Structural Design and Management of Defined Contribution Programs

Transcription

1 Structural Design and Management of Defined Contribution Programs Stuart Brahs Vice President Federal Government Relations Hyderabad, India May 29-30, 2003

2 The History of Private Pension Plans 1875 First private pension plan started by American Express 1921 Tax deferred structure created - Taxes are paid at benefit distribution 1942 Non-discrimination laws put in place 1974 ERISA (Employee Retirement Income Security Act of 1974) enacted to protect employee rights/benefits 1978 Revenue Act created qualified cash/ deferred arrangements (401k plans) 1986 TRA 86 (Tax Reform Act of 1986) reduced contribution limits to increase tax revenue 2001 EGTRRA increased deferral limits, established faster vesting rules and tax credit for employers setting up a first-time plan

3 Pre-ERISA Times 1. Market was primarily dominated by large corporations with Defined Benefit and Cash-Bonus plans 2. Number of employees covered under corporate retirement plans: ,600, ,600, ,000, ,500,000 Source: IRS, BLS, Lexington Institute

4 Pre-ERISA Times 3. Rules governing pension regulation were loose in general and were highly employer-favored: - benefits often did not vest until normal retirement age - if company went bankrupt or out of business, pension benefits could be lost - employer could offer a plan to a select group of employees - bad boy clause - no disclosure requirement to the federal government - lack of minimum funding standards Source: IRS, BLS, Lexington Institute

5 ERISA Times In 1974 the Employee Retirement Income Security Act (ERISA) was passed: - Curtailed employer abuse in retirement programs - Pension Benefit Guarantee Corporation (PBGC) - Rules about eligibility, benefit limits, funding, vesting, reporting and disclosure all came into being - Allowed individual retirement accounts (IRAs) for individuals not covered under an employer-sponsored pension plan

6 Private Pension Assets Shift from DB to DC $60 $20 $137 $234 $431 $636 $1,288 $2,795 $185 $376 $795 $735 $1,463 $900 $1,461 $2,526 $2, Defined Benefit Defined Contribution IRA Source: Federal Reserve and Spectrem Group

7 Key Success Factors in the Shift from DB to DC Plans: During the 1970 s a number of factors came together to make 401(k) plans considerably more attractive to employers than other types of retirement plans available at that time. The major impetus behind the shift can be shared by four distinct parties which responded to the changes in the external environment:! Congress - and to a lesser extent the Executive Branch! Financial Services Firms! Plan Sponsors! Plan Participants

8 Influence of Socio-Economic Trends on Retirement Societal and Consumer Trends: The private sector work force of the 70s and 80s represented a dramatic shift from the prior generation. No longer considered first employer as their partner for life Rampant inflation resulted in employees losing their jobs Many Americans became more aggressive savers and investors Employees did not see the value in the traditional Defined Benefit structure

9 Influence of Socio-Economic Trends on Retirement Business and Economic Trends: In the late 1970s private sector employers in the US were faced with dramatic changes affecting both their work force and their ability and willingness to fund traditional pension schemes. DB plans are costly: High inflation forced higher salary levels and thus increased the liability for benefits Equity market returns were below average resulting in plan investment performance below the expectations used in determining contributions An overall shift in jobs from the manufacturing sector to the service sector These changes accelerated a desire to create a more economical solution to providing pension benefits to these employees

10 Drivers for Switching from DB to DC Plans: Benefits of DC Plans for Employer: - More predictable annual employer costs - Have no open-ended long term liabilities - No obligation to pay PBGC insurance premiums - Lower costs of administering a plan - Desire to provide a retirement plan at a reduced overall cost Benefits of DC Plans for Employee: - Portability - Allow employees more involvement and control over their savings. - Offer more flexible payout options - Assets to be transferred to the survivor - Pre-tax contributions

11 How 401(k) Plans Came into Existence (a) section of the Internal Revenue Code created employer-sponsored qualified retirement plans: profit-sharing, defined benefit, money purchase, stock bonus plans and others ERISA strengthened the rules governing qualified retirement plans 1978 Congress added paragraph k to the 401 section of the IRC to make cash-deferred profit sharing plans less discriminating 1980 Ted Benna, benefits consultant, took advantage of the k paragraph and created the 1 st 401(k) plan 1981 Treasury issued regulations supporting the matching contributions and employee pre-tax contributions via salary reductions 1981 Rapid growth of 401(k) plans

12 New Era of 401(k) Plans 557, , , (k) Plan Growth - Number of Plans 174, ,704 97,614 68,121 37,420 17, , , , E 2004E 2006E Number of Plans 3, (k) Assets Growth (billion) $1,684 $1,149 $720 $144 $300 $1,586 $1,467 2,214 2,701 3, E 2004E 2006E 2008E 2010E 401(k) Source: Federal Reserve, Spectrem Group and Cerulli Associates

13 401(k) Participants Coverage Net Participant base will increase by 6% per year (In Millions) E 2002E 2004E Source: Judy Diamond Money Market Directory, Cerulli Associates estimates

14 Sources of Retirement Income Other Percent ** E Income from Assets Federal Income (I.e. Social Security) Wages in Retirement Private Pension Plans and Annuities, including 401(k) Plans* *401(k) plan was introduced in 1981 ** 18% will come from DC and 9% from DB type of plans Source: Data is based on Current Population Surveys and Social Security Administration estimates

15 The Key 401(k) Components Deferred taxation advantage = stimulus to participate Non discrimination and coverage rules = fairness Matching contribution = employer support Choice of investment options = diversification Portability and roll-over features = continuation

16 How Does 401(k) Work? 1 Participant Recordkeeping & Service: * telephone, Internet, CSA * member education/calculators * financial advice ERISA IRS Pre-tax $$ Sets regulations for plan sponsors in the best interest of plan participants Plan Sponsor Pre-tax $$ + match 401(k) Provider Recordkeeping & Service: * investment management * keeps participant and plan records * performs plan level testing and reporting

17 401(k) Industry Statistics Participation 78% Average deferral percent for lower-paid employees 5.3% Average match 2.5% 15 investment options offered Only 3-4 investment options used Loan and hardship withdrawals are usually permitted Typical vesting schedule became shorter due to the recent legislation changes Trend is towards accelerating eligibility Source: 45th PSCA Survey

18 Need for Advice/ Education 50% of 401(k) participants have no idea how much they need to save for retirement!!! Those individuals who have a 401(k) account: 60% never change their allocation 80% have never rebalanced 75% of automatically enrolled employees remain at the default deferral rate and investment Source: 2001 Retirement Confidence Survey, 2000 University of Chicago study

19 Education Pays Off Three step process: 40% of those people who have run a calculation are very confident about retirement compared to 26% of all people in the US. 50% of the people who used a calculator changed their retirement strategy based on the results. 50% of the people who changed their retirement strategy, INCREASED their retirement savings! For every person that decreased his 401(k) contribution in 2002, two others increased theirs. (Source: Q employee survey for SMB employees sponsored by Principal). Source: 2001 Retirement Confidence Survey, 2000 University of Chicago study

20 Ways Providers and Plan Sponsors Can Assist Participants with Retirement Planning Retirement plan education Retirement planning tools/ Investment advice Plan design (auto-enrollment, shorter eligibility and vesting, offer reasonable number of investment options, lifestyle funds) Holistic financial advice education tools Building lifelong relationships (repetitive education and continuous education) Simple, actionable statements (increased contributions, change investment options, additional products and services) Rollover IRA assistance Retirement income management Next generation advice (call center and managed accounts)

21 Average Number of Investment Options Offered and Used in 401(k) in 2002 % lives lives 1000 lives Total Offered Used Despite of investment options available to participants, many invest in only 3-4 funds Source: PSCA Survey and SPARK

22 Percent of 401(k) Plans Offering Advice Will not consider offering Will consider offering Currently offer 70% 60% 50% 65% 56% 60% 64% 49% 40% 30% 20% 10% 0% 31% 32% 36% 20% 20% 24% 12% 12% 15% 4% ,000 1,001-5, ,000 10,000 + Number of Participants Overall, one in every four plans now offer advice Most common reason for not offering advice is concern over fiduciary liability (82%) Source: BARRA Rogers Casey/IOMA, SPARK

23 Type of Investment Advice Offered by Plans Offering Investment Advice 80.0% 70.0% 74.3% 60.0% 50.0% 40.0% 30.0% 20.0% 31.7% 18.8% 59.6% 59.2% 58.1% 51.2% 52.7% 41.7% 38.3% 36.7% 31.3% 32.6% 31.0% 28.6% 27.1% 23.2% 20.4% 18.2% 18.6% 16.3% 14.3% 15.7% 10.0% 0.0% 4.0% 5.0% 6.1% 1.0% 2.4% 2.7% 0.0% All Plans Number of Participants 1:1 Counseling Internet provider Telephone Hotline Web Conference Other Small companies are the heaviest utilizes of 1:1 counseling investment advice Internet delivery of investment advice increases with the size of the company and reaches the peak for companies with 1,000+ participants Source: 45 th PSCA Survey

24 Economics of 401(k)s Average Plan Cost as a Percent of Assets by the Number of Participants Participants Total 401(k) Investment Administration/ Trustee Fees Plan Cost* Fees Recordkeeping Fees ` , , , * based on the average participant account balance of $40,000 Source: HR Consultants

25 Lifestyle Funds as Investment Option in 2001 and , ,999 5,000+ All Plans A third of 401(k) plans offered life style funds in 2001 compared to less than 20 percent in 1999 Source: 43 rd and 45 th PSCA Surveys

26 401(k) Providers Control Costs Technology Economies of scale Bundled solutions Internet solutions both for plan sponsor and participant Investment options reviews Variable service model depending on the client's size/profitability Outsourcing Increased employee efficiencies Geographical labor advantages

27 Scale and Expertise Number of Paper/ Electronic Transactions 38,887,341 45,182,876 31,680,371 17,746,981 19,754,678 14,795,315 21,518,092 8,948,253 4,454,124 2,609, Paper Electronic Technology allows increased volumes Source: Internal Principal statistics

28 Scale and Expertise $0.30 Cost per Transaction $0.16 Impact of Direct Connect on Cash Transaction Costs $0.08 $ at a lower overall cost Source: Internal Principal statistics

29 Best E401(k) Practices in the US Pure-play e401(k) providers These providers have developed e-platforms that automate administrative/ recordkeeping activities and offer feature-rich Web interfaces for plan sponsors and participants. They partner with mutual fund companies and online brokerage firms to integrate investment options into their platforms, and distribute their platforms through alliances or private-label arrangements with traditional providers looking to offer an e401(k) product Traditional providers with e401(k) platforms These providers have either developed e-platforms in-house, or forged partnerships with pure-play e- platform providers. The traditional players will typically integrate their own proprietary funds into these platforms and push the product through their own distribution networks.