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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