fees and funds:five ways to improve your dc plan

© 2009 Towers Perrin

Fees and Funds:Five Ways to Improve Your DC Plan

Defined Contribution Plan Initiatives

September 15, 2009

© 2009 Towers Perrin 2

Lisa J. Alkon

Lisa Alkon, Principal, National Leader, Governanceand Compliance Advisory group — Towers PerrinBoston office

28 years of retirement consulting on complianceand design issues

Extensive experience with Fortune 1000 clientsin both for-profit and not-for-profit environments

A recognized authority on governance andcompliance issues


Marina L. Edwards

Marina Edwards, Senior Consultant, Governanceand Compliance Advisory group — Towers PerrinChicago office

A national leader for vendor search and feebenchmarking projects

19 years of 401(k), 403(b) and pension planexpertise in qualified and nonqualified plans

Extensive experience with Fortune 1000 clientsand plan complexities

A recognized expert and speaker at definedcontribution conferences and widely quotedin national publications


Peter D. Grant, CFA

Peter Grant, Senior Investment Consultant, InvestmentConsulting Group — Towers Perrin New York office

16 years consulting to 401(k) and pension plans,endowments and foundations

Extensive experience with Fortune 500 clientsand plan complexities

A recognized guest speaker for national definedcontribution and defined benefit conferenceson target date funds, liability-driven investingand portfolio transition issues


Today’s agenda

Welcome and introductions Webcast topics

Fiduciary best practicesVendor assessments and fee reviewsTarget date fundsAnnuity optionsCompany match issues

Questions and answers Closing remarks


DC Plans — Market evolution

DC plan focus has evolved rapidly and issues around plan design areexpected 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

*Source: Seyfarth Shaw’s Fifth Annual Workplace Class Action LitigationReport


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 loanpayoff 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


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


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


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?


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 areasEvolving DC plan investment designsAchieving fundamental plan objectives, such as retirement

income securityAnalytical processes of evaluationFit within a strategic DC plan decision-making framework


3 and 4. Evolution of DC plan — investment design

1980s 1990s 2000s 2010s 2020s

Past

Pres

ent

Futu

re

Issues facing sponsors are cross functional

Addressing longevity risk through TDFs,annuities, etc.

Improving behavior through effectiveeducation and communication

Containing plan costs and fees

Adequate governance/compliance procedures

Simple Structures(<10 options)

Choice Resolution (10-100+ options)

3- to 4-Tier Plan Design (15 options — unlimited)

“Personalized” RetirementToday TomorrowTDFs Investment choiceAdvice engines Index: Percent returns

Issue ResolutionPayout risk (TDFs, annuity, hybrid)Savings properties (auto escalation matches, etc.) Investment vehicles (traditional/Roth; in/out of plan

annuity)Governance/compliance audits

Savings levelTurnkey strategyAge of savings depletion Index: Standard of living


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 savingspatterns with investment strategy decisions (e.g., target date fundasset allocation)

Turnkey Strategies: Incorporating the plan objective (e.g., retirementincome 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 theevaluation of investment design that can be communicated toparticipants once the sponsor determines the investment structure

Standard of Living: Adding another consideration to the objective-setting and ongoing evaluation process that ties corporate benefitstrategy to plan sponsor decision making


3. Target date funds — what we already know

TDFs and risk-based (life strategy or life cycle) funds help participantsby providing one plan option that adjusts investment risk based on eitherage or risk preference

Lawmakers acknowledged benefits of these funds by classifying them asQDIAs in 2008

Target Date Multi-Asset Funds(life cycle)

Age

Money MarketHigh YieldU.S. Inv. Grade Fixed Inc.EAFEDomestic Equity

Age

% A

lloca

tion

Risk-Based Multi-Asset Funds(life strategy or balanced)

% A

lloca

tion

Time

KnowledgeInterest


3. Target date funds — what remains uncertain

However, variability in TDF performance in 2008 and the fairly flatslope of many TDF glide paths indicate that the market has yetto reach consensus on the age-old conundrum: How to adequatelyaddress longevity risk without increasing investment risk

Top 15 Target Date Funds

2.25

3.754

6.75

12.12

14

0

4

8

12

16

One-Year Return at 3/31/09 One-Year Return Distribution

Std. dev. Range

3.1

-38.1

-23.8

-38-35.5

-21.3

-40

-30

-20

-10

0

10

2010Funds

2030Funds

2050Funds

60%Equity/40%Fixed

S&P500

Bar-Agg.

Source: eVestment All iance database


3. Target date funds — fiduciary responsibilities

Fiduciary responsibilities can vary depending upon whether the TDFsare customized or off the shelf (see table below) Addressing longevity risk is not on the list of responsibilities

Sponsors are starting to improve the TDF selection process usingquantitative 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?

NoYesRebalance/monitor portfolio allocations

NoYesSelect/monitor investment managers

NoYesDesign/monitor the TDF “glide path”

YesNoSelect/monitor the TDF manager

Off the ShelfCustomizedFiduciary Responsibilities

Primary Fiduciary Responsibilities: Customized vs. Off-the-Shelf TDFs


3. Target date funds — connecting the planobjective and investment strategy evaluation

Connecting the fundamental objective of retirement income securitywith 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

113 95 114 94 116 98 85 85No pension, 12% savings

81 76 83 76 82 76 76 75No pension, 6% savings

119 109 119 109 119 114104 91Pension, plus 6%savings

Passive TDF50% Worst 10%

Active TDF50% Worst 10%

60% Equity/40% Fixed50% Worst 10%

100% Fixed50% Worst 10%Percentile Outcome

Projected Age for Savings Depletion for 60 Year Olds*

*Assumes retirement at 65, 70% income replacement, $60k salary and Social Security benefits.


4. Why add annuity options to a 401(k)?

Employers are shifting away from offering defined benefit plans to defined contributionplans

Employees are increasinglyresponsible for ensuring they do not outlive theirretirement funds…And they are expected tolive longer

Employees need access totools and products to helpthem meet their retirementincome needs

Employers have several alternatives when considering annuities


4. Annuities — update on common considerations

To help address longevity risk for participants, several annuityproducts today are designed to provide 401(k) participantswith lifetime income upon retirement

While common annuity structures can lessen longevity risks,plan sponsors are just starting to evaluate how to utilize theinvestment 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


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 fiduciarystandards and joint and survivor requirements can apply

Benefits include more favorable rates and featuresFacilitate 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 exposureProvide annuities as in-plan investment option Provides ability to average annuity rates over career, potentially offers

minimum returns and equity exposure, and facilitates guaranteedincome

ERISA requirements, usage, structure, and cost are obstacles toaddress


4. Annuities — the change afoot

A recent DC plan survey by PIMCO of 32 investment consultingfirms indicated Only 22% of respondents indicated they were “unlikely to add

a guaranteed income product” (53% “somewhat likely” and25% “likely” to “very likely” to add guaranteed income product)

Lifetime income (guaranteed minimum withdrawal benefit) was themost appealing product with 84% interest; fixed annuities were secondat 65%

Primary concerns for not including a guaranteed product included— Insurance company default risk (84%)— Cost (72%)— Transparency (68%)


4. Annuities — the change afoot (cont.)

Insurance industry products under review by interestedclients include Lifetime income (guaranteed withdrawal benefit) Fixed annuity Longevity insurance Variable annuity


3 and 4. Next steps to develop strategic game plan

The future of retirement income security depends upon severalkey 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, keyaction 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 asretirement income security


5. Is reinstating the 401(k) match the rightsolution in a recovering business environment?

Many employers changing/suspending the 401(k) match expectthe change to be temporary

For most, the basic expectation is that the suspended matchwill be restored in its pre-suspension form once businessconditions improve

A number of employers are taking a second look at that suppositionwith an eye toward three areas of considerationLink to profitabilityTotal retirement adequacyTotal rewards allocation and health/wealth linkages


5. Finding the right retirement solution:The role of the workforce

Focus on reducingtotal labor costs

Focus on employeeengagement andperformance —

unleashingdiscretionary effort

Employees AreOur Most Important

Investors

Employees AreOur Greatest Asset

Employees Are Our Highest Cost Focus on maximizing

human capital ROI

Wor

kfor

ce C

onsi

dera

tions

Design Perspective


5. Can programs be redesigned to revise incentives,and improve tax efficiency and retirement adequacy?

401(k)match

Cash 401(k)eecontrib.

Current Consumption Future Consumption

Capped orno ret.med.

HealthInsurance

Healthcare

Cash 401(k)match

Current Consumption Future Consumption

HSA

Match

Fundedret. HRA

Healthinsurance

Today’s Employee Compensation Future Employee Compensation

Suspended

401(k)eecontrib.

Cash balance Pension

Match


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


For more information

Lisa [email protected]

Marina [email protected]

Peter [email protected]

fees and funds:five ways to improve your dc plan

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