By Jane Meacham

While acknowledging that maintaining traditional defined benefit (DB) pensions has become either too expensive or too burdensome, several Fortune 500 company retirement plan sponsors would like to replicate for their defined contribution (DC) plans some of the efficiencies from their DB plans, according to a new survey report from BNY Mellon.

The market value of DC plans like 401(k)s is projected to be more than $8.5 trillion by 2018, outweighing their DB counterparts by $1.3 trillion at that point, financial services data analysis firm Cerulli Associates has estimated.

With that shift in mind, BNY Mellon, a global money manager and plan service provider, interviewed plan sponsors at 20 “mega-market” U.S. corporations—defined as managing DC assets of at least $1 billion—about their plans’ outlook over the next few years. In a May report titled “The DC Plan of the Future: DB Principles for the DC Generation,” the large plan sponsors saw the best chances to make DC plans behave more like institutionalized pensions for their participants by taking these three steps:

• Using institutional investment strategies for DC plans;
• Unbundling investment and service fees; and
• Ensuring that participant education and automation work together.

These priorities reflect the most common historical shortcomings associated with DC plans versus DB plans: higher costs; limited access to alternative investments, leading to inability to increase returns and reduce risk through diversification; and uncertain final benefits for retirees.

‘Institutionalizing’ DC plans

To seek greater control over returns at lower cost, 65% of the plan sponsors surveyed by BNY Mellon said they expect to increase their use of alternatives to mutual funds, such as separately managed accounts or collective trusts. These are not subject to oversight from the U.S. Securities and Exchange Commission, so they incur fewer expenses and regulatory reporting.

The large-plan sponsors also predicted reducing their reliance on mutual funds in their DC investment menus, partly because they have the need and ability to demand bespoke funds, often called “white-label” options. Assembling these can simplify investment options and reduce costs below those of brand-name mutual fund offerings. The sponsors also mentioned the benefits of paring their investment lineups to encourage better participation and deferral rates.

Another reason plan sponsors overseeing both DB and DC plans want to boost their use of alternative investments that lie beyond stocks and bonds in 401(k) plans is that pension investments typically outperform their DC offerings, sometimes by as much as 2 percentage points a year.

“Providing access to asset classes that participants did not previously have should allow them to get closer to the level of returns for DB plans and also embrace other characteristics of alternative investments such as downside or inflation protection,” the BNY Mellon report said. It said the plan sponsors interviewed are looking for ways to include alternatives in popular target-date funds.

Unbundling fees

DC plan sponsors increasingly are looking to overcome the challenges of bundled pricing arrangements, BNY Mellon said. These include limited transparency, inflated costs, and potential conflicts of interest that can arise when investment management, recordkeeping, and other administrative fees are rolled together. The sponsors, instead, are seeking unbundled pricing models and adopting buying behaviors as they would in the DB world, the survey said.

The DC plan of the future, BNY Mellon said, will have a more transparent fee structure, particularly on the investment side. The vast majority of large plan sponsors see less reliance on revenue sharing and less reliance on marketing and distribution fees. This unbundling will make fees more competitive, once sponsors can see what they are paying for, the money manager said.

In another predicted trend, plan sponsors will begin to allocate cost to the people who use the services, and those participants taking out plan loans or hardship withdrawals can expect to pay more. Qualified domestic relations orders’ processing fees likely will become another type of employee-specific fee that could be more appropriately paid for by a participant, rather than by the plan or aggregate participants.

The sponsors that have both DB and DC plans could gain opportunities for economies of scale and relationship pricing if fees are unbundled, the report said.

Education, automation working together

While automation of DC plan enrollment and sometimes participant deferral rates, has worked well to get more workers contributing to retirement savings, it has not ensured adequate savings rates, the report said. It also does not provide a retirement road map, so the large sponsors are combining automation with increased education.

For example, “[t]o boost general savings rates, sponsors and their providers are educating participants on growing their nest egg, rather than using it as a slush fund,” the survey report said. They will attempt to do this by providing more detailed modeling of savings outcomes for participants and by analyzing the true cost to them of taking out plan loans, BNY Mellon said.

Encouraging Baby Boomers with high account balances to stay with their employer’s plan even after retirement is also likely to be part of this ramping-up of education, as their rollover defections could lead to decreased economies of scale and higher fees for the plan’s remaining participants.

Last, the BNY Mellon report said sponsors may also “need to look inward to determine their own level of paternalism” to weigh managing plan costs against improving retirement outcomes.