3D/L Capital Management attended the 2022 Dimensional Defined Contribution Annual Conference. 3D/L received permission from Dimensional Funds to publish highlights along with our own feedback on some of the findings. This blog piece should not be construed as an endorsement of Dimensional Funds nor of any of the topics covered below. Contact us if you would like to receive a copy of the presentation, and we will coordinate with Dimensional.
Heimer begins his presentation with a typical behavioral anecdote on how we tend to overmagnify risks relative to probabilistic outcomes. Sharks are viewed as more deadly to humans than cows yet, annual cow-related human deaths are 20 times higher than sharks, on average. Prudential surveyed Austin residents on the age of the oldest person known personally which skewed to the right versus the actuarial average. We tend to over/under-estimate our mortality experience based on personal experiences as well as culturally derived beliefs and imagery.
Heimer cites federal consumer surveys measuring subjective views of mortality vs actual mortality (Figure 1). In a nutshell, younger age cohorts tend to underestimate longevity (pessimistic) while older age cohorts tend to overestimate longevity (optimistic) versus actuarial experiences. University of Michigan studies observed something similar where Age 55 seems to represent the fulcrum between pessimistic to optimistic views of mortality. Survival beliefs on mortality seem to change systematically over one’s life cycle.
Figure 1 – Subjective vs Objective Views of Mortality Flip as One Ages
Heimer believes this pessimistic/optimistic view of mortality between younger versus older people affects their propensity to spend (YOLO Consumption versus Cautious Consumption, respectively) and save for retirement (under vs over saving, respectively). This leads to under-saving during ‘accumulation’ years in the career life cycle and underspending of savings in the post-retirement years.
Heimer sought to test whether mortality beliefs do indeed affect spending/saving patterns across age cohorts. He led a research effort that surveyed 5000 respondents with age brackets from 28 through 78 (excluding milestone years like ‘40’), balanced between male/female and controlling for household income, numerical abilities, and health factors. The survey measured survival beliefs over 1, 2, 5, and 10 years as well as what constituted greater risks to mortality (freak events versus normal events like medical conditions).
Heimer found that younger people held a more pessimistic view of their own survivability and tended to overweight low probability ‘freak’ risk factors such as dying from a shark attack while older people held a more optimistic view of their survivability and overweighted ‘normal’ risk factors such as medical conditions and natural causes. Locality had some secondary influence on mortality views (e.g. more likely to die of a hurricane for residents in hurricane zones).
When compared to actuarial stats from the Social Security Administration (2017), these findings led Heimer to frame a view of a “Dynamic Life-Cycle Model with Precautionary Savings” as younger people under-saved while overweighting risky assets (higher equity mixes) in order to play catch up as the higher incidence of mortality expected did not pan out. This leads to older people holding a more optimistic view of longevity with a propensity to under-consume for fears of living out their retirement savings.
3D/L’s assessment: Heimer’s findings reaffirm our view that ‘accumulation’ planning is distinct from ‘post-retirement income’ planning, not just from an investment point of view but also from a behavioral point of view where future cash flow expectations should be properly mapped to both investment uncertainty and mortality expectations. The retirement age also represents a nexus in expectations such that post-retirement planning should ideally begin five to 10 years prior to retirement. One drawback from Heimer’s study is treating the post-retirement cohort as one cohort rather than multiple cohorts (‘honeymoon’ overspending early stage, steady state middle stage, and late-stage care) where post-retirement spending tends to follow a U-shaped pattern rather than a steady stream.
Fiduciary Best Practices: Incorporating Environmental, Social, and Governance (ESG) Practices into an Evaluation Framework.
Update from Ian Kopelman, DLA Piper.
Not a lot of change from last year’s update. Biden admin removing the ‘cautious’ view of ESG that prevailed under Trump admin. Biden admin confirming ESG is an appropriate approach as long as performed within a financial-based framework (i.e. success/failure of an investment strategy). Nothing magical about ESG – a fiduciary must consider all aspects from a financial standpoint.
The 2021 Department of Labor Proposed ESG Rules have yet to be finalized, but the comment period ended 12/13/2021. Initial proposal: can’t ignore ESG but does provide more color to fiduciary responsibilities. Kopelman cautions using ESG on a stand-alone basis and even more cautious as a QDIA.
The proposal under consideration will also update broader fiduciary practices:
Adds language on investment prudence
Clarifies that a fiduciary may consider climate change (and other ESG) that is ‘material’ to the risk/reward analysis. Kopelman believes this can be codified in the investment policy statement as part of the review process. ESG is one of a number of appropriate considerations that can be spelled out in the IPS.
Removes prohibition of including ESG or ESG-themed investments in a plan’s QDIA (although Kopelman is more cautious when it comes to the QDIA).
The upshot: Defend the process not the results. No process is bulletproof but having a process, and following it rigorously with documentation, is tantamount for plan fiduciaries, especially when they tread into areas beyond pure investment considerations, such as ESG.
Plan Administration, Investment, and Regulatory Hot Topics.
Panel discussion with Daniel Aronowitz (Euclid Fiduciary), Aaron Borders (DFA), Will Hanson (American Retirement Association), Mathieu Pellerin (DFA), and Bonnie Treichel (Endeavor Retirement).
Update on Secure Act 2.0.
Currently in Senate committee; panel feels reasonably confident bill will pass following mid-term elections. Some differences with the House version to be ironed out but agreement on core principles.
Need to cap spending provision to $40 billion, much of it taken up in changes to required minimum distributions (RMDs). Senate version seeks to raise minimum age to 75 but not until 2031 whereas House version would step up age limits gradually.
There are provisions for student loans and emergency savings.
Tax credits for start-up plans ($5000 per year for up to 5 years).
Bare-bones 401(k) employer only to receive safe harbor.
CommonSpirit Health case on active funds and excessive fees. 6th circuit decision on active management and excessive fees raises the hurdle for litigation but hasn’t stopped lawsuits such as those filed against 11 of the largest plan sponsors for holding actively managed target-date funds that have lagged passive comparables, despite the former only charging 11 basis points in some cases. If the lawsuit prevails, it could send a chill through plans that have adopted actively managed funds. The 6th circuit decision should prevail, but this will need to be monitored.
Cybersecurity and access to plan participant data to remain a key regulatory focus.
Cryptocurrency options for DC plans? In general, investment decisions must pass rationale based on prudent process. Hurdle will be high for plan sponsors even if recordkeepers make digital assets an available option. A crackdown or heightened scrutiny on crypto by the DOL could also broaden to self-directed brokerage accounts.