QDIAs Expected to Gravitate to Customization, Managed Accounts

Experts believe managed accounts could gradually replace target-date funds as the QDIA.

Since the passing of the Pension Protection Act a decade ago in 2006, the usage of automatic enrollment paired with a qualified default investment alternative (QDIA) has increased fairly substantially.

The PLANSPONSOR Defined Contribution Surveys of 2006 and 2015 show that automatic enrollment increased from 17.1% to 41.1% during those years, automatic escalation from 5.8% to 16%, and the use of target-date funds (TDFs) or asset allocation funds from 33% to 61.7%. However, in 2015, the most common deferral rate for plans with automatic enrollment was 3%, used by 45% of plans.

While automatic enrollment has increased quite substantially in the past 10 years, it will never become universal because some employees just do not want money taken out of their paycheck and some employers do not want to incur the added cost of providing a company match, says David Godofsky, a partner and head of the Employee Benefits & Executive Compensation Group at Alston & Bird in Washington, D.C.

“Because of the high trajectory that automatic enrollment took immediately after the passing of the Pension Protection Act, we may only see incremental growth in automatic enrollment in the years ahead,” agrees Josh Cohen, head of defined contribution for Russell Investments in Chicago.

Rob Austin, director of research for Aon Hewitt, in Charlotte, North Carolina, says that his company’s Trends and Experience in Defined Contribution Plans survey, conducted every other year, shows that in recent years, automatic enrollment has plateaued. The 2015 report showed that 58% of companies have automatic enrollment, Austin says. In 2013, it was 59%; in 2011, 56%; and in 2009, 58%.

Aside from the use of automatic enrollment, the biggest development in QDIAs in the past 10 years has been the replacement of stable value or money market funds as the default with TDFs, Austin says. “As many as 70% of companies used to use those funds as the QDIA,” Austin says. “Now it is only 3%.”

NEXT: Employers Embrace TDFs

Paula Smith, head of investment services, multi asset strategies and solutions at Voya Financial, Inc., in New York, also notes that stable value and money market funds have been replaced with TDFs “We’ve seen a huge embracing of TDFs to the point that they now represent the vast majority of QDIAs,” Smith says. “I think that will continue. However, we expect plan sponsors to examine their TDFs more closely as to their underlying funds and to monitor them more frequently. Plan sponsors will begin to look more carefully at the construction of TDFs and how the portfolio and fund objectives tie to their participant populations, and that will lead to TDFs evolving to more sophisticated solutions.”

The three directions that Voya expects TDFs to move are from off-the-shelf to customized TDFs; from single manager to an open-architecture, multi-manager TDFs, and from the underlying funds being actively managed to passively managed or a blend of both, says Susan Viston, senior vice president and head of defined contribution and college savings products at Voya Financial, Inc. “With blended funds, you can get a more attractive alpha level and at the same time a competitive fee,” Viston says. “We also expect in the next five years for the correlation between stocks and higher dispersions of returns, which have been favorable for active managers, to reverse, and for less efficient asset classes such as small cap, emerging markets and high yield, to gain favor.”

In addition to a move toward customization and blended underlying funds for TDFs, Viston foresees TDFs putting “more of an emphasis on retirement income and strategies that combine guaranteed and non-guaranteed investment options.”

NEXT: Other options gaining traction as QDIAs

While most companies will continue to use TDFs as their QDIA, managed accounts, custom TDFs and white-label funds are slowly gaining traction, although the uptake for each of these options is still very small, Austin says. Three percent of companies used managed accounts as their QDIA in 2011, and in 2015, that increased to 7%, he says. As companies begin to realize that simply looking at a person’s age as the determining factor for how they should be invested is inadequate, they may begin to warm up to managed accounts, he says.

Likewise, custom TDFs are catching on slowly; in 2011, 15% of companies used custom TDFs as their QDIA, and that increased to 17% in 2015, Austin says. In 2015, 32% of companies used white-label funds, be it as their QDIA or simply an offering in their fund lineup, he adds. Aon Hewitt asked plan sponsors why they did not offer white-label funds in 2015, and 67% said they simply had not considered it. “That tells me that as you have more conversations about the value of white-label funds, we should expect the prevalence to increase,” Austin contends.

Of course, another major development in QDIAs will be higher deferral rates than the 3% standard that most plan sponsors embrace today, paired with automatic escalation, Cohen and Smith agree. “Today, most plan sponsors initially default participants into a 3% or 4% deferral rate,” Smith says. “We recommend an initial 6% deferral rate going up to at least 10%. Paired with the match, people should be saving a minimum of 15%.”

Cohen agrees: “As sponsors have become more comfortable with automatic enrollment, they have begun to realize that the default rates they are using are too low to enable their participants to reach their retirement income goals.”