The Markets October 26, 2016

DC Plans Could See More Smart Beta Approaches

Fee pressure in the DC industry is resulting in tailwinds for the expansion of the “strategic beta” asset class.
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Fee pressure is the dominant theme within the defined contribution industry, suggesting active investment managers may begin to focus more on smart-beta indexing over their traditionally preferred approaches to remain competitive.

This is according to the latest issue of The Cerulli Edge – U.S. Monthly Product Trends Edition, which concludes that DC plan advisers and sponsors are increasingly considering strategic beta as an alternative to traditional active management. Cerulli pegs the trend to a heightened focus on fees that has proven to be a boon for passive managers while simultaneously creating a significant headwind for their active counterparts.

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Cerulli data illustrates corporate defined contribution (DC) asset owners are adopting use of “strategic” or “smart” beta, with asset managers reporting that, on average, 11% of such products are available for corporate DC plans.

“The majority of product development has occurred within the ETF wrapper, a vehicle not as conducive to the DC space, especially within 401(k) plans,” Cerulli observes. “Asset managers that have strategic beta or are in the midst of developing strategic beta should not overlook the DC market as an area of opportunity to grow assets.”

To clarify an important definition, Cerulli notes that the catch-all terms “smart beta” or “strategic beta” simply refer to rules-based styles of strategic indexing that go beyond the traditional factors of market capitalization, momentum or value to build portfolios that seek to deliver market outperformance and better risk-adjusted returns. Unlike the “alpha” outperformance sought by tactical active managers, the outperformance of smart beta is supposed to come from the design of the index and pre-programmed trading rules.   

According to managers interviewed by Cerulli, concerns about lack of diversification of their market-cap-weighted passive strategies has institutional investors (including pensions and DC plans) thinking more about implementing strategic beta in their portfolios.

“The high cost of active strategies is also driving more institutions to strategic beta,” Cerulli says. “Many institutional investors have a collection of active managers with a neutral or conflicting set of exposures at the plan level. Adding strategic beta through a satellite position allows institutions to tilt plans toward a desired exposure.”

NEXT: Important facts about the smart beta market 

The Cerulli analysis goes on to suggest the impending Department of Labor (DOL) fiduciary rule may also accelerate the adoption of strategic beta on DC plan investment menus.

“In order to offer strategies that are in the best interest of their participants, DC sponsors may find themselves converging toward a middle ground,” the report explains. “Strategic beta can be an alternative choice to ensure DC sponsors are offering a product that can potentially provide alpha as well as protect against risk on the downside for a slightly higher fee than passive, but a lower cost than active.”

According to Cerulli, depending on the complexity of the strategy, strategic beta can cost on average anywhere between 25 bps and 50 bps.

“Exceptions to this include custom strategic beta where managers are charging upward of 50+ bps,” Cerulli warns.

The research firm “believes that in order to offer a robust product lineup that will satisfy the needs of best interest fiduciary standards to participants, sponsors should consider placing strategic beta into their menu offerings … In order for strategic beta adoption to succeed in DC plans, asset managers also need to ensure they educate plans sponsors about the methodology of strategies and the suitability of strategies in conjunction with their overall plan menu.”

Citing additional data from an FTSE Russell survey, Cerulli says more than one-third (36%) of investors prefer strategic beta products to be packaged as separate accounts. An additional 26% are interested in managing these products internally.

“The rest of asset owners polled prefer ETFs (11%), collective investment trusts (CITs) (14%), mutual funds (10%), and derivatives (3%),” Cerulli concludes.

More information on obtaining Cerulli Associates research is available online here. 

Compliance October 26, 2016

Settlement Reached for Providence Health Church Plan Challenge

The health system agreed to pay more than $350 million to settle a lawsuit challenging its pension plan's church plan status under ERISA.
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Provident Health & Services has agreed to pay $351 million to settle a lawsuit challenging the church plan status of its pension plan.

The case of Griffith v. Provident Health & Services was granted a stay while another case concerning the church plan exemption, Rollins v. Dignity Health, was appealed to the 9th U.S. Circuit Court of Appeals—this after a district court ruled in favor of the plaintiffs and found, on summary judgment, that only a church could establish a church plan.

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The 9th Circuit agreed with the lower court and, in addition, the U.S. Supreme Court stayed the 9th Circuit’s mandate while it decides whether to review the decision. 

The parties in Griffith agreed to continue to stay their case while they engaged in extensive settlement discussions.

According to the settlement agreement, which includes a motion for approval by the court, Providence will contribute $350 million to the plan via annual contributions to the plan for seven years. In addition, Providence will pay up to $1.9 million in the aggregate ($500 per person) to the total of 3,802 nonvested former participants.

Providence also agreed that, beginning eight years after the effective date of the settlement, and continuing thereafter as long as the plan has not been terminated, it will make annual minimum contributions recommended by the plan’s enrolled actuary to fully fund the plan by December 31, 2029. The settlement agreement says this shall not be interpreted to require that the plan actually be fully funded by such date.

NEXT: Allegations and other church plan challenges

As with other challenges to health care providers’ defined benefit (DB) plans’ church plan status under the Employee Retirement Income Security Act (ERISA), plaintiffs in the Griffith case allege Providence’s plan is not a church plan within the meaning of ERISA Section 3(33) and thus is subject to the provisions of Title I and Title IV of ERISA. They allege that the defendants violated ERISA’s reporting and disclosure provisions; failed to adhere to ERISA’s required minimum funding standards for the plan; failed to establish the plan pursuant to a written instrument meeting the requirements of ERISA; and failed to establish a trust meeting the requirements of ERISA.

In this case, plaintiffs also allege that the church plan exemption violates the Establishment Clause of the First Amendment of the United States Constitution. A lawsuit filed against Holy Cross Hospital systems also raises the constitutionality issue. 

The settlement agreement notes that the Providence defendants “deny each and every allegation of the complaint and believe substantial and meritorious defenses exist for every claim alleged by plaintiffs.” The settlement agreement may be viewed here.

Appellate court decisions that the pension plans of Advocate Health Care and St. Peter's Healthcare System are not church plans under ERISA have also been petitioned to the Supreme Court. Trinity Health and Saint Francis Hospital have also agreed to settlements in cases against them.

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