DC Plans Should Adopt DB Strategies for Success: Northern Trust

Diversification, decumulation, fee structure among strategies to improve outcomes

Northern Trust looked to defined benefit plans for strategies to improve defined contribution plan outcomes in the third installment of its Path Forward series of DC plan research studies. The current study, “Importing Winning DB Strategies Into DC Plans,” was released in October.  

Assets in defined contribution plans account for 57% of all retirement assets, Northern Trust found, and just 27% of companies have an active pension plan. 

Northern Trust came to these conclusions by interviewing 48 plan sponsors in May and June. Together, those sponsors represent more than 1.5 million participants and $200 billion in assets. The firm also interviewed nine investment consulting firms for the report.

There are several benefits to DC plans adopting DB strategies, according to Northern Trust, though the sponsors interviewed largely agreed that efficiency of scale would be the best outcome for DC plans. Specific DB strategies that would benefit DC plans address:

Investment Approach. While the report acknowledges behavioral economists’ conclusion that too many investment options overwhelm participants, Northern Trust said that even in plans with limited options, there should be a mix of styles and assets classes to choose from. 

Additionally, investment products should be examined to see if they’re appropriate for a plan. Common shortcomings in defined contribution plans are overexposure to company stock and underexposure to non-U.S. assets and failure on participants’ part to adjust their allocations as needed.

Another aspect of investment approach that could be improved is the search for better investment results. Easier said than done, but Northern Trust notes that products like professionally managed asset allocation funds can help lift some of the burden from unprepared participants. “When you combine the use of target retirement date funds as a (qualified default investment alternative) with automatic enrollment, you get a plan that gives participants an experience that in many ways resembles that of a traditional, professionally managed DB pension fund,” Jim Danaher, managing director of Northern Trust’s DC solutions group, said in the report.

Decumulation. The report found less than a third of sponsors encourage their participants to leave assets in the plan after they leave the company. Consultants, however, pointed out that higher asset levels help keep total plan costs down. Additionally, keeping their assets in the employer plan gives participants who leave the company but not the plan access to institutional pricing rather than retail pricing, as well as professional oversight.

While most sponsors say less than half of their participants pull their assets in a lump sum when they retire, 20% of sponsors say 70% of their participants take a lump-sum payout. Northern Trust argues that focusing on decumulation is just as important as accumulation.

Governance. Northern Trust argues that shifting resources to defined contribution plans is “among the most important steps plan sponsors can take toward ‘institutionalization’ of DC plans.” Resources should be roughly in proportion to the share of assets in the plan relative to the DB plan, if the company offers one.

Additionally, there should be a clear and streamlined decision making process that staff and sponsors make decisions quickly and efficiently with input from relevant parties.

Fee Structure. Clearly, fee structure is important to the success of a plan. Northern Trust found each of the consultants surveyed suggested unbundling fees and using flat per-participant fees instead of revenue sharing agreements.

Passive strategies can also help improve outcomes by eliminating fees in actively managed funds.

Sponsors and consultants don’t agree on the impact of fees paid in DB and DC plans. Less than 30% of sponsors who offered both plans said their DC fees were higher than fees in the DB plan. Of the three consultants with clients who offered both types of plans, all of them said the fees were higher in the DC plan. They cited lack of scale, more expensive products (especially mutual funds), and a higher allocation to equities in DC plans as the reasons for that discrepancy.

Communication. Finally, sponsors should focus communications with participants on retirement outcomes rather than investment performance. As the report notes, “it’s the outcome that counts.”

Danaher called it “imperative” to give participants a picture of what their monthly payouts would be after they retire. That picture should include the effect of an increase in the participant’s contribution. “Simply communicating an asset total can actually be misleading if plan participants lack the tools to determine what income level even seemingly large asset totals will deliver.”

Overall, plan sponsors are confident that defined contribution plans can be successful. Almost 70% said they were optimistic that they could provide sufficient income for retirees. Furthermore, the plans are widely considered a primary retirement account rather than a supplemental savings account, according to the report. As a result, employers are taking steps to design plans that will serve their employees well.

The hurdles to adopting DB strategies in DC plans are broad and exist at the sponsor and employee level, including disagreements within plan committees about strategy and fiduciary obligations, employee apathy and problems with communication. However, Northern Trust points out that the strategies themselves present hurdles to plan success; for example, creating a properly diversified plan, determining whether an investment vehicle or strategy is appropriate, or selecting useful retirement income options, without taking on undue risk.

Fiduciary liability is no small concern, and the report found little agreement between investment consultants and plan sponsors on the subject. While just 25% of sponsors said they were concerned about fiduciary liability for changes in the plan, 66% of consultants said their clients were concerned about fiduciary liabilities.

Furthermore, consultants were more likely than sponsors to be comfortable with applying institutional strategies modeled after DB plans to DC plans. Nearly half of sponsors said their plans offer between 16 and 25 investment options, while all the consultants surveyed said they would recommend their clients offer just 15 options or less.

Jim Danaher said in the report that another significant obstacle is the participants themselves. “Reluctance to change is a key barrier, even if the change we implement would be beneficial to participants,” he said. “We find that change is often viewed as a benefit being taken away, even if that’s not the case.”

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