Incorporating Lifetime Income Solutions into Custom Target Date Funds

Actuaries Club of Hartford/SpringfieldFall Meeting - November 4th 2015

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CHANGING FACE OF U.S. RETIREMENTFortune 100 Retirement Plan Prevalence for New Hires:

0%10%20%30%40%50%60%70%80%90%

100%

1985 1998 2002 2004 2005 2006 2007 2008 2009 2010 Today

Traditional Pension Hybrid DC Only

0

10

20

30

40

50

1948 1956 1964 1972 1980 1988 1996 2004 2012

Perc

ent o

f Pop

ulat

ion

Total, 65 and older Men, 65 and older Women, 65 and older

Labor Force Participation Rates of Workers 65+:

Source: Towers Watson, BLS

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RETIREMENT WORKED FOR GRAMPA

Current system based on consistency and employer longevity

401(k) originally designed as supplemental savings vehicle

Behavioral biases often get in the way of prudent savings and investment strategies

The marketplace currently offers sophisticated platforms for accumulation of retirement savings, however is lacking sophistication around decumulation

Plan Funding Risk Investment Risk Longevity Risk Inflation Risk

Traditional DB Employer Employer Employer Employee

Traditional DC Employee Employee Employee Employee

New DC Designs Employee Third Party Third Party Employee

Next generation of Plan Design

SUITABILITY VS. FIDUCIARY STANDARD401(k) Standard of care

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The Employee Retirement Income Security Act or ERISA is a Federal law that sets standards of protection for individuals in most voluntarily established, private-sector retirement plans.

ERISA requires plans to provide participants with plan information, including important facts about plan features and funding; sets minimum standards for participation, vesting, benefit accrual, and funding; provides fiduciary responsibilities for those who manage and control plan assets; requires plans to establish a claims and appeals process for participants to get benefits from their plans; gives participants the right to sue for benefits and breaches of fiduciary duty.

Which term best describes most defined contribution plan designs

a) A Secure Retirement Benefit

b) An Investment Portfolio

c) A Savings Account

CONCEPTS FOR PLAN DESIGNQuestions for employers & fiduciariesWhich description best fits members of most defined contribution plans

a) Valued Employees & Esteemed Retirees

b) Risk Tolerant & Savvy Investors

c) Disciplined & Frugal Savers

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Are the answers to these questions in sync?

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Feature UTC Employee Savings PlanA generous 401(k) match. 60% match up to 6% of pay

Immediate eligibility to participate Immediate eligibility for company match

New hires immediately eligible for company automatic contributionsOne year of service required for match

Automation Automatic Enrollment and annual automatic increases up to 10%

Immediate vesting 2 years of participation in the plan required for vesting

Low-cost investment options Funds with expense ratios as low as one basis point

Catch-up contributions allowed UTC allows catch-up contributions

A Roth option UTC has Roth 401(K) contributions and in-plan Roth conversions

WHAT MAKES A GOOD 401(k) PlanUS News and World Report

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EDUCATION AND AUTOMATIONOvercoming behavioral biases

1. New UTC employees are automatically enrolled into the 401k plan, at a savings rate that allows for the full company match. The savings rate automatically increases annually up to 10% of pay.

2. Use of Qualified Default Investment Alternative (customized and age appropriate).

3. Simple investment lineup and low cost investment options.

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UTC PLAN INVESTMENT LINEUP

2055 2050 2045 2040 2035 2030 2025 2020 2015 2010 2005

Fixed Income

Diversifiers

Emerging

Non-U.S. Equity

U.S. Equity - Small

U.S. Equity

Target Retirement Funds

Core Passive Options

Lifetime Income Strategy

U.S. Equity Small Cap

Non-U.S. Equity

Stable Value Fund

Gov./Corp. Bonds

Emerging Equity

U.S. Equity Large Cap

Common Stock & ESOP

UTC Ownership

Risk Parity Fund

Real Asset Fund

UTC’s LIFETIME INCOME SOLUTION

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Starting Retirement Savings at an Early Age

RETIREMENT INCOME ALTERNATIVES

Control Certainty

CompleteControl

Guaranteed Lifetime Income

Complete Control

No Guaranteed Lifetime Income

Traditional Fixed Annuity

Systematic Withdrawal

A balance between control and certainty

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RETIREMENT INCOME ALTERNATIVESSystematic Withdrawals 

Buy & Hold Treasury Bonds

Lifetime IncomeIn Plan

Withdrawal BenefitVariable Annuity 

(Out of Plan GLWB)1Traditional 

Fixed Annuity

Lifetime Benefit

Guarantor

Income Protection

Indicative Income

Fixed Cost

Fees

Liquidity & Control

Upside Potential

1 GLWB – Guaranteed Lifetime Withdrawal Benefit

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Participant & plan sponsor perspectives

Source: AllianceBernstein

Participants

Lifetime Income (Longevity Protection)

Growth Potential (Income Ratchets)

Full Liquidity & Control of Assets

Simplicity & Portability

Institutional Pricing & Transparency

Diversified Insurer Coverage

QDIA (Integrated within Target-Date Portfolio)

Plan Sponsor/Fiduciary

KEY FEATURES OF EFFECTIVE SOLUTIONS

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Secure Income Portfolio - 60% equity/40% bonds, higher fee, secure income via insured withdrawal benefits

Phase-In Period

0%10%20%30%40%50%60%70%80%90%

100%

Allo

catio

n %

Target Date Portfolio - Custom target date allocation, low fee, no secure income

Complete solution over lifecycleAs a young saver, invest in a target-date portfolioAs a pre-retiree, build secure lifetime incomeAs a retiree, withdraw lifetime income

Age

LIFETIME INCOME STRATEGYInvestment & allocation

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40 50 60 70 80 90 100

UninsuredBalance

1. $100k balance remains invested in target date portfolio and starts building secure income

2. Portfolio grows to $200k by the time participant elects to commence 5% guaranteed withdrawals

3. Participant entitled to withdraw $10k per year in retirement (5% of $200k benefit base)

4. If assets are ever depleted, insurer pays $10k annual income (guaranteed for life)

Point of Election

Accumulation Withdrawal Insurer Payout

Insured Benefit Base

Secure Income1

2

3

4

Age

100

200

Balance ($000)

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LIFETIME INCOME ILLUSTRATIONHypothetical portfolio with 5% secure income

Ongoing price discoveryInsurer competitionCapacity & constraintsPotential indications of solvency risk

Adaptable to changing conditionsIntegrate new insurers / enhanced benefitsConform to new regulatory requirementsMinimize participant disruption

Diversification of issuer risk

Insurance Safety Net

MULTIPLE LEAD INSURER DESIGNAdvantages to sponsor

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Approved Insurers

Allocation Formula

Quarterly BlendedWithdrawal Rate

25%

Quarterly Poll 5.2% 5.0% 5.0%

25%50%

Insurer 1 Insurer 2 Insurer 3

Insurance Aggregator

5.1%

Diversification, competition & capacity

Record Keeper (Hewitt)

Multi-insurer aggregator platform

Withdrawal rate process

Aggregator polls insurers quarterly

Allocate via rate & diversification formula

Fixed fee cannot increase

Purchased benefit cannot decrease

Aggregator interfaces with record keeper & insurers

A flexible & extendable operational structure

DELIVERING SECURE INCOME

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Responsibilities

Alliance Bernstein (AB)

Custody and Daily Valuation State Street

Alliance Bernstein (AB), AonHewitt

Manager*/Insurer Selection UTC

Income Benefit Guarantees Lincoln, Nationwide & Prudential

Investment Strategy / Asset Allocation / Glide Path

Operations / Rebalancing

LIFETIME INCOME STRATEGY

* Insurers retain authority to take fiduciary control of investments in group annuity 17

Low utilization rate

Benefit becomes outmoded / Insurers discontinue benefit

Insurer insolvency

Aggregator termination / replacement

Early adopter

Regulatory

Growth, liquidity and control

Flexibility in design

Multi-insurer, insurance safety net

Transferable platform

Design control

Broad support and interest

LIFETIME INCOME DESIGNObstacles / risks and solutions

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The business case for improving designWHY INVEST IN RETIREMENT PLANS

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Background & Supporting Material

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Defines employer objectives for offering retirement benefitsOutlines basic principles used in the design & delivery of benefitsDescribes how benefits offered are expected to meet objectivesIdentifies internal/external constituents who have authority, influence and

accountability for design, implementation & oversightExamples of RPS objectives

Support employee access to secure retirement incomeSimplify choice architecture while offering a broad range of risk/returnEmphasize default design with automatic enrollment & automatic escalationEstablish & maintain a framework to enhance plan features & options with

manageable participant disruptionAddress needs of all plan participants regardless of their “investor” typeOffer low-cost investment options, negotiate institutional feesMaintain access to non-core investments through self-directed window

The Retirement Policy Statement (“RPS”)TOOLS FOR PLAN DESIGN

Source: AllianceBernstein Defined Contribution Investments 21

PARTICIPANT COMMUNICATIONS

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0

10

20

30

40

50

60

70

80

90

100

20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 100

GLIDE PATH COMPARISONE

quity

Allo

catio

n %

Age

Target Retirement Funds / Lifetime Income Strategy

Lifetime Income Strategy

Target Retirement Funds

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INSURER SELECTION & OVERSIGHTSelection criteria and ongoing due diligence

Firm-Level Characteristics Industry position Diversification of business lines

Familiarity with income productsReserves / Capital Strength Risk-Based Capital Statistic (RBCS) Financial strength ratings Credit ratingsHedging Practices / Risk Management Frequency of guarantee valuation & mark-to-market Static / dynamic hedging mix Hedging instruments / counterpartiesLegal / Contract Language Structure of guarantee Entity backing guarantee

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Final Average Earnings (FAE) DB pension for decades

2002 Cash Balance Plan for new hires

2006 Savings Plan introduces Target Date Funds

2008 Auto-enrollment for new hires

2009 FAE pension sunset* announced

2010 Savings Plan in lieu of pension for new hires

2010 Savings Plan accepts Cash Balance Plan rollovers

2011 Savings Plan investment redesign

2012 Introduction of Lifetime Income Strategy

RETIREMENT BENEFITS10 Years of accelerating change at UTC

* Future accrual for active FAE participants converts to cash balance design after 12/31/2014 25

Retiree/Member Perspective

Initial income generation

Protection from risk

Longevity risk

Inflation risk

Insurer credit risk

Downside market risk

Annuity conversion rate risk

Terms and conditions risk

Maximize returns

Access to capital

Employer Perspective

Initial income generation

Transferability to another provider

In-plan or out of plan

Fiduciary/regulatory concerns

Insurer credit risk

Fees

Potential conflicts

Other

Source: Lloyd, 2013

At least 2 perspectives & 2 checklistsTOOLS FOR PLAN DESIGN

Remember to consider your service providers, because you cannot offer the program if they won’t sell their services 26

ACCESSIBLE RESOURCESDownloads from the WebThe Future of Life-Cycle Saving and Investing, Second EditionZvi Bodie, Dennis McLeavey, CFA, and Laurence B. Siegel Research Foundation Publications, (Feb 2008): 1–183http://www.cfapubs.org/doi/pdf/10.2470/rf.v2008.n1The Future of Life-Cycle Saving and Investing: The Retirement PhaseZvi Bodie, Laurence B. Siegel, and Rodney N. Sullivan, CFA Research Foundation Publications, (Oct 2009): 1-76http://www.cfapubs.org/doi/pdf/10.2470/rf.v2009.n4Making Investment Choices as Simple as Possible, but Not SimplerZvi Bodie and Jonathan Treussard Financial Analysts Journal, May/June 2007, Vol. 63, No. 3:42-47http://www.cfapubs.org/doi/pdf/10.2469/faj.v63.n3.4689

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Design principles:

Easier to understand, even lower cost, flexible

New fund lineup messaging:

“Let a professional manage it for you”

Target Retirement Funds

“Do-it-yourself…”

Core Options & UTC Ownership

“Do it yourself with more choice”

Mutual Fund Brokerage Window

Behaviorally informed approachINTEGRATED DESIGN & MESSAGING

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ACCESSIBLE RESOURCESMore downloads and other materialDOL EBSA Final Rules on Qualified Default Investment Alternatives, 2007http://www.dol.gov/ebsa/regs/fedreg/final/07-5147.pdfDOL EBSA Proposed Rules on Annuity Selection in DC Plans, 2007http://www.dol.gov/ebsa/regs/fedreg/proposed/2007017743.pdfDOL EBSA Final Rules on Annuity Selection in DC Plans, 2008https://webapps.dol.gov/FederalRegister/PdfDisplay.aspx?DocId=21588Social Science Research Network for Social Science Research Delivered Dailyhttp://www.ssrn.comCFA Publications for the Latest In Investment Management Researchhttp://www.cfapubs.orgAonHewitt Retirement Research & Statistics Web Sitehttp://www.aon.com/human-capital-consulting/thought-leadership/retirement/default.jspMature Markets Institute for MetLife Research on Aging, Longevity & the Generations https://www.metlife.com/mmi/index.html

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BEHAVIORAL PSYCHOLOGY & RETIREMENT

Focus on what retirement is

for

Focus on what retirement is

forHelp the imagined

“Time Travel”

Help the imagined

“Time Travel”

De-emphasize quarterly returns

De-emphasize quarterly returns

Annuitizationshould be a

default

Annuitizationshould be a

default

Emphasize expected income

Emphasize expected income

Make Default Relevant to

the Individual

Make Default Relevant to

the Individual

Harness people’s Inertia

Harness people’s Inertia

Active decision-making

Active decision-making

Money illusionMoney illusion

FairnessFairness

Products need to be defined in terms of income and not accumulated wealth

Imagining the future helps making a correct decision

Sensitivity to losses increases significantly after retirement

After the age of 60, cognitive capabilities may decrease rather rapidly and significantly

It is easier to plan if income is subdivided in accounts; necessary and discretionary

Collective default options can hurt individual needs

Behavioral Default is to do Nothing

Allowing people to select amongst comparable options is

helpful

Perceived fairness is relevant to retirement

products

Inflation is difficult to internalize

Source: Behavioral Finance and the Post-Retirement Crisis: Study by Shlomo Benartzi, UCLA, sponsored by Allianz of America, April 29, 2010

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PROGRAM IMPLEMENTATIONWhat happens “under the hood”

Lifetime Income Strategy Fund displayed as single option for investment elections and transfers

Quarterly statements include single Lifetime Income Strategy Fund market value & income

Web requests and accounting activity list single Lifetime Income Strategy Fund

Some performance pages will display data for sub-funds

Unique personal rates of return are calculated for participants at plan account-level

Lifetime Income Strategy program implemented through a single shell fund and multiple sub-funds on recordkeeping platform

Investment Manager provides investment direction to record keeper for each participant –specific to date of birth and activity.

Record keeper and Investment Manager exchange balances and activity nightly

Aggregator supports daily record keeping functions for Lifetime Income Strategy

Coordinates competitive bidding and allocation process for quarterly withdrawal rates

Calculates “Income Base” and guaranteed withdrawal amount (“Income Benefit”) per participant

Coordinates insurer payments through Trustee if market value is depleted

Track benefits and elections

Maintain allocated group annuity contracts and insurance company separate accounts

Pay benefits if market value of account is depleted

Participant Lifetime Income Strategy Retirement OptionEquityFund

Secure IncomeFund

InvestmentManager

AggregatorPlatform

Insurer 1

Insurer 2

Insurer 3

BondFund

Structure delivers custom-built, individual Income Benefits

Unique to each participant by date of birth & individual activity31