23 June 2017

Best of Both Worlds: DC Plans Evolving To Include More Institutional Features

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Defined contribution (DC) plans were created almost by accident, as a result of a loophole in the tax code. And in the early years, a lot of the thinking and design that went into DC plans was based on the premise that they were not America’s main retirement savings system. “When DC was a supplementary system, it was logical to have a retail kind of structure because employers were trying to make more choices available to people,” says Seth Masters, Chief Investment Officer of AllianceBernstein Defined Contribution Investments. He says that fee structures were often opaque, fund menus expanded rapidly because the top priority of sponsors was to provide investor choice, and DC plans were often managed by human resources departments and benefits managers rather than investment staff. Today, much of that is changing. “Defined contribution plans are starting to look less like retail platforms and more like institutional structures, which is actually more appropriate,” says Masters.

 

With approximately $4.8 trillion in assets as of midyear 2012, the DC retirement system is now nearly twice as large as the private-sector defined benefit (DB) system, according to the Investment Company Institute. And as more employers consider freezing or even closing their DB plans, DC plan sponsors are quickly adapting to a new reality in which DC plans are fast becoming Americans’ sole vehicle for retirement savings.

The Challenge of Producing Better Outcomes 

“Plan sponsors are increasingly concerned about the actual outcome for the participant,” says Jed Petty, CFA and Director of DC Strategies at Wellington Management. “Previously the end game for DC plans was some aggregate balance that helped supplement participants’ retirement. Now the end game is an outcome of whether or not you have enough money to retire.” He says that sponsors are “institutionalizing” DC plans to make them more effective from an outcome point of view, which includes a wide range of new and evolving practices—e.g., improving investment options, pricing, quality, and risk management, as well as setting up automatic features and using behavioral finance to the sponsors’ and participant’s advantage. He also points to a more institutional mindset in building DC fund menus—that is, designing the menu to make it easier for participants, who by and large are not professional investors, to achieve institutional-style diversification.

“Ultimately a best practice that is emerging, especially for large DC plans, is to customize the DC plan and have it overseen in the same way that DB plans would historically oversee their investments,” says AllianceBernstein’s Masters. He says that part of the reason DC plans need this higher level of expertise is because the investment problem is many times more complex than for DB plans. In the latter case, pooling can help address actuarial challenges such as longevity risk and predicting payout rates. In DC plans, the lack of pooling benefit means that every participant’s investment challenge is unique.

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