D.C. Plans, Regulatory
Environment, Trends and
Predictions
Bob Melia
Delaware Investments
November, 2004
Delaware Investments /
Lincoln Financial Group
Trends and the D. C. Market
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Legislative & Regulatory
Rollover Market & Baby Boomers
Apathy and Inertia
Other Facts and Trends in Retirement Industry
Small Plans
Fees and Fee Transparency
Delaware Investments
Lincoln Financial Group
"I don't make jokes. I
just watch the
government and report
the facts."
- Will Rogers
Delaware Investments
Lincoln Financial Group
Overview
• The Political Context
• Mutual Fund Reforms
• Deferred Compensation Changes
• Bush Savings Proposals
• Next Generation Reforms
• Outlook and Conclusions
Delaware Investments
Lincoln Financial Group
Presidential Race
• If Bush and Republicans won
– Defined Contribution
– Individual Vehicles
– Private Component of Government
Programs
– Tax Investment Income Lightly
– Flatter Income Tax
Delaware Investments
Lincoln Financial Group
Presidential Race
• If Kerry and Democrats won
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Defined Benefit
Employer Vehicles
Government Social Insurance
Tax Investment Income Heavily
Progressive Income Tax
Delaware Investments
Lincoln Financial Group
W
H
A
T
S’
N
E
X
T
Delaware Investments
Lincoln Financial Group
“In America, anybody
can be president.
That's one of the risks
you take.”
- Adlai Stevenson
Delaware Investments
Lincoln Financial Group
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
Delaware Investments
Lincoln Financial Group
“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
Delaware Investments
Lincoln Financial Group
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
Delaware Investments
Lincoln Financial Group
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
Delaware Investments
Lincoln Financial Group
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
Delaware Investments
Lincoln Financial Group
Executive Compensation
• Consensus Proposals
– Deferral Restrictions
– Distribution Restrictions
– Basic Tax Rules
• Key Concerns
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Nonqualified Deferred Compensation Definition
Timing of Deferral Elections
Effective Date
Consequence of Failures
Delaware Investments
Lincoln Financial Group
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
Delaware Investments
Lincoln Financial Group
Other Near-Term Items
• Final DOL Guidance on Automatic Rollovers
• IRS Guidance on Direct Deposit of Tax
Refunds into IRAs
Delaware Investments
Lincoln Financial Group
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
Delaware Investments
Lincoln Financial Group
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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
Delaware Investments
Lincoln Financial Group
Other Major Debates in 2005
• Defined Benefit Plan Reform
– Funding Changes
– Hybrid Plans
• Social Security Reform
• Fundamental Tax Reform
Delaware Investments
Lincoln Financial Group
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
Delaware Investments
Lincoln Financial Group
Other Regulatory Issues
• Roth 401(k) and Roth 403(b) Accounts
• Advice Bill (Boehner)
• Spitzer Fallout / recordkeeping penalties
and fines
Delaware Investments
Lincoln Financial Group
“Politics is the art of
looking for trouble, finding
it, misdiagnosing it, and
then misapplying the wrong
remedies.”
- Groucho Marx
Delaware Investments
Lincoln Financial Group
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
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Lincoln Financial Group
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)
Delaware Investments
Lincoln Financial Group
Annual Rollover of 401(k) Assets
into IRAs (billions)
500
400
300
200
100
0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Delaware Investments
Lincoln Financial Group
Rollovers - How Big ?
• Baby boomers are nearing retirement age
and represent the largest wealth transfer
opportunity in history.
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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)
Delaware Investments
Lincoln Financial Group
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).
Delaware Investments
Lincoln Financial Group
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 inhouse sales force. (Full Service)
Delaware Investments
Lincoln Financial Group
Rollovers Strategies based on
Business Model
Firm Model
Firm Model
Model I:
Investmentonly Firms
Neuberger
Model II:
Hybrid Firms
Key Institutional
Challenges
Key Retail
Challenges
Asset retention
Accessing 401(k)
shareholders
Asset retention
Accessing retail
investors
Asset retention
Asset acquisition
Accessing retail
investors
Asset retention
Asset acquisition
Putnam, MFS,
Manulife
Delaware Investments
Lincoln Financial Group
Model III:
Full-Service
Firms Fidelity,
Merrill
Rollover and IRAs
• 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
Delaware Investments
Lincoln Financial Group
Apathy and Inertia
• Negative Election revisited
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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)
Delaware Investments
Lincoln Financial Group
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.
Delaware Investments
Lincoln Financial Group
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
Delaware Investments
Lincoln Financial Group
Apathy and Inertia
• Plan design to include “Automatic features”
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Auto enroll
Auto invest
Manage my account
Retirement funds (2020, 2025)
Auto increase
– AUTO RETIRE PLAN!
Delaware Investments
Lincoln Financial Group
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
Delaware Investments
Lincoln Financial Group
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
Delaware Investments
Lincoln Financial Group
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
Delaware Investments
Lincoln Financial Group
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
Delaware Investments
Lincoln Financial Group
Trends in Small Plans
Delaware Investments
Lincoln Financial Group
Trends in Small Plans
• New Plan Formation between 2002 and 2007
45000
40000
35000
30000
25000
20000
15000
10000
5000
0
1 - 49
Delaware Investments
Lincoln Financial Group
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.
Delaware Investments
Lincoln Financial Group
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 responded
to 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)
Delaware Investments
Lincoln Financial Group
Fee Transparency, Fee Disclosure and Fee
Pressure – Where are we going?
• Consultants Presence in the Small and Mid
Markets
provider pays consultants
27%
Fee-Based consultants
47%
no consultant used 26%
Delaware Investments
Lincoln Financial Group
Fee Transparency, Fee Disclosure and Fee
Pressure – Where are we going?
•
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
Delaware Investments
Lincoln Financial Group
Fee Transparency, Fee Disclosure and Fee
Pressure – Where are we going?
• 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.
Delaware Investments
Lincoln Financial Group
Fee Transparency, Fee Disclosure and Fee
Pressure – Where are we going?
• 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
Delaware Investments
Lincoln Financial Group
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)
Delaware Investments
Lincoln Financial Group
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
Delaware Investments
Lincoln Financial Group
Final Thoughts
Delaware Investments
Lincoln Financial Group
Questions