The Markets June 9, 2009

Shifts from Equity Insulates Participants from Market Losses

Defined contribution balances continued to slip in the first quarter, but at a slower pace.
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The Callan DC Index lost roughly 6% in Q1, but that loss was mitigated by participants’ failure to rebalance—and to some extent, their general movement away from equity investments. Since the beginning of 2006, the equity allocation of the DC Index has declined 15 percentage points, from 70% to 55% as of the end of March, according to the report.

According to the Callan DC Index, participants were hesitant to transfer balances in Q1, with total Index turnover just 0.35%, compared with 0.51% in the fourth quarter, and well short of the historical quarterly average turnover of 0.73% for the life of the Index.

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When money did move, the report authors said it flowed “less decisively” into stable value funds than in past quarters. While the majority of money movement was from equities to stable value funds in the fourth quarter of last year, in 2009’s first quarter, stable value inflows dropped to just 27% of shifting monies.

Equity funds, including domestic large cap, domestic small cap and international equity attracted inflows, which the report’s authors attributed to a result of a rebound in those sectors. Reflecting their position as a typical default vehicle, target-date funds accounted for nearly one-third of inflows, while company stock and balanced funds experienced much of the outflows tracked by the index.

Target-Dates

The reduced equity allocation drove the Index to outperform what Callan called the “average” 2030 target-date fund (which has 81% in equities) by nearly 2.5 percentage points in the first quarter.

According to the announcement, the Callan DC Index is designed to meet the needs of plan sponsors and investment managers by measuring performance and net flow activity of defined contribution plans. The Index tracks the asset flows and performance of approximately 70 participant-directed plans comprised of more than 800,000 participants and $50 billion in retirement assets dating back to January 2006.

Compliance June 9, 2009

Trade Groups Comment on 403(b) Prototype Program

The deadline for comments on the Internal Revenue Service’s proposal for a 403(b) plan document prototype program was June 1, and trade groups and industry providers had a number of concerns.
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The biggest suggestion among all commenters was to allow prototype plans to include vesting schedules. The SPARK Institute said it believes the most significant revision that is necessary to expand the availability of the prototype program is to permit the use of a vesting schedule in the prototype plan (see “SPARK Offers Suggestions for 403(b) Prototype Program“).

Commenters also expressed concern that the proposed Listing of Required Modifications included with the proposed prototype program did not meet the needs of 403(b) plans that use multiple vendors or that have certain investments bound by contracts, such as annuities. ING pointed out in its comment letter that the IRS included flexibility for such cases in the final 403(b) regulations by permitting employers to satisfy the written plan requirements using a “binder clip” approach where product contracts and other plan documentation can be aggregated to compose the plan.

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Section 5.07 of the IRS Announcement 2009-34 (the proposed prototype program) dictates that the terms of the plan should unequivocally state that “in the event of any conflict between the terms of the plan and the terms of any annuity contract or custodial account under the plan, or any other document that is incorporated by reference in the plan, the terms of the plan shall control.” (See “IRS Releases Proposed 403(b) Prototype Document Program.”)

ING pointed out that this could be problematic for product vendors selected by the plan if one of them did not permit such product features as Roth contributions, cash out of small plan balances, hardships, loans, and maximum loan availability calculated by reference to the total accrued benefit up to $10,000.

“VALIC expressed similar concerns, that the restriction was overbroad and could give rise to unnecessary compliance failures through the interaction of two otherwise compliant documents,” according to Richard Turner, vice president and deputy general counsel for VALIC.

The American Benefits Council requested that the prototype program include language permitting funding vehicles to supersede terms of the plans in certain circumstances. It said it “is concerned about inadvertent operational and form defects as a result of conflicts between plan provisions and provisions in funding contracts or custodial accounts.”

ING suggested that the plan should control with respect to the rights of participants, but not require the underlying products funding the plan that have been approved for use under applicable law to offer optional features.

ING also suggested the LRM be modified to reflect the broader portability of 403(b) plan assets provided by the final regulations and by the Worker, Retiree and Employer Recovery Act of 2008.

ASPPA Concerns

In its comments on the Internal Revenue Service’s proposal for a 403(b) plan document prototype program, the American Society of Pension Professionals and Actuaries (ASPPA) asked the IRS to provide as much information as possible now about the future determination letter program for 403(b) plans.

“The information on costs will be needed as soon as possible since decisions in this area will have to be made quickly by organizations deciding between sponsoring a prototype or using individually drafted plans,” ASPPA said. Currently, 403(b) plans are required to have a plan document in place by December 31, 2009, but the determination letter program is not anticipated to be established until 2010.

In addition to a recommendation to allow prototype plans to include vesting schedules, ASPPA also recommended the agency:

  • incorporate the flexibility permitted under the current M&P/volume submitter program, including the ability to have “minor modifiers” and either allowing plan sponsors to make minor changes to the approved language in the prototype plans (similar to the volume submitter program, where changes simply require the filing of a Form 5307 identifying the change) or creating a separate §403(b) volume submitter program allowing for more flexible designs, as now exists in the qualified plan arena;
  • utilize the same LRM language, where possible, for prototype §403(b) and §401(a) plans;
  • open the program more broadly to churches and church-related organizations.

The ASPPA letter is here.

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