Best Practices in Benchmarking 403(b) Plans

Barbara Williams, CFA

Managing Director

Bridgebay Financial, Inc.

www.bridgebay.com

This article addresses some of the best practices in benchmarking 403(b) plans as a guide for plan sponsors.

Periodic benchmarking of your 403(b) plan is a normal due diligence process that should be conducted by an independent retirement plan advisor or consultant that is well-informed and has experience working with multiple service providers.  This broad experience allows the third-party advisor to properly benchmark your plan against other plans and service providers in the defined contribution market, namely, ERISA-covered and non-ERISA plans. 

The Department of Labor (DoL) has signaled that such a review should be conducted every 3-5 years.  Plan sponsors should conduct a request for information (RFI) through an independent retirement plan consultant to benchmark plan services, fees and administration as a best-practice and document good fiduciary practices.  Refreshing plan features and services assists nonprofit retirement plan sponsors who are dedicated to their participants' ability to have positive retirement outcomes.

Ideally, the independent retirement plan advisor conducting the benchmarking study should not be associated or affiliated with the current or prospective plan provider.  Also, the advisor should not have any conflict of interest or be able to benefit financially from selecting or recommending any specific provider. 

A critical element of the benchmarking process is proper and thorough documentation.  The evaluation criteria must be specifically defined in order to unequivocally demonstrate that an impartial, balanced, and comprehensive review was conducted and that the final decision is rational, defensible and free of any potential conflicts of interest.  Such documentation will definitively exhibit the prudent process for the DoL and demonstrate that the chosen solution was for the benefit of the plan participants. 

The due diligence process should incorporate a review of the recordkeeper's financial strength, delivery of services, plan compliance, reporting services, plan sponsor services, participant services including education, quality of investment choices and fees.  Fortunately, recently mandated disclosure requirements now enable the plan sponsor to receive better information and greater transparency concerning services and total costs.

Investments

On the investment side, many plans rely on the recordkeeper's affiliated investment team to provide investment reviews quarterly.  From a fiduciary perspective, it is also a best-practice to conduct a deep-dive of the investments using an independent third-party investment consultant at least annually to provide an impartial review of the quality, diversification and cost of the investments.  By conducting an annual deep benchmarking review of the plan by an independent consultant the sponsor can still benefit from the recordkeeper's quarterly investment input while also enhancing fund, plan and provider oversight.  This third-party perspective is a tremendous fiduciary benefit that the plan recordkeeper simply cannot provide.

Multiple Providers

When compared to 401(k) plans and other defined contribution plans, 403(b) plans offer many more investment options to their participants on average.  Typically, when multiple vendors are used, many of the investment options are redundant and may not necessarily be best-in-class.  This redundancy in investment options can lead to participant confusion, inertia, poor asset allocation and higher costs for participants.  The use of multiple providers can present complications when trying to evaluate a particular 403(b) plan with regards to its peers. 

Nonprofit plan sponsors with multiple providers with different investments and embedded costs may require retaining an experienced retirement plan consultant to streamline the plan.  Many 403(b) sponsors find it advantageous to move to a single provider with an efficient cost structure and investment offerings that best benefits the participants. 

Understanding Plan Fees

The implementation of 408(b)2 in 2012 represented a major step in assisting plan sponsors in understanding plan fees, re-negotiating those fees and gaining a better understanding of the costs associated with the services being provided.  In many cases, providers have updated the services and expanded their platforms to better serve their clients in an effort to retain existing business.  All of these developments are positive for the discerning 403(b) plan sponsor.

Enhancing Plan Features

There are numerous features in plan design that sponsors can employ to increase the success of their plan and participants' retirement outcomes.  Some key design features include auto-enrollment of current and new employees, auto-deferral, auto-deferral increase, and selection of a Qualified Default Investment Alternative (QDIA).  Providing enhanced participant information on projected retirement savings and income replacement by retirement age are also important participant incentives to increase the success of the 403(b) plan.

The current trend is to de-emphasize participant education and focus on plan design features that optimize participation, asset allocation, and maximize deferrals.

Planning for the Future

When using independent third-party consultants, it is important that the retirement plan adviser have specific experience in an ERISA environment, even if the 403(b) plan is non-ERISA.  This experience and background will ensure that the plan sponsor is attaining the highest standard of prudent care and is implementing best practices.  The advisor should be able to draw from the practices of a wide range of providers so that if the plan services are determined to be limited, outdated, or overpriced, the advisor will be able to recommend better solutions.

Retirement plans offered at different nonprofit organizations are at different stages of development.  Advisors that are familiar with more evolved retirement plans can "see the future" and are able to lay out a blueprint for success.

Many qualified retirement plan advisors that have historically advised 401(k) plans can contribute significantly to 403(b) plan sponsors.  Their expertise and fiduciary knowledge gained from operating in a ERISA world can benefit nonprofit organizations that are now progressing into an ERISA fiduciary environment.  An advisor well-versed in ERISA standards can effectively apply that same level of due diligence, prudence and fiduciary standards to the 403(b) plan of a nonprofit organization. 

Conclusion

Fiduciary oversight of a 403(b) plan has become a challenging role for many plan sponsors, especially if their administrative responsibilities are still burdened with multiple vendors.  Periodic plan benchmarking is a critical function for all plan fiduciaries, regardless of the retirement plan type or size.  Benchmarking helps plan sponsors upgrade plan services, plan design and participant services at a competitive price.

Investment Oversight Best Practices

Nicholas Zaiko

Investment Consultant

Bridgebay Financial, Inc.

www.bridgebay.com

The employer-sponsored defined contribution (DC) plan now represents the primary retirement savings vehicle for most employees.  The increased size, complexity and recent 401(k) plan litigation, demands greater scrutiny of the plan's investment options in addition to enhanced administrative oversight.  These issues are not limited to the 401(k) plans but also 403(b) plans that are under ERISA and DoL.   

Revisiting the Oversight Role

The increased significance of the role of the DC plan now demands additional expert focus on the investment options offered to the participants.  The oversight structure should also adapt to consider the changing relationship between the plan sponsor and the service provider as assets in the DC plan grow.  Additional services may be required as the plan grows and the service providers' ability to deliver those services in a cost-effective way must be evaluated.  Failing to achieve enhanced services or reduced fees as a DC plan grows may result in an unintentional fiduciary breach on behalf of the plan sponsor as recent litigation has shown.  The sponsor may also fail to meet its fiduciary duty to participants if the participation rates, investment selection and education programs are not closely monitored and maintained.

Investment Oversight

The most effective way to increase investment oversight is to include members of the treasury or finance departments in the plan oversight committee.  This is an evolving trend that is spreading throughout the DC market.  Since traditional pension plans or defined benefit (DB) plans directly impact the financial statements, the CFO or Treasurer are typically heavily involved in both the administration and investments in those plans.  In contrast, the DC plan has had minimal impact on the employer's income statement and has historically been overlooked by the treasury group.  Recent litigation on fees and fiduciary breaches have demonstrated that DC plans can have an adverse monetary impact the employer's finances.    Employing the same robust oversight historically reserved for the DB plan to the DC plan will greatly enhance fiduciary compliance and minimize risk.  

As plan assets grow, plan sponsors may consider retaining the services of an independent, retirement plan consultant that has the benefit of working with many different plan providers, investment funds/managers and plan sponsors.  Many bundled 401(k) plans have relied on the affiliated investment consultant provided by the recordkeeper that is an employee of the recordkeeper's parent organization.  Periodically, a plan sponsor should seek a deep-dive review of the investment recommendations by an independent third-party advisor to ensure that the investment line-up is best in class with reasonable fees.

The expertise of a retirement plan advisor will assist the plan sponsor in ensuring that plan fees and services are competitive with other plan providers.  An independent consultant can also point out any deficiencies in the administration of and the investments in the plan. 

The Plan Committee

Plan sponsors should pay close attention to the size and composition of their investment committee.  The cornerstone of an effective committee is ensuring that all members represent experts in their particular field of focus.  The best committees are well rounded, drawing from several different departments.  Each member should focus on a particular area of the plan which aligns with their particular expertise and take the lead in major decisions.  For example, the ERISA attorney should have greater direct input and authority on providing fiduciary and compliance advice.  Similarly, the Treasury professional should focus on the investments, leaving legal compliance issues to the ERISA attorney.  The administrative requirements of the plan should be provided by the benefits manager and Human Resources representative.  Additionally, an advocate for the participants and employees should also provide input to the committee.  Well defined roles and segregation of duties is crucial for an efficient and effective oversight committee.

The committee should be sufficiently small as to avoid getting bogged down in procedure and scheduling conflicts and allow sufficient time for proper oversight by each member.  Exceedingly large committees may have problems assembling enough members at any one meeting in order to establish a quorum and thus inadvertently delay crucial plan decisions. 

Investment vs. Administrative Decisions

Investment and administrative timelines tend to differ dramatically and can often conflict.  Many challenges arise when trying to fit investment decisions into administrative timelines.  The conflict may become so great, that investment decisions end up being made based on administrative pressures rather than investment priorities.  These types of decisions can potentially represent breaches of the plan sponsor's fiduciary duty to the plan participants.  For example, leaving an underperforming fund in the plan because of administrative restrictions after the committee has decided to remove or replace the fund may open the door to fiduciary liability.  On the flipside, the plan investment policy should not be written in such a way as to rigidly trigger automatic action regarding a fund.  The policy should reflect a structure of monitoring that involves the evaluation of numerous important factors.  Any action taken regarding a fund should be reviewed and documented by the committee.

Investment Review Process

A well-designed and methodical investment review and search process is the hallmark of the top institutional DC plans.  Any changes made to the plan should be done so in a well thought out approach which takes into account investment considerations.  While administrative considerations are omnipresent, they should simply inform but never interfere with critical investment decisions.  There are some steps that can be taken to reduce administrative burdens such as utilizing a multi-manager framework and using asset class specific funds.  This makes it significantly easier to simply replace an underperforming fund with a similar fund with better performance.  The best plan sponsors also have an established search process in case a fund change is required at any time, rather than relying on a pre-determined periodic review.  This allows the committee to act swiftly in the case of an unexpected event.  Though periodic review is important, searches should be conducted in response to external events and not simply be restricted by the calendar.

Conclusion

Now rivaling the traditional pension or defined benefit (DB) market in scale, DC plans have taken center stage in employees' retirement future.  As such, professional, expert scrutiny of the investments offered to plan participants is becoming increasingly important.  The plan committee composition and size are crucial to providing diligent and effective oversight in order to protect against fiduciary risk.  Engaging the broad knowledge and specific expertise of an independent investment consultant to share the burden of co-fiduciary status affords the sponsor further protection and market insight.   A detailed and methodical review and search methodology, coupled with a comprehensive pattern of documentation is the one of the best ways to fulfill the sponsor's fiduciary duties to the plan participants.

403(b) Plans Can Follow the 401(k) Plan (ERISA) Model

Nicholas Zaiko

Investment Consultant

Bridgebay Financial, Inc.

www.bridgebay.com

Defined Contribution Plans Converge

In many respects a 403(b) plan is very similar to a 401(k) plan.  They both provide tax advantaged savings vehicles for employees, the major difference being the groups of employees.  403(b) plans are specifically designed for the employees of nonprofit organizations while 401(k) plans apply to employees of for-profit organizations.  Another major difference has been the level of regulation imposed on these two types of plans.  That difference however, is shrinking as recent IRS regulations have been pushing 403(b) sponsors to streamline administrative functions and take a more active fiduciary role in their plan.  A recent survey conducted by the Plan Sponsor Council of America (PSCA) revealed that the number of non-ERISA compliant 403(b) plans is shrinking as plan sponsors adopt ERISA compliance, in light of increased regulation.

Plan Enhancements

403(b) plan sponsors are realizing that a multi-provider, open-ended plan may not be the best type of arrangement for their participants.  While many believed this type of open arrangement absolved the sponsor of fiduciary responsibility, it is now clear that regulators do not believe that participants should be left to fend for themselves.  A 403(b) plan with multiple service providers has no consistency of message, education or investment products.  The IRS and DoL requirements on 403(b) plan sponsors, similar to those that have existed in the 401(k) market for years, provide an integrated retirement plan.   

Fortunately, 403(b) retirement plan sponsors have the ERISA-covered 401(k) plan model to help them comply with ERISA regulations and emulate the best practices and plan features in the 401(k) market.  Some of these enhancements include automatic enrollment, refining the core fund menu, consolidating service providers and improving and unifying the participant education and communication programs.

Fiduciary Responsibility

Evolving 403(b) regulations have required reporting on a plan basis and compelled 403(b) plan sponsors to take on more responsibility as fiduciaries of the plan.  As fiduciaries, employers may retain a retirement plan advisor as co-fiduciary to provide independent advice on the selection of plan providers, operation of the plan, participant education and investments available to participants.   An independent advisor assists the fiduciaries in implementing best practices and developing a prudent due diligence process in overseeing the plan. As in the 401(k) market, the employer negotiates with the plan sponsor on behalf of the participants, minimizing the potential for unsophisticated individuals to be taken advantage of by opaque and costly arrangements.  ERISA compliance also provides that the DoL and IRS with additional authority to oversee 403(b) plans.  The regulators want to see plan sponsors taking a much more active role in monitoring and overseeing the plan.

This additional oversight is similar to the requirements of a 401(k) plan and so an easy way to achieve this level of compliance is simply to establish the same type of due diligence process which is common in the 401(k) plan environment.  The solutions and best practices already exist so 403(b) plan sponsors can source the experience and knowledge of experts in the 401(k) industry and apply best practices to their 403(b) plan. 

Proper Documentation

Many plan sponsors successfully met the December 31, 2009 deadline to draft, approve and adopt a written 403(b) plan document.  This however, is only part of the requirement.  The IRS is also looking to see that the plan is in fact being operated in accordance with the plan document.  As part of their audit, the IRS may seek information from the payroll and human resources department to validate the operation of the plan.  Deviations from the stated plan document could highlight deficiencies with either the plan document or the plan administration.  As part of an annual review, be sure you can produce the 403(b) plan document and that it is consistent with the day-to-day operations of the plan.  Additionally, ensure that the plan document is consistent with the summary plan document (SPD) which is given to the plan participants.  

Focusing on Participants

Many 403(b) plans that have successfully transitioned to ERISA compliance now find themselves in the enviable position of refocusing energy away from compliance and on to participant outcomes.   

Plan sponsors are increasingly adding plan options such as target-date, target-risk and other investment vehicles designed to increase their participants' chances of reaching their retirement goals.  Administrative enhancements achieved by consolidating providers and streamlining operations free up valuable internal resources that can then be redeployed to enhance plan participation and participant education.

Conclusion

Though the challenges of bringing your 403(b) plan up to ERISA standards may seem imposing, take comfort in the knowledge that the solutions already exist and that once the transition has been completed, maintaining a properly documented due diligence process will yield numerous benefits to both the plan sponsor and the participants.  The most obvious benefits include reduced plan costs, enhanced participation, improved participant education and streamlined plan administration.

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.