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© 2010 Northern Trust Corporation northerntrust.com
NORTHERN TRUSTDEFINED CONTRIBUTION SOLUTIONS
THE PATH FORWARD
Designing the Ideal Defined Contribution PlanPresenting the Results of Northern Trust’s 2010 Defined Contribution Industry Survey
2 The Path Forward: Designing the Ideal Defined Contribution Plan − October 2010
1999 2009
56%
45%44%
55%
Defined Benefit Defined Contribution
2025 2040 2055
0%
42%
85%
Private industry State and local government
19%
10%
Total U.S. Pension Assets 1999 vs. 2009
% of U.S. DB Participants in a “Frozen” Plan
Probability that Social Security Trust Fund Exhausted
Source: Bureau of Labor Statistics, April 2010. Source: Congressional Budget Office, 2009. Source: Towers Watson, January 2010.
There is too much riding on the success of the defined contribution system to risk getting it wrong
3 The Path Forward: Designing the Ideal Defined Contribution Plan − October 2010
Northern Trust launches “The Path Forward” thought leadership series to pinpoint DC industry challenges and potential solutions
The question put to a group of
DC plan sponsors and investment
consultants
How would they design the ideal DC plan if they
were free from all existing regulations, laws,
structures, history and standard industry practices?
Participants included some of the
largest, most well-regarded firms
in the United States and several
of the most influential DC
investment consultants
50 plan sponsors managing over $100B in assets
and representing over 970,000 participants
Five leading investment consultants also shared
their views
Conversations focused on
perspectives regarding the
design of the ideal DC plan, with
a particular focus on these key
areas
Plan design and features
Investment options
Employee education and advice
Administration
Fees
Interviews were conducted by Greenwich Associates during July and August of 2010
4 The Path Forward: Designing the Ideal Defined Contribution Plan − October 2010
Note: Two respondents requested anonymity.
Participating firms represent 50 of the largest DC plans and several of the most influential investment consultants in the United States
Accenture plc Idaho National Laboratory Ennis, Knupp & AssociatesACCO Brands Corporation ITT Corporation Hewitt Investment GroupAlcon, Incorporated Kimberly-Clark Corporation Russell Investment GroupAmerican Honda Motor Company Incorporated Lockheed Martin Corporation Slocum AssociatesAutoliv ASP, Incorporated McDonald's Corporation Towers WatsonBaker Hughes Incorporated Mead Johnson Nutrition CompanyBlue Cross of California Monsanto CompanyThe Boeing Company Nestle USA, IncorporatedBridgestone Americas, Incorporated PACCAR IncorporatedBurlington Northern Santa Fe Corporation Pfizer IncorporatedCampbell Soup Company Pitney Bowes IncorporatedCargill, Incorporated PricewaterhouseCoopers LLPContinental Grain Company The Readers Digest Association, IncorporatedElectrolux North America, Incorporated Robert Bosch LLCEnergizer Holdings, Incorporated S. C. Johnson & Son, IncorporatedExelon Corporation Sara Lee CorporationExxon Mobil Corporation Schlumberger LimitedFluor Corporation Texas Instruments IncorporatedFreeport-McMoRan Cooper and Gold Incorporated United Technologies CorporationFreescale Semiconductor, Incorporated UT-Battelle, LLCGATX Corporation Volkswagen Group of America, IncorporatedHonda of America W.R. Grace & CompanyHoneywell International Incorporated Walgreens CompanyHSBC North America Holdings Incorporated The Western Union Company
Plan Sponsors Investment Consultants
5 The Path Forward: Designing the Ideal Defined Contribution Plan − October 2010
The ideal DC plan differs in many ways from our current DC construct
In general, the plan
sponsors and consultants
interviewed for the study
were in broad agreement
about the basic
characteristics of the ideal
DC plan
Simple, automatic and cost efficient
DC plan participants Required to participate
Able to contribution post-tax dollars without
restriction
Prevented from taking loans
DC Plan sponsors Required to contribute to employees’ plans
Allowed to share decision-making power with
participants
Held accountable for providing high levels of fee
transparency
Plan sponsors and
consultants had differing
views regarding
enrollment, contribution
levels and investment
options
Plan sponsors suggest broader investment line-
ups
Consultants promote greater levels of corporate
paternalism regarding participation and
investment decision-making
6 The Path Forward: Designing the Ideal Defined Contribution Plan − October 2010
1. Mandatory Participation for all Employees
Employees are automatically enrolled into the plan on their first day of employment with no election to opt out, thereby ensuring immediate savings
Optional Participation in DC Plan?
Plan Sponsors
Optional Participation in DC Plan?
Consultants
Source: Greenwich Associates Research, 2010.
18
31
YesNo
1
4
YesNo
7 The Path Forward: Designing the Ideal Defined Contribution Plan − October 2010
2. Default employee contributions of 5-6% of salary
Source: Greenwich Associates Research, 2010.
Default Employee Salary Contribution for Auto-Enrollment?
Plan Sponsors
1-2% 3-4% 5-6% 7-8% 9-10% > 10%
5
12
19
2
7
1
Default Employee Salary Contributionfor Auto-Enrollment?
Consultants
1-2% 3-4% 5-6% 7-8% 9-10% > 10%
3
1
This contribution rate automatically increases on an annual basis until it reaches 11-12% of salary, the contribution level commonly recommended for retirement security
8 The Path Forward: Designing the Ideal Defined Contribution Plan − October 2010
3. No limit on post-tax employee contributions
Though limits on employer matching contributions and government-sponsored tax deferral are acceptable, unlimited post-tax employee contributions encourages higher levels of saving
Restriction on Maximum Employee Contribution?
Plan Sponsors
Restriction on Maximum Employee Contribution?
Consultants
Source: Greenwich Associates Research, 2010.
3
38
9
Yes
No
Depends on Employee Salary
1
2
2Yes
No
Depends on Employee Salary
9 The Path Forward: Designing the Ideal Defined Contribution Plan − October 2010
Immediately One Year or Less
Two Years or Less
Five Years or Less
Other
30
2
6
10
2
Immediately One Year or Less
Two Years or Less
Five Years or Less
Other
3
1 1
4. Immediate vesting of employer contributions
Source: Greenwich Associates Research, 2010.
Immediate vesting allows today’s more mobile workforce to recognize immediate benefit from plan participation
How Long Before Fully Vested?
Plan Sponsors
How Long Before Fully Vested?
Consultants
10 The Path Forward: Designing the Ideal Defined Contribution Plan − October 2010
Prohibiting loans removes participant temptation from drawing upon balances for non-retirement related expenses, however those due to hardship are the likely exception to this rule
Allowed to Take Loans AgainstAccount Balances?
Plan Sponsors
Allowed to Take Loans Against Account Balances?
Consultants
Source: Greenwich Associates Research, 2010.
5. Participant loans are not permitted, unless under duress
16
33
YesNo
5
YesNo
11 The Path Forward: Designing the Ideal Defined Contribution Plan − October 2010
Participant-Led
Shared Decision-Making
Plan Sponsor-Led
13
32
5
Participant-Led
Shared Decision-Making
Plan Sponsor-Led
1
1
3
Participants are responsible for investments and asset allocations within guidelines established by sponsors, which enables participants to control their money while ensuring adherence to prudent investment practices
Who holds the decision-making power?
Plan Sponsors
Who holds the decision-making power?
Consultants
Source: Greenwich Associates Research, 2010.
6. Continuation of shared decision-making between plan sponsor and participant
12 The Path Forward: Designing the Ideal Defined Contribution Plan − October 2010
Ideal Number Investment Options Offered to Employees?
Plan Sponsors
Ideal Number Investment Options Offered to Employees?
Consultants
< 3
3-5
6-10
11-15
16-20
21-30
> 30
3
3
14
22
3
3
2
< 3
3-5
6-10
11-15
16-20
21-30
> 30
2
2
1
Source: Greenwich Associates Research, 2010.
7. Optimized investment menus
Investment line ups are required to include asset allocation funds like target date or other managed options, but can also include more flexible options for more informed or active participants
13 The Path Forward: Designing the Ideal Defined Contribution Plan − October 2010
Product-Re-lated Advice
Specific Investment
Strategy Advice
General Re-tirement Planning Advice
Broad-Based Fi-
nancial Counseling
Other
5 5 5
4
Product-Re-lated Advice
Specific Investment
Strategy Advice
General Re-tirement Planning Advice
Broad-Based Fi-
nancial Counseling
Other
35 36
41
32
5
8. Broad-based advice for participants
Source: Greenwich Associates Research, 2010.
Participants have access to advice that not only focuses on investment products, but also long-term financial planning, offered in an environment of reduced concern about potential liability
Types of Advice Offered in Ideal DC Plan?
Plan Sponsors
Types of Advice Offered in Ideal DC Plan?
Consultants
14 The Path Forward: Designing the Ideal Defined Contribution Plan − October 2010
9. High levels of fee transparency
Administrative Expenses
Investment Management Fees
Participant-Initiated Transactions Fees
Other
30
30
29
6
Administrative Expenses
Investment Management Fees
Participant-Initiated Transactions Fees
Other
4
4
4
1
Participants receive clear and concise information regarding administration expenses, investment management fees and participant-initiated transaction fees
What Fees Need to be Communicated?
Plan Sponsors
What Fees Need to be Communicated?
Consultants
Source: Greenwich Associates Research, 2010.
15 The Path Forward: Designing the Ideal Defined Contribution Plan − October 2010
Unbundling enables utilization of “best-of-breed” providers
Ideal DC Plan Service Structures?
Plan Sponsors
Ideal DC Plan Service Structures?
Consultants
Source: Greenwich Associates Research, 2010.
Bundled Offering
Unbundled Offering
Internal Administration
Other
10. Unbundled service structures
Bundled Offering
Unbundled Offering
Internal Administration
Other
39
7
11
4
1
16 The Path Forward: Designing the Ideal Defined Contribution Plan − October 2010
Source: Greenwich Associates Research, 2010.
Some steps can be implemented in the short-term with minimal costs to employers or participants
Path Forward Action Items: Short-Term
1. AutomationPlan sponsors should act immediately to adopt automatic enrollment and auto-escalation features.
2. Simplification of investments
Plan sponsors must take steps to make plans simpler and more efficient. This can be achieved mainly by reducing the number of investment options to plan participants.
3. TransparencyPlan sponsors should be providing all plan participants with detailed information about administrative expenses, investment management fees and participant-initiated transaction fees.
4. Customization of default options
Plan sponsors should set an appropriate default contribution level for employees and work with providers to identify proper default investment options.
17 The Path Forward: Designing the Ideal Defined Contribution Plan − October 2010
Source: Greenwich Associates Research, 2010.
Other alterations – in the medium term – will require plan sponsors to make some hard decisions and accept new costs
Path Forward Action Items: Medium-Term
1. Employer matchPlan sponsors should set a reasonable employer matching contribution level either based on employee contributions or, ideally, independent of employee contribution and tied to employee salary.
2. Improved advice
Plan sponsors should provide participants with robust consultative services in the following areas: product-related advice, specific investment strategy advice, general retirement planning advice and broad-based financial planning.
3. Streamline across geographies
Plan sponsors should eliminate unnecessary differences in plan structure across geographic regions.
18 The Path Forward: Designing the Ideal Defined Contribution Plan − October 2010
Source: Greenwich Associates Research, 2010.
The ideal DC structure requires regulators/politicians to face up to current shortcomings and change regulatory structures
Path Forward Action Items: Long-Term
Reduce liability and fiduciary concerns
Address liability and fiduciary concerns that discourage plan sponsors from providing participants with robust advice.
Encourage more savingEliminate employee contribution caps so all participants can prepare for retirement to the full extent they are able.
Allow annuities in plans
Facilitate the inclusion of annuities within defined contribution plans to provide participants with a reliable stream of income post-retirement to plan “through retirement” rather than “to retirement.”
19 The Path Forward: Designing the Ideal Defined Contribution Plan − October 2010
Key Characteristic Why This Makes Sense
1.Mandatory participation for all employees.
Employees are automatically enrolled into the plan on their first day of employment, thereby ensuring immediate savings.
2.Initial default employee contributions of 5-6% of salary.
This contribution rate automatically increases on an annual basis until it reaches 11% − 12% of salary, the contribution level commonly recommended for retirement security.
3.No limit on post-tax employee contributions.
Though limits on employer matching contributions and government-sponsored tax deferral are acceptable, unlimited post-tax employee contributions encourage higher levels of saving.
4.Immediate vesting of employer contributions.
Immediate vesting allows today’s more mobile workforce to recognize immediate benefit from plan participation.
5.Participant loans are not permitted, unless under duress.
Prohibiting loans removes participant temptation from drawing upon balances for non-retirement related expenses. Hardship withdrawals are the exception to this rule.
6.Continuation of shared decision-making between plan sponsor and participants.
Participants are responsible for investments and asset allocations within guidelines established by sponsors, which enables participants to control their money while ensuring adherence to prudent investment practices.
7. Optimized investment menus.Investment lineups are required to include asset allocation funds like target date or other managed options, but can also include more flexible options for more informed or active participants.
8.Broad-based advice for participants.
Participants have access to advice that not only focuses on investment products, but also long-term financial planning, offered in an environment of reduced concern about potential liability.
9. High levels of fee transparency.Participants receive clear and concise information regarding administration expenses, investment management fees and participant-initiated transaction fees.
10. Unbundled service structures. Unbundling enables utilization of “best of breed” providers.
In review, the ideal DC plan contains 10 key characteristics
20 2010 Program Solutions Conference
Important Information
NOT A SOLICITATION. No information provided herein shall constitute, or be
construed as, an offer to sell or a solicitation of an offer to acquire any security,
investment product or service, nor shall any such security, product or service be
offered or sold in any jurisdiction where such offer or solicitation is prohibited by
law or regulation. This material is provided for informational purposes only and
does not constitute a recommendation of any investment strategy or product
described herein. Opinions expressed are those of the presenter(s) and subject to
change without notice.