Sunday, January 29, 2006

Reform Forms

This week, Congress may well turn its attention to pension reform (or it may not; there are other issues looming, not the least of which is the scramble to fill the House Majority Leader opening). Nonetheless, it seems reasonable to anticipate some kind of action on the legislative front, at least by April.

Most of the focus has been on reforms targeted at defined benefit plans, and that's reasonable in view of the very serious issues regarding pension funding and the apparently precarious funding situation of the Pension Benefit Guaranty Corporation (PBGC, which insures those precariously funded programs (as well as the not-so-precariously funded ones). Additionally, there are several items in bills pending in both the House and Senate that could have a tremendous impact on defined contribution plans, including new rules regarding company stock (in the Senate bill), participant education (Senate), automatic enrollment safe harbor (House and Senate), and advice (House and Senate). Among these, the advice component has, for obvious reasons, garnered much interest in both the provider and advisor community.

At the moment, the advice provisions in the two bills, S1783 in the Senate and HR2830 in the House, are quite different. The House version is that crafted by Congressman John Boehner (R-Ohio) and, in most respects, is the same version he has been championing (and championing successfully in the House) for several years (by my rough recollection, this is the fourth time he has gotten his bill approved by the House). The Senate version is also largely recycled, albeit from previous efforts by Senator Jeff Bingaman (D-New Mexico). Both purport to provide plan sponsors with some protections against being sued for advice given to participants, so long as the financial advisor meets certain qualification and, under the House version, disclosure, requirements.

Boehner's bill is, and has always been, controversial because it would essentially allow advisors who have a financial interest in the funds they recommend to be paid for that advice. It attempts to deal with the potential conflicts of interest by imposing a series of qualification (including the requirement that they be a fiduciary) and disclosure requirements for the advisor, requiring that the fees paid to the advisor be "reasonable," and also that the participant makes the actual investment decision. Needless to say, most fund providers are generally supportive of Boehner's bill - and many advisors (particularly independents) are opposed, to put it mildly.

The Senate version avoids the potential conflict issues by stipulating that the advisor not be affiliated with the funds offered by the plan. Thereafter it imposes many of the same qualification requirements contained in the House version and provides that, if a plan sponsor prudently chooses someone who meets those criteria (and a few others), they will be deemed to have satisfied the duty to prudently appoint/review the advisor, and will be relieved of any primary or co-fiduciary liability for the advice provided.

Now, what’s on the table at present may not be what emerges from Committee (the House and Senate bills have to be reconciled), and given the current acrimony in Congress, there is little guarantee that what emerges from that reconciliation process will pass the full Congress, or that whatever emerges from that process will be signed into law by President Bush. It is also less than certain that the defined contribution measures will survive the process, since the real focus has been on defined benefit funding and reporting.

What’s also less than certain to me is what difference any of this will make to plan participants or plan sponsors. There was a time when advice was touted as a silver bullet of sorts. It was going to cure problems with participation (overcoming people’s inertia around that initial investment decision), deferral rates (helping people understand how much they needed to save to achieve their goals) and, of course, help keep a watchful eye on their asset allocation. However, the big reason cited by plan sponsors at the time for not offering advice was their justifiable concern about being sued as a fiduciary for the advice. To their credit, both the House and Senate version make some attempt to address that concern.

Things have changed, of course. When the Boehner bill first emerged, only a distinct minority of primarily larger plans offered advice - now more than 60% of the plans responding to our annual DC survey do, and that number moves relentlessly (if slowly) higher every year (due in no small part to the growing influence of advisors). In December 2001, the SunAmerica decision gave a thumbs up to a new way for potentially conflicted firms to offer advice via the interposition of an independent asset allocation model, and this has greatly broadened the field of offerings as well.

I’m not saying that additional fiduciary protections wouldn’t be helpful for plan sponsors, and it might well encourage some small number to go where they have been previously hesitant to tread. However, IMHO, the fiduciary issue that looms largest for most plan sponsors still remains in both bills - their obligations in selecting and monitoring the advice giver (a responsibility they should retain, as with any plan provider, IMHO). The good news is that we haven’t stood still waiting for legislative clarity. The industry (and here let’s also give credit to the Department of Labor) has continued to develop alternatives, and plan sponsors have just as clearly responded to both the need and the opportunity to take advantage of these alternatives.

Consequently, to me, the biggest question about the pending advice legislation is will it give us more, and perhaps better, more objective advice – or will it simply give us more advice providers?

- Nevin Adams

For more on the House bill:

For more on the Senate bill:

For more on the SunAmerica decision:

Saturday, January 21, 2006

Second Thoughts

As I noted last week, a growing number of employers are taking a fresh look at their plans’ default options. Sometimes that fresh look is a function of regular, on-going due diligence (ok, maybe that’s not as frequently the reason as we might hope); sometimes the addition of a new plan feature (such as automatic enrollment) provides that impetus; no doubt, sometimes it is the result of a financial advisor’s recommendation.

Regardless of the reason, in those situations where a plan has had a default option in place and then, decides to make a change, the plan sponsor is presented with a choice: What do you do with participants where the “old” default choice was applied? In fact, I recently heard from a reader who said she was seeing a variety of responses: (1) new contributions go to the new default fund, with previous defaults remaining in place, (2) only new participants, and their contributions, directed to the new default fund, with previously defaulted participant elections remaining unchanged, and (3) all defaulted dollars are invested in the new default choice, including the transfer of all previously defaulted balances into the new option.

The third option strikes me as most sound from a fiduciary standpoint. However, the "problem" is that it requires plan sponsors to "redefault" the funds, and they - like many in the advisor/provider space - tend to think that, after the passage of some amount of time, participants "own" the default choice. And after that magical point in time – a point in time that never comes, IMHO – they act as though by changing the investment decision they made for the defaulting participant, they are overriding an affirmative decision by the participant.

While I can understand the sentiments behind that logic, I don’t see how it works in an ERISA context. Last week I noted how the DOL has pretty consistently said that the plan fiduciary "owns" ANY participant investment decision outside of the context of 404c, so it’s hard to see how a decision that was never affirmatively made by the participant could ever become their decision, no matter how many participant statements they received showing that result.

Consider the situation of a plan fiduciary who, once upon a time, deigned to place nondirected investments into a stable value fund, only to have second thoughts later on, and change the default to some kind of asset allocation fund. Changing the default – but only for new participants and/or contributions – to a fund that is not only diversified, but rebalanced on a regular basis, and whose asset mix is reviewed and reevaluated by investment professionals on an ongoing basis. Imagine that participant who had been defaulted into a money market investment – and left there for 30 years by a process that deems him to have sanctioned that investment choice by his lack of volition, particularly if his “participation” in the plan from the very first was the consequence of having been automatically enrolled. Which side would you rather represent in a court of law?

Exactly my point.

- Nevin Adams

Tuesday, January 17, 2006

Default “Ed”

Whether it’s a function of the growing infatuation with automatic enrollment features, a consequence of the growing popularity of lifestyle/lifecycle offerings, or the guiding influence of financial advisors, a growing number of plan sponsors appear to be taking a fresh look at their plans’ default options – the investment choices made for participants who fail to make one. This is a prerequisite for automatic enrollment designs, of course, but plans also have long provided for an interim instruction for that participant who fills out the enrollment form but, for some reason, forgets to make an investment fund selection.

Traditionally, these default choices have been “conservative,” generally some flavor of stable value/money market fund, chosen primarily to serve as a temporary repository for the money until the participant gets around to filling out the proper form. However, the growing application of automatic enrollment features, as well as emerging statistical evidence regarding defaulted participant behaviors, has drawn into question this “common wisdom” as falling short of the standard a prudent fiduciary should apply.

The rationale for that wisdom is simple – analogous to the Biblical parable, where the master leaves his servants with “talents” pending his return. The “bad” servant basically just sticks the ones with which he is entrusted in the ground – literally keeping them safe until the master’s return. However, the “good” servants deploy those talents constructively, and in the process double the investment. Now, these days that kind of “initiative” would probably entitle the servant to jail time – certainly if, instead of doubling the investment, their actions served to wipe it out. Nonetheless, if you ever heard the story in church, there is little question that the “wicked, lazy” servant messed up – big time.

In similar fashion, current “wisdom” says that the traditional default fund choice – some flavor of stable value/money market fund – falls short of the standard a prudent fiduciary should apply. ERISA’s prudent expert is expected to do more than just keep it safe, after all.

The decision to rely on a less volatile investment isn’t exactly unfounded, however. Plan sponsors are aware – as was the “wicked, lazy” servant – that they are dealing with people who, with the advantage of 20/20 hindsight, might not take well to having their money invested “for” them in fund(s) that then lose money.

The problem with that kind of approach is that we know that defaulted participants frequently remain exactly where they were defaulted, changing neither the rate of deferral nor the fund(s) in which those deferrals were invested. We also know that, at least in the eyes of the Department of Labor, “The only circumstances in which ERISA relieves the fiduciary of responsibility for a participant-directed investment is when the plan qualifies as a 404(c) plan.” (see Divining Line).

What that means, of course, is that the plan sponsor is responsible for the prudence of ANY participant-directed investment outside the protections of ERISA 404(c) (we should also note anecdotally how few plans likely are in full compliance with this section). And what all that, taken together, means is that plan sponsors have to ask themselves “Do I think that this default is prudent for the likely term of its investment in this plan?”

That does not, IMHO, mean that a stable value/money market fund cannot be prudently used as a default option. It just means that the plan sponsor/fiduciary has to remember that they own that investment decision - - up till and including the moment at which the participant affirmatively acts to retake that responsibility (and, at least according to the DOL, does so under the full auspices of ERISA 404(c)).

- Nevin Adams

Saturday, January 07, 2006

IMHO: Getting What We Asked For

I was on the phone late last Thursday afternoon with the folks at IBM just before they made their big announcement about changes to their retirement programs. That timing was highly coincidental – and more than a bit ironic, since one of the things I had called to chat with them about was the impact of their last big retirement plan changes, which they unveiled almost exactly a year ago this week. This time, they announced the freezing of their current pension plans and a significant enhancement of the matching formulas for what they now term their 401(k) Plus plan – changes that would not, however, be effective until 2008 – and changes that would not apply to current retirees (see IBM Beefs Up 401(k), Backs Off DB – Come 2008).

A lot has happened in the past year on the pension front, and yet nothing that really needed to happen. We’re still dealing with a “temporary” replacement for the 30-year Treasury bond in pension calculations (even though the Treasury plans to begin reissuing them this year) and, despite repeated legislative forays on the topic, we still don’t have anything resolved on that front (maybe this year). Unfortunately, the legislative forays seem designed more to try and prop up the financial integrity of the nation’s private pension plan insurer (the Pension Benefit Guaranty Corporation) than to, in any substantive way, promote the adoption of new offerings by employers. Also unfortunately, some of the reform measures to that end (not the least of which is a huge increase in the premiums paid into that system) seem at least as likely to winnow the existing field as anything else, and most likely to run off plans that are well-tended rather than those who are in danger of shucking those obligations onto the PBGC. Worse, the Senate’s version still, IMHO, affords a sweetheart deal for the troubled airline industry.

Despite this morass, most pension plan sponsors have resolutely buckled down and tried to make the best of a troubling situation – digging deep to make contributions, and managing their way towards returns that are well in excess of assumptions that the mass media was so incredulous over just a short time ago. Those efforts, in combination with a modest uptick in interest rates, have allowed most to make serious dents in their pension funding gaps.

Nonetheless, there is a palpable sense that the time for traditional pension plans is past, certainly in the private sector. Not so much because of the unstable economic, accounting, and regulatory environment – though all certainly have played a role in the demise. Not even because employers are no longer willing to shoulder the accounting and financial burdens associated with these programs – though one could hardly fault them for exasperation on that front (see “IMHO: Broken Promises”).

Ultimately, I think the thing that is putting the nail in the coffin of these programs is worker antipathy. Let’s face it, we don’t work for the same employer all our lives anymore, and as a result, we don’t value a benefit that is effectively predicated on that assumption. Ultimately, we have a benefit that is expensive and unwieldy for employers to offer, and one that workers neither seem to appreciate nor demand. Recent pressures from accountants and lawmakers have certainly added fuel to the fire – and there’s every indication that the “threat” of pension reform is accelerating the rush to the exits.

This is a disquieting trend – particularly for those of us weaned on the premise of the three-legged stool of retirement security. We often caution workers on the dangers of putting all their eggs in one basket – and yet current developments seem destined to create an environment where our retirement incomes will largely, if not solely, be a function of people’s inclination to save for themselves.

Shifts like that at IBM will be seen by many as a sign of the times – an indication of future trends, a model likely to be replicated by others. To me, it seems more a natural and perhaps necessary response to the priorities we – workers, employers, lawmakers - have all assigned retirement security. Quite simply, we are getting what we asked for. It just may not be what we deserve.

- Nevin Adams

Wednesday, January 04, 2006

(Not) Getting It?

Call me old-fashioned, but at a time when it seems like everyone is advocating “automatic” solutions to get participants to do the right thing(s) about saving for retirement, I can’t help but wonder at the irony of participation solutions that don’t require a “participant” to participate.

In the last of this series, IMHO takes a look at what seems to be the underlying logic behind the automatic alternatives – that participants don’t, or won’t, “get it.” As always, I would appreciate your reactions, comments, and suggestions.

One of the more pervasive themes about retirement plan investors is that they don’t know what they’re doing, generally accompanied by some sort of subtextual survey that purports to prove the point; workers don’t participate as they should, participants don’t save enough, don’t allocate their retirement plan investments sufficiently or regularly. In sum, retirement plan participants just don’t get it. As easy as it seems sometimes to find fault with how participants behave (or fail to), there is, IMHO, plenty of evidence that they do, in fact, “get it.”

For example, we decry the failure of all workers to take advantage of these programs, and point to overall participation rates of 75% as a signal failure of the defined contribution system. But that failure is apparently not because they don’t understand the need, or lack the desire – any number of surveys point to a growing awareness here. Sure, younger workers have a natural tendency to postpone retirement savings in favor of things closer to the here and now – and there are certainly those who simply fall prey to inertia and fail to return that enrollment form. But I would suggest to you that for many, if not most, the real determinant is not awareness, interest, or concern; it’s a simple matter of economics. Simply stated, the more money you make, the more likely you are to participate, and at higher rates. Consequently, those disappointing participation statistics probably tell us as much about disposable income and job security as they do the success (or failure) of plan design and participant education.

There is, of course, the impact of the company match – or more accurately, the “free money” represented by its availability. It may seem foolish for workers not to take advantage of it, but if you are having trouble making ends meet, the “free” money isn’t without strings – it requires an economic choice. On the other hand, numerous studies have demonstrated the correlation between a company match and participation, so clearly the free money message has resonance, even to the point of influencing how much workers choose to save (there is a demonstrated tendency of plan deferral rates to cluster at the level of the match). Clearly, participants do “get it” with regard to the benefits of a company match, even if that means that they aren’t always deferring as much as they should.

Then, there is the concern about making investment choices. Granted, many participants aren’t comfortable making this decision, but the most compelling evidence that participants do “get it” with regard to investment choices was found in a study done by the Vanguard Center for Retirement Research a couple of years ago. That study found that, during the second half of 2003, as a result of the continued upswing in stock prices, the percentage of contributions allocated to stocks among new participants rose to 66% - a sharp contrast with the less than half (48%) by new participants in the first half of the same year, when the stock markets were still struggling. Moreover, Vanguard noted that the trend was also in evidence during the bull market. For example, participants who enrolled in 1999 and 2000 contributed about 72% to equities and just 28% to fixed income. Clearly, participants “get it” – at least at the point of enrollment. They understand stocks versus bonds, they understand market risk, and they appear to understand past performance – they just don’t seem to understand the importance of revisiting those understandings on a regular basis. In fact, the Vanguard study noted that those participants who enrolled in 1999 and 2000 were STILL allocating nearly three-quarters of their contributions to stocks, well after a prudent evaluation might have suggested an alternative course.

We have solutions for that inattentiveness to rebalancing, of course, the most common, these days, being a lifestyle/lifecycle fund. However, participants apparently even have trouble using the lifestyle/lifecycle “pick one” option. Some of the blame for that no doubt lies with how the original lifestyle funds were positioned (few are comfortable with a label like “conservative” or “aggressive” when it comes to investments). But think about how long we have spent teaching participants about the importance of diversification and the dangers of “putting all your eggs in one basket” – and then think of the “just pick one” message of the lifestyle fund. Do they not “get it” – or are we the ones who fail to understand that the new message runs directly counter to what we have been telling them all along?

I began this series because I think an unengaged participant investor is an investor at risk, and I worry that many of the automatic solutions are, or will be, used as substitutions for engaging participants. I also believe that a participant who is engaged is better suited to appreciate the benefit of an employer-sponsored retirement plan, is more likely to take appropriate advantage of those programs – and ultimately, is more likely to appreciate the counsel and support of a trusted financial advisor.

Here’s hoping 2006 brings us a higher level of participant engagement than ever before.

- Nevin Adams

Editor’s Note: For more about the Vanguard studies, see Starting point anchors focus at, and Past Performance Pulling Participant Allocations: Vanguard at