Recent advances in defined contribution plans have markedly boosted workers’ retirement savings. But the jury is out on whether such changes will be enough to close a continuing retirement savings gap, and whether employers are prepared to offer supplemental retirement benefits that might expose them to greater fiduciary and legal liability.
These were key points made during a wide-ranging panel discussion hosted by Prudential Financial on Tuesday. Titled “2015 Global Economic and Retirement Outlook,” the 6-person panel — John Praveen, Quincy Krosby, Michael Lillard and Srinivas Reddy of Prudential, Edward Keon of Quantitative Management Associates and moderator Ron Insana, a contributor to CNBC and MSNBC — prognosticated on macroeconomic and market trends that will impact the insurance and financial services industry in the year ahead.
Closing the retirement gap
Respecting retirement security, Srinivas Reddy, a senior vice president and head of full service investments for Prudential Retirement, said that more companies are implementing target date fund strategies as default investment options. Target date-based mutual funds automatically adjust the equity/fixed income allocation of a plan participant’s portfolio to be consistent with an employee’s age and risk tolerance.
Reddy noted, too, that employees’ tolerance for high default plan participation rates is greater than once believed. Whereas a few years ago the assumed cap on such rates was 2 to 3 percent, plan sponsors have since learned that default rates can be set at 8 to 10 percent without adversely affecting “opt-out rates” (i.e., the percentage of employees who opt out of a plan or elect to contribute a percentage of compensation different from that automatically set by the company).
A Prudential report co-authored by Reddy and distributed at the event, “Guaranteed Lifetime Income and the Importance of Plan Design,” observes that defined contribution plans with “IncomeFlex” — Prudential’s guaranteed lifetime retirement income benefit — boasts lower opt-out rates (3 percent less) than do plans that don’t offer in-plan guaranteed retirement income.
When coupled with auto enrollment, plans offering a retirement income guarantee also enjoy higher plan participation rates than do plain-vanilla DC plans (87 percent vs. 65 percent, respectively). They also claim higher contribution rates (8.4 percent vs. 7.8 percent); and a lower percentage of non-diversified investors who allocate 100 percent of their portfolio to equity or fixed income funds (8 percent vs. 24 percent).
But given the continuing gap between workers’ savings rates and the nest egg needed to secure a lifetime retirement income, industry skeptics question whether advances such as auto enrollment, target date funds and annuity-like guaranteed income benefits will enough to close the gap.
Might supplemental retirement benefits — hybrid plans that combine elements of defined benefit and defined contribution plans, profit sharing plans that give employees an equity stake in their businesses or employee-owned cash value life insurance policies — be needed to close the retirement gap? And if so, are most businesses willing and able to offer such benefits?
During a Q&A with attendees, Prudential’s Reddy said that companies will offer the benefits necessary to recruit and retain qualified talent. But he cautioned that plan sponsors remain wary of offering retirement benefits that might impose a fiduciary responsibility on them to guarantee such benefits — thereby increasing their legal liability.
What investment yields are retirement savers likely to generate on their investments in the year ahead? Edward Keon, managing director and portfolio manager of Quantitative Management Associates (QMA), said that lower returns should be expected across all asset classes in 2015.
“In the current investment environment, a 5 percent yield is a very nice return, particularly given fact that inflation rate is likely to stay low for a very long period of time,” said Keon. “An earnings yield of 6 to 7 percent on equities [adjusted for inflation] is roughly what we can expect over the long run. That’s below historically high equity returns of 10 percent-plus, but compared to current bond yields of less 2 percent, the higher equity yield looks pretty good.”
Keon added that QMA remains more bullish on U.S. stocks than international stocks. While noting that shares of many European companies are now selling at “multiples far below” shares of comparable U.S. companies, it would premature for investors to transition to international equity because U.S. stocks enjoy higher yields and growth potential.
Yet, current returns on U.S. stocks are below historical rates — most especially those of the early dot.com era. Keon attributed this partly to depressed growth rates for GDP and labor force participation relative to prior decades.
The labor Force growth rate over the next 25 years, he said, will be 50 to 100 basis points less than during the post-World War II war period. Nominal GDP growth is likely also to be 300 to 400 basis points below that enjoyed during the post-war years.
The slow-to-moderate growth sentiment is mirrored in QMA’s “2015 Outlook and Review,” which pegs GDP growth rates for the U.S. and Europe at 3.1 percent and 1.3 percent, respectively, in 2015. This compares with 2.2 percent and 1.3 percent in 2014.
Interest rate trends
Michael Lillard, managing director and chief investment officer of Prudential Fixed Income, said the long-term Federal Funds rate — the interest rate at which banks trade balances held at the Federal Reserve — will remain in the 1 to 2 percent range. Helping to keep the rate at a historically low level is a comparably low growth rate in gross domestic product, which Prudential pegs at about 2 percent for 2015.
Guiding Fed policy in part on interest rates are prices of goods and services. Inflation could force a tightening of monetary policy (and, hence, a rise in interest rates). A deflationary spiral, which the panelists believe to be less likely in the U.S., could spur a further loosening of the money supply.
Of the two threats, the latter is the greater of the two, according to Prudential Financial Chief Investment Strategist John Praveen.
“One you go down a slippery [deflationary] slope, it’s very difficult to come out of it,” said Praveen. “It’s much easier to fight inflation than deflation.”
In Prudential International Investment Advisors’ January 2015 “Global Economic Outlook,” a brief distributed at the gathering, Praveen forecasts that inflation will “remain low” this year in both developed and emerging economies. A key reason: weak oil and commodity prices, which are expected to offset inflation-inducing GDP growth.
The low inflation, Praveen adds in the report, will likely prompt the European Central Bank and the Bank of Japan to pursue “quantitative easing” policies (i.e., buying government bonds or other securities so as to reduce interest rates and boost the money supply.)
The first quarter 2015 Outlook & Review of QMA’s Asset Allocation Group echoes Praveen’s forecast, noting also that the anticipated ECB and JOB actions stand in contrast to policies of the Fed and Bank of England, which QMA expects will “exit their zero interest rate policies” this year.
Might an economic crisis or government action in emerging markets, such as the recent move by Russia’s central bank to boost interest rates to counteract the precipitous slide in the ruble, upset monetary policy in the U.S.? Prudential’s Lillard rejected this possibility.
“The rate increase by Russia’s central bank could impact the timing of an interest rate increase by the Federal Reserve,” said Lillard. “But the Fed’s focus will remain on the impact of a rate hike on the U.S. economy.”
QMA’s Keon agreed, adding that interest rates in the U.S. are likely to remain low because of the “the tremendous amount of money” that risk-averse investors are pouring into U.S. securities and fixed income vehicles, most notably U.S. Treasuries.
As to bank practices, Prudential’s Lillard noted that, due to the current regulatory regime, including the imposition of heighted risk-based capital standards requirements, financial institutions are less able today to buy risky assets with bank deposits. Upshot: Don’t expect to see aggressive bank lending, such as that which caused the U.S. economy to overheat during 2007-2009 financial crisis.