Presented by: Don Stone, President and Co-founder Plan Sponsor Advisors Phone:

Presented by: Don Stone, President and Co-founder Plan Sponsor Advisors Phone: 312.214.1500 Email: dstone@psaretire.com Bruce Ashton, Partner Drinker Biddle & Reath LLP Phone: 310.203.4048 Email: Bruce.Ashton@dbr.com David Wolfe, Partner Drinker Biddle & Reath LLP Phone: 312.569.1313 Email: David.Wolfe@dbr.com 1

The Current State of Retirement in the U.S. > The average savings for retirement is only 6% of total income earned. > There is a shortfall between what Americans have saved and what they will need at retirement. This will continue to escalate as one of this country s major social policy issues. > Nevertheless, defined-contribution (DC) plans are likely to continue to be the predominant retirement vehicle for most American workers. Income Replacement April 28, 2011 3 The Current State of Retirement in the U.S. The bad news: > McKinsey study found that the average American family, earning $52,000 per year, will face a 37% shortfall in the income that they will need in retirement. > It is currently estimated that only 59% of all employed Americans have access to some form of a retirement plan and that only 45% of working Americans actually participate in a plan. > A National Institute of Retirement Security survey found that 78% of Americans surveyed do not believe the average worker can save enough on his/her own to provide a secure retirement. > For past 35 years focus was on accumulation. The good news: > The defined contribution system can be improved and we have most of the tools to do it. Income Replacement April 28, 2011 4 2

DB vs. DC Plans in the U.S. Number of Pension Plans by type of plan, 1975-2007 800,000 700,000 600,000 500,000 400,000 300,000 200,000 100,000 0 1975 1980 1985 1990 1995 Source: Form 5500 Findings with the Department of Labor 2000 2005 2010 Total Defined Benefit Defined Contribution Income Replacement April 28, 2011 5 What We are Going to Cover Today > What is driving the change? > What is the current regulatory climate and does it provide guidance to plan sponsors? > How should I go about evaluating income replacement solutions, from a fiduciary perspective, from an investment perspective, from a participant perspective? > What types of products are we talking about? > What other issues do I need to consider? Income Replacement April 28, 2011 6 3

What is Driving Change As a country, we are at a crossroads in seeking ways to narrow the current savings gap. It is our belief that ways to help narrow this gap include the following: > Increase overall access to retirement plans. > Increase plan participation and savings rates. > Help participants better manage their in-plan risks. > Institutionalize defined contribution plans to control cost and provide institutional quality investments and allocations. > Help participants transition from the accumulation stage to the distribution stage at time of retirement by providing tools and appropriate investment vehicles. Income Replacement April 28, 2011 7 Components of Best-in-Class DC Plan Income replacement options must be viewed in context of a particular plan s overall design. It is only one piece of the puzzle in creating a holistic view for retirement benefit planning. Auto -Enrollment Auto-Escalation Risk-Controlled Investment Options Income Replacement Income Replacement April 28, 2011 8 4

The Case for Income Replacement Strategies There is currently a debate as to whether these distribution or lifetime guarantee options should be offered in plan or out of plan. Even so, there is clearly a benefit to looking at distribution options prior to retirement, assuming that various hurdles can be overcome. Income Replacement April 28, 2011 9 The Case for Income Replacement Strategies Earlier consideration would allow a participant the opportunity to address the following risks: > Longevity Risk the risk of out-living one s savings. > Interest Rate Risk the risk that inflation will erode long-term purchasing power. > Market Risk the risk that investment performance will reduce the market value of a participant s portfolio at retirement. > Risk of Ineffective Financial Management the risk that a participant will not manage a lump sum distribution at retirement effectively. Income Replacement April 28, 2011 10 5

The Demographic Challenge Probability of Living to a Specific Age if you're 65 Today 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 75% 65% 91% 37% 24% 80 Years 90 Years 100 Years Source: Society of Actuaries, Key Findings and Issues, Longevity: The Underlying Driver of Retirement Risk, 2005. Risks and Process of Retirement Survey Report, July 2006 52% Women Men Couple - At least one lives to specified age 4% 2% 6% Income Replacement April 28, 2011 11 The Investment Lifecycle Participant s Lifecycle Defined Contribution Plan Accumulation Transition: Retirement Readiness Lifetime Income Growth of Retirement Assets Maximize contributions Select appropriate asset allocation and investment options Rebalance regularly Review goals and objectives annually Minimize Interest rate risk Market risk Longevity risk Guaranteed Retirement Income Participant s Lifecycle Source: Plan Sponsor Advisors Income Replacement April 28, 2011 12 6

Types of Income Replacement Solutions > Annuities. Annuities are insurance products that offer a guarantee but at the cost of forgoing principal. > Fixed. The simplest type of annuity is a fixed annuity. Based on the amount paid to the insurance company, will pay a guaranteed income to the annuitant, either for life or for a specific time period. There are many variations but the underlying concept is the same. A critical consideration as we think about in-plan and out-of-plan below is whether the annuity is immediate or whether the annuitant delays the implementation of the income stream until a later date, e.g., when the annuitant turns 75 or even 85 years of age (often referred to as longevity insurance since it is designed to ensure that funds are available if the annuitant lives a long life). Income Replacement April 28, 2011 13 Types of Income Replacement Solutions Annuities (continued) > Variable. Variable annuities, as the name suggests, vary in how much they will pay the annuitant. > This is based on how the underlying investments, typically stocks and bonds, perform over the period of the annuity. > The benefit over a fixed annuity is that the variable annuity may allow the annuitant to increase his income over time. Income Replacement April 28, 2011 14 7

Types of Income Replacement Solutions Other types of solutions. This category includes a number of very different products designed to replicate the income replacement feature of annuities but without the loss of control of the principal. > However, there is a price to this flexibility, as the payout ratio tends to be lower. > Unfortunately, like annuities, they can be quite complicated and come in a number of variations. Income Replacement April 28, 2011 15 Types of Income Replacement Solutions Other types of solutions (continued) > Guaranteed Minimum Withdrawal Benefit (GMWB). A GMWB, although not an annuity, offers annuity-like features in that it can guarantee a lifetime income stream at a specified payout rate. Although the payout rate tends to be lower compared to a traditional annuity, a participant can still access his/her principal which can continue to grow in an up market, while at the same time experience downside protection in the event of a market decline. If desired, a participant can annuitize upon retirement. Income Replacement April 28, 2011 16 8

Types of Income Replacement Solutions Other types of solutions (continued) > Guaranteed Minimum Income Benefit (GMIB). A GMIB is an inplan option that will allow a participant to experience upside market appreciation prior to retirement. However, once retirement is reached, the asset base will be completely annuitized. > Managed Payout Funds. Developed by mutual fund companies to compete with annuities; these products guarantee neither income nor principal but are designed to deliver predictable income streams over a fixed number of years. However, principal is not protected and payouts may cease if the principal balance becomes depleted. Income Replacement April 28, 2011 17 The Debate: In-Plan or Out of Plan For Participant: Pros for in-plan Dollar Cost Averaging Institutional Pricing Transition from the Accumulation to the Distribution Phase Track Retirement Income Unbiased Best in Class Choices All-in-One Solution Can be Tied to Automatic Enrollment Cons Portability Inability to Transfer to a New Plan Lack of Flexibility Income Replacement April 28, 2011 18 9

The Debate: In-Plan or Out of Plan For Plan Sponsor: Pros for in-plan Benefit for Employees Creates a DB-like Structure Asset Retention in the Plan Employee Retention/Attract New Employees Cons Fiduciary Responsibility On-going Monitoring & Reporting Limited Number of Options Education/Communication One Size Does Not Fit All Difficult to Switch Options/Providers Determining the right choice(s) Income Replacement April 28, 2011 19 Fiduciary Process > Lack of explicit DOL guidance on evaluating income replacement solutions. > Previous guidance on QDIA s and annuities outside the plan provides some help. > Follow a similar process used to evaluate any investment option: Financial strength of the provider Reasonableness of fees Appropriate features for employee population Communication with participants Portability Income Replacement April 28, 2011 20 10

Operational and Other Considerations > Current record keeper s willingness/ability to record keep the solution you choose. > Portability. > Communication challenges with participants. > Pricing. > Complexity. Income Replacement April 28, 2011 21 Operational and Other Considerations > Consider Best Practices plan features with a focus on helping participants increase their assets in the accumulation phase. Tie the existing automatic increase feature to the automatic enrollment option. Reduce ability for participants to get multiple loans; minimize leakage. Incorporate monthly income estimates on participant statement. > If there is more than one plan, look at all plans together to get a better understanding of how all the pieces fit together in order to determine the best income replacement solution. Income Replacement April 28, 2011 22 11

Operational and Other Considerations > Conduct focus groups to get an understanding of participant needs and determine if an in-plan option would be appropriate and if so, what type. > Revisit income replacement strategies after additional data is collected. > If not sure if in-plan is the right solution for your plan, implement an out-of-plan transition strategy until final decision on income replacement strategies are determined. Income Replacement April 28, 2011 23 Additional Best Practices to Consider The Four Components of a Best Practices Defined Contribution Plan Component Target Date/Managed Account Automatic Enrollment at 5-7% Automatic Increases up to at least 10% Retirement Income Option/Strategy Purpose Increases likelihood that a participant will select an appropriate asset allocation and investment options Default into target date/risk-based fund; increases that a participant will save; overcomes participant inertia and ensures a better allocation than most participants will create on their own Increases that a participant will save more; should be tied to automatic enrollment Creates a way for the participant to transition from the accumulation phase to the distribution phase Income Replacement April 28, 2011 24 12

Creating Retirement Income and Managing Risk Bond ladder Managed Payout Fund GMWB GMIB/In plan deferred annuity Longevity Insurance Immediate Fixed annuity Income Replacement April 28, 2011 25 What Plan Sponsors Are Thinking Plan Sponsors Polled - What Are You Likely to Add Next Year? 25% 20% Somewhat Likely Very Likely 15% 17% 15% 10% 13% 15% 5% 0% 7% Managed Drawdown Within Plan 5% Annuities Outside of Plan 3% 2% Insurance Solution in Plan Managed Payout Funds Source: Preliminary Data from Hewitt 2011 Hot Topics in Retirement Income Replacement April 28, 2011 26 13

Do You Want an In-Plan Option? Have you maximized the potential for participants to save? Have you considered the following risk/ uncertainties: Risk/uncertainties Operational issues New products continue to emerge How it will fit in with current advice providers Do you want an in-plan option? Yes No Do you want an out-ofplan option? Longevity insurance Payout funds Variable & fixed annuities GMWB IRA rollover Managed accounts Create/project/plan/ implement Appropriate for participants: Want flexibility control High account balances Legacy is important Do you want a flexible option? GMWB Managed accounts No Do you want a traditional annuity? Deferred fixed annuity Immediate annuitization at retirement DMIB Do you want a stand alone option? No Yes Do y ou want this option to be your default? All assets 100% converted to lifetime income at retirement Wrap around target-date or risk-based funds Yes Appropriate for participants: Need high payout ratio Control is not important Don not have access to DB Plan Legacy is not important Yes Yes Can your record keeper accommodate an inplan option? No Are you willing to conduct a record keeper search? Yes Yes Create Project Plan / Implement Solution Conduct Search Income Replacement April 28, 2011 27 Questions? Income Replacement April 28, 2011 28 14