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While We Weren't Looking… Macro Influences On 401(k) Contributions Exacerbate Stable Value Cash Flow Problems

The stable value world has historically paid more attention to fund flows within the plan than those coming into the plan. That was especially true from early 2001 through much of 2003 when transfers out of equity funds and higher allocations of contributions to conservative investment options produced large stable value inflows. Recently, however, stable value cash flows have been negative for many funds. This is partly the result of contribution and transfer allocation shifts back towards equities. However, it's also due to some dramatic changes in the macro factors influencing contribution growth at the plan level. These forces changed several years ago, but their influence on stable value was masked by the strong participant allocation shifts.

During the 1980's and 1990's sustained growth of both 401(k) plans and the economy produced steady and predictable growth in plan contributions. Wage rates and employment rose comfortably. Plan sponsors worked to increase participation. Many increased their matches as they moved to emphasize defined contribution plans at the expense of traditional defined benefit plans. We all came to expect growth in plan inflows to be the norm, and it helped sustain stable value asset bases when equity funds found such strong favor with participants during the late 1990's.

All this changed with the recession and the turbulence in equity markets. Plan contributions, after all, are a percentage of payrolls on the participant side and depend on the ability to pay benefits on the plan sponsor side. Both payrolls and profitability have suffered over the last several years. The impact on the forces affecting the growth of plan contributions is summarized below. Charts illustrating many of these points are provided at the end of this article.

• Employment in the U.S. grew at a strong 1.9 percent a year rate from 1990 through then end of 2000. Over the last three years, it's declined at about one percent a year. That's a swing of almost 3 percent.
• For those working, wage rates rose steadily in the 3.5 to 4 percent range from 1997 through 2002. Since then, the rate of increase has fallen steadily to about 2.4 percent for the latest data. Since contributions are a percentage of earnings, this slowdown cuts directly into the growth of plan inflows.
• Even when workers are lucky enough to have a job, there's been a shift to employment at smaller firms with fewer benefits, including less pension coverage. After rising fairly steadily from about 50 percent in 1990 to almost 57 percent in 2000, the percentage of U.S. workers employed at a firm that offers any form of pension plan fell to 53.4 percent in 2002, a significant drop in the proportion of workers covered.
• Where workers are lucky enough to have a 401(k) plan, they're not participating at the same levels they did during the economy's and the markets' hey-days. Participation rates have dropped from 77.5 percent of those eligible in 2001 to 72.4 percent in 2003 according to a survey by Plan Sponsor. Analysts of this trend say that the drop is due to lower enrollment rates among new workers, a trend that augurs poorly for the future.
• And even when those eligible are participating, they're doing so at lower rates. Spectrum surveys indicate that salary deferral rates have fallen from a peak of 8.6 percent in 1999 to only 7 percent in 2002.
• The falloff in contributions from employees is bad enough, but there have been declines on the plan sponsor side as well. Employer contributions to 401(k) plans averaged 3.3 percent of payrolls from 1997 through 1999, but only 2.6 percent over the last three years according to the Profit Sharing/401(k) Council. Contributions to profit sharing plans dropped much more steeply.
• Even worse, many firms terminated or suspended the company match altogether. Since many of these were large firms (see the chart, "Companies Suspending/Reducing 401(k) Match 2001-2003"), the number of participants affected is much greater than the number of firms would indicate. This is a major issue, since research shows that the company match is the biggest single factor influencing employee participation.
• With the slowdown in contribution activity, plan withdrawals become more of an issue. A Hewitt survey found that in 2002 only six percent of those changing jobs and taking lump sum distributions rolled their 401(k) balance over to the new employer's plan. In the over 60 group, 39 percent took the lump sum distribution in cash, as did 33 percent of those aged 50-59.

Stable value underwriting has tended to focus primarily on risks of inter-fund transfers and external rate arbitrage opportunities. Recent events make it clear that the exercise needs to be broadened to look at the factors influencing plan contribution and withdrawal levels, as well as those impacting the stable value fund itself.

Source: Department of Labor, Bureau of Labor Statistics

Source: DOL, Bureau of Labor Statistics

Source: EBRI

Source: Profit Sharing/401(k) Council

Source: Munnell & Sunden, "Suspending the Employer 401(k) Match", Center for Retirement Research at Boston College Issue in Brief, June 2003, Number 12, page 4.

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