The Remaking of the DC Market May 8, 2008 EBRI’s 62 nd policy forum Nancy Szmolyan

1 McKinsey has undertaken an extensive research effort into the future of the DC market Bottom-up modeling of impact of market trends Over 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

2 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 I. Rapid sponsor shift from DB to DC I. Rapid sponsor shift from DB to DC II. Aging workforce retiring for the 1 st 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

3 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

4 DC market projections $Billions The DC market will almost double in the next 10 years driven by high contributions Source: McKinsey DC Model 4, DC assets2006 DC assets2006 DC assets2006 DC assets 3,509 New contributions 147 New participants 184 New plans 2,663 IRA rolloversIRA rolloversIRA rolloversIRA rollovers 546 Other withdrawals 3,060 Asset appreciation 7, DC assets2015 DC assets2015 DC assets2015 DC assets Inflows +3,840Outflows -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)

5 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 assets Percent, $Billions Other funds Asset allocation fundsAsset allocation fundsAsset allocation fundsAsset allocation funds 100% = , , E , E

6 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 Active / OtherActive / OtherActive / OtherActive / Other % Passive % 69% 20% 29% 80% % Active / OtherActive / OtherActive / OtherActive / Other Passive 79% 11% 89% % 84% $2.3 $3.7 $4.7 $4.1 $5.5 $7.8

7 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% $ * 5% 8% 5% 24% 58% $ ** Recordkeeping Revenue sharing Advice IRA rollover Asset Management Available to TPAs Available to integrated players PRELIMINARY ESTIMATES

8 Product innovation moving beyond accumulation and transition to retirement income products Source:Press search Annuity basedIncome management fundsHybrid 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 Benefit Income Advantage Personal PensionBuilder IncomeSolutions Platform for life Guarantee (out of plan) i4LIFE Advantage + Lifetime Income Premier Income Funds Preferred Income Funds

9 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 independence 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.:

10 Consolidation is most likely in the fragmented small plan segment, where economics are under pressure Source:Pensions & Investments; Access Research; McKinsey analysis Plan provider Percent of AuM, Micro (<50 partici- pants) Medium (250-1,000) Medium (250-1,000) Medium (250-1,000) Medium (250-1,000) Medium (250-1,000) Medium (250-1,000) Large (1,000-5,000)Large (1,000-5,000)Large (1,000-5,000)Large (1,000-5,000)Large (1,000-5,000)Large (1,000-5,000) Small (50-250) Small (50-250) Small (50-250) Small (50-250) 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

11 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