Sunday, March 27, 2011

Comparison “Points”

Every year about this time, we get reports from firms that purport to tell us how much time is spent in preparations for the NCAA basketball tournament—and, no, not by the teams and coaches. The “studies” (ironically, they’re always put out by firms that are in the business of helping people find jobs) generally make some assumptions about the amount of time people spend on the workplace pools as well as how many people will participate, and their compensation levels, and—voila—the productive time ostensibly “lost” to these activities. Now, they make a lot of assumptions to get to that result, including the assumption that, but for these pools, people would be doing nothing but working. But the results give journalists something easy—and “fun”—to write about, and the rest of us to read and talk about (some day someone should do a study on how much time and money is wasted writing and reading about those “studies”).

Our lives are filled with such reports: perhaps valid points that are, like it or not, supported by data that is—well, let’s just say it’s “squishy.” These reports are designed to provide some interesting if “low hanging” fruit for media coverage—and it works. The sponsoring firm gets some free press, the journalist gets some easy copy, and the reader—well, you get some interesting, if not completely meaningful, information.

And our industry is no exception. Here are some of the industry “data points” that, IMHO, are things we probably shouldn’t care about.

How the tiny minority of participants who realign their balances in any given month choose to do so.

Let’s face it, in any given month—heck, in any give YEAR—only the tiniest numerical sliver of retirement plan participants make a change in how their accounts are invested. Those who do could be doing so for any number of reasons, but inevitably those who do seem to be selling—and buying—the wrong things at the wrong time, fleeing stocks when the market takes a tumble and buying at the peak. And yes, it’s hard to avoid a certain “can you believe these idiots?” undercurrent in reporting on these movements.

Sure, highlighting the missteps of the few can provide fodder for reinforcing positive long-term investing messages. But the vast majority of participants never—ever—touch their balances.

Not that we should be wholly comfortable with that.

The investment performance of defined benefit versus defined contribution plans.

Every so often, a report comes out that reminds us that defined benefit plans turn in a better performance than defined contribution plans. What we’re apparently supposed to draw from that is that DB plans are better-managed in terms of asset allocation by professionals, better able to negotiate lower fees than their DC counterparts, and generally provide a better return on investment. In other words, DB plans are “better.”

But those who get to that result generally do so by sampling against a finite number of plans, and sampling matters (sampling ALWAYS matters). Plan size is a factor, of course, but while a defined benefit plan is ostensibly a single pool of money being managed to obtain a certain aggregate objective, a defined contribution plan is an aggregation of individually managed objectives. Now, I’m not saying that all, or even most of, those individually directed DC plan allocations are as well-designed or maintained as that put in place by a DB investment committee, but unless your defined benefit plan has a single participant, those programs have completely different objectives and timeframes. You might as well be comparing a sports car to a Hummer; which is “better” depends on the distance, the terrain, the length of time you have to complete the journey – oh, and how much fuel you have.

That said, in 2009, guess which did “better”?

That “average” 401(k) balance.

If there is one number I wish our industry would quit publishing, it’s the average 401(k) balance. As noted above, “averages” have their limitations, but the variations in this particular average are enough to make one’s head spin. Here you have participants who may (or may not) have a DB program, who are of all ages, who receive widely different levels of pay, who work for employers that provide varying levels of match, and who live (and may retire) in completely different parts of the country. But in preparing this number, we slop them all together and create—mush.

Worse than mush, actually. That number is never “enough” to provide anything remotely resembling an adequate source of retirement income, a point that is reiterated somewhat incessantly (and without the caveats about what it is an average of) in the press. I’ll allow that some of the permutations of this calculation—such as when we see that average by age demographic—can be instructive for longer-term trends, though my strong preference is for a median reading, but an average 401(k) balance is akin to an average reviewer rating on It’s mathematically accurate—and completely useless.

IMHO, averages often obscure as much as they reveal—and this average does so more than most.

—Nevin E. Adams, JD

See “DB Returns Beat DC Returns Through 2008

Sunday, March 20, 2011

Court Costs

Last week brought to light an aspect of 401(k) litigation that doesn’t generally get a lot of coverage—and the participant-plaintiff was presented with a $50,000 bill.

Now, at some level, this case was “just” another stock drop suit where some kinds of accounting issues contributed to a sudden (and ostensibly unexpected) drop in the price of company shares, including those held in the company’s 401(k) plan.1 These types of cases have cropped up one after another in the wake of the market downturn, and while the fact patterns behind the drop in share price vary slightly, the suits themselves allege pretty much the same thing: The plan fiduciaries kept the stock as a plan investment after it was no longer prudent to do so; to wit—after it suffered a precipitous drop in value.

Most of these cases don’t seem to get very far, the courts either deferring to a “presumption of prudence” (see “IMHO: Prudent Mien?” or, as in this case, finding that ERISA 404(c)’s safe harbor provided shelter (see”Court Gives Baxter 404(c) Protection in Stock Drop Suit”).

What’s interesting to me about this case isn’t that it is a stock drop suit, not that the judge found 404(c) applicability as a shield (honestly, I’m not “getting it” in this case), and certainly not that the employer prevailed (that seems a pretty common result in stock drop cases). No, what I found interesting—and what one would hope that plaintiffs who get lured to these actions in the future might want to keep in mind—is that they might lose more than just their day in court.

Not that it was an all-out victory for the defendants. Sure, they’ll get $50,000 from the participant-plaintiff, but they had asked for roughly $500,000—and that didn’t include attorney fees! But in this case, after spending some time discussing whether such awards could be made and on what grounds, Judge Gottschall decided that such fee awards were allowed—and then proceeded to pick apart the itemized requests for reimbursements with the fine-tooth comb of someone auditing a business expense reimbursement request (disallowing most for either a lack of specificity or an inability to document the origins of the expense).

Regardless, I found the list of expenses to be eye-opening2, and while the defendants may well have had other resources to tap to cover them, it was a stark reminder of just how expensive litigation can be, how much court costs, even when you win.

But maybe there’d be less of that if those who set such things in motion had to spend some of THEIR money when they’re wrong.

—Nevin E. Adams, JD

1 Specifically, U.S. District Judge Joan B. Gottschall of the U.S. District Court for the Northern District of Illinois granted the assessment of some $50,000 in costs associated with the litigation against David E. Rogers, who filed the suit against Baxter International in 2004. The suit, rejected by this same judge in 2010, alleged that Baxter continued offering company stock in its 401(k) plan after it was no longer prudent to do so (specifically, after its stock twice took tumbles after the reporting of disappointing earnings results, one involving fraud at a Brazilian subsidiary). Judge Gottschall ultimately dismissed the suit because she found that the employer qualified for protection under ERISA 404(c)’s safe harbor (see “Court Gives Baxter 404(c) Protection in Stock Drop Suit”).

2 From Baxter and former Baxter CEO Harry Kraemer:

(1) $23,163.44 for transcripts and video recordings of court hearings and depositions,
(2) $6,956.60 for photocopying court documents and preparation materials for depositions,
(3) $112,648.13 for exemplification and copying costs incurred in connection with responding to discovery requests (including nearly $78,500 in fees paid to an “e-discovery vendor” to process data into a readable format that could be reviewed and produced to plaintiff, as well as $15,000 spent digitalizing documents that existed in hardcopy format—at a rate the court said was about twice as expensive as simply copying them),
(4) $163,474.09 for the cost of computerized legal research.

From former Baxter CFO Brian Anderson:

(1) $4,070.95 for transcripts,
(2) $10,673.10 for photocopying,
(3) $2,687.04 for exemplification of trial exhibits,
(4) $173,150.00 for expert-witness expenses (apparently without providing any supporting documentation, so it was rejected).

Sunday, March 13, 2011

“Conversation” Starters

There’s been a lot of talk coming from Washington of late about the need to have “an adult conversation” with the American people.

That conversation ostensibly includes discussion around the need to make changes to how this country spends its money and/or how much it needs to fund that spending. Almost certainly that “adult” conversation means decreasing entitlement benefits and/or increasing the tax “contributions” we make to fund those entitlement benefits. The politicians wonder if we’re ready for it; personally, I think the politicians are the only ones who aren’t.

Still, when someone talks about the need for an “adult” conversation, what they mean is that we need to talk about things you’d probably just as soon not think about, much less talk about. Those are generally serious topics with painful choices.

Regardless, we’re only just beginning to have those “adult conversations” with retirement plan participants. Sure, we talk about the need to save as much as they can, beginning as soon as they can—but still, for the very most part, the goals (and goal line) are vague and ambiguous. Here’s the adult conversation I think we should be having:

1. Social Security won’t be as much as you think it will be.

The Social Security Administration notes that for a worker retiring at age 66 in 2011, that maximum benefit amount is $2,366 per month, a figure based on earnings at the maximum taxable amount for EVERY year after age 21. In other words, that’s probably more than most of us would get. Note that the maximum benefit depends on the age a worker chooses to retire, among other things1. And that, of course, assumes that the current questions regarding Social Security’s longer-term financial viability are addressed, and/or that current benefit levels aren’t reduced.

In sum, the odds that you’ll get that current maximum aren’t large—and the odds that current benefits will be reduced seem pretty good.

2. Everybody doesn’t have a pension, and you probably don’t.

Now, by “pension” I mean the traditional defined benefit pension plan; one that, in the private sector anyway, was largely employer funded. According to EBRI, in 2008, 31% of all private-sector workers participated only in a 401(k)-type defined contribution plan, and 3% participated only in a defined benefit pension plan, while 12% were covered by both. So, only about 15% of private-sector workers were covered by a pension plan (coverage is much more common in the public sector).

The rest? Well, they didn’t have any kind of workplace retirement plan.

Despite this, studies pop up every so often that indicate that a remarkably large number of workers think they DO have a pension. Where do you fall out?

3. You won’t be able to work as long as you think you will.

According to the U.S. Census Bureau, the average retirement age in America is 62 (the average length of retirement is 18 years). Several years back, McKinsey & Co. did a survey and found that while nearly half of baby boomers expect to work past 65, only 13% of current retirees surveyed actually worked past that age. Forty percent of current retirees were forced to stop working earlier than they had planned (being laid-off was the most common reason, and the survey was taken well before the recent downturn). The average age when current retirees left the workforce, according to McKinsey: 59.

Think you’ll work past 65?2 You may, but perhaps not in the job you think.

4. You aren’t saving enough. That goes double if you’ve been automatically enrolled in your retirement savings plan.

How much you need to save is, of course, a matter of personal circumstances and even preference. It’s also impacted by things like the amount of support provided by Social Security, how old you are when you retire, and more importantly how—and how long—you live after you quit working. That said, if you’re only saving up to the level of the employer match (at least at most companies), and you don’t have a pension (see above), then it’s likely you’re not going to have enough saved at retirement to last you through your retirement. In fact, many workers don’t even save to the level necessary to receive the maximum employer match.

As for those who are automatically enrolled, they typically start their savings at a much lower rate than those who have taken the time to fill out an enrollment form. So you’ll have even less.

As for how much you need, last year a study by Hewitt Associates (now Aon Hewitt) said that the average U.S. employee would need 15.7 times their final pay in retirement resources to maintain their current standard of living during retirement.

How much do—and will—you have?

There you have it: the makings of an adult conversation with American workers. Have you had it with the participants you work with?

—Nevin E. Adams, JD

1 Not that Social Security isn’t an important source of retirement income. The biggest source of retirement income for Americans has been Social Security, and many older Americans (age 65 or older) rely entirely on their monthly Social Security checks. According to the Employee Benefit Research Institute (EBRI), in 2009, Social Security accounted for 49.0% of elderly women's income, compared with 35.9% of elderly men’s income. Compare that to pensions and annuities, which in 2009 accounted for 21.2% of elderly men's income, compared with 16.6% of elderly women’s. MORE at

2 One of the most common responses of workers who know—or suspect—they haven’t saved enough is to assume that they’ll just keep working a few years longer. After all, these days most of us have jobs that can be done well beyond the traditional retirement age. And would that we could: working, and saving, five years longer will “cure” a surprising number of inadequate retirement savings situations.

Sunday, March 06, 2011

Underlying Assumptions

Last week the Government Accountability Office (GAO) issued two reports focused on 401(k) plans: one on target-date funds, the other on potential conflicts of interest. As seems to be its custom in such reports, the GAO communicates its conclusion in the titles: “Key Information on Target Date Funds as Default Investments Should Be Provided to Plan Sponsors and Participants” and “Improved Regulation Could Better Protect Participants from Conflicts of Interest”—and, IMHO, there’s little controversy in those statements.

The reports themselves offer a great informational primer on target-date fund designs and issues (you’d be surprised how many plan sponsors still don’t quite grasp the concept of “glide path”) as well as the fee structures and revenue-sharing components that underlie the 401(k) retirement savings system. Both reports acknowledge that efforts are already under way to remedy the shortfalls the reports identified in both, while at the same time promoting solutions to those shortfalls that may not be cost/impact-justified.

As you peruse the target-date fund report (see “GAO Urges More Help with TDFs for Plan Sponsors”), you’re struck once again by the wide variety of answers to the question, “What is an appropriate asset allocation for participants at retirement age?” much less the assumptions that underpin it. One might well expect to find different assumptions regarding the markets, investment classes, and how the latter will respond to the former over the course of decades—and, in fact, these assumptions lie at the core of the target-date fund glide path and design. One might well expect (though many apparently didn’t) that those differences of opinion would translate into very real differences in asset allocation, even at retirement age.

There are, however, assumptions imbedded in these TDF approaches that, IMHO, are not nearly as well-communicated and/or understood by plan sponsors; assumptions that are predicated on certain participant behaviors that, in the words of the GAO report, “may not match what many participants actually do.” There is the assumption about what participants will do at the target date—either transfer those assets to another vehicle or retain their investment in the TDF.

This, of course, is the essence of the “to versus through” debate that has, since the 2008 financial crisis, drawn increasing scrutiny, if only because, IMHO, most plan sponsors (and plan participants) assumed that their target-date fund investment was designed to take them TO that date, not beyond it. Of course, that assumption bears within it another assumption: that the participant has managed to achieve a certain level of savings accumulation. Many haven’t, of course, and this knowledge underlies the assumption of those who employ the “through” approach to TDF designs, assuming that a longer equity exposure will serve to shore up that shortfall. Which, by the way, is another assumption imbedded in the “through” designs—that the participant will leave the money invested in that TDF (if not the plan itself) past their projected date of retirement.

Moreover, even the “to” TDF camp tends to assume that participants will buy an annuity at retirement, though they frequently don’t.

The GAO report noted that each of the eight TDF managers it contacted “considered contribution rates in establishing its asset allocation strategy,” noting that “some explicitly noted that these assumptions did not match the general pattern of contribution rates.” It will surprise few to learn that their assumptions were generally higher, but that they “hoped that rates will increase as workers adjust to DC plans serving as the sole employer-based retirement account,” according to the GAO report.

And, of course, since a growing number of participants were defaulted into TDFs to begin with, nobody has any real idea if they will behave the way participants have historically or not.

That said, the GAO has recommended that the Employee Benefits Security Administration (EBSA) (1) amend the QDIA regulations such that fiduciaries are required to document whether factors beyond age or retirement date are relevant, (2) provide guidance to plan fiduciaries on the limitations of benchmarks on those funds, and (3) expand participant TDF disclosures to provide information regarding the assumptions concerning participant contribution and withdrawal intentions. EBSA was at least open to the first two (though not commenting directly, since they are currently in the process of recrafting those regulations), though it resisted the last as being a “very complicated and subjective undertaking which could affect a plan sponsor’s decision to offer any target date fund option(s),” according to EBSA’s response to the GAO report.

But, IMHO, if that gives a plan sponsor pause in offering a particular option—well, perhaps it should.

—Nevin E, Adams, JD

See also “IMHO: When You Assume…

The GAO target-date fund report is at