Fees and Funds:Five Ways to Improve Your DC Plan


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Employers: Now’s the time to review your employees' retirement savings plan and remind employees of the value of planning for the long term. The current environment offers a number of opportunities to enhance your program while reducing plan costs.

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Fees and Funds:Five Ways to Improve Your DC Plan

  1. 1. Fees and Funds: Five Ways to Improve Your DC Plan Defined Contribution Plan Initiatives September 15, 2009 © 2009 Towers Perrin
  2. 2. Lisa J. Alkon  Lisa Alkon, Principal, National Leader, Governance and Compliance Advisory group — Towers Perrin Boston office  28 years of retirement consulting on compliance and design issues  Extensive experience with Fortune 1000 clients in both for-profit and not-for-profit environments  A recognized authority on governance and compliance issues © 2009 Towers Perrin 2
  3. 3. Marina L. Edwards  Marina Edwards, Senior Consultant, Governance and Compliance Advisory group — Towers Perrin Chicago office  A national leader for vendor search and fee benchmarking projects  19 years of 401(k), 403(b) and pension plan expertise in qualified and nonqualified plans  Extensive experience with Fortune 1000 clients and plan complexities  A recognized expert and speaker at defined contribution conferences and widely quoted in national publications © 2009 Towers Perrin 3
  4. 4. Peter D. Grant, CFA  Peter Grant, Senior Investment Consultant, Investment Consulting Group — Towers Perrin New York office  16 years consulting to 401(k) and pension plans, endowments and foundations  Extensive experience with Fortune 500 clients and plan complexities  A recognized guest speaker for national defined contribution and defined benefit conferences on target date funds, liability-driven investing and portfolio transition issues © 2009 Towers Perrin 4
  5. 5. Today’s agenda  Welcome and introductions  Webcast topics  Fiduciary best practices Vendor assessments and fee reviews  Target date funds   Annuity options  Company match issues   Questions and answers  Closing remarks © 2009 Towers Perrin 5
  6. 6. DC Plans — Market evolution  DC plan focus has evolved rapidly and issues around plan design are expected to grow  Corporate cost containment  Inadequacy of Social Security benefits for majority of population  Increasing emphasis on DC plans to adequately provide retirement income security  Employee concerns over retirement assets and retirement income security  For ERISA class actions, the monetary value of the Top 10 private plaintiff settlements entered into or paid in 2008 totaled $17.7 billion*  By comparison, 2007 totaled $1.8 billion *Sourc e: Seyfarth Shaw’s Fifth Annual Workplace Class Action Litigation Report © 2009 Towers Perrin 6
  7. 7. 1. Fiduciary best practices  Important time frames to remember  Collect and review DC plan investment fees (investment fee + revenue share) at least annually  As an interim step, every two to three years, obtain market pricing on the DC plan through a “request for information” (RFI)  Take the DC plan out to bid once every five to six years through a “request for proposal” (RFP)  Determine if company-driven events (layoffs, plant closings) will create restrictions on your stable value fund or loan payoff provisions  If DC plan has company stock  Understand if your advice product includes company stock in the analysis  Consider hiring an independent third-party fiduciary/trustee to advise on company stock (directed or discretionary)  Document, document, document © 2009 Towers Perrin 7
  8. 8. 2. Vendor search and fee reviews  Vendor assessments — areas to consider  Will there be a new plan design?  Are there new services that will be added?  Will the investment line-up be refreshed at that time?  Ensure you have a 404(c) checklist and clarity surrounding the vendor services © 2009 Towers Perrin 8
  9. 9. 2. Vendor assessments and fee reviews (cont.)  Fee reviews — areas to consider  What tools is the vendor providing toward full-fee disclosure?  Evaluate need for attorney-client privilege  Understand various benchmark approaches and potential risks — Large plans (assets >$500M) typically require customized RFI — “Plain vanilla” plans may be able to rely on non-RFI approaches  Assess whether the plan generates “excess revenue” — Do qualified diversified investment alternatives (QDIAs) Generate revenue to the vendor? — Seek to lower the investment share classes — Establish an “ERISA budget account” for excess revenue  Obtain clarity on pricing associated with nonqualified plans  Review equitability of fee structure to participants  Create a Fee Policy Statement © 2009 Towers Perrin 9
  10. 10. 2. Vendor assessments and fee reviews (cont.)  Vendor contract review and negotiation — areas to consider  Review notification timeline required if either party chooses to leave  Are there fees associated with leaving?  Understand whether there is a separate contract for the advice/managed account product  Implement vendor service guarantees with fees at risk for nonperformance  Has there been discussion or financial commitments from the vendor about retirement readiness/replacement income? © 2009 Towers Perrin 10
  11. 11. 3 and 4. Investment design introduction  The next segment of this Webcast focuses on DC plan investment design  Investment design, and products such as target date funds (TDFs) and annuities, are considered with respect to four areas Evolving DC plan investment designs  Achieving fundamental plan objectives, such as retirement income security Analytical processes of evaluation  Fit within a strategic DC plan decision-making framework  © 2009 Towers Perrin 11
  12. 12. 3 and 4. Evolution of DC plan — investment design Issues facing sponsors are cross functional “Personalized” Retirement  Addressing longevity risk through TDFs, Today Tom orrow  TDFs  Savings level annuities, etc.  Investment choice  Turnkey strategy Future  Advice engines  Age of savings depletion  Improving behavior through effective  Index: Percent returns  Index: Standard of living education and communication Issue Resolution  Containing plan costs and fees  Payout risk (TDFs, annuity, hybrid)  Savings properties (auto escalation matches, etc.)  Investment vehicles (traditional/Roth; in/out of plan  Adequate governance/compliance procedures annuity)  Governance/compliance audits 3- to 4-Tier Plan Design (15 options — unlimited) Present Choice Resolution (10-100+ options) Past Simple Structures (<10 options) 1980s 1990s 2000s 2010s 2020s © 2009 Towers Perrin 12
  13. 13. 3 and 4. DC plan evolution — plan sponsor actions  The actions we see today that start personalizing retirement include  Savings Levels: Understanding how to improve DC plan decisions and investment design by combining quantitative analysis of savings patterns with investment strategy decisions (e.g., target date fund asset allocation)  Turnkey Strategies: Incorporating the plan objective (e.g., retirement income security) in the evaluation of alternative turnkey strategies, and including in the analysis unique benefit elements (pension benefit) and corporate demographics  Age of Savings Depletion: Using a quantifiable metric in the evaluation of investment design that can be communicated to participants once the sponsor determines the investment structure  Standard of Living: Adding another consideration to the objective- setting and ongoing evaluation process that ties corporate benefit strategy to plan sponsor decision making © 2009 Towers Perrin 13
  14. 14. 3. Target date funds — what we already know  TDFs and risk-based (life strategy or life cycle) funds help participants by providing one plan option that adjusts investment risk based on either age or risk preference  Lawmakers acknowledged benefits of these funds by classifying them as QDIAs in 2008 Interest Knowledge Target Date Multi-Asset Funds Time Risk-Based Multi-Asset Funds (life cycle) (life strategy or balanced) % Allocation % Allocation Money Market High Yield U.S. Inv. Grade Fixed Inc. EAFE Domestic Equity Age Age © 2009 Towers Perrin 14
  15. 15. 3. Target date funds — what remains uncertain  However, variability in TDF performance in 2008 and the fairly flat slope of many TDF glide paths indicate that the market has yet to reach consensus on the age-old conundrum: How to adequately address longevity risk without increasing investment risk Top 15 Target Date Funds One-Year Return at 3/31/09 One-Year Return Distribution 10 3.1 0 16 14 -10 12.12 -20 12 -21.3 -23.8 -30 8 -40 -35.5 -38 -38.1 6.75 2010 2030 2050 60% S&P Bar- Funds Funds Funds Equity/ 500 Agg. 4 3.75 4 40% 2.25 Fixed 0 Std. dev. Range Sourc e: eVestment Allianc e database © 2009 Towers Perrin 15
  16. 16. 3. Target date funds — fiduciary responsibilities  Fiduciary responsibilities can vary depending upon whether the TDFs are customized or off the shelf (see table below)  Addressing longevity risk is not on the list of responsibilities Primary Fiduciary Responsibilities: Customized vs. Off-the-Shelf TDFs Fiduciary Responsibilities Customized Off the Shelf Select/monitor the TDF manager No Yes Design/monitor the TDF “glide path” Yes No Select/monitor investment managers Yes No Rebalance/monitor portfolio allocations Yes No  Sponsors are starting to improve the TDF selection process using quantitative analysis and incorporating the savings program objective. Key issues being added to the analysis include  Does the company sponsor a DB plan?  What is the combined participant and employer savings profile?  How are participants’ assets currently invested, and what is their demographic profile?  What is the targeted probability of retirement income security? © 2009 Towers Perrin 16
  17. 17. 3. Target date funds — connecting the plan objective and investment strategy evaluation  Connecting the fundamental objective of retirement income security with the TDF scenario analysis helps to resolve key issues  Implications of the current benefit design and its adequacy in providing long-term investment security  How to connect the investment decision-making process to the investment program’s underlying objective  The shortcomings of common participant savings practices Sample Scenario Analysis Illustration Projected Age for Savings Depletion for 60 Year Olds* 100% Fixed 60% Equity/40% Fixed Active TDF Passive TDF Percentile Outcome 50% Worst 10% 50% Worst 10% 50% Worst 10% 50% Worst 10% Pension, plus 6% 104 91 119 114 119 109 119 109 savings No pension, 6% savings 76 75 82 76 83 76 81 76 No pension, 12% savings 85 85 116 98 114 94 113 95 * Assumes retirement at 65, 70% inc ome replac ement, $60k salary and Soc ial Sec urity benefits. © 2009 Towers Perrin 17
  18. 18. 4. Why add annuity options to a 401(k)? Employees are increasingly responsible for ensuring Employees need access to they do not outlive their tools and products to help retirement funds… them meet their retirement And they are expected to income needs live longer Employers are shifting away from offering defined benefit Employers have several plans to defined contribution alternatives when considering plans annuities © 2009 Towers Perrin 18
  19. 19. 4. Annuities — update on common considerations  To help address longevity risk for participants, several annuity products today are designed to provide 401(k) participants with lifetime income upon retirement  While common annuity structures can lessen longevity risks, plan sponsors are just starting to evaluate how to utilize the investment option either in plan or out of plan  Recent surveys indicate that only a few sponsors have added annuities. Limited usage most likely is due to:  Additional legal requirements (especially for in-plan options) despite recent DOL safe harbor addressing annuity provider selection  Benefit portability  Participant usage  Complexity in communication and participant education  Less attractive annuity benefit due to low interest-rate environment  Credit risk © 2009 Towers Perrin 19
  20. 20. 4. Annuities – what are the choices? Provide annuity distribution option from Plan at retirement  Plan purchases annuity, and then distribute at retirement or hold in plan  Both purchase and holding of annuity subject to ERISA fiduciary standards and joint and survivor requirements can apply  Benefits include more favorable rates and features Facilitate annuity payment at retirement  Plan distributes lump sum that is rolled into IRA annuity; also can facilitate out of plan product usage for appropriateness  Out of plan option reduces, and can remove ERISA fiduciary exposure Provide annuities as in-plan investment option  Provides ability to average annuity rates over career, potentially offers minimum returns and equity exposure, and facilitates guaranteed income  ERISA requirements, usage, structure, and cost are obstacles to address © 2009 Towers Perrin 20
  21. 21. 4. Annuities — the change afoot  A recent DC plan survey by PIMCO of 32 investment consulting firms indicated  Only 22% of respondents indicated they were “unlikely to add a guaranteed income product” (53% “somewhat likely” and 25% “likely” to “very likely” to add guaranteed income product)  Lifetime income (guaranteed minimum withdrawal benefit) was the most appealing product with 84% interest; fixed annuities were second at 65%  Primary concerns for not including a guaranteed product included — Insurance company default risk (84%) — Cost (72%) — Transparency (68%) © 2009 Towers Perrin 21
  22. 22. 4. Annuities — the change afoot (cont.)  Insurance industry products under review by interested clients include  Lifetime income (guaranteed withdrawal benefit)  Fixed annuity  Longevity insurance  Variable annuity © 2009 Towers Perrin 22
  23. 23. 3 and 4. Next steps to develop strategic game plan  The future of retirement income security depends upon several key factors  Understanding the cost in terms of required savings and contributions  Offering simple solutions that participants can easily understand  Education that addresses prudent investment and saving behavior  Assuming DC plans are the preferred savings vehicle going forward, key action steps include  Quantifying the plan’s basic objectives (e.g., what is the target age of savings depletion and level of retirement income security)  Measuring how saving practices and investment strategies combine to support objective attainment  Having a strategic game plan that connects the decision-making process and action steps to a plan objective, such as retirement income security © 2009 Towers Perrin 23
  24. 24. 5. Is reinstating the 401(k) match the right solution in a recovering business environment?  Many employers changing/suspending the 401(k) match expect the change to be temporary  For most, the basic expectation is that the suspended match will be restored in its pre-suspension form once business conditions improve  A number of employers are taking a second look at that supposition with an eye toward three areas of consideration  to profitability Link Total retirement adequacy  Total rewards allocation and health/wealth linkages  © 2009 Towers Perrin 24
  25. 25. 5. Finding the right retirement solution: The role of the workforce Workforce Considerations Employees Are Our Most Important Investors Employees Are Focus on employee Our Greatest Asset engagement and performance — unleashing discretionary effort Employees Are Our Highest Cost Focus on maximizing human capital ROI Focus on reducing total labor costs Design Perspective © 2009 Towers Perrin 25
  26. 26. 5. Can programs be redesigned to revise incentives, and improve tax efficiency and retirement adequacy? Today’s Employee Compensation Future Employee Compensation Matc Matc h h Suspended Cash 401(k) 401(k) Cash 401(k) 401(k) ee match ee match contrib. contrib. Health Health Health Funded Cash Capped or HSA care Insurance Pension insurance ret. HRA balance no ret. med. Current Consumption Future Consumption Current Consumption Future Consumption © 2009 Towers Perrin 26
  27. 27. 5. Other defined contribution design considerations  Enhancement to include Roth 401(k) contributions  Allow employees window during 2010 for in-service withdrawals for conversion to Roth IRA  Limitations on in-service withdrawals  Unused vacation/sick time as contributions  Investment advice versus investment education © 2009 Towers Perrin 27
  28. 28. For more information Lisa Alkon 617.638.3922 lisa.alkon@towersperrin.com Marina Edwards 608.838.8640 marina.edwards@towersperrin.com Peter Grant 212.309.3620 peter.grant@towersperrin.com © 2009 Towers Perrin 28