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Subject: Executive Update
Date: Mon, 2 Nov 92 13:00:39 EST
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11/2/92


TITLE Executive Update

401(k)s Put Workers' Retirements In Own Hands

But Employers Are Beginning To Realize Many May Not Be Up To Task
Virginia Munger Kahn In New York

There's a revolution under way in how people save for retirement,
and the change has significant implications for companies and
their employees.  Benefits

By the year 2000, assuming current trends continue, company-
financed pension funds will no longer be the dominant vehicle for
funding retirements. Instead, most individuals will rely on
401(k)s and other employee-directed defined contribution plans
such as those for public-sector workers.  A key difference
between defined contribution plans and company-directed pension
funds - referred to as defined benefit plans because benefits are
determined based on factors such as years of service and salary
that are set out in advance - is that responsibility for defined
contribution plans lies with individuals rather than professional
investment managers.  The change has been under way for the last
10 years, but only recently have companies and their investment
advisers begun to recognize the burden placed on employees to
make wise investment decisions and the need for programs to edu-
cate workers.  The problem is the large percentage of defined
contribution assets sitting in guaranteed investment contracts
-financial vehicles that are marketed by insurance companies and
offer a guaranteed return - and other low-risk, shorter-term
funds. Industry surveys indicate that as much as 65% of employee
contributions go into such vehicles.  Long-term studies have
shown these assets do not do a good job of keeping up with infla-
tion. The only assets that do are equities.  If individuals do
not alter the way they allocate their savings, employers and
financial advisers now warn, millions of Americans will not be
able to retire when they want to or will experience a substan-
tially diminished standard of living when they do retire. And
companies and government agencies will face pressures to kick in
additional resources.

"It will become a public policy question," said Kirk Loury, vice
president of marketing at New York Life Insurance Co., which has
just completed a study on 401(k) plan participants.  The issue is
a critical one for baby boomers who are now in their 40s and only
have 401(k) plans.

These people will be vocal, says Loury, and "ultimately, you'll
have greater regulation," if not the revocation of self-directed
plans and return of company-managed plans.  The key to avoiding
this outcome, employers and advisers agree, is to sharply step up
employee education.

As several executives noted, however, companies must be careful
to avoid potential legal problems.  "We feel a need to continue
to educate the work force," said Bill O'Connor, director of taxes
at General DataComm Inc. in Middlebury, Conn. But "the area is
fraught with liability questions." The company cannot be seen as
giving advice because it then could become legally responsible
for the performance of the investments, he said.

Defined contribution plans got their start in the late 1970s,
when inflation was soaring and pension plans faced an increasing
regulatory burden due to the Employee Retirement Income Security
Act of 1974.  Not only were defined benefit plans increasingly
expensive to administer, but companies were faced with making
long-term commitments in an uncertain return environment.

Defined contribution plans are less expensive to run because much
of the administrative burden can be shifted to a mutual fund or
insurance fund, which presumably could spread its costs out over
a larger base. Administrative costs usually run 25% less than in
a defined benefit plan, and companies can pass whatever expenses
are associated with these funds onto their employees.  "There is
a lot of cost shifting in these plans," noted Brian Ternoey, a
principal at A. Foster Higgins & Co., the Princeton, N.J., bene-
fits consulting firm.  Just as attractive for companies is the
fact that they no longer are liable for providing a specific
benefit far off in the future. Their only obligation is to moni-
tor the plan and make sure it is managed responsibly.  Because of
their low costs and limited liability, defined contribution plans
have found particular favor with smaller companies. And because
smaller companies create most new jobs, the number of individuals
and amount of assets covered by defined contribution plans is
growing far faster than those covered by defined benefit plans.
"All new pension coverage created in recent years has been in de-
fined contribution plans," observed Richard Heinz, director of
the Office of Research and Economic Analysis for the Labor
Department's Pension and Welfare Benefits Administration arm in
Washington. By the year 2000, there should be more money in de-
fined contributions than defined benefits, he added.  Defined
benefit plans currently hold an estimated $1.3 trillion in assets
compared with $1 trillion for defined contribution plans.  "We
figure (defined contribution plans) will grow 15% to 20% a year
in assets, while (defined benefit plans) will decline at a 3% to
6% annual rate," said Charles Salisbury, president of Baltimore-
based T. Rowe Price Trust Co., the trustee for 500 401(k) plans.
Contributing to the growth in defined contribution plans have
been major changes in employment patterns, particularly rising
work force mobility.  Thirty years ago, people used to change
jobs three to four times in their careers. Now they have eight to
10 jobs throughout their lives, notes Heinz.

Whereas defined benefit plans reward those who stay with one com-
pany for an extended period of time, employees usually are vested
in defined contribution plans within a matter of months, and the
funds in the plans are portable between jobs.  Whereas a company
may contribute only a minimal amount of money into a traditional
pension plan on behalf of a new employee in the early years, both
employees and companies tend to put more money into defined con-
tribution plans from the beginning.

"You have a much higher present value," said Douglas Culver, a
principal at benefits consulting firm William Mercer Inc. in Los
Angeles.  What worries Culver and others is that while 401(k)s
and similar plans were initially viewed only as savings vehicles
for individuals or supplements to existing pension plans, these
plans today are being asked to function as primary retirement
programs.  And unfortunately, most of the money in these plans is
invested in low-yielding funds.  Professionally managed defined
benefit plans tend to have at least 50% to 60% of their assets in
equities. But as Culver noted, 401(k) plans are typically invest-
ed at least 60% or 70% in fixed-income instruments.  In fact, 74%
of 401(k) plans have no money invested in equities, according to
figures compiled by Michael Goldstein, an analyst at Sanford C.
Bernstein & Co. Only 4% have more than 50% of their assets in-
vested in stocks.  The differences in how defined benefit and de-
fined contribution plans are allocated reflects the relative so-
phistication of the people making the investment decisions, note
advisers.  Investment professionals know that equities, despite
their more volatile nature, have provided real returns of better
than 7% on a compound annual basis over the last 60 years, ac-
cording to long-term studies conducted by Ibbotson Associates of
Chicago. By contrast, intermediate-term government bonds have
provided returns just 2% above inflation.  "We have shifted in-
vestment expertise onto the individual. (But) clearly, the aver-
age person is not that sophisticated," said General DataComm's
O'Connor. "We have gnawed away at that (problem). What is our
responsibility?" The answer for General DataComm and many other
companies is to ramp up efforts to educate employees. Several
pointed to the Labor Department's new 404(c) rules as an impor-
tant impetus.

The rules, which take effect in January 1994, lay out conditions
under which companies can relieve themselves of liability for the
investment decisions of employees in defined contribution plans.
To the extent that they can provide their participants with "suf-
ficient information" to make "informed investment decisions,"
companies will be relieved of liability.  Specifically, the rules
require that companies offer at least three distinct investment
alternatives, that they lay out the risk and return characteris-
tics of those alternatives and that they provide information on
past and current investment performance.  The two primary mes-
sages that Atlantic Electric recently tried to convey to its em-
ployees in rolling out its modified 401(k) plan were that "risk
is associated with expected returns" and "diversification," said
Ronald Justis, senior benefits specialist at the Atlantic City,
N.J.-based electric utility.  General DataComm tried to communi-
cate to its employees the central importance of the plan to their
retirements and the dramatic impact that compounding has on in-
vestment returns. The company wanted to make employees "aware of
the risk-return relationship" of each alternative, said O'Connor.
The results of these initial efforts were encouraging. According
to Diana Fuller, benefits specialist at General DataComm, employ-
ees are "champing at the bit to get into other options." Current-
ly, 60% of the 401(k) plan is in guaranteed investment contracts.
Justis said younger employees at Atlantic Electric are directing
as much as 75% of their contributions into stock-based accounts,
although the company's matching contribution is automatically go-
ing into a GIC. Older employees are still directing a majority of
their funds into fixed-income assets.

Critical to the education effort will be mutual fund companies.
Because of their name recognition and experience with retail cus-
tomers, mutual funds are garnering the largest segment of the
growing 401(k) market.

"We have to tell (individuals) to put themselves in harm's way,"
said Salisbury, whose firm helped both General DataComm and
Atlantic Electric roll out their new plans. "We're empowering
people to make an enlightened decision." Among the tools
Salisbury's firm uses is a computer program that allows people to
play "what if" games.  "Harnessing technology and information and
delivering it to the individual, that's what we're driving for,"
he said.  Loury said companies like his ultimately will offer
some sort of financial advisory for 401(k) participants.  These
are the types of market responses that David George Ball, assis-
tant secretary of labor for the Pension and Welfare Benefits Ad-
ministration, thinks will head off future problems with defined
contribution plans.  Ball is convinced that the education efforts
undertaken by mutual fund companies and others seeking to profit
from the trend toward employee-directed retirement plans will
result in a shift in how individuals allocate their portfolios.
"If you have the necessary information, you will make the ration-
al choice," he said.  Not everyone is so convinced, though.

"People are risk-averse," noted Steven Kronheim, a partner with
the Rogers & Wells law firm in New York.  Indeed, Salisbury ex-
pects the trend toward 401(k)s will result in less money for more
risky, entrepreneurial ventures and more money for fixed-income
investments.  But, like others, he believes education is criti-
cal.  "There is no choice in the matter," said Salisbury. "We
have to make lemonade out of lemons."

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