Over the last several years, there has been a growing level of awareness surrounding the various roles that retirement plan advisors and consultants play when serving their clients. The increased awareness can be attributed to the establishment of organizations dedicated to promoting fiduciary best practices, as well as the increased exposure to content available at a growing number of industry conferences. Not surprisingly, this has led to the creation of new business models, new credentials and new expertise.
The sections of the ERISA dealing with fiduciary responsibility, in name, have evolved into marketing terminology. For example, ERISA §3(38) Investment Manager is now a bell or whistle made available by the advisor or the service provider. An unfortunate side effect of this trend is the wide disparity in the quality of the delivery system. Some claim to be ERISA fiduciary “experts” using ERISA fiduciary as a sales feature, when really their expertise is in sales or asset gathering. Even among genuine experts, there are many who lack the depth in understanding the many nuances that distinguish the roles. In a recent competitive situation we observed an advisor team, acting as an ERISA §3(38) Investment Manager, state to a client that they are equivalent to a fully Discretionary Trustee, but that they could do it for less. This claim, in the form of salesmanship, was plainly inaccurate and disappointing, yet it happens all too frequently.
While we find that the uptick in the use and discussion of the various fiduciary roles exciting on some levels, the misuse that occurs with client consulting can be problematic. In the example above, by that advisor claiming that selecting funds for their client is the same as a being a fully discretionary trustee, it substantially diminishes the robust list of services provided by a discretionary trustee that goes well beyond fund selection. Many of those services are equally, if not more, important to the Plan Sponsor and the participants. For that reason, we have created a comprehensive chart that explains the PRACTICAL differences for the various fiduciary services available in the market. Click here
Thursday, November 17, 2011
Tuesday, November 8, 2011
401(k) Advice, Good but only if Used
There was an article in the Wall Street Journal yesterday titled 'Thanks but No Thanks on 401(k) Advice' found here.
http://online.wsj.com/article/SB10001424052970204346104576638933476020932.html
The gist of this article is that more and more 401(k) plans are offering outside help in the form of participant level investment advice, but that uptake on this advice is generally low.
The fact that more plans are giving participants access to advice, in one form or another, is a very good thing or at least it should be. Many surveys show that formal advice leads participants to better decision making and that leads to better outcomes in the form of income replacement rates. However, if only 25% of the people who have access to advice through their retirement plans actually take advantage of it, then this is an issue. My feeling is that many if not most of the advice programs out there are good, very good or great. So why aren't the participants using these services? I have my thoughts.
Firstly, from a behavioral perspective, it has been my experience that many participants would be better described as speculators rather than investors. The key differnce is in expectations. Investors have an expected return on investment (ROI).
Ex.) I invest $10,000 in a 4% bond, I have an expected outcome of 4% interest for the term of the bond and a return of my $10,000 when the bond matures.
Most participants in 401(k) plans do not have an expectation of ROI, rather what they have is hope. I think, in part, this stems from the experience level of most participants as it pertains to investing. The great majority of investment professionals set minimum requirements on who they will look to as potential clients, such as net worth, or minimum investment amounts, e.g. $250,000. Many 401(k) participants would never qualify to work with investment professionals and are ill-equipped to understand the basics of investing, what the experience will be like, what market volatility is and how that will translate to emotional bias' and poor decision-making. Subsequently, the first and perhaps only investing experience they have is with their 401(k) plan and the only reason they get this access is from the aggregation of the asset of the plan.
Next, behaviorally, we've observed that for most participants that savings is a low priority. Most have a set-it forget-it mentality when it comes to decisions they make. For example, they decide to join the plan at a deferral rate of 4%, when we look back at them 3-4 years from now, they are still deferring just 4%. Asset Allocation is a best guess. The simple act of rebalancing, which is additive, doesn't happen in the aggregate. These and other issues lead to the poor income replacement statistics that we've all been seeing.
So, again, how do we take a valuable service like participant advice and get the uptake on it to be higher than the 25% figure in the article?
1.) Remove the price barriers. Not saying that advice should be free, far from it, what I am saying is that if the participant feels they will pay more for advice, they are likely to not take it. Instead, have the fee for advice be a plan-level fee. I.E. 25 basis points to the Plan Sponsor. If the Plan Sponsor chooses to pass along fees to the plan, then everyone pays for it. It becomes a fee neutral decision for the participant to use it or not.
2.) Make advice the default. Like other automatic provisions, usage goes up SUBSTANTIALLY if you make it a plan default. Our experience is that when we make advice programs a plan default we see a usage rate north of 85%.....that's right, 85% or 60% HIGHER than what the Wall Street Journal article says is the industry norm right now.
3.) Change the conversation at the participant level. Give them information in a way that they truly can understand. Most participants are return-centric, not benefit-centric. They look at what the investments did last quarter. In general, as mentioned, most are ill equipped to do anything with performance information, positive or negative. However, if we communicate to them at what age they will be able to afford to retire, give them the REAL number on what that is for a variety of ages, 66, 67, 68, etc. then they will truly know if they are on target to retire with enough income or not. If they are on a shortfall, we can communicate to them the earliest age that they can afford to retire or show them the impact of saving more.....what a novel concept, use the 401(k) Savings Plan as just that, a SAVINGS PLAN!
4.) Use the advantages offered in the Pension Protection Act of 2006. Automate savings, automate escalation, default people to Qualified Default Investment Alternatives, and automate rebalancing.
Those are real, practical solutions that can be implemented easily for many plans and will change the dialogue with Plan Sponsors and participants from investments and fees to something that really matters more which is income replacement rates.
http://online.wsj.com/article/SB10001424052970204346104576638933476020932.html
The gist of this article is that more and more 401(k) plans are offering outside help in the form of participant level investment advice, but that uptake on this advice is generally low.
The fact that more plans are giving participants access to advice, in one form or another, is a very good thing or at least it should be. Many surveys show that formal advice leads participants to better decision making and that leads to better outcomes in the form of income replacement rates. However, if only 25% of the people who have access to advice through their retirement plans actually take advantage of it, then this is an issue. My feeling is that many if not most of the advice programs out there are good, very good or great. So why aren't the participants using these services? I have my thoughts.
Firstly, from a behavioral perspective, it has been my experience that many participants would be better described as speculators rather than investors. The key differnce is in expectations. Investors have an expected return on investment (ROI).
Ex.) I invest $10,000 in a 4% bond, I have an expected outcome of 4% interest for the term of the bond and a return of my $10,000 when the bond matures.
Most participants in 401(k) plans do not have an expectation of ROI, rather what they have is hope. I think, in part, this stems from the experience level of most participants as it pertains to investing. The great majority of investment professionals set minimum requirements on who they will look to as potential clients, such as net worth, or minimum investment amounts, e.g. $250,000. Many 401(k) participants would never qualify to work with investment professionals and are ill-equipped to understand the basics of investing, what the experience will be like, what market volatility is and how that will translate to emotional bias' and poor decision-making. Subsequently, the first and perhaps only investing experience they have is with their 401(k) plan and the only reason they get this access is from the aggregation of the asset of the plan.
Next, behaviorally, we've observed that for most participants that savings is a low priority. Most have a set-it forget-it mentality when it comes to decisions they make. For example, they decide to join the plan at a deferral rate of 4%, when we look back at them 3-4 years from now, they are still deferring just 4%. Asset Allocation is a best guess. The simple act of rebalancing, which is additive, doesn't happen in the aggregate. These and other issues lead to the poor income replacement statistics that we've all been seeing.
So, again, how do we take a valuable service like participant advice and get the uptake on it to be higher than the 25% figure in the article?
1.) Remove the price barriers. Not saying that advice should be free, far from it, what I am saying is that if the participant feels they will pay more for advice, they are likely to not take it. Instead, have the fee for advice be a plan-level fee. I.E. 25 basis points to the Plan Sponsor. If the Plan Sponsor chooses to pass along fees to the plan, then everyone pays for it. It becomes a fee neutral decision for the participant to use it or not.
2.) Make advice the default. Like other automatic provisions, usage goes up SUBSTANTIALLY if you make it a plan default. Our experience is that when we make advice programs a plan default we see a usage rate north of 85%.....that's right, 85% or 60% HIGHER than what the Wall Street Journal article says is the industry norm right now.
3.) Change the conversation at the participant level. Give them information in a way that they truly can understand. Most participants are return-centric, not benefit-centric. They look at what the investments did last quarter. In general, as mentioned, most are ill equipped to do anything with performance information, positive or negative. However, if we communicate to them at what age they will be able to afford to retire, give them the REAL number on what that is for a variety of ages, 66, 67, 68, etc. then they will truly know if they are on target to retire with enough income or not. If they are on a shortfall, we can communicate to them the earliest age that they can afford to retire or show them the impact of saving more.....what a novel concept, use the 401(k) Savings Plan as just that, a SAVINGS PLAN!
4.) Use the advantages offered in the Pension Protection Act of 2006. Automate savings, automate escalation, default people to Qualified Default Investment Alternatives, and automate rebalancing.
Those are real, practical solutions that can be implemented easily for many plans and will change the dialogue with Plan Sponsors and participants from investments and fees to something that really matters more which is income replacement rates.
Thursday, October 20, 2011
New Retirement Plan Limits for 2012 (COLA)
Not my usual kind of post, but this blog should be a source for all relevant Qualified Plan news and the IRS changing the Annual Limits for plans is pretty important information. Below is all of the changes, and there were some changes.
Internal Revenue Service cost-of-living adjustments applicable to dollar limitations for retirement plans.
Internal Revenue Service cost-of-living adjustments applicable to dollar limitations for retirement plans.
401(k), 403(b) & 457 Elective Deferral Limit increases from $16,500 in 2011 to $17,000 in 2012
Catch-Up Contribution Amount stays unchanged at $5,500
415 Defined Contribution Annual Additions Limit increases from $49,000 to $50,000
Compensation Considered increases from $245,000 to $250,000
Income Subject to Social Security Tax (Taxable Wage Base) increases from $106,800 to $110,000
There are others that are important for use with Non-Discrimination and Top-Heavy tests, but the above are the relevant ones to Plan Sponsors and participants.
Monday, September 19, 2011
DOL to Reconsider Fiduciary Rules
The Department of Labor announced that it would be re-proposing its rule on the definition of fiduciary due to requests from the public via Congress that the agency provide more input on the rule.
Anticipated changes include but are not limited to:
-Clarifying that fiduciary advice is limited to individualized advice directed to specific parties
-Addressing concerns about application of the rules to routine appraisals
-Clarifying limits of the rule's application to arm's length commercial transactions, such as swap transactions.
-Addressing the impact of the new regulation on current fee practices of advisors and brokers, and looking at exemptions permitting brokers to receive mutual fund, stock, and insurance commissions.
The full article, available through PLANSPONSOR.com, can be seen here.
Anticipated changes include but are not limited to:
-Clarifying that fiduciary advice is limited to individualized advice directed to specific parties
-Addressing concerns about application of the rules to routine appraisals
-Clarifying limits of the rule's application to arm's length commercial transactions, such as swap transactions.
-Addressing the impact of the new regulation on current fee practices of advisors and brokers, and looking at exemptions permitting brokers to receive mutual fund, stock, and insurance commissions.
The full article, available through PLANSPONSOR.com, can be seen here.
Thursday, September 15, 2011
How often is prudent to conduct a vendor search?
As a general rule for Plan Sponsors, it is always good to have a market evaluation that is current on hand. This way, you will always be aware of what the marketplace is offering and have a good idea as to whether your plan is current and still in the best interest of the participants. The question is, how current does this need to be and at what point do new services outweigh the financial and time costs of making plan changes.
Historically, this was always a matter of opinion. When asked, I've usually answered every three to five years should be sufficient to gauge what is new in the market and determine if a change is warranted and disclaimed that by saying that more frequent is also fine. However, it appears that this thought needs to be amended somewhat.
It now appears that if a Plan Sponsor wants to be prudent and avoid a litigation risk in the unlikely event of a law suit, that they should adopt a policy of conducting a market study AT LEAST every three years.
In the preamble to its 2010 service provider fee disclosure rules, the Department of Labor (DOL) assumes/suggests plan sponsors conduct an RFP about every three years. While, in general, preambles are not laws, the 2011 Seventh Circuit Court of Appeals decision in George v. Kraft Foods is reinforcing concerns that this is the new normal for a prudent plan fiduciary.
Kraft's 401(k) plan participants sued for breach of fiduciary duty alleging Kraft should have done an RFP every three years and this failure resulted in payment of excessive investment fees to the plan's service provider. A lower court accepted Kraft's defense that it relied on expert outside consultants to ensure fees were competitive when extending that service provider's contract multiple times and granted summary judgment in Kraft's favor. On appeal, the Seventh Circuit rejected that as an absolute defense and sent the case back for a trial, which could end up costing more than settling.
This decision on appeal has lead some to assert that the rule should be vendor search every three years. However, this is not a mandate at this time. Certainly, as an employee of a service provider, I can tell you that it is not in my firm's best interest to have our clients search the market every three years for a possible vendor change. However, as a fiduciary, we would say that adopting a policy of market evaluation periodically is a very good idea. By formalizing a policy and setting a timeframe, whether 3 years or some other, and then following it, a Plan Sponsor would be engaging in a Prudent Process to verify that what they are offering is still prudent to offer.
This would also reenforce the idea that service providers should earn their fees, not just at the time they win a client, but on a continuous basis. This will enforce better competition and ultimately better service for Plan Sponsors and participants.
Historically, this was always a matter of opinion. When asked, I've usually answered every three to five years should be sufficient to gauge what is new in the market and determine if a change is warranted and disclaimed that by saying that more frequent is also fine. However, it appears that this thought needs to be amended somewhat.
It now appears that if a Plan Sponsor wants to be prudent and avoid a litigation risk in the unlikely event of a law suit, that they should adopt a policy of conducting a market study AT LEAST every three years.
In the preamble to its 2010 service provider fee disclosure rules, the Department of Labor (DOL) assumes/suggests plan sponsors conduct an RFP about every three years. While, in general, preambles are not laws, the 2011 Seventh Circuit Court of Appeals decision in George v. Kraft Foods is reinforcing concerns that this is the new normal for a prudent plan fiduciary.
Kraft's 401(k) plan participants sued for breach of fiduciary duty alleging Kraft should have done an RFP every three years and this failure resulted in payment of excessive investment fees to the plan's service provider. A lower court accepted Kraft's defense that it relied on expert outside consultants to ensure fees were competitive when extending that service provider's contract multiple times and granted summary judgment in Kraft's favor. On appeal, the Seventh Circuit rejected that as an absolute defense and sent the case back for a trial, which could end up costing more than settling.
This decision on appeal has lead some to assert that the rule should be vendor search every three years. However, this is not a mandate at this time. Certainly, as an employee of a service provider, I can tell you that it is not in my firm's best interest to have our clients search the market every three years for a possible vendor change. However, as a fiduciary, we would say that adopting a policy of market evaluation periodically is a very good idea. By formalizing a policy and setting a timeframe, whether 3 years or some other, and then following it, a Plan Sponsor would be engaging in a Prudent Process to verify that what they are offering is still prudent to offer.
This would also reenforce the idea that service providers should earn their fees, not just at the time they win a client, but on a continuous basis. This will enforce better competition and ultimately better service for Plan Sponsors and participants.
Tuesday, August 23, 2011
MEPs, Mediocre Employer Protection....Just Kidding, continued
As a follow-up to an earlier post from July 6th regarding Multiple Employer Plans, this author recently discovered (thanks Alan) an article that discusses the matter in much greater detail, linked here
http//www3.cfo.com/article/2011/8/retirement-plans_trouble-ahead-for-multiple-employer-retirement-plans
This article, published on cfo.com, titled 'Trouble Ahead for Multiple-Employer Retirement Plans?" is very thorough in its description of MEPs, concerns of the DOL and what the perceived and actual benefits to employers are for participating in them.
This author beleives that meaningful gains can be had in both the area of fiduciary relief and in economies of scale, but that it requires properly vetted and structured MEP programs. Given the amount of recent attention given to these programs, and a trend towards "open" MEPs, or MEPs of unrelated employers, the DOL was promted to make its voice heard on the matter.
Based on the DOLs comments, and our own interpretations of the statutes, we still believe that MEP programs can work well, but from a prudence perspective, we believe they are better structured as "closed" MEPs, meaning that the employer is CLEARLY related. An example of this can be a corporate entity and a group of franchises of the corporate entity.
Final thoughts (for now):
When, as a Plan Sponsor, evaluating whether to adopt a MEP or, as an advisor, whether to advise a client on the merits of a MEP program, I think a detailed evaluation of the structure should be documented and stored in employer minutes, thus, aiding in satisfying the fiduciary requirement of prudent selection. Even though the decision to join a MEP is typically stated as a settlor function, meaning business decision, the control of assets that typically follows puts that decison maker into fiduciary status.
In the previously linked article, the author raises the concern of a TPA sponsoring a MEP program which would be then offered out to its clients. This is a perfect example of an issue that would be discovered if the MEP program is vetted structurally. Under this scenario, the TPA, as an employer would be the primary adopter (or MEP Sponsor) and therefore clearly a fiduciary to the plan. Any financial benefit that TPA would then receive from the MEP, for example fees they charge to administer it for any/all future adopting employers, could then be (and likely would be) interpreted as self dealing. This is a clear violation of the Prohibited Transaction rules of ERISA, but one that the TPA likely isn't even aware they are violating. This is just an example, but their are many other equally risky scenarios that can play out. Caution is advised before proceeding into these types of arrangements without an expert level of understanding. In other words, if there was every a place to consult rather than sell to a client, this is it.
http//www3.cfo.com/article/2011/8/retirement-plans_trouble-ahead-for-multiple-employer-retirement-plans
This article, published on cfo.com, titled 'Trouble Ahead for Multiple-Employer Retirement Plans?" is very thorough in its description of MEPs, concerns of the DOL and what the perceived and actual benefits to employers are for participating in them.
This author beleives that meaningful gains can be had in both the area of fiduciary relief and in economies of scale, but that it requires properly vetted and structured MEP programs. Given the amount of recent attention given to these programs, and a trend towards "open" MEPs, or MEPs of unrelated employers, the DOL was promted to make its voice heard on the matter.
Based on the DOLs comments, and our own interpretations of the statutes, we still believe that MEP programs can work well, but from a prudence perspective, we believe they are better structured as "closed" MEPs, meaning that the employer is CLEARLY related. An example of this can be a corporate entity and a group of franchises of the corporate entity.
Final thoughts (for now):
When, as a Plan Sponsor, evaluating whether to adopt a MEP or, as an advisor, whether to advise a client on the merits of a MEP program, I think a detailed evaluation of the structure should be documented and stored in employer minutes, thus, aiding in satisfying the fiduciary requirement of prudent selection. Even though the decision to join a MEP is typically stated as a settlor function, meaning business decision, the control of assets that typically follows puts that decison maker into fiduciary status.
In the previously linked article, the author raises the concern of a TPA sponsoring a MEP program which would be then offered out to its clients. This is a perfect example of an issue that would be discovered if the MEP program is vetted structurally. Under this scenario, the TPA, as an employer would be the primary adopter (or MEP Sponsor) and therefore clearly a fiduciary to the plan. Any financial benefit that TPA would then receive from the MEP, for example fees they charge to administer it for any/all future adopting employers, could then be (and likely would be) interpreted as self dealing. This is a clear violation of the Prohibited Transaction rules of ERISA, but one that the TPA likely isn't even aware they are violating. This is just an example, but their are many other equally risky scenarios that can play out. Caution is advised before proceeding into these types of arrangements without an expert level of understanding. In other words, if there was every a place to consult rather than sell to a client, this is it.
Wednesday, August 17, 2011
Quantifying the Drivers of Retirement Success
The collective retirement industry spends an extortionate amount of its resources on marketing efforts to promote the quality and superiority of its various investment managers. In fact, most industry professionals would agree that “absolute return”, “alpha”, and “compound interest” are the concepts that really stimulate plan sponsors and participants to act. On a path laden with headwinds and hazards for most participants, absolute returns and manager outperformance are perceived to assemble a path with less resistance. Meanwhile, focusing on—and chasing—these elusive concepts typically does little to materially improve a client’s retirement outlook relative to other important factors.
In a recent article written by Jason Grantz and David Blanchett (available here), the driving factors of a successful retirement outcome were explored and quantified on a relative basis. The authors analyzed four factors that contribute to positive (or negative) retirement outcomes: asset quality, actuarial assessment & intervention, asset allocation, and savings rate. In somewhat of a surprising revelation, the study concluded that asset quality, defined as selecting an asset sufficient to consistently outperform its peers, was the least important driver of success. It accounted for just 4% of the relative importance the factors promoting success.
This analysis tells us that focusing on picking the next great mutual fund is not the activity that’s going to maximize the probability of retirement success for a retirement plan or its participants. We all know that savings is important, but historically it has been difficult to relay the relative importance of savings in quantitative terms, which is now possible. The analysis conducted for this paper suggests that savings rate is clearly the primary driver of retirement success by a wide margin.
Although improving savings rates can be difficult, spending additional time having meetings with participants, sending targeted mailers or implementing “smart” plan defaults like automatic enrollment and automated progressive savings are some relatively easy things to implement in order to improve deferral rates in retirement plans.
In a recent article written by Jason Grantz and David Blanchett (available here), the driving factors of a successful retirement outcome were explored and quantified on a relative basis. The authors analyzed four factors that contribute to positive (or negative) retirement outcomes: asset quality, actuarial assessment & intervention, asset allocation, and savings rate. In somewhat of a surprising revelation, the study concluded that asset quality, defined as selecting an asset sufficient to consistently outperform its peers, was the least important driver of success. It accounted for just 4% of the relative importance the factors promoting success.
This analysis tells us that focusing on picking the next great mutual fund is not the activity that’s going to maximize the probability of retirement success for a retirement plan or its participants. We all know that savings is important, but historically it has been difficult to relay the relative importance of savings in quantitative terms, which is now possible. The analysis conducted for this paper suggests that savings rate is clearly the primary driver of retirement success by a wide margin.
Although improving savings rates can be difficult, spending additional time having meetings with participants, sending targeted mailers or implementing “smart” plan defaults like automatic enrollment and automated progressive savings are some relatively easy things to implement in order to improve deferral rates in retirement plans.
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