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Government, Education, and Utility Sectors, Could be fit for an Aggressive Target Date Fund Glide Path

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Executive Summary

  • The U.S. Department of Labor (DOL) gave guidance for fiduciaries of defined contribution (DC) plans to consider the demographics of plan populations in assessing target date fund (TDF) glide paths.

  • The governmental, education, and utility sectors, though distinctly different, have important commonalities in the types of TDFs they should select.

  • Aon believes that most—but not all—plans in the governmental, education, and utility sectors have characteristics that make them suited for TDF glide paths that are more aggressive than the industry average TDFs built for the average American plan population.

    • Their potential to earn and save—sometimes called “human capital”— tends to be more predictable than that for workers in other sectors. The lower risk in this aspect of their circumstances allows for greater capacity to take risk with their financial assets, such as TDFs.

    • They are more likely to have benefits from a defined benefit pension plan. Given the lower risk nature of pension benefits, the participants should have more risk in their investments, such as TDFs, to maintain appropriate levels of risk for their holistic financial situations.

  • Addressing these population characteristics typically can be done with either an off-the-shelf product or a custom TDF.


It should come as no surprise that TDFs don’t give personal investment advice for individuals. They don’t account for all of the unique characteristics of every person. Whenever there is more than one participant in a plan, the TDFs must attempt to balance the needs of multiple people with different characteristics and investment needs. A TDF is ultimately a one-size-fits-all default investment built for the “average” participant, based only on their expected retirement date.

How should plan sponsors determine the “average” participant? Should it be the average participant in the world, or should it be the average participant in the plan? Fortunately, the DOL provides clear guidance in its February 2013 publication entitled, “Target Date Retirement Funds—Tips for ERISA Plan Fiduciaries.” It says that fiduciaries should consider the “possible significance of other characteristics of the participant population, such as participation in a traditional defined benefit pension plan offered by the employer, salary levels, turnover rates, contribution rates, and withdrawal patterns.” That is, the characteristics of the plan population should drive the characteristics of the plan’s TDF.

There are many characteristics of populations in the governmental, education, and utility sectors that make them different from the average employee group (and different from each other). Not all of those characteristics are material for selecting TDFs, and many will vary by individual plan. However, we frequently see two important characteristics in populations in these sectors that create suitability for above-average levels of return-seeking assets, such as equities. These characteristics are (1) lower risk in their “human capital” and (2) participation in open defined benefit plans (including traditional and cash balance). We’ll discuss each in more detail.

Lower Risk in "Human Capital"

The human capital / financial capital theory influences the construction of many TDFs1. The theory states that people have two main forms of capital for their retirement needs:

  • Human capital—the potential to earn and save for retirement.
  • Financial capital—assets intended for retirement income, such as stocks and bonds.

Human capital is typically viewed as bond-like because it is based on a predictable stream of wages or contributions. Alternatively, financial capital is mostly a mix of stocks and bonds. Young participants’ capital tends to be mostly human capital, since they have low account balances and many years of future earnings ahead of them. Because their human capital is bond-like, their financial capital can be invested aggressively (lots of equities) to balance out their total risk exposures. As participants get older, their wealth includes less future earnings and higher balances of financial assets. As a result, their financial assets need to become less aggressive to ensure they are not taking too much risk.

However, human capital is not always as certain as bonds and can have uncertainty that makes it somewhat equity-like, especially when there are characteristics such as:

  • Uncertainty of the rate of long-term pay increases.
  • Significant exposure to performance-based compensation or overtime hours, especially when these can be influenced by the economic environment.
  • Potential for layoffs, especially during an economic downturn.

Most populations of government workers and employees of educational institutions and utilities tend to exhibit these characteristics less than the average population, which is more exposed to the same economic cycles that influence the returns of equities. That is, government workers and employees of educational institutions and utilities tend to have human capital that is more bond-like than average. This allows them to take more risk in their DC plan to balance out their total risk exposures. We see this as most relevant for mid-career participants, as described in the following table and graph.

Impact of Pensions on Selecting Target Date Funds

A disproportionate share of people in the governmental, education, and utility sectors have defined benefit pensions (including traditional designs and cash balance plans). This should affect what they do in their DC plans. This is because a defined benefit plan is a low-risk asset for participants as it is a protected source of income; thus, having a defined benefit plan can allow participants to take more investment risk in their DC plan to balance their total exposures. Without making such an adjustment, participants with pension benefits would have too few return-seeking assets (e.g., equities). The following exhibit shows how this might impact the glide path.

The following exhibit shows the prevalence of defined benefit plans for salaried employees in utilities and public universities, compared to all salaried employees, based on data from Aon’s Benefit SpecSelectTM tool2. It is noteworthy that each of these sectors has well-above-average prevalence of open defined benefit plans. Utilities are noteworthy because they have a particularly large proportion of “closed” plans, where senior employees were grandfathered into the defined benefit plan, but new hires are not included. Typically, employers with closed defined benefit plans have a high prevalence of defined benefit accruals among older employees and low prevalence among younger employees. For universities, it is worth highlighting that this data focuses on public universities, which have a much higher prevalence of defined benefit plans than private universities. Other governmental sectors are not included due to limited data, but anecdotally, we know that they have above-average prevalence for defined benefit plans.

Of course, for each individual employer, their population circumstances are dictated by their specific benefit programs, not what others in their sector have. In that sense, the main thesis of this paper is about tendencies for these sectors, not necessarily what is right for every employer in these sectors.

Length of Employee Service Strengthens the Impact

Longer employee service—the length of time they spend with their employer—also impacts the case for a higher risk glide path. Longer service gives more confidence in asserting that employees in these sectors have lower risk “human capital” because these employees stay in their sectors for larger portions of their careers. Further, it increases the likelihood of vesting in the defined benefit plan as well as the significance of these benefits for the employees.

The DOL Bureau of Labor Statistics produces some information showing employee service in different sectors. The following table includes some of that information:3

Mixed Populations

Any DC plan with more than one participant has a mixed population. The degree of heterogeneity may influence the preferred solution, but it shouldn’t stop the fiduciaries from reviewing the population tendencies and determining if they should affect the glide path.

In some cases, populations will exhibit generational trends, such as older employees having benefits from a pension plan while younger participants do not. This is common when there is a closed or frozen pension plan. In such a case, the shape of the glide path might reflect the different circumstances of each age cohort, which would evolve over decades as the group with pension benefits gradually exits the plan.

Regardless of a plan sponsor’s situation, fiduciaries should:

  • Consider the prevalence and importance of population characteristics.
  • Build or select a glide path for their average participants.
  • Make sure that the glide path is reasonable for participants who are different from the average participant.


Most (but not all) DC plans for the governmental, education, and utility sectors have demographic characteristics that make them better suited for TDFs with more aggressive glide paths.

Implementing a more aggressive glide path may be done with off-the-shelf products or custom TDFs. There are a wide variety of risk levels available from off-the-shelf products. A custom approach may be preferable if the plan sponsor wants to:

  • Have more control over the glide path to address their changing population.
  • Use open architecture to implement their best ideas for underlying managers.
  • Include more sophisticated asset classes to improve participants risk-adjusted returns.
  • Gain full fee transparency.
  • Cost, materiality, and governance will influence the ultimate outcome.

We highlighted three specific sectors—government, education, and utilities—because they frequently have characteristics that point toward suitability for a higher risk TDF glide path: predictable compensation, pension benefits for most employees, and long service populations. Of course, the generalizations this paper makes about these sectors will have varying degrees of applicability for each employer, and they should know how well these trends match their own demographics. As the cliché says, if the shoe fits…


“Bureau of Labor Statistics: Employee Tenure in 2018.” USDL-18-1500.
“Target Date Retirement Funds—Tips for ERISA Plan Fiduciaries.” U.S. Department of Labor. February 2013.
Donaldson, Scott J., Francis M. Kinniry, Jr., Vytautas Maciulis, Andrew J. Patterson, and Michael A. DiJoseph. “Vanguard’s approach to target-date funds.” 2015.
Idzorek, Tom and David Blanchett. “Beyond Target-Date: Allocations for a Lifetime.” 2009 Morningstar Indexes Yearbook.
“Human capital and target date funds.” BlackRock. 2018.
Bailey, Sabrina, Lee Freitag, Gaobo Pang, Paul Root, and Amanda Beers. “Glidepath Innovation to Drive Better Participant Outcomes.” Northern Trust. March 2017.

1 Vanguard, BlackRock, Morningstar and Northern Trust are among the other TDF providers that explicitly state that their glide paths are influenced by the human capital / financial capital theory.
“Vanguard’s approach to target-date funds.” 2015
“Beyond Target-Date: Allocations for a Lifetime.” 2009 Morningstar Indexes Yearbook
“Human capital and target date funds.” BlackRock. 2018
“Glidepath Innovation to Drive Better Participant Outcomes.” Northern Trust. March 2017

2 Benefit SpecSelectTM is one of Aon’s proprietary tools to help plan sponsors understand the  benefit programs of their peers and competitors. It includes data for nearly 1,100 participating organizations representing over 50 industries. While we summarize the results for this paper, the tool has additional detail on the types of defined benefit plans as well as which employees are receiving benefits from them, in addition to detailed information on other benefit programs.

3 Bureau of Labor Statistics: Employee Tenure in 2018 USDL-18-1500

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