DC Best Practices Webinar Series - Part 2: Lowering Total Plan Costs, Simplifying Investment Options and Reducing Fiduciary Risk Blue Prairie Group Matt Gnabasik Managing Director October 25th, 2012
Introduction (Forward) Why host a webinar on defined contribution best practices? Recent macro events and new research have systematically exposed the main structural flaws of 1 st and 2 nd generation participant-directed defined contribution plans: - Chronic under participation and low savings rates; - Poor investment allocations leave participants exposed to unnecessary risk levels; - High costs and difficult-to-understand cost structures; - Excessive leakage out of plans through loans and cashing out account balances; - Lack of an established way to turn retirement assets into guaranteed income for life. 2
Introduction (Forward) In summary, there is a growing consensus that traditional DC plans need to be structurally modified to address their inherent limitations - this is what people often refer to as the DB-ification of DC plans. As concerned sponsors and consultants, it s up to us to redesign the basic structure of our plans in order to drive as many participants toward retirement security as possible. That is how we will solve the looming retirement crisis, one plan at a time. With so much complexity, we thought it necessary to host a this webinar series that will explain in detail best practices for defined contribution plans. These webinars will provide a roadmap for plan sponsors to objectively evaluate their plan and to redesign it with the explicit goal of putting as many people as possible on the path towards retirement security, while minimizing organizational and fiduciary risk. 3
Introduction continued Why a webinar and am I qualified to host it? - This webinar series is based on my soon-to-be-published book, DC Best Practices: Solving the Retirement Crisis One Plan at a Time. - I ve spent my entire 20-year career working with all types of ERISA plans around the country. - I am the author of Smart Choices: Selecting and Administering a Safe 401k Plan, that covered best practices. - I founded Blue Prairie Group, a fee-based retirement and investment consulting firm that has a long track record of embracing best practices in the institutional ERISA marketplace. 4
Blue Prairie Group s DC Best Practices Checklist 5
Overview of Today s Content - Total plan fees and costs - Investments - Fiduciary governance 6
Best Practice #3 Lowering Plan Fees and Costs With the DOL fee transparency mandates finally here, fee transparency is finally here. We think that s a good thing. Here s how to approach fees. - Total cost equation = Investment Fees + Recordkeeping Fees - You want both to be low - Start with your covered service provider s 408(b)(2) disclosure - Confirm accuracy - Make sure to understand - Investments are relatively easy - Mutual funds are the coin of the realm - It s easy to use Morningstar star to benchmark investment fees - Recordkeeping fees are more difficult but doable - Good: Use third-party sources - Best: Conduct a Request for Information (RFI) 7
Best Practices #3 Fee Levelization 8
Best Practices #3 Fee Levelization 9
Best Practices #3 Fee Levelization 10
Best Practices #3 Fee Levelization 11
Best Practice #4 Simplifying Investment Options Rethinking the DC portfolio: Target Date Funds - Target date funds are the centerpiece: - Data re target date funds - The underperformance of DC participants compared to DB plans - Key considerations: - Glidepath ( to vs. through ) - Asset classes - Underlying managers - Costs - Custom vs. off-the-shelf 12
Three critical participant behaviors that need to be addressed Participant challenges Choice Participant behaviors Participants get overwhelmed with too many choices Supporting data People prefer having more choice 1 Too much choice leads to making no choice Engagement Engagement levels vary dramatically throughout working years 45% of participants neither call nor go online to engage with their retirement plan 2 Less than 7% of participants rebalance during the course of a year 2 Expertise Participants are underdiversified, or otherwise sub-optimally allocated Participants invest, on average, in only 3 4 funds 3 1. Social psychologists Sheena Iyengar, PhD of Columbia University Business School and Mark Lepper, PhD of Stanford University studied the consequences of excessive choice in a 2000 paper in the Journal of Personality and Social Psychology (JPSP, Vol. 79, No. 6) 2. Searching for Certainty, 2011, J.P. Morgan Retirement Plan Services 3. J.P. Morgan Retirement Plan Services 2011 Source: JP Morgan Asset Management FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION 13
The defined contribution participant disconnect Level of engagement (Less) DC Menu Segments Asset Allocation Funds Core Menu Designed for participant investor types Delegators Prefer professional management Doers Asset allocation Manager selection Prefer control Value professional oversight in manager selection/ due diligence Varying levels of engagement How participants see themselves ( type ) 1 % of participant assets in each menu segment 1 69% 18% 30% 80% (More) Brokerage Self-directed Sophisticates Prefer significant flexibility/choice 1% 2% For illustration and discussion purposes only. 1 Source: J.P. Morgan Retirement Plan Services Source: JP Morgan Asset Management FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION 14
Defining Help Three types of professional investment help: Source: AON Hewitt 15
People Fare Better When Using Target Date Funds Source: AON Hewitt 16
Are DC plans structured to deliver the best outcomes for participants¹? Standardized 2 three year returns: Highs, lows and medians by investment strategy 30% 24.6% 25% 25.5% Personal Rate of Return 20% 15% 10% 5% 16.4% 9.4% 12.8% 10.3% 10.6% 0% -5% -10% -5.4% -5.0% Target Date Fund Users Do It Yourself-ers Brokerage Users 1 Source: J.P. Morgan Retirement Plan Services proprietary research. Analysis measurement period is December 31, 2008 through December 31, 2011. The above data represents a sampling of participant data. It does not represent the returns of any individual product or portfolio. Exclusive reliance on the above is not advised. This information is not intended as a recommendation to invest in any particular manner. Rate of return for the measurement period is aggregated by investment strategy. Historical rate of return is not a guarantee of and may not be indicative of future results. 2 Returns are standardized using the Interquartile Methodology. See the following slide, Important Disclosures for Personal Rate of Return Methodology, for additional information. Source: JP Morgan Asset Management FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION 17
Are DC plans structured to deliver the best outcomes for participants¹? (cont.) Standardized 2 three year returns: Highs, lows and medians by investment strategy, by age Personal Rate of Return 33% 28% 23% 18% 13% 8% 3% -2% 16.3% 10.0% 20.8% 0.1% 29.0% 16.2% 10.3% 23.5% 26.3% 16.1% 10.1% 25.2% 26.5% 16.1% 9.3% 24.4% 24.3% 15.5% 8.3% 23.6% 23.1% -7% -12% -5.1% -3.2% -3.8% -5.7% -4.7% -5.4% -4.4% -6.1% -4.6% 20-29 Target Date Funds Do It Yourselfers Brokerage 30-39 Target Date Funds Do It Yourselfers Brokerage 40-49 Target Date Funds Do It Yourselfers Brokerage 50-59 Target Date Funds Do It Yourselfers Brokerage 60 + Target Date Funds Do It Yourselfers Brokerage Age groups and investment strategies 1 Source: J.P. Morgan Retirement Plan Services proprietary research. Analysis measurement period is December 31, 2008 through December 31, 2011. The above data represents a sampling of participant data. It does not represent the returns of any individual product or portfolio. Exclusive reliance on the above is not advised. This information is not intended as a recommendation to invest in any particular manner. Rate of return for the measurement period is aggregated by investment strategy. Historical rate of return is not a guarantee of and may not be indicative of future results. 2 Returns are standardized using the Interquartile Methodology. See the following slide, Important Disclosures for Personal Rate of Return Methodology, for additional information. Source: JP Morgan Asset Management FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION 18
Taking simplification a step further Target Date Funds Core Menu Innovation SM Model Brokerage Window 2050 Large Growth Large Value Large Core 2045 2040 2035 Small/Mid Value Small/Mid Growth Int. Dev. Lg Eq. Int. Dev. Smid Eq. Emerging Mkts REITs Diversified Equity 2030 2025 2020 US Agggregate MBS US High Yield Bank Loans EMD USD EMD Local Diversified Income 2015 MM or SV Cash Alternatives Information is hypothetical and shown for illustrative purposes only. The current model depicted above is illustrative and discussion purposes only. Inflation sensitive portfolio can be added to the core portfolio building blocks. Source: JP Morgan Asset Management FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION 19
Best Practice #4 Simplifying Investment Options Rethinking the DC portfolio Summary: - Focus on selecting good target date funds - Keep the core menu simple - Cover the corners - Use more passive and lower cost funds 20
Best Practice #5 Reducing Fiduciary Risk Best Practices That Can Help Protect Your Clients: - Keep participants best interests in the forefront. - Hire and listen to outside experts. - Negotiate lower rates for participants. - Do not subsidize the costs of other benefits. - Take advantage of investment advisory services. - Follow the Investment Policy Statement. - Avoid proprietary mutual funds. - Select share classes with the least expense to participants. - Use revenue sharing for the benefit of the participants. Source: The Standard Case Study: Tussy v. ABB, Inc. 21
Best Practice #5 Reducing Fiduciary Risk - Avoid naming the plan sponsor as a fiduciary. - Avoid naming key corporate sponsors as fiduciaries. - Carefully craft delegation authority. - Define the roles of plan sponsors and fiduciaries. - Plans should be created or amended to include reasonable time limits within which claims must be filed. - Plans should be created or amended to give the claims fiduciary discretion to construe the terms of the plans. - Plans should warn participants that their failure to exhaust the internal claims procedure will result in a motion of dismiss. - Plan should advise participants that the plan has the right to correct and recoup any overpayments. Source: Chubb Special Report 22
Best Practice #5 Reducing Fiduciary Risk - Include a Section 404(c) provision in defined contribution plans. - Hire an outside fiduciary. Plans that include company stock should consider: - Hard-wiring the investment. - Converting the employer stock fund into an ESOP. - Encouraging diversification outside the company stock. Source: Chubb Special Report 23
Best Practices Summary I. Benchmark Your Plan From the Perspective of Maximizing Retirement Readiness for Employees and Minimizing Organizational/Personal Fiduciary Risk II. III. IV. Implement Automatic Plan Design Features and Revisit the Employer Matching Contribution and Eligibility Provisions Focus on Lowering Total Plan Fees and Costs Streamline the Core Menu to 8-10 Low Cost Options Representing Key Asset Classes, and Redesign Your Investment Menu with the Primary Emphasis on Target Date Funds V. Reduce Risk Through Fiduciary Governance To be continued in Part III of the webinar series 24
Questions? 25
Bio & Contact Info Thank you Matt Gnabasik 140 S Dearborn St, Ste 300 Chicago, IL 60603 312.376.8435 matt@blueprairiegroup.com 26