Northern Trust Study: ‘Winning Strategies’ to Improve Outcomes for Defined Contribution Plans

CHICAGO--(BUSINESS WIRE)--As defined contribution (DC) plans evolve into the primary retirement savings vehicle for American workers, a new study from Northern Trust suggests they could improve retirement outcomes for participants by adopting practices developed over decades by defined benefit plans and other institutional investors.

“Plan sponsors are beginning to recognize the importance of alternative asset classes in providing broader diversification to their participants, which will help create opportunities for wealth creation and mitigate various risks, including inflation risk”

Executing a more disciplined investment approach, designing more efficient fee structures and encouraging participants to maintain their assets in the plan structure after retirement would all help to improve results in DC plans, Northern Trust found in a survey of prominent corporate retirement plan sponsors and investment consultants. But the survey also identified hurdles to implementing these practices, including resistance to perceived changes to benefits and concerns over fiduciary liability.

“Our research shows defined contribution plans need to shift their focus from simply accumulating assets to driving more successful outcomes in retirement security for participants,” said Jim Danaher, Managing Director of Defined Contribution Solutions at Northern Trust. “During the last decade, employers, industry providers and regulators have made significant improvements to DC plan design. But more work is needed to overcome challenges such as ensuring adequate funding, implementing appropriate investment diversification and offering effective ‘decumulation’ strategies for those who reach retirement in these plans.”

The Path Forward: Importing Winning DB Strategies into DC Plans, the third installment of Northern Trust's research series on the future of DC plans, pinpoints best practices from investment models used by pension plans, endowments and foundations and identifies how they can be implemented by DC plans to improve retirement outcomes for participants. The report is based on interviews with plan sponsors representing more than 1.5 million participants and almost $200 billion in assets, as well as leading investment consulting firms in the United States.

Interviews, which were conducted by research firm Greenwich Associates, found that nearly 70 percent of plan sponsors are optimistic that DC plans are capable of providing sufficient retirement income to working Americans. But respondents also believe that DC plans could improve their chances of participant success by importing winning strategies from institutional investors. These include:

Investment Approach: Establish a streamlined investment menu that includes simplified pre-mixed default options, access to alternatives and cost effective investment strategies.
Fee Structure: Minimize overall participant cost by utilizing institutional investment vehicles, maximizing the plan scale, conducting regular fee benchmarking and reducing or eliminating revenue sharing.
Governance: Dedicate appropriate resources and attention in proportion to DC assets invested, create efficient decision-making process and be mindful of fiduciary liability.
Decumulation: Enhance the plan’s decumulation strategy by providing education about distribution options, offering appropriate asset preservation and income generating investment products, and maintaining an ongoing dialogue with retirees.
Communication: Maintain lifetime engagement with participants through personalized communications clearly focused on specific outcomes.

The 2012 survey included a strong focus on investments, where plan sponsors and consultants say institutional models and approaches could have a positive impact on outcomes for DC plan participants. Institutional features would include a streamlined menu of eight to 10 investment options; an age-based asset allocation default option, such as a target retirement date fund; access to alternative asset classes, such as real estate or TIPS; and cost-efficient vehicles such as passively managed index options implemented through collective investment trusts.

“Plan sponsors are beginning to recognize the importance of alternative asset classes in providing broader diversification to their participants, which will help create opportunities for wealth creation and mitigate various risks, including inflation risk,” said Northern Trust Chief Investment Officer Bob Browne. “On the expense side, plan sponsors can hold down fee levels by employing index strategies, institutional funds, CITs and other lower-fee investment vehicles whenever possible.”

Additional Findings

The survey found some gaps between identification and implementation of these best practices, however. While all consultants surveyed say they recommend a limit of 15 investment options to help participants make better choices, nearly half (46 percent) of plan sponsors maintain 16 to 25 options and 8 percent offer more than 25 options. Three quarters of plan sponsor do not offer access to alternative asset classes. Mutual funds are the most popular investment vehicle, used by 79 percent of DC plan sponsors surveyed. However, the shift to CITs is under way, with 73 percent of participating DC plan sponsors offering CITs and many remaining plans considering them for future use.

As participants enter retirement, DC plans could improve outcomes by maintaining a relationship with retirees, so they continue to get the benefits of institutional pricing and professional oversight of investment options in the plan. Yet the survey found a significant portion of retirees take lump-sum payouts from their DC plans, and only 31 percent of plan sponsors encourage participants to keep their assets in the plan. Nearly two-thirds (65 percent) of plan sponsors offer income planning tools to retirees and many (58 percent) offer income education and advice.

On issues from limiting investment options to keeping retirees in the DC plans, survey respondents identified potential roadblocks to adoption of strategies from defined benefit plans and other institutional investors. Plan sponsors cited resistance from participants, who tend to view any change as a loss of benefits. Concern over fiduciary liability can also be an impediment, although plan sponsors and consultants have differing views on its impact. While 66 percent of consultants said their plan sponsor clients voice concerns over fiduciary liabilities related to investment changes in their DC plan, only 25 percent of plan sponsor respondents saw it as a significant concern.

The Path Forward survey also addresses governance issues and fee structures of DC plans compared to DB plans and communications with participants up to and into retirement. For its research, Northern Trust engaged Greenwich Associates to conduct telephone interviews during May and June 2012 with 48 DC plan sponsors at some of the largest, most well-regarded firms in the United States, as well as nine influential investment consultants. More details of the study, including comments from participants, can be found in the full report on Northern Trust’s website.

“Plan sponsors should be commended for their persistent and, at times, costly efforts to encourage employees to participate in DC plans, to contribute appropriate amounts and to manage their accounts in a manner that facilitates asset accumulation,” said Susan Czochara, senior product manager of Northern Trust’s DC Solutions Group. “But now that the Baby Boomer generation is approaching or moving into retirement, and DC has emerged as a primary mechanism for funding retirement in the United States, it is incumbent upon plan sponsors to shift a significant portion of their attention to the decumulation phase, and through design strategies, help participants extend the duration of plan assets through their retirement years.”

This edition of Northern Trust’s research series, The Path Forward, builds on two previous studies that examined challenges in DC plan design and implementation. A 2010 survey of plan sponsors found the ideal DC plan structure would include mandatory enrollment and automatic increases in contributions, among other features. In 2011, Northern Trust’s research addressed the challenges of engaging employees younger than age of 35 in DC plan participation.

The Defined Contribution Solutions Group at Northern Trust is committed to helping plan sponsors meet the varied needs of their plan participants. The experienced team employs a consultative approach to help clients design a comprehensive service suite that leverages Northern Trust’s broad range of investment strategies and asset servicing options. Northern Trust manages approximately $78 billionⁱ in DC plan assets and has more than $200 billion in DC assets under custodyⁱⁱ.

Asset Management at Northern Trust begins with listening and leads to answers beyond the expected for our clients. The multi-asset class investment management business is comprised of Northern Trust Investments, Inc., Northern Trust Global Investments Limited, Northern Trust Global Investments Japan, K.K., the investment advisor division of The Northern Trust Company and The Northern Trust Company of Connecticut and its subsidiaries which offer investment products and services to personal and institutional markets.

About Northern Trust

Northern Trust Corporation (Nasdaq: NTRS) is a leading provider of investment management, asset and fund administration, banking solutions and fiduciary services for corporations, institutions and affluent individuals worldwide. Northern Trust, a financial holding company based in Chicago, has offices in 18 U.S. states and 16 international locations in North America, Europe, the Middle East and the Asia-Pacific region. As of June 30, 2012, Northern Trust had assets under custody of US$4.6 trillion, and assets under investment management of US$704.3 billion. For more than 120 years, Northern Trust has earned distinction as an industry leader in combining exceptional service and expertise with innovative products and technology. For more information, visit www.northerntrust.com or follow us on Twitter @NorthernTrust.

ⁱ As of September 30, 2012

ⁱⁱ As of Dec. 31, 2011