American Failure

“The individual system with the 401(k) is a monster, especially for people 60 years old or more,” says Angelien Kemna, a leading European investor and pension executive. 

Kemna is no bleeding-heart liberal.

She arrived at this conclusion after leaving one of the top private-sector jobs in global finance—CIO and CEO of ING Investment Management in Europe—and moving to Atlanta, Georgia, with her husband around 2008. As a finance professional who had spent her career in senior academic and industry positions, what she witnessed shocked her.

“When the crisis really hit, we saw how pensioners in Atlanta were truly affected,” Kemna recalls. “We lived in a townhouse, in a gated community, and were by far the oldest residents when we moved in. Then, all of a sudden, we saw a lot of elderly people coming to live with their children. Even worse, about 100 miles from Atlanta, they had a tent camp.”

All over America, the richest nation on earth, bands of semi-nomadic senior citizens live in glorified tent camps, relocating with the seasons to work temporary, low-wage jobs in warehouses, big-box stores, and occasionally the public sector. For a few weeks last summer, the county’s mass media took notice when a startling feature on the plight of the first world’s elderly dispossessed ran in Harper’s magazine.

Art by Chris Buzelli“Aging isn’t what it used to be,” wrote journalist Jessica Bruder in “The End of Retirement,” published August 4, 2014. “In an era of disappearing pensions, wage stagnation, and widespread foreclosures, Americans are working longer and leaning more heavily than ever on Social Security, a program designed to supplement (rather than fully fund) retirement.” Bruder went on to describe the story of an RV dweller in her mid-sixties who had spent her life in the labor force—working as a building inspector, cocktail waitress, general contractor, store owner—but, as she said, “never managed to get myself a pension.” And so she joined a migratory wave of hundreds flocking to retail warehouses—or “fulfillment centers”—and shelved products from 6 pm to 4:30 am, by request. The night shift paid an additional 75 cents per hour. Major radio stations and other media outlets picked up the story, interviewing Bruder about the deplorable situation. Then the news cycle moved on, and public attention went with it.

Yet one sector hasn’t lost focus on this creeping crisis: retirement services. Kemna’s experience in recession-era Atlanta inspired her to take the CIO position at APG (or ABP, as it was known then), the Netherlands’ civil service pension and the world’s second-largest defined benefit retirement system. Receiving the recruitment call, she recounts, “I said, ‘I’ve seen so much misery and if I can do anything to help to safeguard the money for the participants of the pension funds that we work for, then I would really feel that I’m contributing.’”

Meaningful contribution to improving America’s failing retirement system presents a much greater challenge for those who choose to stick with it. It’s also a massive business opportunity. Nearly 100 million people in America belong to a defined contribution (DC) plan. More than 80% of plan sponsors doubt their employees’ ability to manage their incomes once retired, according to Prudential. Three out of five DC members either feel they’re off track in saving or don’t know where the track is. And roughly 80% call guaranteed monthly payouts—an option that isn’t truly available—a “must have,” data from State Street Global Advisors show. Half already believe their target-date fund will provide this, according to AllianceBernstein. It won’t.

Securing US retirements is the ultimate low-hanging fruit, a broken industry begging for disruption. But unlike, say, with taxis or hotels, an app won’t fix defined contribution. Powerful regulation—the Employee Retirement Income Security Act of 1974 (ERISA) foremost—and stakeholders incentivized to retain the status quo have proven insurmountable obstacles to the solution all parties seem to agree on: guaranteed lifetime income for retirees.

Various players quibble on the details, but this essentially means a longevity-hedged, annuity-like product underwritten by insurers and wrapped into DC plans’ default target-date option. Someone who made no changes to their 401(k) would, after retirement, enjoy guaranteed paychecks for the rest of his or her life in addition to a (slightly smaller) liquid account balance—though the checks might only begin at age 80. But like Uber or Airbnb, this disruptive force’s greatest selling point would be harnessing the power of crowds. The capital needed to secure one retirement far exceeds what’s required, per capita, to guarantee 10,000. And US workers pay the spread in savings they never get to enjoy or, worse yet, years of life they don’t get to enjoy. By redirecting all that value now left on the table, financial services firms have the rare opportunity (for this business) of truly contributing to social good while profiting handsomely from their take. And a number of the industry’s leading players are set on doing just that.

“When we went public with our plans for entering the DC retirement income space, a client sent me a note saying, ‘It’s nice to see you guys come up with a new idea every 10 years!’” says Jess Yawitz, founder, chairman, and CEO of NISA Investment Advisors. “I laughed, but it’s true. We don’t go chasing every new trend.” Yawitz has built a firm and a fortune on the decline of defined benefit (DB) pension plans in corporate America—although you wouldn’t know it to look at him. The security guard at NISA’s St. Louis, Missouri headquarters told me on my way in, “Jess dressed up for you: Khakis and a golf shirt.”

Yawitz’s firm creates and runs liability-driven investing (LDI) programs for a who’s who of companies that used to offer pensions to new employees. Private sector DB plans have closed en masse as corporations look to cut risk and volatility from their books. NISA steps in to complete the job, matching future liabilities to company assets and—according to many top corporate CIOs—doing it better than anyone in the business. Its clients have pivoted from the DB world to DC. NISA aims to join them.

“The initial reaction we’ve heard is, ‘You’re doing something so different. Where’s your comparative advantage?’ And I don’t think I’ve done the best job of explaining the compatibility we see between LDI and retirement income,” Yawitz says over coffee (him) and breakfast (me) in the 17th-floor boardroom at NISA’s shiny new headquarters. “When we first started thinking about LDI in, oh, ’71, we saw these long-dated liabilities and thought maybe there was a role for long bonds—a cash-match portfolio that’s a simple version of LDI. When we talk retirement income, it’s really step two: There are expenses beginning at about age 65 that need to be funded”—See where he’s going?—“and we were the first mover on funding one long-dated liability stream. The conceptual underpinning for LDI is a first cousin to the need for retirement income. The regulation, constituents, and names are different, but at 30,000 feet, it looks the same.”

 For all the details closer to the ground, Yawitz brought in Mark Fortier. As with new services, NISA rarely adds senior team members, preferring to develop and promote talent from its deep bench of young staffers. But one exception heralded another, and Fortier joined in March as co-head of DC solutions. He previously held a similar role at AllianceBernstein, where he became one of the few US investment professionals with practical experience wrapping annuity products into DC plans. Anyone who’s read about this topic will be familiar with Fortier’s work: The custom retirement income stream guaranteed for United Technologies’ default DC plan members. In 2010, the US Treasury and Department of Labor requested Fortier’s testimony during a major hearing on lifetime income options for retirement plans. He spoke of the promising potential for creating secure income in target-date portfolios—an idea he’s now charged with implementing at NISA. 

For all of the firms angling to serve this market, they must first create one. There’s no first-mover advantage for plan sponsors; straying from peers brings regulatory risk without obvious reward. Persuading clients to implement retirement income strategies—and thereby create market momentum—means reframing their outlook.

“Prudence, as ERISA defines it, is measured by what others do,” Fortier says. “There’s a reason why innovation has been so challenging in this space. But philosophically, what’s the risk of inaction versus action? If a plan sponsor has decided that the objective of its plan is retirement income, and the existing design creates a huge tail risk in outcomes, implementing a guaranteed income benefit means they didn’t ignore it.”

Regulators have been signaling loud and clear (or as clearly as regulators ever get) that they’re not looking to punish DC plan sponsors for innovating via income options. Since February 2013, the Labor and Treasury Departments have issued six publications guiding and assuring sponsors on retirement income-related compliance. In October 2014, the Labor Department published a letter confirming that including deferred annuities in target-date funds won’t jeopardize Qualified Default Investment Alternative—or QDIA—status. This April, the regulator followed up with encouraging guidance on providing members with retirement income education. Participants across the board called the recent action a “breakthrough” for the industry-in-waiting.

“We have meetings with the Department of Labor and other officials in DC,” says Robert Krebs, who leads NISA’s DC efforts alongside Fortier. “They ask us, ‘What do we need to do to get sponsors to do this?’”

Simplify, economize, and sell employees on it, according to one sponsor who has done his homework. Intel’s Assistant Treasurer of Retirement Investments Stuart Odell is precisely NISA and its competitors’ target market for early adoption. He runs a “mega-plan” with 50,000 or so active participants and $14.5 billion in total assets. He’s a self-professed “paternalistic and philosophical” steward, earning myriad prizes and accolades for innovative and aggressive DC plan design. Intel—a founding member of Silicon Valley’s tech scene—affords him the flexibility to set aside peer risk and optimize the system. Most importantly, Odell buys into the premise of secure retirement income streams.

“If Intel said, ‘We bought you a deferred annuity,’ the
50-year-olds will thank you. The 30-year-olds would say,
‘I ascribe zero value to this.’” —Stuart Odell“I do believe there’s a need for some type of consistent income for participants that is structured into DC plans,” Odell says. “There’s a really big problem that when you hit retirement age, you have what appears to be a big pot of money and no experience in how to manage it properly. And the situation is worse than ever before. Historically, DB provided a built-in income stream to take care of all of the basics. DC was the icing on the cake. Today, it’s the opposite.” 

But Odell, like many—if not most—of his sophisticated corporate peers, feels he’s facing a major problem armed with an untenable toolkit.

“Longevity risk insurance, which is what you’re buying, is not something people understand very well,” he says. “The income products themselves are still challenging for participants to get their arms around. Likewise for record keepers, who have built barriers that make implementation very challenging. Anything that doesn’t work with their daily accounting system requires customization—and that requires a lot of time and money.”

Which leads to Odell’s next issue with income products: Value. It’s not that he sees longevity insurance as overly expensive, but rather as a suboptimal use of a finite benefits budget. “With investments in a retirement plan, it has to start at the top and you prioritize it over other types of benefits,” he says. The price of an annuity feature dictates the opportunity cost of whatever incentive it replaces. And at least among Intel staffers, one specific incentive wins out in almost any tradeoff.

“Employees, when you ask them, just want cash compensation,” according to Odell. “And CEOs tend to give people what they want: Their 2% to 3% raise every year. If instead Intel said, ‘We bought you a deferred annuity,’ the 50-year-olds will thank you. The 30-year-olds would say, ‘I ascribe zero value to this.’ In the DC world, you only have to do as much as the guy next door to attract and retain talent. Providing a deferred annuity is not going to convince a someone to come work at Intel as opposed to Cisco down the street.”

Anyone looking to make a killing in financial services must only pull off one simple task: Persuade employees to want an annuity product. Plan sponsors, insurers, governments, future taxpayers, and, eventually, retirees will throw ticker tape parades in your honor. Policy experts from across the globe will beg you to reveal your secret. But as much as providers reliably highlight “participant awareness” and “member education” as critical factors in making secure DC income a reality, as a business strategy they’ve all but abandoned it. Ingrained biases and reams of data on DC member behavior indicate that demand will only come from plan sponsors on behalf of participants, not the other way around.

The two firms perhaps best situated to serve an eventual market—NISA and Boston-based State Street Global Advisors (SSgA)—share this outlook, along with years of focused and well-capitalized commitment to DC 2.0. They pitch plan sponsors a tight argument: Workforce management. All societal, peace-of-mind, and quality-of-life matters aside, no corporation wants senior (aka expensive) staff “retiring in place.” The notion of age dictating retirement died with DB plans. People stop working when they can afford it. Executives have every incentive to ensure readiness begins before productivity runs out, or so the argument goes.

Where the two firms diverge is in product design philosophy. If NISA is Apple circa 2000, SSgA is Dell. The former: A perfectionist’s laboratory convinced that the ideal product creates its own demand. The latter: A commercial operation set on delivering what the market wants at the most competitive price.

As much as providers reliably highlight “participant awareness”
and “member education”
as critical factors in making secure DC income a reality, as a business strategy
they’ve all but abandoned it. SSgA’s design fundamentals align almost perfectly to resolve Odell’s critiques. Although there’s no evidence the asset management giant has engaged with Intel, it knows its target market. “We have three principles,” says Fredrik Axsater, global head of DC for SSgA. “One: Simplicity. Lifetime income must be a default feature and it must be understandable for participants and sponsors.” Variable annuities, which Fortier used in building United Technologies’ custom DC program, struggle on this count. “Two: A smooth journey. We want to avoid big shifts in asset allocation and point-in-time risk. Three: Create value. Here, we can leverage our scale,” Axsater continues. “And part of value, of course, is price.”

Ask about the value of simplicity for NISA, and they’ll reply by complimenting their clients’ sophistication and chuckling. DC retirement income security is a knotty, complicated problem. That’s what they like about it. “When we got down to the nitty-gritty of LDI—before it was called LDI—we used to warn people that they were going to need some Advil,” Yawitz laughs. To the team in St. Louis, plan sponsors don’t need easy; they need right.

A rising tide lifts all boats. Whoever coined that phrase probably wasn’t thinking about the market in guaranteed lifetime income products for US defined contribution plans, but they might as well have been. SSgA, NISA, and leading insurer Prudential all said as much when asked who would “win” the provider race and corner the market. “It needs to be more than one winner,” Axsater says. “I don’t see how one firm could create enough momentum.”

As clients of the leading providers stay locked in a Canadian standoff (“Please, go ahead.” “Oh no, I insist, you first.” “I couldn’t possibly, please do go on.”), the door remains wide open for a bold first-mover. Prudential already has more than 7,000 plans offering its DC income product, according to institutional income chief Sri Reddy. Unlike deferred annuities, Prudential’s option sets a floor to monthly payouts beginning the day of retirement and guarantees them through a participant’s lifetime. By cutting out intermediaries, the insurer can offer its self-underwritten products at about 35% of retail cost. Or the disruptive provider could be even more homegrown. 

“One idea I’ve proposed is Intel buying the longevity risk,” Odell muses. “For someone who worked here all their life, we could provide a guarantee that if they didn’t manage their 401(k) well, or had a catastrophic health problem, and still make it to age 80, we’ll cover them from there. If you structured that over large populations and pooled the risk, it wouldn’t be all that expensive.”

And how did that go over in the C-suite?

“The truth is, it didn’t go very far. On the DC side, once people leave Intel, there’s not much risk remaining with the company. Unless it was a bad PR story, maybe—‘Intel Retiree Is a Walmart Checker.’ For now, those stories aren’t out there. No one’s worried about the 75-year-old Intel granny being a Walmart checker.” Should Odell ever need to strengthen his argument, he can pay a visit the nearest Amazon warehouse.