Retaining Retirement Plan Rollovers:
Rationale and Process
A DSG White Paper
By
James R. Sholder
March 2012
The Diversified Services Group, Inc. 303 W. Lancaster Avenue, Suite 1C, Wayne, PA 19087
The Diversified Services Group, Inc. Page 1
Retaining Retirement Plan Rollovers: Rationale and Process
Introduction
Most defined contribution (DC) plan providers are facing a common problem – the continuous loss of assets due to distributions resulting from job changes and retirement. Many of these assets will roll over into IRA accounts, frequently invested with other asset managers. Industry-wide, rollovers from DC plans to IRAs are currently estimated to be in the range of $300 to $400 billion per year.
Considering demographic trends, this can only become a larger problem as 10,000 boomers reach retirement age each day. And, it’s retirees who have, over time, accumulated the most assets within their retirement plans. Many of these future retirees will soon be considering whether they should move their DC plan assets away from their current plan provider. This issue has not gone unnoticed, and many plan service providers are currently developing programs to retain these customers and their assets. While each company situation (and size) is different, the cumulative financial impact over time can be substantial – especially since losing a block of assets in one year really means losing a stream of revenues those assets would have provided for as long as they were held. Moreover, it seems illogical to help a person grow their assets for 20 or 30 years, only to lose these assets once they've reached their peak levels. Although the departure of plan participants who change jobs or retire is part of the normal ebb and flow of this business, and thus to be expected, there is a real opportunity to hold on to these assets with a focused retention effort. While the actual implementation of such a program can be rather challenging, particularly for a firm that may need to modify parts of its organization, we believe the effort can be financially worthwhile. In this paper, we will examine both macro and micro views of this rollover retention opportunity, and then outline a process for a company that wants to improve their retention results.
The Retirement Plan Marketplace
Over the past few decades, the financial services industry has worked diligently to provide appropriate products for the consumer to accumulate savings, while also communicating the importance of putting aside substantial amounts toward retirement. Though many consumers still need to save more for their retirement, this effort has clearly had an effect, yielding a retirement asset marketplace in the trillions of dollars. Just looking at private-sector retirement plans, this market has reached $11.2 trillion as of the 3rd quarter of 2011.
The Diversified Services Group, Inc. Page 2 A breakdown of these assets is shown on the following chart. DSG estimates that today’s total is now closer to $12.0 trillion.
Private Sector Qualified Retirement Plans
1 Assets as of 3rd Quarter, 2011Total = $11.2 Trillion
Although the recent economic disruption and recession caused retirement assets to drop precipitously after they peaked around 2007, the numbers are gradually building again, due to market advances as well as continuing contributions. (See the following chart).
1 Source: Investment Company Institute, December 2011.
Private DB
Plans
DC Plans
IRAs
$4.6T $4.3T $2.3T [401(k) = $2.9T]The Diversified Services Group, Inc. Page 3 Private Sector Retirement Plans
2007- 2010, by Year; 2011, by Quarter2 ($ Trillion)
Although retirement plan assets in the 3rd quarter of 2011 dropped off significantly, DSG estimates that the year-end 2011 level was more in the range of $12.0 trillion, based on recent improvements in the equity markets.
The Rollover Opportunity
A sizeable chunk of DC plan assets can be expected to move from these plans into IRAs each year, as people change jobs or retire. Recent estimates generally place this annual rollover into IRAs as being in the $300 to $400 billion per year range.3
The assets from these transfers will be available, presumably, to be accessed during retirement to provide or supplement retirement income. These transfers represent enormous asset flows that
2
Source: Investment Company Institute, December 2011. Note: private sector retirement plans include 401(k), 403(b), private DB plans, and IRAs.
3 Source: McKinsey White Paper: "Winning in the Defined Contribution Market of 2015," September 2010.
McKinsey estimated rollovers would be $1.5 trillion over a five-year period, i.e., $300 billion per year.
Another source: “Retirement Number That's Changing the Debate,” Linda Stern, Reuters, May 26, 2011, quoted FRC Research as projecting rollovers into IRAs at $2.0 trillion over a five-year period, or $400 billion per year.
$0 $2 $4 $6 $8 $10 $12 $14 11.7 9.1 10.6 11.7 12.1 12.2 11.2 12.0 2007 2008 2009 2010 1st Q 2nd Q 3rd Q 4th Q (DSG est.) 2011
The Diversified Services Group, Inc. Page 4 will be occurring – and likely increasing – every year into the foreseeable future. And, most of these assets are "up for grabs" – on average, DC plan administrators retain only 27% of assets rolled into an IRA from the plans they administer (best-in-class firms may retain over 50%).4 Thus, we see a four-fold opportunity deriving from this situation:
1. An opportunity for retirement plan service providers to retain a much larger share of assets that are currently rolling out of their DC plans,
2. An opportunity for plan providers, and other companies, to capture these assets from other firms while they are in flux,
3. The potential to aggregate non-qualified assets held by these retained clients, and, 4. The ability to offer additional product cross-sells.
The potential opportunity can be enormous.
The Value of a Customer
So far, we've seen that there are substantial volumes of assets that are moving, or about to move, from DC plans into IRAs. In the recent past, there have been a number of companies that have chosen to focus on managing a client's assets during the accumulation stage, but (deliberately or implicitly) ignoring them at the time the client terminates employment and makes a decision about moving those assets away. In essence, this strategy gives a higher value to bringing in new clients vs. retaining existing clients – at least at the point of retirement (or job change).
Prior to 2007, when some companies were bringing in assets much faster than they were going out, perhaps this made some sense. But, in today's environment, can companies afford to let their long-term clients slip away?
It might be useful to consider what a client is worth to you over the life of their relationship with your firm. One way to think about a customer's value is via a simple "equation," as shown below:
CV = ∑ ( ) ( )t=0
Where: CV = Customer Value
PV = Present Value of the sum from year 1 to year n of (AR – AC) n = Number of years that the client does business with your firm AR = Annual revenues attributed to the client
AC = Annual costs attributed to the client
Acq. Cost = The original cost to acquire that client
The Diversified Services Group, Inc. Page 5 Thus, the equation is another way of saying that customer value is equal to the present value of each year's revenue from that client less that year’s related costs over the period of the customer relationship, minus the original cost of acquiring that customer.
This is certainly not rocket science, and a bit of an oversimplification, but it does help to put things into perspective when considering the value of retaining a client. Only four key variables come into play: revenues, related costs, the cost of acquisition, and time. (Also the rate used to calculate present value, but this is not a variable under the marketer’s control).
Thus, when thinking about retaining a client, we should ask the following questions:
Revenues: how large, and how will they change over time?
Related costs: how large, related to revenues, and are they typically lower for an existing client than for a new client?
Acquisition cost: are there any additional acquisition costs required to retain a client, and if so, how does that compare to acquiring a new client?
Time: how long would a retained client be expected to remain as a client? And what would be the timing of various revenues and costs?
The Case for Retention: A One Person Model
What is it worth to keep a DC plan client after they retire? We have created a simple "thought experiment" that may help shed some light on this question.5
Consider, as an example, one individual – Mr. Ideal Client – who begins saving in a 401(k) plan at the age of 30; saves until retirement at age 65; then withdraws from those savings to help generate income for a period of 30 years. With these factors as our starting point, we created a simple model that makes use of the following assumptions:
Start saving: age 30
Retire: Age 65
Retirement period: 30 years
Salary: $40,000 at age 30, increasing at 3% per year
401(k) investment: 10% of salary each year; stops at age 65
Inflation rate: 3%
Return on 401(k) investments before retirement: 6.5% (after fees)
Return on investments after retirement (assuming more conservative): 5% (after fees)
Retirement income withdrawal: 4% in 1st year; increased by inflation rate thereafter
Discount rate: 5.3%6
5 Admittedly, using a naïve model, assuming ideal conditions. For purposes of simplicity, we have chosen to use
constant growth and withdrawal rates, rather than try to include any of the variability that typically occurs during a long client relationship.
6
Source: Cost of Capital by Sector, NYU.edu, January 2012; based on average of 225 Diversified Financial Services Firms.
The Diversified Services Group, Inc. Page 6 Using these assumptions, we first created a model that projects the pattern for Mr. Client’s DC plan assets over time, as shown below.
Retirement Savings, Pre- and Post-Retirement
($ Assets)
A few comments may be helpful when reviewing this chart:
Beginning with an initial investment in his 401(k) and with consistent savings, Mr. Client is able to grow his retirement plan to approximately $800,000 by the time he retires.
It is not until his later years, as he approaches the Retirement Inflexion Point, that dollar increments from year-to-year become substantial.
The model builds in a little bit of safety by assuming a 4% withdrawal rate – the figure often identified by financial advisors as their rule-of-thumb "safe" withdrawal rate.
The assets will continue to grow for a number of years after withdrawals begin, due to the fact that investment returns continue to exceed withdrawals, at least for a while.
This model assumes "ideal conditions," i.e., constant growth rates with no variation, and no sequence of return risk during the withdrawal phase. But we believe it is sufficient to illustrate the point of this exercise, i.e., the value of retention.
$0 $100,000 $200,000 $300,000 $400,000 $500,000 $600,000 $700,000 $800,000 $900,000 30 35 40 45 50 55 60 65 70 75 80 85 90 95 100 Client Age Pre-Retirement Post-Retirement
The Diversified Services Group, Inc. Page 7 Just looking at the chart, it quickly becomes obvious that there is value for retaining a client who has accumulated a significant level of assets, even though those assets will be declining over time after retirement begins. But how much is that retention worth compared to the accumulation phase, and how does the timing and decline of assets affect that value?
Assuming that the retention phase would begin when Mr. Client turns 65, we have chosen to analyze this by asking the following questions:
1. When Mr. Client turns 65, what has been his (monetary) worth to our firm over the entire period he has been accumulating assets? To answer that, calculate the future value at age 65 of the net revenues generated from his assets7 during the accumulation phase.
2. At age 65, what will be his (monetary) worth to our firm if he remains a client until age 95? To answer that, calculate the present value at age 65 of the net revenues generated from his assets during the distribution phase.
Thus, at the point where Mr. Client turns 65, we can specify how much of his (monetary) value comes from his past contributions to revenues, and how much of it will come from his revenue contributions in the future. The future portion of his value represents the value for retaining him as a client when he reaches retirement.
Based on the assumptions specified earlier, the model yields the following results:
Client Value at Age 65
Client Value $ % Accumulation Value (FV of pre-retirement revenues) $80,324 60% Retention Value (PV of post-retirement revenues) $54,366 40% Total $134,690
This set of calculations yields two important observations:
1. Keeping only one client for many years can add significant value to the firm.
2. Retaining that client after retirement can provide a very meaningful share of that value – in this case, 40%. Another way of stating this: if you do not retain him, you give up 40% of the value he could generate for your firm.
7
Note: we used 0.5% of assets to estimate net revenues for both accumulation phase and distribution phase. These calculations do not include acquisition costs, either for the accumulation or retention phase.
The Diversified Services Group, Inc. Page 8 Changing some of the variables in the projection model will alter the results somewhat, but not the general conclusion that retaining a client when they withdraw from their DC plan can account for a significant portion of that client's potential value.
A number of scenarios, with different assumptions, were fed into the model, with the following results.
Alternative Scenarios/Sensitivity Analysis
Change in Assumptions
Retention Value, % of Total Customer Value
Beyond Age 65
Increase discount rate to 7% 32%
Decrease discount rate to 3% 53%
Lower 401(k) contribution to 5% of salary 40%
Raise net revenues to 1% of assets 40%
Increase salary at 5% per year 43%
Lower returns on investment by 1% 34%
Reduce longevity to age 85 37%
Although the dollar measures of value for these scenarios may change significantly, the share of the client’s measurable value due to retention does not vary by much. The model confirms that a client provides substantial value to a company while he is saving for retirement. But it also indicates that he can provide a very meaningful amount of value after retirement, if these assets can be retained (and even though asset levels will continue to drop during most of the retirement period).
Aggregating the Individual Clients
The previous section gives an indication of the value derived from an individual client and why retaining that person makes sense. When all of a retirement plan’s participants are grouped into a "book of business," we can see the overall impact from focusing on retention. Based on our model, it can be seen that financial services firms who seek to capture and manage assets will generally find their success depending on four factors:
1. The amount of assets they manage
2. The length of time that they hold the assets
3. Their effectiveness at preventing assets from going elsewhere 4. Their ability to do all of this in a cost-effective manner
The Diversified Services Group, Inc. Page 9 There are other reasons, not easily measured, that also make retention of assets at retirement an important consideration:
1. The relative stability of the assets owned by retirees, i.e., retirees are much more likely than pre-retireds to keep their assets invested where they have chosen, once that choice is made.
2. Although it's beginning to change, most of the financial services competition continues to focus attention and efforts on the accumulation side of the chart, leaving more of an opening and less competitive pressure for those firms who seize the opportunity on the distribution side.
3. A retained client will often provide additional opportunities to capture and consolidate other (non-DC plan) assets.
4. Additionally, some products will not allow external transfers once distribution has begun (e.g., immediate annuities).
Building a Retention Program: Desirability and Feasibility Issues
Companies that have not yet initiated a rollover retention strategy will need to determine whether such an effort would be, first, desirable for their firm and its current situation, and then whether it would be feasible, given their capabilities and resources.
At first blush, there would appear to be a good rationale for most companies to develop a
retention program to keep clients as they enter retirement. However, a number of factors that are specific to your firm must be considered. For example, an evaluation of desirability should consider the following:
Size of your DC plan business, in terms of assets.
The number of plan participants, particularly those approaching retirement age.
Annual losses due to rollovers and current retention rates.
Revenues that are lost each year due to rollovers. Keep in mind that loss of assets in one year represents the loss of a stream of revenues those assets would provide for as long as they are maintained. Over time, the cumulative financial effect can be substantial. In general, does it appear that the development and implementation of a rollover retention program would be financially justified? In past projects conducted by DSG, we have found it useful to construct a retention planning model that allows for testing of assumptions and variables, under different future scenarios.
Some companies have already decided that retaining rollover assets is desirable for them, and others have yet to make that decision. In any event, the next step in the process is to determine feasibility of such a program for your firm. When evaluating the feasibility of a retention program these issues should be considered:
The Diversified Services Group, Inc. Page 10
If your company uses financial advisors, some financial agreement or working
arrangement may be needed to prevent discord before you try to retain the client, since the advisors often assume they "own" the client.
It is important to keep in mind that not all retirement asset distributions can be targeted as retention possibilities. Some may be "hardship withdrawals;" some may already be established as mandatory rollovers; some may already be set up as guaranteed income payouts.
Given the constraints of your firm’s capabilities and resources, you may need to decide between conducting the retention effort in-house or using an outside vendor that allows you to outsource these programs.
Defining and Implementing the Retention Process
Implementing a rollover retention process can be daunting, especially for those firms with little expertise in segmenting and directly contacting the targeted clients. Thus, the decision to move forward must consider such hurdles. Once the decision has been made to initiate a rollover retention program, we would suggest the following major steps:
1. Data Synthesis: specify and collect appropriate data to determine the size of the
opportunity and the appropriate targets for the retention program. The chart on the next page outlines a generic logic flow for a retention project’s data needs, from a high-level perspective. Note that for advisor-related accounts, the chart assumes the following:
There is an allowance for financial advisors to opt out of participation in the program.
If advisors participate, they will be able to keep some high asset accounts for their own rollover efforts; the lower asset accounts will be handled through the company's retention program. The "cut point" between low asset and high asset accounts would be negotiated with the financial advisor.
Some small share of revenue will likely go to the participating advisors for any of the low asset accounts that are retained.
2. Retention Model Development: after the data collection phase, build a spreadsheet model which will include variables that are based on several key assumptions, such as:
Annual distribution rate, % of all retirement plan assets.
% of advisors who participate in the program.
"Cut point" between high asset and low asset categories.
Fees paid to participating advisors, based on retained assets.
Projected costs to implement a retention program
Estimated growth rate of retirement plan assets, % per year.
Estimated company revenues, as % of assets.
The Diversified Services Group, Inc. Page 11
Sizing the Annual Retention Opportunity: A Broad Overview
Total Annual Distribution from DC Plans Retention Targets Mandatory Rollovers ($1K to $5K) > $5K Asset Accounts Direct Accounts: All Asset Levels
Advisor-Related Accounts
Participating Advisors
Low Asset Accounts
Total Annual Retention Opportunity
High Asset Accounts Non-Participating
Advisors Not Accessible
The Diversified Services Group, Inc. Page 12 3. Testing: using the retention model, forecast the profit potential for a retention program
over a period of years, and identify estimated ROIs by account type, and at the individual client level. Based on these projections, a Go/No-Go determination to take the next step can be made.
Conducting a test would be the next logical step. This would allow for determining the accuracy of the key assumptions, with only moderate expenditure. The test could be conducted with a small group of selected advisors, or perhaps within a specific geographic region. It would be used to more accurately verify or determine key assumptions that allow for a more realistic estimate of profit potential. The test would also provide an opportunity to evaluate potential products, responses by asset level and client demographics, and possible resource requirements.
4. Test Analysis and Rollout; Long-Term Action Steps: following the collection of data from the testing phase, critical assumptions in the retention model can be revised with more accurate information. At this point, the decision can be made whether to roll out the program on a larger scale or not. Implementing the full, longer-term retention program will likely need to include the following:
establishment of a retention team, including any financial advisor arrangements
development of a communication strategy
specification of product offerings
addition of retention-related website capabilities
installation of some, or all, of the following: electronic messaging, direct mail programs, inbound telemarketing function, outbound telemarketing capability
Final Comments
In this overview document, we've outlined a case for building and implementing a program8 to retain retiring clients and their rollover assets. Then, we described in general terms what some of the key considerations and probable actions would be for a firm that wishes to proceed with a retention program.
It goes without saying that this overview does not penetrate into the level of detail that would ultimately be required, but it was our intent to highlight some of the key issues and decisions that
8 DSG firmly believes that an important element of a successful retention program will also include
relationship-building efforts prior to the client’s retirement. Although these pre-retirement activities have not been the focus of this white paper, we recommend they be included as a key part of the overall retention strategy.
The Diversified Services Group, Inc. Page 13 must be considered. Creation of the actual retention program will require that the management team completes some or all of the following:
Specify the available segments to target for retention and estimate the financial impact for various retention rates.
Establish agreements with financial advisors, if needed.
Identify the products that will be offered to the retained clients for placing their assets.
Develop an in-house organization for capturing/retaining rollover assets (or arrange with an outside vendor).
Create an ongoing retention process, supported by appropriate communications efforts.
Establish a database and critical metrics to monitor and manage the retention program on an ongoing basis.
Throughout this white paper, it has been quite obvious that defining, developing, and implementing a successful retention program will require serious effort and significant
commitment of resources. Additionally, the installation and execution of such a program can be complex and challenging. That is why we suggest a careful, incremental approach for companies who are about to embark on this sort of effort. Ultimately, for many, we believe the effort will be worthwhile.
The Diversified Services Group, Inc. Page 14
About DSG’s Retirement Market Practice
DSG has built a substantial background of expertise and developed a dedicated focus on the retirement income market opportunity over the past decade. This is based both on consulting and research efforts, beginning with a groundbreaking annuitization research study in 1996 which placed DSG at the forefront of this industry.
DSG efforts have included the development of retirement market strategies and tactics, proprietary research, and a series of syndicated research studies on retirement topics. Through our consulting engagements we have helped to develop enterprise-wide retirement income strategies and retirement asset rollover retention programs. These strategies have addressed the concerns of retirees, pre-retirees, retirement plan sponsors and administrators, and financial advisors.
Key among DSG activities was the formation of the Retirement Management Executive Forum (RMEF), which DSG originated in 2003. This invitation-only group of high-level executives with a focus on the retirement income market was established to provide a forum for executives to enhance their knowledge and share ideas with their peers in the industry. As the originator and manager of the RMEF, DSG has established close relationships and expanded our knowledge base in this industry sector.
Contact DSG
To learn more about DSG services and how we can help leverage your efforts to build or expand your retirement management business, please contact:
Borden Ayers, Principal The Diversified Services Group, Inc. 303 West Lancaster Avenue, Suite 1C
Wayne, PA 19087 Phone: 610-989-1710, ext. 21 Email: [email protected]
