Sunday, May 29, 2011

London “Bridges”

I was in London for a few days last week, and while it afforded a good opportunity to visit with a number of providers in the European retirement plan market, the primary purpose of my trip was to acknowledge the fund manager and consultant standouts recognized by PLANSPONSOR Europe (which has just celebrated its one-year anniversary).

The luncheon itself was fascinating: As is often the case with such gatherings here, many of the attendees were well-acquainted with each other, a number had common employment histories and, as in the U.S., even those who worked for competing firms at the moment seemed to sense that it could change at any time.

Once we got past the potential impact of the latest Icelandic volcanic ash cloud, the traffic disruptions attendant with President Obama’s visit (which, of course, had been impacted by the latest Icelandic volcanic ash cloud), and the beautiful weather (which, fortunately, was apparently completely unaffected by the latest Icelandic volcanic ash cloud), the discussion turned to “shop.”

The group had some interesting questions for me:

Why are American pensions so heavily invested in stocks?

For the record, this audience apparently felt that a 60/40 allocation to stocks/bonds was the mirror image of a prudent allocation. Of course, every fund is different, and every fund’s allocation is different. I mentioned that I thought that, certainly over the long haul, American pensions have likely benefited more than they have suffered from their exposure to equities. However, regardless of the realities, I know that those who make those decisions believe that. One of the consultants at my table asked a corollary to the first question: why more American pensions haven’t adopted a stronger LDI (liability-driven investment) focus.

To that, I offered three observations: First, I think most American plan sponsors still believe they can, in fact, do “better” by pursuing alpha. Second, while I think most American plan sponsors who have given some thought to LDI are intrigued with the concept, they aren’t quite convinced that the “theory” will work in reality. But finally, I sense that more have embraced the concept than is probably appreciated, albeit in baby steps (purists will, of course, argue that incremental adoption can actually serve to undermine the effectiveness, but…).

Are target-date funds now totally discredited?

The question was actually posed in a way that suggested that, whether they were or not, they should be. That said, my short answer here was, absolutely not; that while 2008 had certainly shaken some, the rebound in the markets seemed to have taken much of the edge from that issue. I noted that while I’ve seen data that suggest some are more interested in something other than a pure “date-based” allocation approach, and that, while there is more discussion around the whole “to versus through” retirement date design, my sense was that most providers hadn’t made significant shifts to their approach (or assumptions), and that few plan sponsors (and no participants) had made any changes in their target-date fund, or allocations to that suite.

In sum, I told this audience that I thought that the market rebound had given our industry a second chance on target-date designs—but that I wasn’t sure anyone was taking advantage of that, sadly.

Why are Americans so opposed to annuities?

I told the audience that I have, on more than one occasion, noted that if we could figure out how we taught participants that annuities were “bad,” and could deploy that to teach them how retirement savings were good, we’d be on to something. That said, I still think that there is a behavioral issue here—one that makes individuals reluctant to hand over a large pot of money today to someone else (particularly a large, faceless institution) so that they can have little pieces of that returned to them over a long period of time. That the annuity ostensibly is expensive, that the individual may lack trust in the institution to which they are expected to hand over a life’s savings, that they can’t access those funds in an emergency—those are also legitimate issues.

All that notwithstanding, I think things could change—and perhaps change dramatically—if American plan sponsors were, in any credible way, encouraged to connect this post-employment investment decision to their workplace retirement plans. The reality today is that most plan sponsors see this as an extension, rather than a reduction, of liability (and with reason, IMHO); there is a palpable sense that product development is still ongoing (and that the best model isn’t yet on the market); and beyond that, we all know that the Labor Department is evaluating alternatives/approaches as well.

In sum, employers have no compelling reason to jump in here, alongside several key indicators that suggest doing so could be expensive and/or premature. Consequently, they are inclined to wait—and until that dynamic changes, it seems unlikely that participants will be overcoming their current reluctance, either.

Lessons Learned

Asked to share insights on “lessons learned” by the American pension system, I noted a couple. First off, I noted that I thought we had never helped workers appreciate the value of a pension, and that, certainly from a financial standpoint, employers had probably never fully appreciated what it would take to fulfill that promise. Moreover, that we were only just beginning to focus on helping workers appreciate what it would take to provide a lifetime of post-retirement income—and that, for some, that message would come too late to be of value. That whereas workers once blithely assumed that the market would “fix” their savings shortfalls, today’s most common unrealistic assumption was that they would simply be able to work longer (this, by the way, is a problem of a different ilk for employers in the UK, who might actually have to provide that employment).

One lesson that I thought we were only recently beginning to “get” was that, if retirement security is going to rely on a defined contribution system—particularly one where “defaults” are driving utilization—you can’t be coy about what it’s going to take. And defaulting people into these programs at contribution levels that don’t even maximize the match, much less come close to what needs to be saved to achieve financial security in retirement—well, that is literally setting people up…to fail.

—Nevin E. Adams, JD

Sunday, May 22, 2011

Loan Arranging

The headlines last week were all about how new legislation had been introduced to cut down on the “leakage” from 401(k) plans.

That leakage, roughly defined as pulling money out of retirement savings before retirement, has been a concern of many for some time. About once a year, someone puts out a report about the number of outstanding loans from these programs and/or the uptick in hardship withdrawals (see IMHO: Double Dipping) ; and, from 2008, see IMHO: Safety “Net”). Not surprisingly, with the sluggish U.S. economy and the so-called jobless recovery, people seem to be dipping into these accounts at higher rates. And yet, for all the hyperbole around such things, the actual rate seems to be pretty consistent (allowing for differences in the data samplings).

That said, last week, Senators Herb Kohl (D-Wisconsin) and Mike Enzi (R-Wyoming) introduced the Savings Enhancement by Alleviating Leakage in 401(k) Savings Act of 2011 (the SEAL Act), which, among other things, was designed to “[limit] the most 401(k) loan practices that provide easy access to retirement funds but adds costs and fees to pension plans” (see “Legislation Aims to SEAL 401(k) ‘Leakage’”).

From the bill’s summary, the only real “limitation” on loans was capping the number outstanding at any one time to…three. Beyond that, it gave participants longer to stave off having an outstanding loan turned into a “deemed distribution” (a euphemistic term for treating that loan you previously took out as a distribution and subjecting it to income taxation), and it allows participants to continue making contributions after taking a hardship (the current six-month restriction being a vestige of the sense that if you could afford to keep contributing after taking a hardship, you really weren’t in a hardship situation). The SEAL act would ban 401(k) loan debit cards—but did anyone ever think THAT was a good idea?

Now, I’m sure that keeping those repayment windows open longer will compound someone’s recordkeeping headaches, but it seems to me a reasonable means of giving participants time to restore that money to their retirement accounts, rather than simply forking over a big chunk of it to the IRS. Moreover, I think we all know that a properly administered hardship request can alleviate the hardship without imposing a six-month “penalty” on retirement savings (and matching contributions). As for “only” letting participants have three loans out at one time—well, IMHO, that’s hardly a limit at all.

In fact, headlines notwithstanding, the bill might have been more accurately (if less acronymically melodic) titled the “Making It Easier for Participants To Repay Outstanding Loans and Keep Saving” bill.

All in all, the legislation may or may not actually forestall 401(k) leakage, but IMHO, it’s certainly a plumber’s helper.

—Nevin E. Adams, JD

Sunday, May 15, 2011

Change Parse

Three things every adviser (and provider) wishes plan sponsors understood about recordkeeping conversions:

Everybody wants to change providers on January 1. Everybody can’t.

If your plan year end is December 31 (and it is, for the vast majority of plans), there are some real benefits to making a provider change at that point in time. Plan reporting—both participant and regulatory (Form 5500)—is quite simply neater when you finish the reporting year at the same time you conclude your arrangements with a provider. Anything else is going to require someone somewhere to “splice” together reports at some point. Doing so doesn’t have to be a big deal—but it can be “awkward.”

There are some reasons not to make those kinds of changes at year-end, of course. First off, there’s generally quite a queue wanting to do so. You may well be able to get in that queue, but your new provider will likely have their hands full with a lot of plans just like yours. More significantly, your soon-to-be-ex provider likely will as well—and guess who is likely to get the most/best attention?

Bear in mind also that a 1/1 change means that a lot of the preparation, review, and/or testing—not to mention participant communications—will happen during a time of the year when people are generally more inclined to be worrying about other things.

Your provider search will take longer than you think.

Human beings are, generally speaking, poor judges of time requirements, particularly on things they don’t have a lot experience with (like provider searches) and that require the involvement/input of committees (like provider searches). We tend to assume that we’ll have more time available for such things than actually winds up being the case, and we tend to assume that such things will take less time than they actually do. We also tend to make those types of assumptions about the participation of other members of the team. It’s not just that those assumptions tend to be optimistic, it’s that, all too frequently, they are wildly optimistic.

Your provider and/or adviser will likely make a good faith effort to provide a timetable of events, and will likely take pains to emphasize to you the amount of time it will take to actually conduct this process. Doubtless they will remind you—and remind you more than once—just how important it is that you make the time commitment—and deadlines—noted in that timetable.

My advice: Take whatever timetable they give you—and double it.

A big part of the reason your provider search will take longer than you think…is you.

Conversions generally involve providers—both new and soon-to-be-ex—and frequently involve an adviser in addition to the members of the employer team. Every one of these parties is, generally speaking, highly motivated to see the conversion take place. Now, one could argue that you, the plan sponsor, who set all this in motion, has as much motivation as anyone. However, the reality is that, unless you have some SERIOUS servicing issues, your motivation for change is probably somewhat less than the others.

Change, after all, is generally disruptive. A change of providers inevitably brings with it additional work, greater time commitments, and what sometimes feels like an incessant series of questions about things to which you never previously gave much thought. Moreover, you’ll have to think about how to communicate this change to your participants—and deal with the inevitable flurry of questions from THEM about how to do things to which THEY never previously gave much thought.

However, these realities are generally not top of mind when we enter into discussions about making a provider change. So, while the search is generally set forth on a wave of optimism and hope, it can, before long, find itself bogged down in the inevitable administrative minutia that consumes so much of a plan sponsor’s time. And the longer it takes, the worse it can become.

So, considering those issues, what should a plan sponsor thinking about making a provider change do? Well, I would suggest you start early, allow plenty of time for slippage in schedule, and be open to the possibility of making a mid-year change instead.

—Nevin E. Adams, JD

Sunday, May 08, 2011

Out of Proportion

Without question the retirement plan industry has prospered from the long-standing practice of relying heavily – and in some situations, completely - on asset-based fees.

Now, you can certainly argue that that has resulted in plans paying for services they would not otherwise have engaged, and that it has, in some cases, led to plans paying more than they might if they had been more cognizant of the dollars expended. Indeed, one can argue that the imbedding of those fees inside the fund structure has made it easy, perhaps too easy, for the industry to collect its tolls without drawing the kind of scrutiny they were entitled to.

On the other hand, that structure has made it easier for the industry to provide a broad-based level of sophisticated services to plans of all sizes, and has doubtless made it possible for plans to contemplate hiring an adviser that, regardless of the need and/or benefit, would otherwise have been discouraged by an explicit charge for those services.

That said, there are some issues attendant with the current asset-based fee structure that, IMHO, bear discussion:

Asset-based fees go up – pretty much all the time.

For most of the existence of the 401(k), the markets have been fairly good, and as they say, a rising tide lifts all boats. In this particular case, rising markets have also meant rising fees. Proportionately rising fees, of course, but rising fees nonetheless. That, in turn, has meant that those who make their living off asset-based fees have seen some pretty nice pay increases over time – without necessarily having to do anything more or different to “earn” them. Even in bad markets, the steady flow of contributions has cushioned the blow that might otherwise have tamped them down.

Asset-based fees go down when the work – and risks – go up.

One of the great ironies of asset-based fees is that they do sometimes go down, and at the most “inconvenient” times. One need look back only as far as the fourth quarter of 2008 to remember a precipitous decline in asset values – and asset-value-based fees - at the very same time that many noted a steep increase in the “care and feeding” of plan sponsors and participants who had been shaken by what was happening to their retirement plans (not to mention their plans for retirement). Of course, it would probably be viewed as unseemly (at best) to raise your fees during such times – but that is when your work, and your risks, are generally rising.

The bigger your balance, the more you pay.

Admittedly, when you’re talking about fees based on assets, it makes sense that the more assets you have, the more fees you pay. Perhaps that makes a modicum of sense when you are talking about things like investment management (even then, it seems to me that those with large balances are carrying an ironically disproportionate, albeit proportionate amount of the fees). As “industry insiders”, we all know this – indeed, some go so far as to see a more high-minded result; the “rich” underwriting the costs of the less rich, if you will.

On the other hand, it’s not just the rich that have larger balances – frequently those are the balances of lower-income workers who have, nonetheless, been long-time diligent savers. So, said another way, it’s older, longer-tenured workers are underwriting the costs of the folks who have just joined the plan.

Different funds “share” differently

We all know that different types (and brands) of mutual funds charge different fees. What is less obvious to many plan sponsors is that different types (and brands) of mutual funds provide different amounts of revenue sharing. It is not atypical for a plan sponsor to sit down with a recordkeeper, to figure out what the recordkeeping charges will be, to determine what the aggregate amount of the revenue-sharing rebates will be, and then to determine how to manage the difference. But if some funds provide higher levels of revenue-sharing, then the participants investing in those funds are, effectively, shouldering a larger proportion of the administrative costs of the plan.

There are administrative ways to “level” these fee allocations, but many plan sponsors aren’t even aware that this has crept in.

Out of “sight” IS out of mind.

To me the biggest issue with those “imbedded” asset-based fees is that you never really see how much actual money you’re paying. Oh, it’s not like the fees aren’t “disclosed”, and it’s not as though it’s rocket science to figure it out, at least at a high level. But most plan sponsors are lured into what I consider to be the faux comparisons of basis points, rather than actually stopping to figure out what 100 basis points times the assets in a particular fund actually adds up to – and who gets how much for what.

The reality of our world is that a large, and growing number, of retirement plan advisers are already “fee for service”, and the fee disclosure regulations are widely seen as accelerating that trend.

That said, our industry has gotten comfortable, some even complacent, with a fee system structure that tends to raise, not lower, fees over time, a system that apportions fees on a basis that often has little to do with the costs of providing the services it supports, and one that tends to obscure the real costs of the services they ostensibly underwrite.

The current structure may have been “convenient” – but just because it’s “proportionate”, doesn’t mean it’s always fair.

- Nevin E. Adams, JD