The Remaking of the DC Market

1. The Remaking of the DC Market EBRI’s 62nd policy forum Nancy Szmolyan Nancy_szmolayn@mcKinsey.com 212- 446 -7793 May 8, 2008

2. McKinsey has undertaken an extensive research effort into the future of the DC market Over 50 industry interviews to ID market trends and likely impact Bottom-up modeling of impact of market trends • 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

3. Context: A confluence of external forces has led to the dawn of a new era for the DC market • Description and impact I. Rapid sponsor shift from DB to DC • 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 II. Aging workforce retiring for the 1st time on DC savings • Likely reductions in social security benefits and growing life expectancy has shifted the risk of retirement to individuals and is changing product needs • 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 III. Most fundamental regulatory shift in 30-year history of DC

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: • 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 • Asset allocation funds will account for 35% of AUM, share of passive assets will double • 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 • A 4-way race betweenat-scale integrated players, leading insurers, IODC players and new entrants (e.g., consultants, financial advisors) to capture advice, asset allocation and retirement income opportunities • Accelerated consolidation of DC administrators/record-keepers

5. 4,134 The DC market will almost double in the next 10 years driven by high contributions • DC market projections • $Billions • Money-in-motion opportunity for AMs of $6.8T • (~$2.8T in inflows and ~$4.0T in asset rebalancing) • Drivers are: • Adoption of auto enroll • DB plan freezing • Longer time in DC • Inflows +3,840 • Outflows -3,209 • 7,825 • 184 • 147 • 2,663 • 3,060 • 3,509 • 546 • 4,134 • 7,825 • 4,134 • 2006 DC assets • New contributions • New participants • New plans • IRA rollovers • Other withdrawals • Asset appreciation • 2015 DC assets Source: McKinsey DC Model

6. 100 Asset allocation funds are on track to become one of the most successful innovations in financial services • Share of DC assets • Percent, $Billions • 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 • 100% = • 4,134 • 5,465 • 7,825 • 65 • 80 • Other funds • 97 • 35 • Asset allocation funds • 20 • 3 • 2006 • 2010E • 2015E Source: McKinsey analysis

7. 5 Passive products are poised to grow significantly in DC, similar to the trend experienced in DB • Passive share of DB assets* • $Trillions, Percent • Passive share of DC assets • $Trillions, Percent • $7.8 • 8 • $5.5 • 6 • $4.7 • 5 • 79% • $4.1 • 4 • $3.7 • 4 • 84% • 69% • $2.3 • 2 • Active / Other • 71% • 89% • Active / Other • 80% • 21% • 31% • 29% • 16% • Passive • Passive • 20% • 11% • 1995 • 2001 • 2006 • 2006 • 2010 • 2015 * Top 200 DB plans (Private and Government) Source: Pensions & Investment, McKinsey analysis

8. 10 Economics in the DC industry will be highly skewed towards Asset management, IRA rollovers and Advice • PRELIMINARY • ESTIMATES Estimated revenues pools for mega 401(k) plan segment $Billions • $20 • 5% • 8% • 5% • 24% Available to integrated players Available to TPAs • $10 • Recordkeeping • 6% • Revenue sharing • 9% • 1% • Advice • 18% • IRA rollover • 58% • Asset Management • 66% • 2006* • 2015** * 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

9. Product innovation moving beyond accumulation and transition to retirement income products • Annuity based • Income management funds • Hybrid products • IncomeFlex • SponsorMatch • Income Replacement Funds • Personal PensionBuilder • Clearcourse • Guaranteed Income for Life Benefit • + • Managed Payout Funds • Income Advantage • Lifetime Income • Premier Income Funds • i4LIFE Advantage • Preferred Income Funds • IncomeSolutions Platform for life Guarantee • (out of plan) • Key questions • In-plan vs. out of plan options? • Likely winning products? Source: Press search

10. A wide range of advice models are emerging to meet the differing needs of plan sponsors • EXAMPLES • Small independent automated tool providers e.g.: • Managed account provider eg.: • Independent advice providers: • Basic financial education for mass market e.g.: • Indepen-dent • Specialized HNW / executive advice e.g.: • Level of independence • Bundled • Providers e.g.: • Integrated players e.g.: • Salaried worksite advisory forces e.g.: • DC provider • Automated, online/ • call-center based • Managed accounts • Worksite/1:1 financial planning • Delivery model

11. 17 Consolidation is most likely in the fragmented small plan segment, where economics are under pressure • The smaller plan segments are much more fragmented than larger segments… • …creating opportunities for a consolidator • Plan provider • Percent of AuM, 2005 • 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 • Top 3 • 26 • 28 • 32 • 45 • 54 • 30 • 25 • Top 4-10 • 41 • 25 • 29 • 43 • 42 • Others • 33 • 30 • 17 • Micro • (<50 partici-pants) • Small (50-250) • Medium (250-1,000) • Large (1,000-5,000) • Mega • (> 5,000) Source: Pensions & Investments; Access Research; McKinsey analysis

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

13. The Remaking of the DC Market EBRI’s 62nd policy forum Nancy Szmolyan Nancy_szmolayn@mcKinsey.com 212- 446 -7793 May 8, 2008