Sponsors Focus on Better Designing Plans to Meet Retirement Income Needs

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1 Survey: Defined Contribution Trends 2014 (Part 1) Sponsors Focus on Better Designing Plans to Meet Retirement Income Needs Summary Defined contribution (DC) plan sponsors are increasingly engaging in internal discussions around whether or not the current proprietary, single-manager target-date-funds (TDFs) provide the best path for meeting the retirement income needs of participants. The discussions are being fuelled in part by last year s Department of Labor s (DOL) guidance 1 - and this year s subsequent DCIIA 2 supplement - around the selection and monitoring of TDFs. Part of the guidance is for plan sponsors to evaluate whether non-proprietary or in some cases custom TDFs could provide better outcomes for their participants when compared to proprietary TDFs. The below findings are part 1 of this survey, which investigates the actions plan sponsors are taking in regards to the TDFs offered in their plan line-up. Key Findings: The majority of plan sponsors view the objective of the DC plan as to provide a primary source of retirement income for plan participants. Few investment committees are measuring the effectiveness of the investment options in the DC plan by evaluating if participant income replacement ratios are being met at retirement. A significant number of plan sponsors only offering a DC plan could be operating under the premise that their employees primary source of retirement income will come from either Social Security or savings vehicles outside of the DC plan. There could be a significant number of plan sponsors shifting from proprietary, single-manager TDFs to custom TDFs over the next 18 months. Plan sponsors identified a reduction in total investment expense as the most valuable component in the decision to use custom TDFs. When it comes to switching to custom TDFs, some plan sponsors are concerned about costs, potentially increased complexities and feel they are unable to quantify the incremental benefit when compared to off-the-shelf options. A significant number of plan sponsors are considering delegating investment manager selection and oversight to a discretionary 3(38) investment fiduciary within certain aspects of the DC plan. The most common DC option where this is being considered is custom TDFs. Per the DOL guidance, DC plan sponsors appear to be ready to evaluate whether or not their current proprietary TDFs are genuinely providing their participants with the best potential retirement outcomes. However, plan sponsors also need to continue to evolve their management of these plans and align the goals and subsequent success metrics - with that same purpose. As fiduciaries, improving the participants retirement outcomes should be the primary goal of all plan sponsors. This survey suggests that plan sponsors are taking the necessary steps to potentially increase the likelihood those goals are met. 1 U.S. Department of Labor (DOL) Target Date Retirement Funds - Tips for ERISA Plan Fiduciaries (February 2013) 2 Defined Contribution Institutional Investment Association (DCIIA) DCIIA Guide To U.S. Department Of Labor Tips On Selecting Target Date Funds (February 2014) 2014 SEI 1

2 SEI s Defined Contribution Research Panel recently completed a survey of executives from defined contribution (DC) plan sponsors in the U.S. to gauge their current thinking around how target date solutions will be implemented moving forward. The poll was completed by 285 executives, representing DC plans ranging in size from $25 million to over $5 billion. The poll was conducted in February 2014 and this summary is the first of two parts. The findings below focus on participant responses around target date funds (TDFs). If you have any questions, please seiresearch@seic.com. Section I: DC Plans Are Becoming the Primary Source for Retirement Income The role of the defined contribution plan as it pertains to retirement income has evolved. For years, the defined benefit (DB) plan was viewed as the primary vehicle that provided retirees with income through retirement and the responsibility to provide that income was the plan sponsor s. However, the past two decades have continued to see a shift away from DB plans. Consider: Is the objective of the company s DC plan to provide a primary or supplemental source of retirement income? While all of the organizations participating in this survey offer employees a DC plan, less than half (47 percent) still operate a DB plan. Further signaling a transition is the fact that for more than half (58 percent) of those organizations, the DB plan is closed or no longer being offered to new hires. More than one third (34 percent) have taken the additional step of freezing or ending benefit accruals in the plan for existing participants, bringing those plans a step closer to termination. The impact of this shift has not been lost on plan sponsors. As would be expected, the majority (57 percent) of plan sponsors in this poll view the objective of the DC plan as providing a primary source of retirement income for plan participants. However, somewhat surprisingly, there was no significant change in that percentage when participants offering just DC plans were separated from those offering both DB and DC plans. More than one third (39 percent) of the survey respondents only offering a DC plan said the objective was to provide supplemental retirement income. This could suggest they feel their DC plan cannot provide sufficient retirement income to be primary, or that employees primary retirement income will come from either Social Security or savings vehicles outside of the DC plan SEI 2

3 Section II: Measuring the effectiveness of DC plan investments The effectiveness of the investment management of DB plans really began to strengthen once plan sponsors shifted the benchmark for success. For years, DB plan sponsors focused exclusively on generating returns above benchmarks with minimal emphasis on whether those assets were enough to meet the plan s liabilities. The economic events of the past 15 years have changed this thinking. Being forced to try to improve the funded status of plans in low return and/or low interest rate environments shifted focus to the liabilities in the plans. DB plan sponsors are now using highly sophisticated strategies designed to manage the plans assets in tandem with the plan s liabilities (e.g. liability driven investing). It appears as though the majority of investment committees for DC plans are focused on investment performance and not as much on the liability which is represented by the participants income replacement needs. This is why there is talk within the industry about DBizing or institutionalizing the investments in DC plans. DC plan sponsors should consider the lessons learned by DB plan sponsors in that meeting the participants income replacement ratio is a critical measure of the effectiveness of the plan s investments. While accountability for the liabilities in DC plans doesn t ultimately reside with the plan sponsor, they do have fiduciary responsibilities for prudently selecting and monitoring the investment options. The below chart illustrates poll findings around the measurements being used for DC plan investments. Through which of the following ways does your Investment Committee measure the effectiveness of the investment options in the DC plan? While ongoing review of investment performance in accordance with the IPS is a critical oversight responsibility, more plan sponsors should also be focused on evaluating if retirement income needs are being met. The low number of plans using this as an effectiveness measure does not align with the high number of plan sponsors saying the DC plan is the primary source of retirement income SEI 3

4 Section III: The use of Target Date Funds (TDFs) According to the survey, there is little debating that TDFs are the most popular Qualified Default Investment Alternative (QDIA) as 81 percent of the participating organizations currently offer them in their DC lineup. Of that group offering TDFs, 12 percent currently offer custom TDFs while the remaining 88 percent offer proprietary or pre-packaged options. Of those currently offering TDFs, which type does your company use? The size of the plan definitely seems to be a differentiator when it comes to offering custom TDFs. Of the survey participants offering TDFs, only seven percent of the group with $750M or less in DC assets provide custom TDFs compared to 26 percent of the group above $750M. Whether or not the organization also offers a DB retirement plan is a factor when it comes to custom TDFs. DB plans have historically invested in much more sophisticated models using active, institutional money managers rather than retail funds. Many DB plan sponsors are accustomed to these investments and have the necessary infrastructure in place to address and oversee the complexities these types of investments bring. Just over 15 percent of the poll participants who offer DB plans also offer custom TDFs to their participants. Section IV: Plan sponsors not currently using custom TDFs have concerns While the assumption would be that the previously mentioned scrutiny by the DOL and DCIAA would almost immediately lead to changes in how plan sponsors implement TDFs, roadblocks still exist. Plan sponsors remain concerned about costs, potentially increased complexities and whether or not their participant demographics are different enough to warrant such changes. Some plan sponsors feel as if they lack the internal resources for ongoing oversight of more sophisticated TDFs. The reasons for not currently offering custom TDFs are illustrated in the below graphic. What are the reasons your organization doesn t currently implement custom TDFs? 2014 SEI 4

5 Section V: Plan sponsors are considering changing to custom TDFs Last year s guidance from the DOL suggested that plan sponsors using proprietary TDFs should consider whether a custom or non-proprietary TDF would be a better fit for their plan. The guidance stated a custom TDF may offer advantages to your plan participants by giving you the ability to incorporate the plan s existing core funds in the TDF 3. Companies appear ready to respond to the DOL s advice. More than one third (37 percent) of the poll participants said their organization is either somewhat likely or likely to implement or revise custom target date solutions in the next 18 months. Nearly half (43 percent) said it is somewhat likely or likely they will implement retirement income solutions in that same timeframe. How likely is your organization to make any of the following changes to the DC plan within the next 18 months? As more DC plan sponsors look to implement custom TDFs, the concerns listed in the previous section become real. Custom TDFs are very complicated vehicles and require high levels of expertise, resources and ongoing oversight. Until recently, custom TDFs primarily existed only among the mega plans 4 as they have generally had the infrastructure in place to support this strategy. For those plan sponsors that don t have that infrastructure but still want to implement custom TDFs, discretionary or outsourced models can help. These models give plan sponsors the option to hire a third-party to be the fiduciary in regards to manager selection and asset allocation. Nearly half (42 percent) said the organization would consider outsourcing investment manager selection in some areas of their DC plan. Of that group, 43 percent said they would do so when implementing custom TDFs. 3 U.S. Department of Labor (DOL) Target Date Retirement Funds - Tips for ERISA Plan Fiduciaries (February 2013) 4 Mega plans are defined as $500 million or more according to Cogent Research 2014 SEI 5

6 Section VI: Why are plan sponsors implementing or considering custom TDFs? One of the core benefits of custom TDFs is that they provide the plan sponsor with greater control over matching the funds with the specific needs of their employees. When organizations are going through the decision-making process around shifting to custom TDFs, a number of different components will drive their decision. The poll results suggest that a reduction in total investment expense and the ability to mix active and passive funds are viewed as valuable components of custom TDFs. The chart below shows which components plan sponsors feel are most valuable and is split between those already using custom TDFs and those not. Which of the following components does your organization consider most valuable in deciding to implement custom TDFs? Conclusion The DOL s guidance did not result in immediate changes when it comes to the types of TDFs being offered by DC plan sponsors. However, this survey suggests that more plan sponsors are considering evaluating and potentially implementing custom TDFs in place of their existing proprietary TDFs. The survey also shows some disconnects between how plan sponsors view the purpose and goals of the DC plan and the ways they ultimately manage the plans. Changes could be on the horizon when it comes to TDFs. Any questions on this poll or for more information around SEI s defined contribution services SEIResearch@seic.com or call This information is for educational purposes only. Not intended to be investment, legal and/or tax advice. Please consult your financial/tax advisor for more information. Information provided by SEI Investments Management Corp., a wholly owned subsidiary of SEI Investments Company. SEI SEI 6