Session 22, Evolution of Target-Date Funds Moderator: Erik Troutman, FSA, MAAA

Transcription

1 Session 22, Evolution of Target-Date Funds Moderator: Erik Troutman, FSA, MAAA Presenters: Matthew Brancato, CFA, CPA Jerome Clark, CFA, MBA Joe Fazzino, MBA

2 Incorporating Lifetime Income Solutions into Custom Target Date Funds Society of Actuaries 2015 Investment Symposium March 27, 2015

3

4 CHANGING FACE OF U.S. RETIREMENT Age in Years % 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Life expectancy at birth Labor Force Participation Rates of Workers 65+ Male Female (est'd) 2050 (est'd) Prevalence Types of Retirement Plans Traditional Pension Cash Balance + Pension Equity DC Only Sources: MetLife, U.S. Bureau of Labor Statistics, AonHewitt Percent of Population Total, 65 and older Men, 65 and older Women, 65 and older 80% 60% 40% 20% 0% Defined Contribution Formula as Primary Retirement Vehicle 35% 56% 65% 75%

5 MOVING FORWARD WITH PLAN DESIGN Examination of risks & regulatory standards Plan Funding Risk Investment Risk Longevity Risk Inflation Risk Traditional DB Employer Employer Employer Employee Traditional DC Employee Employee Employee Employee New DC Designs Employee Third Party Third Party Employee Old Standard of Care New Source: AllianceBernstein with creative credit to Nationwide 3

6 FUNDAMENTAL CONCEPTS Questions for employers & fiduciaries Which description best fits members of most defined contribution plans a) Valued Employees & Esteemed Retirees b) Risk Tolerant & Savvy Investors c) Disciplined & Frugal Savers Which term best describes most defined contribution plan designs a) A Secure Retirement Benefit b) An Investment Portfolio c) A Savings Account Are the answers to these questions in sync? 4

7 UTC PLAN INVESTMENT LINEUP Lifetime Income Strategy Target Retirement Funds Fixed Income Diversifiers Emerging Non-U.S. Equity U.S. Equity - Small U.S. Equity Mix & Monitor Core Passive Options UTC Ownership Stable Value Fund Gov./Corp. Bonds U.S. Equity Large Cap U.S. Equity Small Cap Non-U.S. Equity Emerging Equity Common Stock & ESOP Mutual Fund Window Mutual Funds 10,000+ Funds Available 4,000+ no load/transaction fee 250+ Mutual Fund Families Real Asset Fund Risk Parity Fund 5

8 LIFECYCLE SAVING & INVESTING Theory & practice Principle 1: Focus not on the financial plan itself but rather on the consumption profile that it implies Principle 2: View financial assets as vehicles for moving consumption from one location in the life cycle to another Principle 3: A dollar is more valuable to an investor in situations where consumption is low than in situations where consumption is high Theory Lifetime budget constraint Total Wealth concept Importance of constructing contingent claims Prices of securities matter! Risky assets in the life-cycle model Asset allocation over the life cycle Practice Manage realistic expectations, Forecast income on statements Securing income guarantees Negotiate reasonable fees for value Budget risk relative to point in cycle Source: Bodie, Treussard & Willen,

9 PUTTING THEORY INTO PRACTICE Lifetime Income Strategy A 21 st Century Pension Design Secure retirement QDIA offered through a defined contribution plan Professionally managed investments Retirement income guaranteed by insurance contracts Combines a guaranteed floor income benefit with upside potential, liquidity, optional joint life and beneficiary features Offers security & certainty in retirement like traditional pensions while preserving the freedom & flexibility participants want today 7

10 RETIREMENT INCOME ALTERNATIVES A balance between control and certainty Control Certainty Systematic Withdrawal Complete Control Traditional Fixed Annuity Complete Control No Guaranteed Lifetime Income Guaranteed Lifetime Income 8

11 RETIREMENT INCOME ALTERNATIVES Systematic Withdrawals Buy & Hold Treasury Bonds Lifetime Income In Plan Withdrawal Benefit Variable Annuity (Out of Plan GLWB) 1 Traditional Fixed Annuity Lifetime Benefit Guarantor Income Protection Indicative Income Fixed Cost Fees Liquidity & Control Upside Potential 1 GLWB Guaranteed Lifetime Withdrawal Benefit 9

12 KEY FEATURES OF EFFECTIVE SOLUTIONS Participant & plan sponsor perspectives Participants Plan Sponsor/Fiduciary Lifetime Income (Longevity Protection) Growth Potential (Income Ratchets) Full Liquidity & Control of Assets Simplicity & Portability Institutional Pricing & Transparency Diversified Insurer Coverage QDIA (Integrated within Target-Date Portfolio) Source: AllianceBernstein 10 10

13 LIFETIME INCOME STRATEGY Investment & allocation Allocation % 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Phase-In Period Age Target Date Portfolio - Custom target date allocation, low fee, no secure income Secure Income Portfolio - 60% equity/40% bonds, higher fee, secure income via insured withdrawal benefits Complete solution over lifecycle As a young saver, invest in a target-date portfolio As a pre-retiree, build secure lifetime income As a retiree, withdraw lifetime income 11

14 LIFETIME INCOME ILLUSTRATION Hypothetical portfolio with 5% secure income Balance ($000) Point of Election 3 Secure Income Uninsured Balance Insured Benefit Base Age Accumulation Withdrawal Insurer Payout 1. $100k balance remains invested in target date portfolio and starts building secure income 2. Portfolio grows to $200k by the time participant elects to commence 5% guaranteed withdrawals 3. Participant entitled to withdraw $10k per year in retirement (5% of $200k benefit base) 4. If assets are ever depleted, insurer pays $10k annual income (guaranteed for life) 12

15 MULTIPLE LEAD INSURER DESIGN Advantages to sponsor Ongoing price discovery Insurer competition Capacity & constraints Potential indications of solvency risk Adaptable to changing conditions Integrate new insurers / enhanced benefits Conform to new regulatory requirements Minimize participant disruption Diversification of issuer risk Insurance Safety Net 13

16 DELIVERING SECURE INCOME Multi-insurer aggregator platform A flexible & extendable operational structure Record Keeper (Hewitt) Aggregator interfaces with record keeper & insurers Insurance Aggregator Diversification, competition & capacity Approved Insurers Insurer 1 Insurer 2 Insurer 3 Withdrawal rate process Quarterly Poll 5.2% 5.0% 5.0% Aggregator polls insurers quarterly Allocate via rate & diversification formula Allocation Formula 50% 25% 25% Fixed fee cannot increase Purchased benefit cannot decrease Quarterly Blended Withdrawal Rate 5.1% 14

17 LIFETIME INCOME STRATEGY Responsibilities Investment Strategy / Asset Allocation / Glide Path Alliance Bernstein (AB) Operations / Rebalancing Alliance Bernstein (AB), AonHewitt Custody and Daily Valuation State Street Manager*/Insurer Selection UTC Income Benefit Guarantees Lincoln, Nationwide & Prudential * Insurers retain authority to take fiduciary control of investments in group annuity 15

18 LIFETIME INCOME DESIGN Obstacles / risks and solutions Low utilization rate Benefit becomes outmoded / Insurers discontinue benefit Insurer insolvency Aggregator termination / replacement Early adopter Regulatory Growth, liquidity and control Flexibility in design Multi-insurer, insurance safety net Transferable platform Design control Broad support and interest 16

19 WHY INVEST IN RETIREMENT PLANS The business case for improving design BECAUSE YOU CAN Managing service providers at the enterprise reduces cost & improves outcomes IT S RIGHT Addressing social impact enhances employment & commercial brands IT CREATES FLEXIBILITY IN MANAGING WORKFORCE Retirement ready workforce increases flexibility & reduces severance costs IT ENHANCES EMPLOYEE ENGAGEMENT & LOYALTY Actively supporting employees differentiates employment & improves engagement IT WILL ENHANCE BARGAINING POWER Retaining assets in the pension plan reduces costs for members & the enterprise IT WILL ATTRACT HIGHER QUALITY SERVICERS Elevating plan status internally & externally makes it a more desirable prospect IT LEVERAGES EXISTING INFRASTRUCTURE Aligning plan objectives & retirement income creates consistent, whole-life approach Source: Lloyd,

20 Background & Supporting Material

21 PARTICIPANT COMMUNICATIONS Lifecycle-based Young / Mid-Life Savers: Accumulation Saving, diversification & long-term investing Simple, concise Quarterly fund fact sheets Pre-Retirees: Building Protection Saving, diversification, long-term investing & planning for certainty of income at retirement Consistent formatting with other options Near-Retirement Participants: Ready to Retire? Maximizing guaranteed retirement income Statements include account balance and guaranteed income On demand, participant-specific Retirees: Collecting Retirement Income Income preservation / purchasing power benefit estimates 19

22 TOOLS FOR PLAN DESIGN The Retirement Policy Statement ( RPS ) Defines employer objectives for offering retirement benefits Outlines basic principles used in the design & delivery of benefits Describes how benefits offered are expected to meet objectives Identifies internal/external constituents who have authority, influence and accountability for design, implementation & oversight Examples of RPS objectives Support employee access to secure retirement income Simplify choice architecture while offering a broad range of risk/return Emphasize default design with automatic enrollment & automatic escalation Establish & maintain a framework to enhance plan features & options with manageable participant disruption Address needs of all plan participants regardless of their investor type Offer low-cost investment options, negotiate institutional fees Maintain access to non-core investments through self-directed window Source: AllianceBernstein Defined Contribution Investments 20

23 GLIDE PATH COMPARISON Target Retirement Funds / Lifetime Income Strategy Equity Allocation % Lifetime Income Strategy Target Retirement Funds Age 21

24 INSURER SELECTION & OVERSIGHT Selection criteria and ongoing due diligence 22

25 TOTAL WEALTH & LIFETIME INCOME Sources, timing & contingent claims Accumulation Phased? Consumption Human Capital Retirement Financial Capital Mortality Risk Employment Risk Longevity Risk Inflation Risk Source: Morningstar 23

26 MORE TOOLS FOR PLAN DESIGN The Retirement Plan Audit Ask the following questions Is it designed to emphasize secure retirement income as a default outcome? Does it address the needs of the broad range of members in the plan? Can it function effectively with little or no employee direction? Is it flexible enough to respond if members face unexpected circumstances while they are working or in retirement? Then take the following actions Frame thinking in terms of retirement income and lifestyle Help people identify with their older selves Make default options relevant to the individual Use auto-enrollment and auto-escalation Provide Future Enrollment and Future Escalation options for those opting out Design defaults with built-in income conversion features Emphasize accumulated retirement income on account statements Focus attention on contribution rates and their effect on the future Source: Strobl,

27 RETIREMENT BENEFITS 10 Years of accelerating change at UTC Final Average Earnings (FAE) DB pension for decades 2002 Cash Balance Plan for new hires 2006 Savings Plan introduces Target Date Funds 2008 Auto-enrollment for new hires 2009 FAE pension sunset* announced 2010 Savings Plan in lieu of pension for new hires 2010 Savings Plan accepts Cash Balance Plan rollovers 2011 Savings Plan investment redesign 2012 Introduction of Lifetime Income Strategy * Future accrual for active FAE participants converts to cash balance design after 12/31/

28 TOOLS FOR PLAN DESIGN At least 2 perspectives & 2 checklists Retiree/Member Perspective Employer Perspective Initial income generation Initial income generation Protection from risk Longevity risk Inflation risk Insurer credit risk Downside market risk Annuity conversion rate risk Terms and conditions risk Transferability to another provider In-plan or out of plan Fiduciary/regulatory concerns Insurer credit risk Fees Potential conflicts Maximize returns Access to capital Source: Lloyd, 2013 Other Remember to consider your service providers, because you cannot offer the program if they won t sell their services 26

29 ACCESSIBLE RESOURCES Downloads from the Web The Future of Life-Cycle Saving and Investing, Second Edition Zvi Bodie, Dennis McLeavey, CFA, and Laurence B. Siegel Research Foundation Publications, (Feb 2008): The Future of Life-Cycle Saving and Investing: The Retirement Phase Zvi Bodie, Laurence B. Siegel, and Rodney N. Sullivan, CFA Research Foundation Publications, (Oct 2009): Making Investment Choices as Simple as Possible, but Not Simpler Zvi Bodie and Jonathan Treussard Financial Analysts Journal, May/June 2007, Vol. 63, No. 3:

30 INTEGRATED DESIGN & MESSAGING Behaviorally informed approach Design principles: Easier to understand, even lower cost, flexible New fund lineup messaging: Let a professional manage it for you Target Retirement Funds Do-it-yourself Core Options & UTC Ownership Do it yourself with more choice Mutual Fund Brokerage Window 28

31 ACCESSIBLE RESOURCES More downloads and other material DOL EBSA Final Rules on Qualified Default Investment Alternatives, DOL EBSA Proposed Rules on Annuity Selection in DC Plans, DOL EBSA Final Rules on Annuity Selection in DC Plans, Social Science Research Network for Social Science Research Delivered Daily CFA Publications for the Latest In Investment Management Research AonHewitt Retirement Research & Statistics Web Site Mature Markets Institute for MetLife Research on Aging, Longevity & the Generations 29

32 BEHAVIORAL PSYCHOLOGY & RETIREMENT Products need to be defined in terms of income and not accumulated wealth Perceived fairness is relevant to retirement products Fairness Focus on what retirement is for Help the imagined Time Travel Imagining the future helps making a correct decision Inflation is difficult to internalize Money illusion De-emphasize quarterly returns Sensitivity to losses increases significantly after retirement Allowing people to select amongst comparable options is helpful Active decisionmaking Annuitization should be a default After the age of 60, cognitive capabilities may decrease rather rapidly and significantly Behavioral Default is to do Nothing Harness people s Inertia Make Default Relevant to the Individual Emphasize expected income It is easier to plan if income is subdivided in accounts; necessary and discretionary Collective default options can hurt individual needs Source: Behavioral Finance and the Post-Retirement Crisis: Study by Shlomo Benartzi, UCLA, sponsored by Allianz of America, April 29,

33 PROGRAM IMPLEMENTATION What happens under the hood Participant Lifetime Income Strategy Retirement Option Investment Manager Equity Fund Bond Fund Secure Income Fund Aggregator Platform Insurer 1 Insurer 2 Insurer 3 Lifetime Income Strategy Fund displayed as single option for investment elections and transfers Quarterly statements include single Lifetime Income Strategy Fund market value & income Web requests and accounting activity list single Lifetime Income Strategy Fund Some performance pages will display data for subfunds Lifetime Income Strategy program implemented through a single shell fund and multiple sub-funds on recordkeeping platform Investment Manager provides investment direction to record keeper for each participant specific to date of birth and activity. Record keeper and Investment Manager exchange balances and activity nightly Aggregator supports daily record keeping functions for Lifetime Income Strategy Coordinates competitive bidding and allocation process for quarterly withdrawal rates Calculates Income Base and guaranteed withdrawal amount ( Income Benefit ) per participant Coordinates insurer payments through Trustee if market value is depleted Track benefits and elections Maintain allocated group annuity contracts and insurance company separate accounts Pay benefits if market value of account is depleted Structure delivers custom-built, individual Income Benefits Unique personal rates of return are calculated for participants at plan account-level Unique to each participant by date of birth & individual activity 31

34 WHY TARGET DATE FUNDS HAVE REVOLUTIONIZED THE DC MARKET Jerome A. Clark, CFA Portfolio Manager, T. Rowe Price Retirement Products March 2015

35 Target Date Utilization is Expected to Continue to Increase Significantly Sources: Callan, Casey Quirk. As of June 30,

36 WHY TARGET DATE FUNDS WORK FOR RETIREMENT PLANS AND THEIR PARTICIPANTS

37 Benefits of Target Date Funds for Participants Provide broad diversification Asset allocations shift gradually over time High acceptance and adoption among participants Very little engagement required from participants in order to implement the solution The principal value of target-date funds is not guaranteed at any time, including at or after the target date, which is the approximate date when investors plan to retire. These funds typically invest in a broad range of underlying mutual funds that include stocks, bonds, and short-term investments and are subject to the risks of different areas of the market. In addition, the objectives of target-date funds typically change over time to become more conservative. 4

38 Target Date Funds Address Three Key Components of 401(k) Plans 5

39 Target Date Funds Address 401(k) Plans Primary Investment Objectives 6

40 Primary Investment Objectives of 401(k) Plans TARGET DATE FUNDS ADDRESS THE PRIMARY OBJECTIVES OF A RETIREMENT ACCOUNT 7

41 Target Date Funds Address the Investment Risks of Participants 8

42 Three Primary Investment Risks 9

43 Market Risk The two primary objectives of plan sponsors should determine how the three investment risks are balanced. 10

44 Market Risk 2008 WAS NOT THE FIRST BEAR MARKET AND IT WON T BE THE LAST CALENDAR YEAR RETURNS OF THE S&P 500 INDEX FROM The S&P 500 Index has returned less than -5% approximately one out of five calendar years since Past performance cannot guarantee future results. Source of data: Ibbotson. 11

45 Addressing Market Risk IMPACT OF EQUITY ALLOCATION ON SHORT-TERM LOSSES 1 The remainder of the allocation is assumed to be in fixed income and would be the percentage required to equal 100%. These charts show the percentage of the time that specific equity and fixed income allocations were able to provide the stated withdrawal rate, adjusted for CPI to last throughout a 20-year or 30-year retirement period based on the historical performance of the indices representing equities and fixed income securities. Please see slide 18 for information about this analysis. 12

46 Longevity Risk LIFE EXPECTANCIES HAVE INCREASED DRAMATICALLY AND ARE EXPECTED TO CONTINUE INCREASING ODDS OF AT LEAST ONE MEMBER OF A 65-YEAR OLD COUPLE LIVING TO AGE Participants long life expectancies indicate longevity should be a priority. Source: Society of Actuaries, July

47 Addressing Longevity Risk 1 The remainder of the allocation is assumed to be in fixed income and would be the percentage required to equal 100%. These charts show the percentage of the time that specific equity and fixed income allocations were able to provide the stated withdrawal rate, adjusted for CPI to last throughout a 20-year or 30-year retirement period based on the historical performance of the indices representing equities and fixed income securities. Please see slide 18 for information about this analysis. 14

48 Inflation Risk CPI MAY NOT FULLY REPRESENT INFLATION RISK IN RETIREMENT COMPARISON OF CPI VS. CPI MEDICAL CARE January 1961 through December 2014 EQUIVALENT OF $100, YEARS AGO CPI Medical Care CPI SINCE 1960: CPI CPI annual Medical growth Care was annual 3.91% growth was 5.66% CPI annual growth was 3.91% CPI Medical Care $400, % CPI $223, % Both CPI and CPI-Medical Care are indexed, January 1961 = 100 Source: Bureau of Labor Statistics. 15

49 Addressing Inflation Risk IMPACT OF INFLATION ON RECEIVING A 4% OR 4.5% WITHDRAWAL RATE THROUGHOUT A 30-YEAR HORIZON 1 The remainder of the allocation is assumed to be in fixed income and would be the percentage required to equal 100%. These charts show the percentage of the time that specific equity and fixed income allocations were able to provide the stated withdrawal rate, adjusted for CPI to last throughout a 20-year or 30-year retirement period based on the historical performance of the indices representing equities and fixed income securities. Please see slide 18 for information about this analysis. 16

50 Target Date Funds Address Challenges in Participant Behavior 17

51 Participants Savings Behaviors Indicate a Need for Adequate Equity Participants undersave for retirement, indicating a need for help through adequate capital appreciation. 1 PSCA s 56 th Annual Survey of Profit Sharing and 401(k) Plans (reflecting 2012 plan experience). 2 Non-highly compensated workers. 18

52 Participants Asset Allocation Decisions TARGET DATE FUNDS ADDRESS PARTICIPANTS LACK OF ASSET ALLOCATION KNOWLEDGE AND PROPER UTILIZATION The accounts included are 401(k) accounts that are currently active and that have a positive balance and do not include any assets invested in target date products. Stock includes company stock as well as other equity. Source: T. Rowe Price Retirement Plan Services. For illustrative purposes only. 19

53 Participants Asset Allocation Decisions MANY PARTICIPANTS IMPLEMENT EXTREME ASSET ALLOCATIONS BOTH YOUNG AND OLD PARTICIPANTS NEED ASSET ALLOCATION HELP Source: T. Rowe Price Retirement Plan Services 401(k) accounts that are currently active, have a positive balance, and do not include any assets invested in target date funds. Cash includes money market and stable value funds. 20

54 Participants Decision Behavior INVESTMENT BEHAVIOR CAN BE A PARTICIPANT S OWN WORST ENEMY By chasing performance, participants tend to buy high and sell low. From the New York Times: How Greed and Fear Kill Returns (March 24, 2010). 21

55 Participant Behavior MORE LIKELY TO STAY THE COURSE: Based on June 30, 2013 data for plan participants in retirement plans administered by T. Rowe Price. 22

56 T. Rowe Price Investment Services, Inc US-9038 (3/15) TRENDS AND WHAT S NEXT: Q&A

57 THANK YOU.