% deferral rate often doesn’t capture the full company match either, resulting in lost opportunity for participants. Participant inertia, which is the secret sauce of automatic programs, can actually work against participants when they leave their deferral rate at a low 3%.

Another symptom of tentative design decisions is a plan that has excellent participation for the population hired after automatic enrollment was implemented, but has a large number of non-participating employees hired before the implementation of auto enrollment.

WI: What are clients doing to address these issues?
TK: Depending on where a plan lies on the design continuum, there are various plan design decisions that can help to close these gaps and improve the financial wellness of their workforce. Some of these solutions might include:

Increasing the automatic enrollment default deferral rate to align with the plan match. For example, a plan that matches 50% of first 6% deferred would automatically enroll at 6%.
If that creates too large of an expense burden for a company, some plan sponsors will maintain a lower initial default deferral rate, but will implement an automatic annual increase to get the participants up to the plan match or beyond. On a related note, we see a growing trend whereby many plans with automatic increase programs are extending that increase to 10%, 12% or even 15%.
For the population hired before the company implemented automatic enrollment for new hires, sponsors are looking at the cost implications of retroactively auto enrolling all currently eligible but not participating employees. Some companies address the additional match expense by modifying the match formula to create a cost-neutral design.
Companies with higher turnover rates that are exploring automatic programs are considering automatically enrolling eligible employees after a longer employment period, such as two to three years. Turnover rates tend to be significantly reduced at that point and the sponsor can help ensure career employees are contributing to their retirement plan.

WI: How are plan sponsors measuring the effectiveness of automatic programs?
TK: Traditionally, plan sponsors have measured plan effectiveness by standard metrics, such as participation rate and average deferral rate. The maturity of automatic programs has led many plan sponsors to think about what the actual replacement ratios are for their employees as a way to measure plan effectiveness. Replacement ratio refers to the percentage of pre-retirement income that is available to a retiree. We believe that an individual needs 70-90% of pre-retirement income in retirement. This is made up of income sources that include retirement plan balances, individual savings and Social Security.

When we help our clients with this analysis, we look across the entire plan and cross-cut the data a number of ways―across salary groups, age, years of service and so on―to identify trends and opportunities that can inform intelligent plan design decisions.

We evaluate this information against overall plan goals. For example, there may be discrimination testing issues, a desire to improve employee financial wellness, manage plan expenses, or some combination of these or other considerations. Plan design can help address these goals.

WI: What longer term trends in plan design are you seeing or anticipating?
TK: The retirement design pendulum has been swinging from the paternalistic defined benefit plan of 40 years ago to the current environment where employer contributions are dependent upon employee deferral behavior. Today we are seeing more plan sponsors looking at making employer contributions that are not dependent upon employee deferral behavior, such as profit sharing contributions. This helps to ensure that all employees, even those who can’t or don’t defer, have money contributed to their retirement account.

We also see an increase in plan sponsors who are looking at retirement plan design in the context of overall employee financial health. We believe intelligent plan design can play a significant role in financial wellness. Together with effective education and engagement programs, we can help employees make positive financial decisions and lead better financial lives.