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 (www.PSCA.org) is a national organization whose members include companies and non-profit organizations.

Plan Sponsors can view the results of the survey here

 

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

Principal

Bridgebay Consulting, LLC

Scott E. Galbreath

Chang Ruthenburg & Long PC

View Presentation

Simplify the Defined Contribution Fund Menu

Nicholas Zaiko

Investment Consultant

Bridgebay Financial, Inc.

www.bridgebay.com

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. 

Conclusion

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.

Open Architecture

Nicholas Zaiko

Investment Consultant

Bridgebay Financial, Inc.

www.bridgebay.com

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.