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

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