Fading fast: traditional retiree benefits are disappearing. can new products help employers recruit and retain talent?

A persistent undercurrent of Anxiety plagues Americans these days. Despite so much positive economic news, people worry about their safety net. It has apparently become too expensive for private industry to maintain, and now it is unraveling.

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First, the good news: From 2002 through the first quarter of 2007, the net worth of American households has grown 44.7% to $56.2 trillion, according to the Federal Reserve's Flow of Funds report. In the four years ending July 31, the economy added 8.3 million jobs, according to the Department of the Treasury. Unemployment in July was down to 4.6% from 5.4% in August 2004, according to the Bureau of Labor Statistics, and 138 million were employed in nonfarm jobs.

But on pensions and pre-65 retiree health insurance, the news has been bad. Private employers, who have seen health-care costs rise dramatically, no longer want the additional responsibility of funding employees' retirements that could last 30 years or more. Even governments are feeling the pinch and are cutting back on benefits for new employees.

Replacement plans have emerged, but they place more burden on employees even as they remove long-term liabilities from corporations. Employers help to fund these new plans, but they offer few guarantees. Some workers fund them inadequately, if at all. Many feel unprepared and disinclined to manage the risks of outliving their money in retirement, and they fear becoming impoverished by a costly illness that strikes before they qualify for Medicare.

Retiree benefits traditionally have helped employers attract and retain employees, but benefit brokers say they've spent much of their time in recent years helping employers scale back on benefits. That doesn't mean retiree benefits have lost their power, but it does mean that employers, employees, brokers and public policy-makers are in uncharted territory. "We face one of the most uncertain futures in my 32 years in this business," said Chris Mooney, vice chairman and executive vice president in the Employee Benefits Practice of The Willis Group, speaking primarily about health care. "But there is also a lot of excitement and great opportunity."

The evolution actually has been more than 30 years in the making, according to industry veteran Dallas Salisbury, president of the Employee Benefit Research institute. He said the enactment of the Employee Retirement Income Security Act of 1974 "was a terrible day for the insurance industry" because most "defined benefit" pension plans were insured plans into which employers paid. "After ERISA, money moved out of insurance companies and to independent third-party investment management firms, as companies wanted to keep the excess and portfolio earnings that insurers had previously been keeling to bear risk" he said.

It's Up to Employees

In the years since ERISA, employers largely have avoided setting up plans in which they are responsible for paying income to retirees. Instead, they have opted for DB plans that pay single-sum distributions or have turned to defined-contribution plans such as 401(k)s, in which the only distribution option is also a single sum, said Salisbury. On the retiree health side, employers have either stopped offering retiree medical plans or offer plans in which the retiree pays all costs, he said.

The latest trend has been for employers to make annuities available to retiring employees with single-sum retirement accounts at better terms than have traditionally been available on the individual market, Salisbury said. Some new products offer an option within a 401 (k) plan so that employees can buy additional amounts of retirement income each payday.

One benefits adviser active in this area is Mercer Investment Consulting, a unit of broker Marsh & McLennan. Phil Suess, a principal of the business, said there is increased interest among employers about how to replicate income features commonly found in pension plans. One is the income accumulation option. Administrators also are making use of so-called "annuity platforms," which plan participants can call to receive quotes from insurance companies on how much of a monthly benefit they can buy with a lump-sum distribution.

What makes these products different from more traditional immediate annuities is that these options are liquid, said Suess. "To be successful, they have set up these options so they can operate as any other option under the 401(k) plan,' he said."What that means is that participants now can transfer in and out." Transferring out cancels the benefit and usually comes at a cost, "but it does represent an option previously unavailable," he said.

Use of accumulation annuity products has been "very limited" so far, Suess said. "That's driven by the fact that they are still relatively new products, and there is a limited number of providers."

He says there's more interest in distribution annuity platforms.

Product development has been driven by insurers. "They've had an ongoing challenge as to how do we participate in the retirement boom," said Suess."They've been feeling a little left behind, relative to the mutual fund industry."

Annuitization of retirement plan lump sums protects retirees against "longevity risk"--the risk of outliving their money. But there are other risks, such as inflation. To address "inflation risk," more employers are demanding inflation-indexed annuity options for their participants, said Salisbury.

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Employers also worry that participants aren't adequately funding their plans or actively managing their investment choices. Kent Lonsdale, executive vice president in the Mid-Atlantic Region for Gallagher Benefit Services, a unit of broker Arthur J. Gallagher, said better information and resources are part of the benefit-improvement picture. These include better disclosure of fees, decision-making support and investment-monitoring tools, especially on Gallagher's Web site.

A challenge that plan sponsors face is getting young employees to contribute to the plan, but many Gallagher clients have older employees who are under-funded and need to contribute more. Lonsdale said employers are also showing renewed interest in allowing phased retirements since employers face a talent gap and older employees, short on savings, need to keep working longer.

Pre-65 Retirees 'Out in the Cold'

On the health-care side, Willis' Mooney said employers are moving away from retiree medical plans "as fast as they can, creating an enormous gap, particularly for pre-65 retirees." He said some 15% to 20% of 55- to 65-year-olds are currently uninsured. Even government-provided retiree health plans are under pressure.

He said the United States has a viable post-65 health-care system, "but the pre-65s are out in the cold"Willis' value proposition is to help employers reduce costs and relieve workloads in human resources departments, while also educating employees about their plight so they'll choose better health behaviors. One creative initiative is guaranteed-issue, individual health contracts furnished on a group basis, in which the employer makes a defined contribution that can be spent by the employee, he said. So far, employers that have offered this feature under their existing health plans "are just getting hammered" and those who buy are "the walking wounded:' Mooney said.

Mooney sees long-term promise in defined-contribution plans, such as Health Savings Accounts and Health Reimbursement Arrangements. The

HSA, in particular, is owned by the employee and is portable, but it has not been available long enough for account owners to have saved significant amounts.

Rob Cola, president of Brown & Brown Consulting, a unit of broker Brown & Brown, predicts that only government and unions will provide retiree health benefits in the future, and he said private-sector employees no longer expect it. One way to plan is to fund an HSA,"but there aren't a heck of a lot of cost-effective options out there for people trying to bridge that gap and retire before age 65."

Cola advises people to work as long as they can. "That's what people are doing," he said. "The only reason they're staying with their employer is for the benefits." Some workers plan to take advantage of COBRA, a law that allows retirees to continue in their former employer's health plan for 18 months at their own expense. That may be cheaper than buying an individual plan that might have pre-existing condition exclusions, he said,"but that's really no bargain, either."

So do retiree benefits still have any power?

According to survey results released by MetLife in July 2007, they do. "What we're seeing--and what we expect to see--is a growing interest in retiree benefits," said Ron Leopold, M.D. and vice president of employer sponsored benefits. The reasons: A lot of people are moving into the years in which they think about retirement more seriously, and employers increasingly want to retain tenured employees.

In competing for those employees, employers will need to differentiate themselves from their competition, Leopold said. The survey indicates that they still face cost-containment pressure. But they will allow employees to customize their benefits through Web technology, and they will offer more voluntary products for which employees pay-"certainly things like retiree dental," said Leopold. "MetLife is launching into retiree dental in a very big way." Medicare doesn't pay for dental, he noted, and Medicare supplements often don't, either.

But, he added, employee behavior also has to change. "We're terrible at saving for retirement and great at saving for a plasma TV~,' he said. "We're at the point in time where we need to flip-flop that."

Key Points

* More employees are likely to benefit from retirement savings plans than from old pension plans.

* If employees fail to fund them, however, they will suffer in retirement.

* Most private employers no longer offer pre-65 retiree health coverage to employees.

RELATED ARTICLE: Perception vs. Reality: These Are the Good Old Days.

Employer-provided pensions can help people sleep better. But despite the anxiety Americans feel about seeing them replaced by defined-contribution retirement plans, pensions never really benefited that many retirees.

Pensions, of course, traditionally are earned by employees who stay with a firm long enough to become fully vested-usually in 20 to 25 years. The number of individuals that spent 25 years or more working with one company in the private sector, however, never exceeded 20%, according to Dallas Salisbury, president of the Employee Benefit Research Institute. And 30 years ago, during the perceived "good old days" of pensions, only 9.8% of post-65 retirees from the private sector reported having pension income. That compares to 23.9% in 2001, the all-time high; that figure was only slightly lower as recently as 2006.

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Perception, however, appears to be reality for Americans. Salisbury said the "good old days," when everyone retired with a gold watch and a pension after working a full career for one company, never really existed. To understand why we think they did, "all one needs to do is flip back to much of the rhetoric of the world around us," he said. "The business media has been filled for ages" with the good-old-days myth. But the average worker in 1952 had from seven to 10 jobs during a working career--about the same as today, he said.

In fact, today's pension and retirement plans help to underline the fact that the United States always has had a mobile work force:They provide some private-sector retiree benefits for the many rather than extravagant benefits for the few. Salisbury said more than 25 years' worth of EBRI employee surveys show that, while employer-provided health plans have always been the No. 1 benefit choice for about 70% of those polled, 45% of workers now prefer a retirement savings plan as a second choice over a pension, which placed a distant third at 10%.

These results may be because those who earned pensions, with their long vesting periods, were subsidized by the many who left the employer and forfeited what they contributed. "If the public policy objective is to have programs designed to benefit the broadest conceivable number of people, and if you think about all the changes in the last 40 years that move in the direction of immediate vesting of contributions to a 401(k) plan as opposed to 20-year vesting ... it's saying, philosophically, that we'd rather that 80 people each have $10 than 20 people have $100;" Salisbury said.

The changes represent a move from a "final-pay formula" to a "career-average formula;' and the old systems were adequacy-oriented rather than equity- and equality-oriented, said Salisbury.

"If people will save the money that can go into the DC savings plans--and that's a big 'if--and if ever), time they change jobs, they roll it over, and if they allow the money to accumulate, then this new system will leave more people better off than the old system did," he said."It will not leave as man}, people very well off. But the vast majority of people, if the money is preserved, will end up with more."

Of course, pensioners never got access to the principal and thus were not tempted to take it and blow it on a big vacation. That explains why insurers see opportunity in helping DC-plan participants turn at least some of their plan assets into annuity income, Salisbury said.

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Employers That Offer
Benefits Geared Toward
An Aging Work Force

Only 18% of employers have
supplemented their plan with
resources and programs
specifically for an older work
force, a percentage that has not
changed since 2004. Larger
companies lead the way.
%

No of Employees

Total              18
2 to 49             9
50 to 199          16
200 to 999         23
1,000 to 4,999     26
5,000 to 24,999    31
25,000+            37

Source: Fifth Annual MetLife Study of Employee
benefits Trends

Note: Table made from bar graph.

The Role of Benefits
In Employees' Decision
To Accept and Keep
Their Jobs

Benefits are important in recruiting
and retaining employees,
particularly among those nearing
retirement.
%
                 Important Reason for    Important Reason for
                 Coming to Employer      with Employer
All Full-Time           28                      33
Employees
Single                  10                      24
Young Families          41                      41
Baby Boomers            29                      36
Pre-Retirees            34                      50

Source: Fifth Annual MetLife Study of Employee
Benefits Trends

Note: Table made from bar graph.

Employers Concerned
About the Impact of an
Aging Population on
Their Work Forces

Larger employers are more likely
to be concerned about retaining
old workers

No. of Employees

Total             36
2 to 49           28
50 to 199         36
200 to 999        32
1,000  to 4,999   45
5,000 to 24,999   47
25,000+           53

Source: Fifth Annual MetLife Study of Employee
Benefits Trends

U.S. Retirement Assets, Year-End 2006
($ Trillions)

Individual Retirement Accounts   $4.2
Defined Contribution Plan*       $4.1
Government Pension Plans          $4.2
Private defined Benefit Plans    $2.3
Annuities **                     $1.6

* Defined contribution plans include private employer-sponsored
defined contribution plans including 401(k) plans, 403(b) plans, and
457 plan  assets.

*** Annuities include all fixed and variable annuity reserves at life
insurance companies less annuities held by IRAs. 403(b) plans,
457 plans, and private pension funds.

Source: Investment Company Institute.