D.C. Plans, Regulatory Environment, Trends and Predictions Bob Melia Delaware Investments November,...

D.C. Plans, Regulatory Environment, Trends and Predictions

Bob Melia Delaware Investments

November, 2004

Delaware Investments / Lincoln Financial Group

Delaware Investments Lincoln Financial Group

Trends and the D. C. Market

• Legislative & Regulatory

• Rollover Market & Baby Boomers

• Apathy and Inertia

• Other Facts and Trends in Retirement Industry

• Small Plans

• Fees and Fee Transparency


"I don't make jokes. I just watch the government and report the facts."

- Will Rogers


Overview• The Political Context

• Mutual Fund Reforms

• Deferred Compensation Changes

• Bush Savings Proposals

• Next Generation Reforms

• Outlook and Conclusions


Presidential Race• If Bush and Republicans won

– Defined Contribution– Individual Vehicles– Private Component of Government

Programs– Tax Investment Income Lightly– Flatter Income Tax


Presidential Race• If Kerry and Democrats won

– Defined Benefit– Employer Vehicles– Government Social Insurance– Tax Investment Income Heavily– Progressive Income Tax


WHATS’

NEXT


“In America, anybody can be president. That's one of the risks you take.”

- Adlai Stevenson


Political Outlook• The House

– Factor: Redistricting– 90% Likelihood Will Stay Republican

• The Senate– Factors: Retirements, Including 5 Southern Dems– 60% Likelihood Will Stay Republican

• The White House– Factors: Debates, Turning Out the Base, Nader– 65% Likelihood Will Stay Republican


“The Democrats are the party that says government will make you smarter, taller, richer, and remove the crabgrass on your lawn. The Republicans are the party that says government doesn't work and then they get elected and prove it.”

- P.J. O’Rourke


Impediments Regardless of Elections

• Narrowness of Congressional Margins– Especially in Senate Where Minority Party Can

Stop Things

• Large Federal Budget Deficits

• These Are Particular Challenges for Big Tax Changes and Social Security Reform


Mutual Fund Reforms

• Late Trading– SEC’s Proposed Hard 4 p.m. Close

• Market Timing– Fund and Plan Sponsor Responses– SEC’s Proposed Mandatory Redemption Fee

• Fiduciary Dimensions of Trading Restrictions


Mutual Fund Reforms• Scrutiny of Revenue-Sharing

– SEC, DOL and Congress

• Outlook for Mutual Fund Reforms– Modification to Hard 4 Rule– Likely Abandonment of Mandatory Redemption

Fees– Continued Attention to Fee Transparency, Levels

and Structure


Executive Compensation• Consensus Proposals

– Deferral Restrictions

– Distribution Restrictions

– Basic Tax Rules

• Key Concerns– Nonqualified Deferred Compensation Definition

– Timing of Deferral Elections

– Effective Date

– Consequence of Failures


Executive Compensation• Jobs Act recently Enacted New Rules

– Election to defer in prior year– Election to defer bonus at least 6 months in advance– Rabbi trust and taxation of benefits when “restricted” to pay benefits– Distributions legislatively defined (specific time and specific schedule) and “2nd

deferral” more restrictive (12 moths)– Key employee further restrictions (6 months from SS) – No Haircut provisions – 20% penalty and immediate taxation for non-compliance. Clear guidance and

IRS audit activity – Effective 1-1-05 for deferrals after 1-1-05


Other Near-Term Items

• Final DOL Guidance on Automatic Rollovers

• IRS Guidance on Direct Deposit of Tax Refunds into IRAs


Bush Savings Proposals• Changing Tax-Favored Savings

– Lifetime Savings Accounts (LSAs)– Retirement Savings Accounts (RSAs)– Employer Retirement Savings Accounts (ERSAs)

• Outlook– LSAs & RSAs Introduced, ERSAs Later This Year– Chances for Enactment Turn on Election Outcome– Odds of Enactment Differ by Vehicle


Portman/Cardin Next Generation• IRA Reform and Simplification

• Faster Vesting of Profit-Sharing Contributions

• Portability Enhancements

• Sidecar IRA Enhancements

• Promotion of Auto Enrollment

• Expanded Saver’s Credit

• Annuitization Incentives


Other Major Debates in 2005• Defined Benefit Plan Reform

– Funding Changes– Hybrid Plans

• Social Security Reform

• Fundamental Tax Reform


Conclusions• Likely in Short Term

– SEC Mutual Fund Reforms

– Exec Comp Restrictions

• Possible in Medium Term– RSAs

– Portman/Cardin Next Generation Reforms

– Defined Benefit Plan Changes

• Longer-Term Debates– Permanence, LSAs and ERSAs, Social Security Reform,

Fundamental Tax Reform


Other Regulatory Issues

• Roth 401(k) and Roth 403(b) Accounts

• Advice Bill (Boehner)

• Spitzer Fallout / recordkeeping penalties and fines


“Politics is the art of looking for trouble, finding it, misdiagnosing it, and then misapplying the wrong remedies.”

- Groucho Marx


Rollovers and IRA’s

• Between 2004 and 2010 $2.4 trillion will be rolled over from Q.P. to IRAs

• What is the “roll” of the advisor in the rollover market


Rollover and IRAs

• In 2004 - 9.5 million distributable events

• 1/3 use an advisor

• Of those that use an advisor, more than half had known that advisor for more than 7 years

• 17% had known the advisor for 1 year • High correlation between age and balance (1/3

of the advisor users had >$100,000)


Annual Rollover of 401(k) Assets into IRAs (billions)

0

100

200

300

400

500

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010


Rollovers - How Big ?

• Baby boomers are nearing retirement age and represent the largest wealth transfer opportunity in history.– Am Express – IRA Solutions Center (800#)– Schwab – letter and call center (45% retention)– DAC – technology solution connection to brokerage– Principal – The Baby Boomer IRA (mix between annuity

and mutual funds) – T. Rowe – Retirement year funds (2020, 2030 etc)


Rollovers and IRAs

• Where is the money going

In 1999, for the first time ever, the $2.5 trillion in assets held in IRAs exceeded those held in defined contribution plans ($2.4 trillion) and defined benefit plans ($2.2 trillion).


Rollovers and IRAs

• Model I: Firms without a proprietary 401(k) platform (Investment only)

• Model II: Firms with a proprietary 401(k) platform and IRA product (Hybrid firms)

• Model III: Firms with proprietary 401(k) and IRA product and who distribute products directly to plan sponsors via an in-house sales force. (Full Service)


Rollovers Strategies based on Business Model

Firm Model

Firm Model

Key Institutional Challenges

Key Retail Challenges

Model I:

Investment-only Firms Neuberger

Asset retentionAccessing 401(k) shareholders

Asset retentionAccessing retail investors

Model II:Hybrid Firms Putnam, MFS,

Manulife

Asset retention

Asset acquisitionAccessing retail investors

Model III:Full-Service Firms Fidelity, Merrill

Asset retention

Asset acquisition


• And in the end it's not the years in your life that count. It's the life in your years.

• Ballots are the rightful and peaceful successors to bullets

» Abraham Lincoln

Rollover and IRAs


Apathy and Inertia

• Negative Election revisited– half of participants never revisit their initial asset

allocations– Despite 10 years of effort and Millions spent in “education”

The needle has not moved. Participants do not understand financial matters.

– Managed Accounts– As choice goes up – participation goes down– Congress (bi-partisan) supports negative elections – Bills to support automatic enrollment (fiduc relieve, ramp up

elections, retirement age funds)


Apathy and Inertia• only 8 percent of participants knew that money market funds only

contain short-term securities

• Past investment performance and brand play highest correlation to asset allocation decisions

• Enron has not affected participants’ perception of risk

• 80% of respondents do not know that the

best time to transfer to a bond fund is when interest rates are

expected to decrease.


Apathy and Inertia• Participants incorrectly perceive money

market funds to have more risk than domestic bond funds, and government bonds funds to have less risk than both.

• 40% of participants do not realize they can lose money in a bond fund

• two-thirds do not realize they can lose money in a government bond

• 86% of participants state that their allocation is at or near their target, but only 20% of these participants have rebalanced in the past year


Apathy and Inertia

• Plan design to include “Automatic features”– Auto enroll– Auto invest– Manage my account – Retirement funds (2020, 2025)– Auto increase

– AUTO RETIRE PLAN!


Apathy and Inertia

Science may have found a cure for most evils; but it has found no remedy for the worst of them all - the apathy of human beings

Helen Keller


Other Trends in D.C. Market – 403(b) plans 403(b) Market has $600 Billion and 6.5

Million participants / 401k plans held an estimated $1.75 trillion

Mutual Funds 19%

Fixed Annuities 48%

Variable Annuities 33%


Other Trends in D.C. Market – 403(b) plan

• From 1990 to 2001 the D.C. Industry grew at 15% per year. For 2005 and beyond, growth will be between 0% and 5%.

• Market Saturation in 401(k) segment

• Market saturation in small, mid, large and macro markets

• Only the micro market will have sustained growth


Other Trends in D.C. Market- 403(b) plans

• 403(b) Market Especially the ERISA 403(b) Market will continue to grow– Baby Boomer demographic and industry trends– Favorable legislative trends (MEA, Special Elections

under 415, Portability, public school exemption on non, discrimination)

– Compares favorably with 401(k) plans – Employee complaints of fees – Efficiency of ERISA based plan in admin and

distribution


Trends in Small Plans


Trends in Small Plans

• New Plan Formation between 2002 and 2007

0

5000

10000

15000

20000

25000

30000

35000

40000

45000

1 - 49 50 - 99 100 - 499 1000+


Trends in Small Plans (less than 750 employees)

• 1995 – 6% of DC assets

• 2000 – 20% of DC assets

• 2006 - 50% of DC assets– Micro Market may not be as affected by our

next topic, fee disclosure and fee transparency.


Fee Transparency, Fee Disclosure and Fee Pressure – Where are we going?

• 2 studies: 70-80 percent of sponsors unaware of revenue sharing of asset based fees by providers (2002 – pre scandal)

• 23 percent of plan sponsors have respondedto the mutual fund industry scandal by making changes to the investment options available to employees in their 401(k) plans, while another 29 percent are considering such changes. (post scandal)

RESULT: Pressure on investment mgmt and asset based fees)



• Consultants Presence in the Small and Mid Markets

provider pays consultants27%

Fee-Based consultants47%

no consultant used 26%



• The most cited complaints that service providers have in the consultant market are:

1. Consultants often pressure providers to reduce fees

2. Demand open architecture and “low fee” funds

3. Negotiate for high cost under utilized features

4. Sales process is extended and more expensive

5. Compensation demands (finder fees, trails)

RESULT – Pressure on fees and revenue



• Results of Scandal– SEC wall to wall audits of several firms will likely lead

to additional fee disclosure

• Scale and critical mass even more critical in light of fee pressure (continued consolidation and

partnerships) • Larger providers are converting “client service”

cost into investments in automation and back office support.



• Fewer Proprietary Assets

• Increased Gov’t Scrutiny

• Increased Competition in a saturated market

• Growing suspicion and scrutiny by sponsors

RESULT – More disclosure, thinner margins, more consolidation, movement toward lower cost services and lower cost funds


Final Thoughts

I believe that all government is evil, and that trying to improve it is largely a waste of time(H.L. Mencken)

The mystery of government is not how Washington works but how to make it stop. (P.J. O’Rourke)


Final Thought

•Legislative & Regulatory

•Rollover Market & Baby Boomers

•Apathy and Inertia

•Other Facts and Trends in Retirement Industry 403(b) plans

Small Plans

•Fees and Fee Transparency


Final Thoughts

Questions

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