The Markets July 11, 2011

PSNC 2011: "Committeed" Relationships

Deciding what investments should be included in a retirement plan’s menu and monitoring those investments is a huge amount of risk and liability for just one person; plan sponsors need an investment committee.
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Michael W. Kozemchak, Managing Director, Institutional Investment Consulting, told attendees at the PLANSPONSOR National Conference that as sponsors think about who should be on the committee, they should think about who might be a fiduciary to the plan already and move from there. Attila T. Toth, Principal, Portfolio Evaluations, Inc., added that for his clients, the committee usually includes representation from the finance and HR departments. He said most organizations don’t have committee members outside of the organization, unless it’s a company’s board.  

However, Doug Halman, Director of Finance, for the Indianapolis Art Center, which is a nonprofit still in the process of starting up its investment committee, said it struggles with the skill set of its current board, so it is trying to recruit outside folks with investment skills to serve on the board. The organization has targeted the owner of an investment advisory firm to come on the board and chair the investment committee, but the Art Center will also have someone from the finance department and audit department on the committee.  

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Halman noted that sometimes individuals on other nonprofits’ committees will sign on to help an organization start its own.Toth added that committee members need to have liability insurance and they should make sure they have the right amount and right type of insurance. Kozemchak advised sponsors to have a third party take a look at the liability insurance policy to make sure the promised coverage is there. He said the right amount of coverage is plan specific, but typically it’s around 50% of plan assets. However, plans with company stock, for example, may need more.

Kozemchak also said that as sponsors think about staffing the committee, they should look for people that will show up and be prepared and involved. He recommended three to six members regardless of plan size.Toth made the distinction that some committee members are appointed, something that will be specified in the Investment Policy Statement. He also recommended having a committee charter that details members’ duties.  

Though his organization is in the early stages of putting an investment committee charter together, Halman said it will address conflicts of interests, identifying what conflicts there could be that would cause someone not to be eligible for the committee or that would cause them to be put off the committee.Kozemchak said the charter should also address the process for adding or removing members and the process for electing officers.

The consensus of the group is that committees need to meet quarterly. Toth recommended that committees not only look at the plan’s funds and how they are doing, but also talk about plan design features that are working or not working, and discuss disclosure obligations and plan communications. 

Kozemchak suggested committees review how funds are performing in relation to the IPS, and how the economy is doing. He noted that administrative tasks create headaches for plan sponsors more so than investments, so committees should get a report from the plan’s recordkeeper on what participants are doing and communications.  

Sponsors should aggregate all provider and consultant information quarterly. In addition, the committee may want the relationship manager from the recordkeeper there, or for a larger plan, the committee may want an investment analyst and communications specialist from the recordkeeper to be there. It may also want the plan’s consultant or adviser present.  

Special committee meetings might be called for major market events. As examples from the recent market crisis, Kozemchak says his clients that were invested in mortgage backed securities, securities lending, or stable value funds breaking the buck, had special meetings. They might also be called for issues with funds, a change in control such as when vendors consolidate, or a change in control at the sponsor – which would require a talk about employer stock funds.  

Toth noted that committees generally don’t include enough detail in their documentation. Kozemchak said documentation will include meeting minutes, the meeting agenda, all collateral material gathered before the meeting, and actions taken. Then, Toth added,the minutes should be circulated to all membersa few days after the meeting.

IMHO July 11, 2011

IMHO: “Starting” Points

You may have missed it, but there was a bit of a “dust up” in our industry last week. 
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It started on July 7 when TheWall Street Journal ran a front-page story titled “401(k) Law Suppresses Saving for Retirement” (a story that is still, as I write on Saturday morning, on WSJ.com’s most popular listing).  And, no, that article wasn’t talking about discrimination testing rules, the imposition of annual contribution limits, talk of a mandatory limit on loans, or the imposition of mandatory annuitization of distributions.  Rather, it was talking about…automatic enrollment.

The report claimed that “40% of new hires at companies with automatic enrollments are socking away less money than they would if left to enroll voluntarily,” citing data from the Employee Benefit Research Institute (EBRI).  The problem, according to the report, was that “[m]ore than two-thirds of companies set contribution rates at 3% of salary or less, unless an employee chooses otherwise.”

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 Well, duh.  That, as they say, is the law.

EBRI quickly took issue with the WSJ’s characterizations, outlining in some detail the non-partisan group’s extensive history in examining these trends, and then noted that “The Wall Street Journal article reported only the most pessimistic set of assumptions,” failing to “cite any of the other 15 combinations of assumptions reported in the study” referenced in the report.  More significantly, EBRI’s Jack VanDerhei commented later that same day that the WSJ managed to completely ignore the reality that automatic enrollment is “increasing savings for many more—especially the lowest-income 401(k) participants.”

Now, while EBRI was, IMHO, rightly miffed to see its data and analysis mis-, or perhaps less-than-fully, represented, the authors of the Pension Protection Act were no less maligned.  The law was designed to help more employers make it easier for more employees to become participants, and for those participants to become more-effective retirement savers, and it seems to me that, in just about every way, it has been a huge success.  Are there those who once might have filled out an enrollment form and opted for a higher rate of deferral (say to the full level of match) that now take the “easy” way and allow themselves to be automatically enrolled at the lower rate called for by the PPA?  Absolutely.  However, as the EBRI data show—and, for anyone paying attention, have shown for years now—the folks most likely to be disadvantaged by that choice are higher-income workers, most of whom, IMHO, should know better.   

The simple math of automatic enrollment is that you get more people participating, albeit at lower rates (until design features like contribution acceleration kick in).  Said another way, participation rates go up, and AVERAGE deferral rates dip—initially.1  Then, over time, as contribution-acceleration designs take hold, we’re likely to see those average deferral rates increase2.  But for some, it will mean less savings, and for many, perhaps not savings enough. 

There are, however, some things plan sponsors can do now to keep things moving in the right direction sooner:

Auto-enroll workers at higher rates, perhaps as high as the level at which they will receive the full company match.  Sure, the Pension Protection Act calls for 3% as a minimum to be eligible for its safe harbor—but there’s no law/rule that says you can’t go higher.

Auto-enroll ALL workers, not just new hires.  Since the PPA’s introduction, PLANSPONSOR’s DC Survey has consistently shown that two-thirds of employers adopting automatic enrollment do so on a PROSPECTIVE basis (see IMHO: A Prospective Perspective).  Do you really care more for the people you just hired than those who have devoted years of loyal service?

Remind ALL participants of the importance of actively saving for retirement.  It may be a bit counter-intuitive to try to reach automatically enrolled participants who didn’t even take the time/expend the energy to fill out an enrollment form, but it’s important.  By most measures, workers who save only to the level of the company match won’t have saved enough to provide a financially secure retirement.  However, a generation of participant behaviors suggests that they assume that saving to the level of the match is the “right” answer, and it’s likely that they will assume that the level of automatic enrollment established is “enough.”  We all know better.

IMHO, automatic enrollment designs are, literally, a starting point—for plan sponsors and their soon-to-be participant savers alike (3).  

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The WSJ article is online at http://online.wsj.com/article/SB10001424052702303365804576430153643522780.html?mod=WSJ_hp_LEFTTopStories.  EBRI’s response is at https://ebriorg.wordpress.com/  

1 Complicating the picture is that the PPA took hold just ahead of an economic downturn that led a small, but noticeable, group of employers to reduce and/or suspend their match (and a not-so-small group to lay off lots of workers), while health-care costs continued to rise and, based on previous surveys, likely siphoned some participant contributions from retirement savings. 

2 VanDerhei notes on EBRI’s blog that “[t]he other statistic attributed to EBRI dealt with the percentage of AE-eligible workers who would be expected to have larger tenure-specific worker contribution rates had they been VE-eligible instead. The simulation results we provided showed that approximately 60 percent of the AE-eligible workers would immediately be better off in an AE plan than in a VE plan, and that over time (as automatic escalation provisions took effect for some of the workers), that number would increase to 85 percent.”

(3) This from a column I wrote about automatic enrollment designs in 2005: “More troubling still – there is at least one published study that indicates that, over time, the establishment of a default deferral rate seems to lower the overall rate of deferrals in the plan.  Mostly, this seems to be a result of an increase in the number of workers who simply leave their choices in the hands of the default option.  But it is hardly beyond the realm of reason to imagine a scenario where workers take the establishment of a default rate as being the “right” answer for them as well.

All in all, advisors should remember that the results of automatic deferrals, however encouraging at the outset, should not be left unattended.  An “automatic” deferral is a start, perhaps even a good start.  It should not, however, be the end of the matter. 

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