Friday, November 2, 2012

Impact of Fee Disclosure Regulation on 403(b) Sponsors and Participants - Plan Sponsor Council of America (PSCA)

The Plan Sponsor Council of America (PSCA) completed a national survey of 403(b) plan sponsors in October, 2012 on the impact of recent fee disclosure regulations on plan sponsors and participants.   The PSCA ( is a national organization whose members include companies and non-profit organizations.

Plan Sponsors can view the results of the survey here


Wednesday, July 18, 2012

Plans Sponsored by Governments, Churches and Other Tax Exempt Organizations

Presented at the Western Pension and Benefits Council Conference in Seattle, WA

Providing employees of governments, churches and other tax exempt organizations the best opportunity to save for retirement. This workshop will cover: what qualifies as a governmental plan, church plan, or plan sponsored by a tax exempt organization, respectively; what types of qualified and non-qualified plans can such organizations offer; eligible investments; how such plans differ from qualified plans maintained by for-profit employers; what are the unique challenges of such plans and practical issues involved in maintaining and administering such plans.

Presented by:

Scott Ann Selzer
Polycomp Administrative Services

Mary Ellen Mullen, CFA
Bridgebay Consulting, LLC

Scott E. Galbreath
Chang Ruthenburg & Long PC

Friday, April 13, 2012

Simplify the Defined Contribution Fund Menu

Nicholas Zaiko
Investment Consultant
Bridgebay Financial, Inc.

Fiduciary committees of most 401(k) and 403(b) plans agonize over the selection and monitoring of the best in class investment options for their retirement plans yet ultimately the investment decision to incorporate those funds in an appropriate asset allocation is in the hands of the individual participant.  In many cases participants have neither the knowledge nor skill to build optimized, diversified portfolios.  Plan sponsors have wrestled with the problem of providing enough investment options to allow participants to achieve this goal, yet the sheer number of investments often times overwhelms and confuses plan participants.  Striking the proper balance between too many and too few choices while at the same time walking the tight rope of fiduciary liability can be vexing for plan sponsors.  In many cases offering too many funds is just as bad as offering too few.

Growth of the Fund Menu
Proper diversification is the goal of any optimal portfolio, particularly for retirement assets which must endure the volatility of a long investment time horizon.  With that in mind, plan sponsors have diligently added numerous market-cap and style specific equity funds causing the average number of funds in an investment line-up to rise dramatically.  Today, the average 401(k) plan has more than 18 different investment options.  In the case of 403(b) plans, the average is more than 30 investment options.  Many participants may invest in one or two funds at most and therefore miss out on the benefits of diversification afforded them by the full fund menu.  Despite having access to a diverse fund menu, many participants still have concentration risk.

When a participant is overwhelmed with investment options they may react in several different yet equally inefficient ways.  They may invest all of their retirement savings in a single fund and be exposed to concentration risk.  A participant may simply evenly distribute their savings among all of the funds, resulting in overlap and inadvertently large exposures to volatile asset classes like emerging markets and small cap equity.  This confusion results in either under-diversified or over-diversified portfolios, neither of which are suitable to achieving the participant's retirement goals.

Allocation Funds
Many plan sponsors have sought to help participants invest in optimized portfolios by adding target-date or risk-based allocation funds.  While good in theory, a poor communication and education program has often caused participants to fundamentally misunderstand how these types of vehicles are intended to work.  This is evidenced by those participants who contribute money to multiple target-date funds, thus negating the effect of the glide path and resulting in duplication of sectors and holdings.  Most target-date funds are engineered to be the sole and primary retirement savings vehicle and are asset allocated with that assumption in mind.  An ill-informed participant who invests in several target-date funds alters their individual risk profile in ways they may not expect or intend.

Over the years, participant behavioral research has shown that the vast majority of participants do not have the time, understanding or interest in learning proper investment techniques, and nor should we expect them to become experts.

Virtues of Simplicity
The best solution to the information overload experienced by many participants lies in the hands of the plan sponsor.  Through a methodical and comprehensive selection process, the plan sponsor should develop a fund line-up that includes an array of well diversified investment options managed by investment managers that are best-in-breed among their peers.  Many sponsors have found it useful to segment the plan investments based on the type of investor.  While all options are available to all participants, this segmentation creates a framework for the participants based on their level of sophistication and involvement. 

Typically, asset allocation funds such as target-date or target-risk funds are intended for participants who want a one-stop solution.  These structures offer diversification across multiple asset classes and are managed by professional asset managers.  Target-date funds are professionally allocated and slowly reduce exposures to volatile asset classes in favor of less volatile asset classes as the participant approaches retirement age.  Over time, the intended risk profile gradually declines as the fund approaches the target retirement date.   

The second group of investments represents the core funds and is intended for the do-it-yourself investors who want more control over their individual risk profile. The core funds are broadly diversified funds investing in specific and defined market capitalizations and styles.  Plan sponsors can employ multi-manager or diversified single manager strategies to provide exposure to a wide range of asset classes including domestic equity, global equity and fixed-income.  Communicating the intended investment strategies and goals of each fund to participants is the plan sponsor's primary concern, in order to ensure that participants can make informed allocation decisions.  Sponsors can utilize best-in-class managers for each asset class and retain the flexibility to replace underperforming managers. 

Some sponsors may offer a third group of investments beyond the traditional equity and fixed income asset classes.  This typically includes a brokerage window and/or professionally managed accounts.  The brokerage window gives sophisticated investors access to a wide range of funds, stocks or ETFs.  Brokerage windows may provide exposure to specialist and esoteric investment strategies that may not be appropriate for all investors.  Participants with substantial balances and a higher level of sophistication tend to use this feature.  The segmented framework allows participants to navigate the plan more easily and select the solution that is most appropriate for them. 

With the average number of funds in the plan lineup swelling over the last 5 to 10 years, today's participants are bombarded by a cacophony of investment options that many find simply overwhelming.  The freedom to choose has instead been transformed into confusion and inaction.  Changing participant behavior is much more difficult than simply optimizing the plan fund line-up to accommodate plan participants' natural inclinations.  Though many other factors will influence plan participation, providing a clear, organized and simplified fund lineup will result in one less hurdle for your plan participants and move them one step closer to achieving their retirement goals.

Wednesday, February 1, 2012

Open Architecture

Nicholas Zaiko
Investment Consultant
Bridgebay Financial, Inc.

As fiduciaries, plan sponsors must act for the sole benefit of their plan's participants. Decisions born of the need for corporate convenience may lead to less-than ideal arrangements or investment options for plan participants. Sponsors need to evaluate whether the convenience of one-stop shopping is worth the potential fiduciary risk of foregoing open architecture.

The conventional wisdom regarding bundled service providers is that the convenience offered by an all-in-one solution is particularly attractive to smaller 401k plan sponsors who might not have the scale or staffing necessary to administer the plan in-house. These types of companies are typically spread thin already, with many individuals wearing many hats. Tight resources tend to push plan sponsors to make the easy choice of working with bundled service solutions. These service providers come in several forms. They can be a broker, a mutual fund firm, a payroll processor or an insurance company.

Truly open architecture goes well beyond the simple ability to add non-proprietary funds to a plan's line-up. In a open architecture, all of the service providers are either unbundled or entirely separate entities. The goal of open architecture is to have the flexibility to monitor and trade out each individual component, independent of the other services with a minimal amount of disruption to the plan. The primary service providers to a typical DC plan include the recordkeeper, investment or fund managers, custodian or trustee, plan investment consultant, managed account provider, and the education/communications provider. Ideally, each of these service providers is a separate, unaffiliated entity without any vested interest in the actions of any of the other providers.

The key is to then take a "best-of-breed" approach and select only the best recordkeeper, TPA, mutual funds and investment consultant. A recent study which compiled the characteristics of an ideal 401k plan supported this approach and demonstrated that such plans do not use bundled providers. By managing each component individually, the sponsor maintains the flexibility to replace any element that may suffer from poorer or declining quality service without disturbing any of the other services. The modular nature and the ability to use best-in-class providers are the major strengths of open architecture.

In contrast, bundled service providers typically rely on investment products to drive revenues, making other peripheral services an afterthought and generally a loss leader. Ancillary services such as plan administration and recordkeeping tend to suffer when pushing investment products is the primary source of revenue.

Additionally, by obscuring the actual cost for each service in the bundled fee, such providers make it difficult to accurately benchmark total plan fees. Independent providers bring with them a built-in check-and-balance mechanism regarding the quality and fees of other service providers. Though many bundled providers may tout the benefits of the "economies-of-scale" that come with their arrangements, the inherent conflicts of interest may actually result in higher fees than a truly open architecture solution.

In recent years we have seen numerous lawsuits brought against plan sponsors for various breaches of fiduciary duty. In 2011 we witnessed the result of the high-profile class action suit against Walmart for breach of duty regarding the investment choices in the 401k plan. The plaintiffs discovered that het plan's bundled service provider had placed high-fee funds into the plan and the broker was receiving trailing commissions for having placed those funds in the plan.

The mere fact that it took plan participants so long to discover the breach of fiduciary duty indicates how well high fees can be hidden within the bundled arrangement. 2012 promises to be a year of greater disclosure and transparency on behalf of bundled service providers. The new fee disclosure requirements outlined under sections 408(b)(2) for provider to plan sponsor disclosures and 404(a) of the Employee Retirement Income Security Act (ERISA) offer to shed light on the bundled service provider. This has the potential to reshape the bundled provider industry and reinvigorate plan sponsors' interest in pursuing open architecture.

While a bundled solution may work for plans of a relatively small size, the modular and best-in-class approach afforded plan sponsors by using open architecture and the potential for lower, more competitive fees must not be ignored.

Friday, January 13, 2012

Selecting and Monitoring Fiduciary Advisors

Nicholas Zaiko
Investment Consultant
Bridgebay Financial, Inc.

Effective December 27, 2011, the Department of Labor's Employee Benefits Security Administration (EBSA) issued its final rule regarding the provision of investment advice to participants in individual account plans, such as 401(k) and 403(b) plans, and beneficiaries of individual retirement accounts. The final rule affects plan sponsors, fiduciaries, participants, and beneficiaries of participant-directed retirement plans. Essentially, the rule enables providers of investment advice acting as fiduciary advisers to offer investment guidance to participants provided certain conditions set forth in the regulations are satisfied.

The Need for Advice
Recent studies have indicated that participants who receive professional investment advice consistently outperform those who go it alone. Constructing a proper asset allocation is key to the long-term success of any retirement strategy and most participants are ill-equipped to make such a potentially life-altering decision on their own. The DOL's new participant investment advice regulation attempts to offer participants another means of achieving their retirement goals.

Not all investment advice that has been provided in the past has been impartial or in the participant’s best interest. Sometimes there have been conflicts of interest unknown to the plan sponsor. In selecting a fiduciary advisor the plan sponsor still retains fiduciary responsibility in selecting the form of investment advice they offer to their participants.

Best Fit
There are numerous factors to consider when selecting a fiduciary adviser to a plan. The last few years have seen dramatic growth in the independent investment consulting industry and with the passage of the new regulation, more solutions are sure to follow. The first step is to determine what type of investment advisory service is the best fit for the plan participants. Traditionally, plans have relied on an eligible investment advice arrangement ("EIAA") through a fiduciary adviser to help employees make informed investment decisions, but this is no longer the only available option.

Third-Party Advice
Web-based investment guidance services and managed accounts offered through an independent, third party are increasingly popular options. These firms are unaffiliated with any of the plan’s fund providers or managers. According to the new regulation, their methodology for building an asset allocation must not be in any way impacted by the funds selected. In other words, they must not have a vested interest in or receive any additional financial benefit from using one fund over another. The methodology must be fund and share class neutral. In order to determine the best option for their participants, plan sponsors should conduct a thorough analysis based on their company's demographics and plan objectives.

Identifying Fiduciaries
Another important factor which is often overlooked in selecting a fiduciary adviser is determining exactly who can act as a fiduciary adviser. Many brokers may offer investment advice to participants but most are protected by regulations from taking on fiduciary liability. In many cases, if the adviser is not receiving compensation directly from the act of offering advice, they are not considered a fiduciary under the current law. Eligible fiduciaries generally come in four categories: a registered investment adviser (RIA), an advisor for a bank providing services through the trust department, an insurance company representative and a representative of a registered broker-dealer. Plan sponsors should check with the fiduciary adviser to confirm their status as an eligible fiduciary to the plan and receive confirmation in writing that they are acting as a fiduciary.

Establish Evaluation Criteria
The next step in selecting a fiduciary advisor is for the plan sponsor to establish objective criteria for evaluating an adviser that fits the needs of its participants. The retirement plan committee is responsible for creating a documented checklist that can then be used to evaluate fiduciary advisers. Some general criteria should focus on identifying any potential conflicts of interest, fee and compensation arrangements that may cause the adviser to pressure participants into less appropriate products. The firm’s experience and depth of services in providing fiduciary advice and specifically the qualifications of the professionals providing the advice are important. Checking for any disciplinary actions against the fiduciary adviser or the firm should be conducted at the onset and on an annual basis for any potential change in status.

The fiduciary adviser’s professional credentials and investment experience are critical. Many large firms may be impressive marquee names yet the individuals providing the advice may be junior, less skilled advisers than small boutique firms whose advisers may be highly experienced professionals providing high caliber advice.

Ongoing Monitoring
Once a suitable fiduciary adviser has been selected, it is important that the sponsor establish a process for ongoing monitoring of the adviser. Best practices dictate that a plan sponsor review their plan's fiduciary adviser at least once a year. There are a multitude of factors to consider, but a prudent approach would include a deep dive of the adviser and documenting their process. This would include confirming that all required documentation and notifications were provided. Another factor to consider would be determining whether the adviser is actually complying with the new participant investment advice regulation.

Revisiting the relative cost of the investment advice program in relation to participant adoption and utilization is a prudent way to quantify the value added by the fiduciary adviser. If participant adoption is relatively low compared to the cost, perhaps more education is required or the plan sponsor may want to scale back on the services offered . A thorough review should also include inquiring into and following up with participant comments and feedback. Any participant complaints should be addressed immediately. Participant feedback, whether positive or negative is a good way to stay ahead of any potential fiduciary liability issues. Fine-tuning the plan based on participant comments may lead to increased participation rates, if done in a prudent way. Updating the firm’s and fiduciary adviser’s status for any disciplinary actions should be part of the annual evaluation.

The most important fiduciary benefit of conducting this due diligence review is documenting the decision making process and the results. Comprehensive documentation of the information collected to render decisions that impact the plan is the best way to protect the plan sponsor from fiduciary liability. While investment returns may go up and down, a detailed accounting of the due diligence process is the plan sponsors' greatest asset. An annual review of the plan's fiduciary adviser will go a long way to fulfilling a plan sponsor's fiduciary duty.

Most participants lack the skill, training or time to construct a disciplined, asset allocated, long-term investment strategy. Short-term trends often lead them to make mistakes and risk their long-term success. Individual investors are driven by emotion, causing them to make the same investment mistakes over and over. The DOL's new participant investment advice regulation attempts to offer participants another means of achieving their retirement goals. Plan fiduciaries are responsible for evaluating and understanding the advice options they offer to their participants. Realizing the plan sponsor's role in delivering this essential service is an important fiduciary duty. Establishing a defined strategy for implementing participant investment advice is key to fulfilling a plan sponsor's fiduciary obligations.