The Remaking of the DC Market

1
The Remaking of the DC Market
EBRIs 62nd policy forum
Nancy Szmolyan
Nancy_szmolayn_at_mcKinsey.com 212- 446 -7793
May 8, 2008
2
McKinsey has undertaken an extensive research
effort into the future of the DC market
Bottom-up modeling of impact of market trends
Over 50 industry interviews to ID market trends
and likely impact

• 10 Plan sponsors across all segments and plan
  sizes
• 10 DC industry experts and pension consultants
• 30 industry players including
• Recordkeepers
• IODC players
• Integrated players
• Insurers

• Detailed modeling of market growth and size by
  2015 including bottom up modeling of flows by
  tax segment and by plan size
• Detailed modeling of flows by asset class
  including target date flows, re-allocations, and
  passive management trends
• In depth analysis of economics by player and
  impact of changes in default option from stable
  value to asset allocation funds

3
Context A confluence of external forces has led
to the dawn of a new era for the DC market
Description and impact
I. Rapid sponsor shift from DB to DC

• Continuing sponsor shift from DB to DC retirement
  plans, with 60 of employees having DB-only plans
  in 1980, declining to 10 in 2004

• Transformation of DC from a tax-advantaged,
  individual savings account market to the bedrock
  of US retirement
• Renewed interest in DC, rapid product development
  and differentiated strategies and customer value
  propositions

II. Aging workforce retiring for the 1st time on
DC savings

• Likely reductions in social security benefits and
  growing life expectancy has shifted the risk of
  retirement to individuals and is changing product
  needs

• 2006 PPA
• Rapid adoption of auto enrollment
• Asset allocation funds as QDIAs
• New opportunities for participant advice
  solutions
• DOL fee disclosure/Form 5500 more transparent
  plan costs, institutional pricing
• 403 regulations increased fiduciary
  responsibilities for sponsors driving
• Reductions in the number of plan providers used
• Lower fees
• DOL 2008 requirement for index fund option

III. Most fundamental regulatory shift in 30-year
history of DC
4
A remade DC Market by 2015

• The changes sweeping the DC landscape imply five
  profound shifts in the
• size and structure of the industry by the year
  2015
• DC market will nearly double in size to reach
  7.8 trillion in AUM the largest sector of the
  retirement market when considering IRA rollovers
  from DC plans
• Asset allocation funds will account for 35 of
  AUM, share of passive assets will double
• Continued shift in industry economics More than
  90 of industry revenues will be generated by
  asset management, advice, and the rapidly growing
  IRA roll-over market versus traditional
  recordkeeping
• A 4-way race between at-scale integrated players,
  leading insurers, IODC players and new entrants
  (e.g., consultants, financial advisors) to
  capture advice, asset allocation and retirement
  income opportunities
• Accelerated consolidation of DC
  administrators/record-keepers

5
The DC market will almost double in the next 10
years driven by high contributions
4,134
DC market projections Billions
Money-in-motion opportunity for AMs of 6.8T
(2.8T in inflows and 4.0T in asset
rebalancing)

• Drivers are
• Adoption of auto enroll
• DB plan freezing
• Longer time in DC

Inflows 3,840
Outflows -3,209
7,825
184
147
2,663
3,060
3,509
546
4,134
7,825
4,134
2006 DC assets
New contributions
New participants
New plans
IRA rollovers
Other withdrawals
Asset appreciation
2015 DC assets
Source McKinsey DC Model
6
Asset allocation funds are on track to become one
of the most successful innovations in financial
services
100
Share of DC assets Percent, Billions

• 3 major drivers of growth
• Dominance of asset allocation funds (target date)
  as QDIA
• Strong demand from participants that self select
  their investment option
• Switching and re-mapping of assets from stable
  value/MM funds

100
4,134
5,465
7,825
65
80
Other funds
97
35
Asset allocation funds
20
3
2006
2010E
2015E
Source McKinsey analysis
7
Passive products are poised to grow significantly
in DC, similar to the trend experienced in DB
5
Passive share of DB assets Trillions, Percent
Passive share of DC assets Trillions, Percent
7.8
8
5.5
6
5
4.7
79
4.1
4
3.7
4
84
69
2.3
2
Active / Other
71
89
Active / Other
80
21
31
29
16
Passive
Passive
20
11
2006
2001
1995
2010
2006
2015
Top 200 DB plans (Private and
Government) Source Pensions Investment,
McKinsey analysis
8
Economics in the DC industry will be highly
skewed towards Asset management, IRA rollovers
and Advice
10
PRELIMINARY ESTIMATES
Estimated revenues pools for mega 401(k) plan
segment Billions
20
5
8
5
24
Available to integrated players
Available to TPAs
10
Recordkeeping
6
Revenue sharing
9
1
Advice
18
IRA rollover
58
66
Asset Management
2006
2015
Recordkeeping fees is 4 bps Revenue sharing
fees is 15 bps on 40 of assets Advisory fees is
35 bps on 1 of assets Asset Management fees is
42 bps and IRA rollover
fees is 51 bps (assumed to be 20 higher than
asset management fees) on 22.5 of assets
(assumed to be the typical capture rate by DC
providers) Recordkeeping
fees is 3 bps Revenue sharing fees drop to 10
bps on 50 of assets Advisory fees remain at 35
bps but share of assets under advisement rises to
10 Asset Management fees
drops to 38 bps because of increased use of
separate accounts/commingled trust and although
IRA rollover fees drops to 45 bps
(assumed to be 20 more than asset
management fees) the share of IRA rollovers
captured goes up from 22.5 to 35 as providers
get better at IRA rollovers Source McKinsey DC
Model McKinsey analysis
9
Product innovation moving beyond accumulation and
transition to retirement income products
Annuity based
Income management funds
Hybrid products
IncomeFlex
SponsorMatch
Income Replacement Funds
Personal PensionBuilder
Clearcourse
Guaranteed Income for Life Benefit

Managed Payout Funds
Income Advantage
Lifetime Income
Premier Income Funds
i4LIFE Advantage
Preferred Income Funds
IncomeSolutions Platform for life Guarantee (out
of plan)

• Key questions
• In-plan vs. out of plan options?
• Likely winning products?

Source Press search
10
A wide range of advice models are emerging to
meet the differing needs of plan sponsors
EXAMPLES
Small independent automated tool providers e.g.
Managed account provider eg.

• Independent advice providers
• Basic financial education for mass market e.g.

Indepen-dent

• Specialized HNW / executive advice e.g.

Level of independence
Bundled Providers e.g.
Integrated players e.g.
Salaried worksite advisory forces e.g.
DC provider
Automated, online/ call-center based
Managed accounts
Worksite/11 financial planning
Delivery model
11
Consolidation is most likely in the fragmented
small plan segment, where economics are under
pressure
17
The smaller plan segments are much more
fragmented than larger segments
creating opportunities for a consolidator
Plan provider Percent of AuM, 2005

• Strong distribution (e.g., deep home office
  relationships with selected wirehouses)
• IT Ops platform flexible enough to enable rapid
  and cost efficient migration of acquired plans
• Partnerships to access or structure proprietary
  default investment options
• Investment underway to develop transition and
  income solutions

Top 3
26
28
32
45
54
30
25
Top 4-10
41
25
29
43
42
Others
33
30
17
Micro (lt50 partici-pants)
Medium (250-1,000)
Large (1,000-5,000)
Small (50-250)
Mega (gt 5,000)
Source Pensions Investments Access
Research McKinsey analysis
12
Considerations for the management agenda
1. Is target date the winning structure, or do we
expect emergence of new asset allocation products?
2. How big will be the share of default products
and impact on the DC industry and players?
3. Will the trend to unbundled pricing improve
the economics of record-keeping?
4. What are likely winning income products, will
they be in plan versus out of plan?
5. Which advice delivery model will offer the
best value to future retirees? Does the answer
differ by segment
6. Is consolidation likely in the small and large
plan segment?
13
The Remaking of the DC Market
EBRIs 62nd policy forum
Nancy Szmolyan
Nancy_szmolayn_at_mcKinsey.com 212- 446 -7793
May 8, 2008