Defined contribution plans have become one of the fastest-growing segments of the retirement industry, representing $7 trillion of the $24 trillion in retirement system assets in 2014, according to data from the Investment Company Institute.
Private companies have been at the forefront of the change, but government entities are following suit, which means DC plans will become even more important in the years ahead, according to a white paper by Jeffrey Snyder, vice president and senior consultant at Cammack Retirement.
Also see: How to benchmark a DC plan
The move to more DC plans in government is just one of nine hot trends for DC plan sponsors to pay attention to in 2015, Cammack found.
- Public employers shifting to defined contribution plans: Many states and municipalities have started to offer DC plans to new and existing employees as they attempt to battle the underfunded status of their traditional pension plans. The weight of these financial burdens has been significant and has forced some major U.S. cities toward bankruptcy (e.g. Detroit, Mich., and Stockton, Calif.). Led by the success of Washington States Plan 3, this trend will continue to gain momentum in 2015, the white paper found.
- Behavioral finance gains in importance: Retirement plan sponsors are focusing less on selecting and monitoring investments and fees in their plans and moving more toward understanding who their participants are and what interventions will work best to help them prepare for retirement. Retirement committees are monitoring how participants use their plan and are developing effective participant education, communication and messaging, Cammack said. Employers are reducing the number of investment options in their plans as a way to encourage employees to participate in the plan. Plan sponsors also are exploring automatic features like auto enrollment and auto escalation to help participants save enough for retirement, the white paper said.
- Less is more: Plan sponsors will continue to consolidate their investment menus, Cammack found. This consolidation consists of a formal process to review and evaluate the funds available in the lineup, and the selectin of one fund, or possibly two funds, in each of a core set of asset classes, Cammack found. A typical consolidated plan investment menu might range from 15-20 investment options (counting the target date suite of funds as just one fund).
- Diversifying plans with additional asset classes: Plan sponsors are considering adding new asset classes to their portfolios as they reduce the number of options in each asset class they offer. These classes include Treasury Inflation Protected Securities and Real Estate Investment Trusts, along with shorter duration fixed income products that are suited to a low interest rate environment, Cammack said. Especially within asset allocation funds (e.g., target date funds, lifestyle or balanced funds), consideration is being given to weightings towards alternatives, such as direct real estate, commodities, hedge funds and private equity. Challenges with valuation of these particular asset classes has led to the creation of liquid alternatives which are valued daily but still lack in performance.
- Focus on fees prompting plan sponsors to use alternative investments: As plan sponsors focus more on reducing plan fees, many of them are considering alternative investments, such as collective trusts, separate accounts and exchange traded funds, which are typically lower cost investments, Cammack said. A focus on fee disclosure in 2014 led many investment committees to move toward passive investments or index funds, where very little portfolio turnover results in lower trading costs, the report found. Federal and state regulations prohibit collective trusts in 403(b) plans, Cammack added.
- Employers must adapt to the challenges of the fixed annuity and stable value fund marketplace: The majority of DC plan assets sit in fixed annuities/stable value funds or in the qualified default investment alternative, which is usually a target date, lifestyle or balanced fund, Cammack said. Since the market downturn in 2008, many banks, insurers and investment management companies have departed from the stable value business, resulting in limited space to provide the wrap or guaranteed return of some percentage equal to or greater than 0%, Cammack said. The limited wrap capacity has driven up the expenses associated with stable value funds and taken away some of the choices employers have when coming up with an investment strategy. The low interest rate environment and the threat of increased rates also pose a challenge. Employers must perform manager due diligence with vigilance, ensuring that any selected fund remains a prudent investment, backed by a financially secure guarantor today and in the future, Cammack said.
- QDIAs will continue to grow: Knowing that employees are likely to choose an investment strategy and stick with it, qualified default investment alternatives will continue to grow in the coming years, Cammack said. Target date funds, managed accounts, lifecycle funds and custom portfolio funds are options that take some of the guesswork out of retirement savings for employees as someone else manages the investments in those accounts.
- Guaranteed income options: As defined benefit plans go by the wayside, employees continue to search for ways to turn their accumulated retirement money into a steady stream of income when they retire, the report found. The next challenge for investment managers, insurance companies and third-party providers will be to develop products and services to meet this demand, and for regulators to provide some type of fiduciary protection to encourage adoption, Cammack found. The company pointed out that the Treasury and Internal Revenue Service released new regulations in 2014 for the inclusion of deferred income annuities in DC plans, but so far the market for annuities in plans is still soft, Cammack said.
- Retirement plan scrutiny and regulation will continue in 2015: Regulators and legislators want to promote retirement security. Because of this, they will continue to focus on the fees paid to service providers, withdrawal of balances before and after retirement and better defining target-date fund vintages, Cammack said. An update to the fiduciary definition also is expected in 2015, which will impact advisers who work within the retirement plan space.
Cammack Retirement Group is a provider of investment advisory, consulting and actuarial services.
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