Regulatory trends intersecting with shifting market conditions pose challenges, present opportunities.
A perfect storm is a phenomenon that occurs at the confluence of a combination of weather patterns rarely seen together. The result is a storm of unusual magnitude. In business, trends, like storms, vary in size, speed and severity. Occasionally, multiple macro-trends run into each other and create conditions that have a significant and broad-reaching impact, such as Y2K, or fundamentally change an industry, like the passage of ERISA in 1974. The retirement industry currently sits at the intersection of several major disruptive events that could be every bit as transformative as the passage of ERISA. So how did it come to this, and where does one go from here?
Retirement Market shift: the low-pressure system
For decades, the IRA market experienced slow growth in both overall size and size in relation to other segments of retirement savings marketplace. By 2010, the total of U.S. based retirement dollars residing in IRAs had quietly eclipsed the total assets residing in employer sponsored defined contribution plans.1 To date, this growth in IRAs is largely attributable to an aging population retiring and also a shift in employment trends resulting in shorter tenure. Even though an individual’s retirement savings traditionally enjoyed greater protection inside of an ERISA-covered plan, this trend persists.
Given that the purpose of these savings does not change in the rollover process and that the amount of retirement assets being held in IRAs continues to expand, we saw the regulatory move by the DOL as inevitable with the only questions being that of timing and extent.
DOL fiduciary rule: the high-pressure system
Since the DOL published its new fiduciary rules, financial services firms everywhere are considering what the DOL’s action means to them. Specifically, these firms are considering how this new regulation affects their businesses and their customers both now and in the future. There is plenty of turmoil within the industry as a result of this regulatory initiative. Since April when the rules were announced, there have been failed congressional efforts to block the rules and several lawsuits have now been filed against the DOL. In the midst of all this activity, the SEC recently indicated that they would be introducing their own set of rules in April 2017. While clarity and specific data on the impact to the industry begin to emerge, a fundamental shift in how the financial services industry conducts business is upon us.
While cost of compliance with the Best Interest Contract Exemption (BICE) may be less than the industry originally feared, there will be pain associated with compliance. As with anything, the devil is in the details. How the DOL ultimately views the concepts of “best interest” and “reasonable compensation” in the IRA space remains to be seen and will play out over the next couple of years. Amidst the uncertainty of interpretation and implication, one thing is now clear; the status quo is no longer.
Regulatory events, trends and the bigger picture: the confluence of fronts
While the stated intent of the DOL is to provide increased protection for individuals with IRA accounts, we see DOL’s actions as an evolutionary component of addressing a much larger problem; the retirement crisis in the U.S. and the stresses it places on the Social Security System. While you will find mixed opinions on exactly how dire the situation really is, the numbers are black and white.
According to a recent GAO report the median retirement savings for households with members between 55-64 is $104,000, estimated to be worth $310/month in an inflation-protected annuity. The same report goes on to state that a full 29% of Americans over the age of 55 have no savings or traditional pension while Social Security benefits account for the majority of income for most Americans over the age of 65.2,3
While the findings of the GAO are troubling enough, the $104,000 average balance for that specific group is the high water mark for approximately 80% of all IRA accounts and the median account size is closer to $35,000 when one digs deeper.4 The total retirement savings shortfall, among households between 24-64, is estimated to be between $6.8 trillion and $14 trillion, depending on the financial measure. This shortfall is based on the assumption that individuals will work until the age of 67.5 With so many saving so little and living longer, the ability to meet future retirement obligations becomes understandably worrisome.
There are of course several ways to relieve pressure on the system. Some of the remedies are viewed as political hand grenades that many are less than eager to jump on. The apparent low hanging fruit is to put more of the onus back onto the individual, not unlike what the passing of the ACA attempts to accomplish in healthcare. A major roadblock here is the fact that only about half of all U.S. workers have access to an employer sponsored defined contribution plan.6 This lack of access to retirement plans through the workplace has to be addressed and leads us to the other major regulatory pressure on the industry.
The States, which are also dealing with pension challenges, are currently leading the charge in this area. With New Jersey recently joining the list of more than 25 states that have introduced their own version of a mandatory retirement program, many programs identify a payroll deducted IRA or IRA-like product as default vehicles. The specifics on proposed legislation vary on a state-to-state basis but do mandate employers with as few as 5 employees to offer a retirement program, as is the case in California. With so many States already in process, we would not be surprised to see activity in this area at the Federal level in the future. Either way, we expect to see further IRA market expansion beyond the current trends as a result.
Here is where we find our perfect storm. The growth of the IRA market beyond defined contribution plans in relative size gives the situation critical mass. The addition of state mandates to address the savings gap accelerates and compounds the challenges. Lastly, the DOL’s rules effectively take a historically institutional business and a historically retail business and throws them into the same bucket.
All of this creates challenges across the board for industry service providers. The combined pressures will stress organizations at the people, process and technology levels.
Where to find blue skies
In a recent industry presentation conducted by Fidelity, it was estimated that there would be $3 trillion of retirement assets in flux as a result of the DOL rule.7 While estimations are just that, there is real precedent that would lend credence that the estimate is not hyperbole. In 2013 the UK passed a similar law. With their industry remaining status quo from a process and technology perspective, the results were account minimums being raised nearly uniformly to £100,000 (approx. $147,000) by 2015, approximately twice the minimum investment amounts in 2013, according to the United Kingdom’s Financial Conduct Authority (FCA). Access to professional advice and education below that bar remains a challenge.
Bringing it back home, with a majority of people in the US with retirement savings less than $100,000 and nearly a population five times the size of the UK, with even remotely similar results there is going to be an industry shake up of unprecedented scale.
Service providers are challenged with addressing a growing market in an environment where cost of service and compliance are rising against contracting revenue on a per unit basis in certain market segments.
For some firms it will be a fork in the road. It will come to a decision whether or not to remain in the business of providing IRAs below certain asset levels, if at all. AIG and Met Life have already made the choice to bow out of the business completely, selling off their advisory businesses. Many firms are simply raising their account minimums to levels that make operational sense for them, as we have seen elsewhere.
If the decision is made to remain in the IRA business, the “how” becomes an entirely different process. In the midst of these changes entire blocks of retirement accounts may be in limbo while these decisions are being vetted and ultimately made. Herein lies the opportunity!
None of the above changes the fact that this is still a service business, which makes it inherently people oriented. Attempts at fully automating service businesses in this and other industries in the past have not worked very well. While technology innovation is a key factor in overcoming these challenges, it is not a silver bullet. The firms that successfully align their businesses with these market dynamics will emerge as thought leaders in the industry. These firms will have to find ways to deliver more value more efficiently by providing:
- More cost effective products;
- Access to professional advice and retirement education to a broader population;
- Customer service to a growing tech savvy population
Given the sheer size, volume and fragmentation of the existing and anticipated IRA market growth, the firms that successfully leverage technology to enhance the reach of their people, processes and best practices in order to achieve these service levels stand the greatest chance of thriving in this new environment.
1 Investment Company Institute: https://www.ici.org/pressroom/news/ret_10_q4
2 US Government Accountability Office: Report to the Ranking Member, Subcommittee on Primary Health and Retirement Security, Committee on Health, Education, Labor, and Pensions, U.S. Senate: May 2015 https://www.gao.gov/assets/680/670153.pdf
3 Social Security Administration: Research, Statistics, & Policy Analysis, Social Security Bulletin Vol. 75, No. 2, 2015
4 Investment Company Institute: Investment Company 2015 Factbook https://www.ici.org/pdf/2015_factbook.pdf
5 National Institute on Retirement: The Retirement Savings Crisis: Is it worse than we think?, June 2013 https://www.nirsonline.org/storage/nirs/documents/Retirement%20Savings%20Crisis/retirementsavingscrisis_final.pdf
6 Bureau of Labor Statistics: https://www.bls.gov/ncs/ebs/benefits/2015/ownership/civilian/table02a.pdf
7 Positioning Your Practice to Capture Opportunities Proposed DOL Investment Advice Rule –Fidelity – March 2016