Press Release

Time May Not Be On Automatically Enrolled Employees' Side

Hewitt Study Shows Automatic Enrollment in 401k Plans Works Against Some Employees, Helps Others

LINCOLNSHIRE, Ill.--Hewitt Associates--Research shows that automatic enrollment--the practice of automatically signing up employees to participate in a company's 401k plan unless they specifically choose not to--can increase participation rates, but what is its impact over time? New research by Hewitt Associates, in conjunction with faculty and researchers from Harvard University and the University of Chicago(i), shows that automatic enrollment can work against some employees' asset accumulation, affecting their ultimate retirement income security.

Earlier research(ii) indicates that while automatic enrollment increases 401k plan participation rates, automatically enrolled participants tend to remain at the company's default elections, which often involve contribution rates of just 2-3 percent and conservative, low-returning investment funds, such as money market or stable value funds.

"While automatic enrollment clearly results in increased and immediate participation, our research shows that in some cases, it can actually work against employees over time," said Lori Lucas, defined contribution consultant, Hewitt Associates. ``This is due to the fact that employees tend to remain at the rate and fund into which they are defaulted for years, even though these defaults may be inappropriately conservative for their situation. For employees who would have participated even without automatic enrollment, this can offset much of the benefit of early participation. It is imperative that employers counteract this default behavior through plan design and communication."

The Hewitt study examined the participation and default behavior of 100,000 eligible employees hired before and after automatic enrollment was initiated at three U.S. companies over a two-to-three-year period(iii).

The Cost of Participation

The study indicates that many employees remain at the contribution rate and asset allocation elections from the automatic enrollment default even after years in the plan. At Company B, more than three-quarters (76 percent) of automatically enrolled employees with five months of tenure were contributing at the default savings rate of 3 percent and had 100 percent in the default money market investment fund. Two years later, while the number had dropped, it was still high--more than one-third (39 percent) of automatically enrolled employees with 26 months of tenure were contributing 3 percent and invested 100 percent in the money market option.

In contrast, only 2 percent of participants hired prior to automatic enrollment were contributing at the default rate, and invested 100 percent in the most conservative investment option (see chart).

"Participation is important, but for some automatically enrolled employees the quality of participation is poor because employees are remaining inappropriately at the conservative default elections," said Lucas. ``The tragic result is that these participants may not achieve their retirement goals."

Automatic Enrollment and Employee Tenure

Poor quality of saving under automatic enrollment is especially troublesome, Lucas notes, given that the primary benefit of automatic enrollment--increased participation --declines over time. For example, at Company A, the percent of employees with five months of tenure who had ever participated under automatic enrollment was 92 percent versus 24 percent prior to automatic enrollment--almost a 70 percentage point difference.

For employees with 36 months of tenure, the percent of employees having ever participated in the plan (98 percent) was still higher than for employees hired before automatic enrollment (64 percent), but the difference at that tenure level declined to 34 percentage points.

"It's important to understand that this decline is not because automatic enrollment becomes less effective at increasing participation, but because 401k participation tends to increase with tenure in the absence of automatic enrollment," said Lucas. ``By automatically enrolling employees who would have participated in the plan eventually, plan sponsors may get employees into the plan earlier, but at the cost of long-term savings because of persistently poor quality savings and investing behavior by automatic enrollees. Plan sponsors need to take steps to see to it that participants aren't lulled into a false sense of security just because they are automatically enrolled in the plan."

Action Needed by Employers, Employees

While the U.S. Treasury(iv) has encouraged the use of automatic enrollment in order to increase participant rates, it is important that employers and employees understand the best use of this feature.

"Automatic enrollment should be viewed as an enhancement, not a replacement for solid communication to employees about retirement investment decision making," said Lucas. ``Clear communication and targeted education are key."

Lucas also cautions employers that employees may be viewing default elections as cues from the company about the appropriate contribution rate and investment fund. ``Given the stickiness of defaults, employers may want to consider default funds and contribution rates that are more appropriate for the average participant over the longer term," she said.

For example, Lucas suggests, a balanced fund with some equity exposure may be a more appropriate starting point for the average participant than a stable value fund; and a default contribution rate that starts at the company's maximum match rate or steps up to that rate over time, instead of a default contribution rate of 2 -3 percent may be more suitable.

About Hewitt
Hewitt Associates LLC (www.hewitt.com) is a global management consulting and outsourcing firm. With 2000 revenues of nearly $1.3 billion, the firm is the largest employee benefits consulting firm in the United States. The largest provider of defined contribution services for large employers, Hewitt administers programs to more than 4.3 million employees.

Hewitt Study on Automatic Enrollment - - Other Findings

• The Hewitt study, conducted in conjunction with faculty and researchers from Harvard University and the University of Chicago, examined the participation and default behavior of 100,000 eligible employees hired before and after automatic enrollment was initiated at three U.S. companies over a two to three year period.
• Auto Enrollees and 401k Cash Withdrawals - Hewitt's study also reveals that when they leave their jobs, automatically enrolled employees are more likely to take a cash distribution instead of rolling their 401k balance into their new employers' plans or IRAs. For Company A, there is a 6 percent increase in the probability that automatically enrolled employees would take the cash distribution. At Company C, the likelihood increases by 20 percent. "Past Hewitt studies show that the lower the balance, the more likely the employee is take a cash distribution," said Lucas. ``This certainly holds true for automatically enrolled participants, who tend to have lower balances due to their tendency to stick with low default contribution rates and conservative default funds, with low returns."
• Pay Level and Automatic Enrollment - According to Hewitt's research, compensation level is a key factor in determining employees most likely to be - - and remain at - - defaults. At all three companies studied, lower paid employees are most likely to remain at default. At Company A, employees in the bottom third of the pay distribution are 30 - 32 percent more likely to be at default compared to employees in the top third of the pay distribution, while those in the middle third are approximately 15 - 17 percent more likely to be at default. At Company B, the lowest paid employees are 20 - 24 percent more likely to be at default, while employees in the middle of the pay scale are 16 - 20 percent more likely to be at default.

(i) "For Better or For Worse: Default Effects and 401k Savings Behavior" by James J. Choi, David Laibson, Brigitte Madrian and Andrew Metrick, in conjunction with Hewitt Associates.
(ii) Hewitt Associates press release "Automatically Enrolling Employees Not a Cure All," July 18, 2000
(iii) Company A has 40,000 employees. Under automatic enrollment, employees have a 2 percent default contribution rate and a stable value default investment fund.
Company B has 30,000 employees. Under automatic enrollment, employees have a 3 percent default contribution rate and a money market default investment fund.
Company C has 30,000 employees. Under automatic enrollment, employees have a 3 percent default contribution rate and a stable value default investment fund.
(iv) July 18, 2000 ``Preparing for the future by increasing national savings," Treasury Secretary Lawrence H. Summers Remarks to the National Tax Association, Washington, D.C.

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