The Remaking of the DC Market

May 8, 2008

EBRI’s 62nd policy forum

Nancy Szmolyan

Nancy_szmolayn@mcKinsey.com212- 446 -7793

2

McKinsey has undertaken an extensive research effort into the future of the DC market

Bottom-up modeling of impact of market trendsBottom-up modeling of impact of market trends

Over 50 industry interviews to ID market trends and likely impactOver 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

• 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

• 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

III. Most fundamental regulatory shift in 30-year history of DC

III. Most fundamental regulatory shift in 30-year history of DC

I. Rapid sponsor shift from DB to DC

I. Rapid sponsor shift from DB to DC

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

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

Description and impact

• 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

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

• 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

• 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

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:

1. 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

2. Asset allocation funds will account for 35% of AUM, share of passive assets will double

3. 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

4. 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

5. Accelerated consolidation of DC administrators/record-keepers

5

DC market projections$Billions

The DC market will almost double in the next 10 years driven by high contributions

Source: McKinsey DC Model

4,134

4,134

2006

DC assets

3,509

New contributions

147

New participants

184

New plans

2,663

IRA

rollovers

546

Other withdrawals

3,060

Asset appreciation

7,825

7,825

2015

DC assets

Inflows +3,840 Outflows -3,209

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

Money-in-motion opportunity for AMs of $6.8T

(~$2.8T in inflows and ~$4.0T in asset rebalancing)

6

Asset allocation funds are on track to become one of the most successful innovations in financial services

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

Source: McKinsey analysis

Share of DC assetsPercent, $Billions

Other funds

Asset allocation

funds

100% =

97

3

4,134

2006

80

20

5,465

2010E

65

35

7,825

2015E

7

Passive products are poised to grow significantly in DC, similar to the trend experienced in DB

* Top 200 DB plans (Private and Government)Source: Pensions & Investment, McKinsey analysis

Passive share of DB assets*$Trillions, Percent

Passive share of DC assets$Trillions, Percent

4

5

2

Active /

Other

2006

31%Passive

20011995

71%

69%

20%29%

80%

6

2010

21%

Active /

Other

Passive

79%

11%

89%

4

2006

8

2015

16%

84%

$2.3

$3.7

$4.7$4.1

$5.5

$7.8

8

Economics in the DC industry will be highly skewed towards Asset management, IRA rollovers and Advice

* 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

Estimated revenues pools for mega 401(k) plan segment$Billions

6%9%

1%18%

66%

$10

2006*

5%

8%

5%

24%

58%

$20

2015**

Recordkeeping

Revenue sharing

Advice

IRA rollover

Asset Management

Available to

TPAs

Available to

TPAs

Available to

integrated players

Available to

integrated players

PRELIMINARY ESTIMATES

9

Product innovation moving beyond accumulation and transition to retirement income products

Source: Press search

Annuity based Income management funds Hybrid products

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

IncomeFlex

Clearcourse

Income Replacement Funds

Managed Payout Funds

SponsorMatch

Guaranteed Income for Life BenefitIncome Advantage

Personal PensionBuilder

IncomeSolutions Platform for life Guarantee (out of plan)

i4LIFE Advantage

+

Lifetime IncomePremier Income Funds

Preferred Income Funds

10

A wide range of advice models are emerging to meet the differing needs of plan sponsors

EXAMPLES

Automated, online/call-center based

Delivery model

Managed accounts

DC provider

Level of

ind

ep

en

den

ce

Indepen-dent

Bundled Providers e.g.:

Integrated players e.g.:

Small independent automated tool providers e.g.:

Managed account provider eg.:

Worksite/1:1 financial

planning

Salaried worksite advisory forces e.g.:

Independent advice providers:

•Basic financial education for mass market e.g.:

• Specialized HNW / executive advice e.g.:

11

Consolidation is most likely in the fragmented small plan segment, where economics are under pressure

Source:Pensions & Investments; Access Research; McKinsey analysis

Plan providerPercent of AuM, 2005

26

41

33

Micro(<50 partici-pants)

28

43

Medium

(250-1,000)

45

25

30

Large

(1,000-5,000)

54

32

Small

(50-250)

42

30

29

17

Mega (> 5,000)

Top 3

Top 4-10

Others

25

The smaller plan segments are much more fragmented than larger segments…

…creating opportunities for a consolidator

• 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

12

Considerations for the management agenda

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?

1. Is target date the winning structure, or do we expect emergence of new asset allocation products?

The Remaking of the DC Market

May 8, 2008

EBRI’s 62nd policy forum

Nancy Szmolyan

Nancy_szmolayn@mcKinsey.com212- 446 -7793