Resilience check-up
RESILIENCE CHECKLIST

Resilience check-up: How did your plan hold up?

Market volatility is a matter of when, not if. Consider this outline to help prepare your plan participants for the next time.

Extreme volatility like what we saw in March puts pressure on every aspect of a DC plan, from its investment objectives to the way information is shared with participants. It’s also a real-world stress test that may help identify potential enhancements. We’ve gathered resources to help plan sponsors explore:

  • How participants fared during the volatility?
  • How plan design can boost participant resilience?
  • How can participant communications help keep participants on track?

Explore the tabs below for resources and insights to help you explore how volatility may have affected your plan during the pandemic and identify potential improvements.

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How did participants fare?

What does resilience mean when it comes to participants’ retirement savings? It may depend on where they are in their careers.

Younger participants need growth and have the time to recover from market shocks. They may have more exposure to both the market ups and downs. Continuing to invest throughout volatile periods may help younger participants potentially invest at attractive valuations prior to market rebounds.

Mid-career participants are likely accumulating significant savings balances, but still need to manage growth even as they begin to limit the downside.

Late career and retired participants may need consistent risk exposure for growth and to combat inflation, but also need to limit the downside to keep their retirement spending strategies on track.

Recommendation
This may be a good time to review assumptions about your participants' risk tolerance. Are they aligned with your QDIA's objectives and performance?

 


With the above in mind, here is a potential checklist for measuring how participants fared during the volatility.

1. Did the QDIA perform according to your expectations – across all participant cohorts?

Most flows, and often a sizable portion of plan assets, are in the Qualified Default Investment Alternative (QDIA), which is most frequently a target date fund. For the most part, assessing how participants fared means reviewing the QDIA.

When assessing the funds against your expectations, measure performance against the low point of the recent selloff. Month or quarter-end data can mask how participants experienced volatility and its potential for driving poor selling decisions that may lock in losses.

The target date fund glidepath simplifies the task of measuring the impact of volatility on various age cohorts.

Ask

  • What were your expectations for younger, mid-career, and older participants?
  • Would the performance for mid to late-career participants encourage or discourage them from staying the course?
  • Did younger participants who stayed the course capture a significant portion of the market rebound?
  • To what extent was the downside mitigated for participants closest to retirement?

2. How is the target date fund designed for volatility?

Different target date funds manage volatility in different ways in support of the retirement outcomes they seek on behalf of participants. As part of your assessment, you may wish to explore the following questions with your QDIA provider:

  • How are older and retired participants protected against volatility?
  • How did the TDF navigate the recent market volatility? Past volatility?
  • How has it evolved over time?
  • How does the TDF set participants up to be able to have the income they want in retirement?
  • How is the asset allocation aligned with the objectives for different age cohorts?

As seen in the chart below, we saw different performance across investment grade fixed income and high yield (sub-investment grade fixed income). This likely hurt the performance of the near-retirement vintages of QDIAs that hold sizeable weights to high yield, underscoring the importance of high quality fixed income for near-retirees.

Asset Class Performance

 

Performance data quoted represents past performance and does not guarantee future results. Source: Morningstar as of May 31, 2020. “Peak to trough” represents the period from 20 February 2020 to 23 March 2020, a period chosen because equity markets, as measured by the S&P 500, saw their highest value of the year at the beginning of the period and their lowest at the end of the period. Indices represented are BBgBarc US Agg Bond TR USD and BBgBarc US Corporate High Yield TR USD. Returns include reinvestment of dividends and capital gains. Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index.

The mix of high quality and high yield within the fixed income exposure, as well as the allocation to equities, helped drive a range of outcomes across target date funds during the recent volatility. To illustrate, the chart below compares the BlackRock LifePath Index Retirement Fund, which has a 60% allocation to high quality fixed income, to a representative peer index.

TDF Performance

 

Name Year 3 Year 5 Year 10 Year Since Inception
BlackRock LifePath® Index Retire K 0.19% 3.54% 3.42% N/A 4.64%
S&P Target Date 2020 TR USD -2.99% 2.82% 3.34% 5.95% 4.55%

Source: Morningstar, BlackRock, as of May, 31 2020. "Peak to trough" represents the period from 20 February 2020 to 23 March 2020, a period chosen because equity markets, as measured by the S&P 500, saw their highest value of the year at the beginning of the period and their lowest at the end of the period. BlackRock LifePath Index Retirement Fund, Class K share returns based on monthly net returns. Index performance returns do not reflect any management fees, transaction costs or expenses. Past performance is no guarantee of future results. Indexes are unmanaged and one cannot invest directly in an index. The S&P Target Date Index Series is designed to track the performance of a diversified array of financial assets and the investment opportunity generally available in target date funds. The S&P Target Date Index Series comprises multi-asset class indices, each corresponding to a particular target retirement date. The asset allocation for each index in the series is determined once a year through survey of large fund management companies that offer target date products. Each index is fully investable, with varying levels of exposure to equities, fixed income and commodities. For further information please consult the S&P Target Date methodologies at: https://us.spindices.com/documents/methodologies/methodology-sp-target-date.pdf . Copyright © 2020 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.

3. How are participants invested, and how may that have impacted their retirement readiness?

Participant allocations may not be in alignment with a target date benchmark, especially for plans with legacy defaults that have not been reenrolled or plans with a significant number of "do-it-yourself" participants. The misalignment may mean that participants within the same company likely had very different experiences of the volatility, complicating both the immediate assessment and ongoing workforce management."

A recent case study using BlackRock plan design analysis compared legacy populations within a recently merged firm. Participants from the acquired company (Company B) were reenrolled into the current default, target date funds. Company A auto-enrolls new hires into the default target date fund but did not reenroll its legacy population.

An analysis of allocations across both populations shows considerable misalignment. In this case, the large allocation to capital preservation most likely meant that the majority of legacy Company A participants experienced less volatility, but it potentially came at an opportunity cost from being underexposed to growth across all age cohorts.

Allocations by age

Allocations by age

 

Source: BlackRock Plan Design Analysis. For illustration only.

Reenrolling both populations into the current default may place all participants on equal footing.

Additional resources
BlackRock plan design analysis can help measure the impact of potential investment line-up changes.
Strategic plan design

Can plan design boost participant resilience?

Many plan sponsors and participants may need to consider immediate actions in response to the recent volatility. We believe, however, it’s equally important to take a long-term view to strengthen the plan for future market volatility, which will inevitably happen again.

Here are three options to consider:

1. Are the plan defaults helping or hindering participant savings?

Plan default rates and auto-escalation caps can ensure that most participants are making at least some contribution to their retirement security. However, participants tend to stay with defaults and caps – which may hinder their savings if the rate is too low. 

A case study illustrates the point. We compared participants who remained at the default deferral and auto-escalation cap (“Passive Participants”) and those who were more engaged and made some active investment or savings decision (“Active Participants”). Unsurprisingly, “Active Participants” save more:

Avg. deferral rate

 

Source: BlackRock Plan Design Analysis. For illustration only.

The size of the “opportunity cost” that “Passive Participants” experienced because of the plan sponsor selected defaults and caps may be more surprising. The following chart projects the potential difference that 2% of additional savings may make:

Average projected participant DC balance

Average projected participant DC balance

 

Assumptions
Starting contribution age: 25
Salary at age 25: $50,0001
Default portfolio mix: 100% Target date strategy
Default total contribution amount (employee + employer): (5% + 4%) = 9% vs (7% + 4%) = 11%
*Based on BlackRock’s Future in Focus® tool. Please see the Assumptions and Methodologies for more information about the inputs used and for the tool’s assumptions and methodology. The projections or other information generated by the Future in Focus App (“App”) regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Actual participant outcomes may vary with each use and over time.
1Rounded mean income of the 25-29 age group. U.S. Census Bureau, Current Population Survey, 2018 Annual Social and Economic Supplement.

What may be most striking to some passive participants is the potential to have to work an additional 3 years to reach the same savings level as their active peers.

Plan sponsors may wish to consider:

  • raising the default rate,
  • adding or increasing the auto-escalation rate (which is now capped at 15% for Safe Harbor plans as part of the SECURE Act), and
  • reenrolling participants into the new rates, including those who opted out of saving.

2. Do plan sponsors need to reconsider their match strategy?

Matching contributions not only directly contribute to participants’ retirement savings, they can increase participant efforts by encouraging them to defer more to maximize the match.

Unfortunately, balance sheet concerns driven by the pandemic have forced some companies to consider whether to suspend or reduce elective and non-elective contributions. Plan sponsors should discuss changes with their legal team in order to avoid triggering non-discrimination violations or threatening the plan's tax-qualified status.

There are several alternatives that may bring some relief while still encouraging participants to save, including stretching the employer match to adding auto-escalation.

The following chart illustrates a scenario that initially reduces the employer’s matching costs while encouraging greater savings to potentially improve the participant’s long-term savings. The details are:

  • The plan sponsor previously matched 100% of the first 3% of participant contributions. Now the plan matches 50% of the first 3% (and at the same time increased the cap on the match to 6%), reducing their expense the first year.
  • Auto-escalation begins the next year, increasing the participant contribution to 4% and the employer match adjusts to 50% of the first 4%.
  • Two years later, auto-escalation has increased participant deferral to 6% and the employer match is now 50% of the first 6% contributed.
  • At the end of the period, the employer match expense is back to its original level after a short-term savings. Meanwhile, auto-escalation and the match stretch has positioned participants to achieve an even better retirement outcome.

Average projected participant DC balance

Average projected participant DC balance

 

Assumptions
Starting contribution age: 25
Salary at age 25: $50,0001
Default portfolio mix: 100% Target date strategy
Default employee contribution: 3% vs 3% with 1% auto-escalation up to 6%
Employee matching contributions: 3% at 100 cents per dollar vs 6% at 50 cents per dollar
*Based on BlackRock’s Future in Focus® tool. Please see the Assumptions and Methodologies for more information about the inputs used and for the tool’s assumptions and methodology. The projections or other information generated by the Future in Focus App (“App”) regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Actual participant outcomes may vary with each use and over time.
1Rounded mean income of the 25-29 age group. U.S. Census Bureau, Current Population Survey, 2018 Annual Social and Economic Supplement.

3. Is company stock concentrating participant risk?

Many plans have reduced or eliminated company stock as an investment option for new hires, but plan reviews by BlackRock have found company stock concentration in longer tenured and lower income workers, many of whom prefer to invest in a company they think they "know best".

In addition to the risk of investing future retirement security in a firm a participant already depends on for their wage income, company stock is by definition a concentrated position. The following chart compares the 15-year average return and risk for single stocks against an equally weighted stock index. The results show less return and almost twice the risk for the single stock exposure.

15-year average annualized risk and return of single stock vs equally-weighted stock index (2005-2019)

Annualized risk and return

 

* This chart shows the average annualized 15-year return and standard deviation of every single stock in the S&P 500 (as of 12/31/19) with 15-calendar years of history vs an equally-weighted composite index of these stocks for the period 2005-2019. Of the S&P 500 component companies as of 12/31/19, 397 had 15-calendar years of history for inclusion in the analysis.

There are several potential steps a plan sponsor can take to mitigate company stock concentrations, including:

  • introducing caps on holdings,
  • offering auto-diversification tools to reduce exposure over time, and
  • reenrollment into the QDIA.

Finally, hiring a third-party fiduciary to recommend and/or execute a company stock divestment plan may reduce a plan sponsor’s liability.

Additional resources
Here are some strategies to consider for managing company stock risk.
9 misconceptions about company stock

Are you getting ahead of participant concerns?

No one knows when extreme market volatility will occur – only that it will occur and that many participants will look for guidance. Getting in front of participants quickly can help prevent participants from taking action that might ultimately damage their retirement readiness.

Volatility resources, such as the video shown here, may help get important insights to participants quickly:

Investing tips to manage through market volatility

Pointers on actions you may want to avoid and actions you should consider taking when the markets become volatile.

A communications plan may include:

  • Reinforcing that if they are able to stay the course during a downturn, it often turns out to be a smart response.
  • Illustrations of historic selloffs and market recoveries.
  • Advising caution about loans or withdrawals during volatility. See what to tell participants about tapping into their retirement savings.

Plans should work with their record keepers to ensure that messaging is consistent with call center enquiries.

Recommendation
Review flows and account activity, including withdrawals and loans, to identify potential issues or concerns.
Communications