The Department of Labor (DOL) created a regulatory safe harbor in 2007 to limit the liability of a plan sponsor that invested contributions on behalf of employees into default investments. The safe harbor allowed plan sponsors to choose from three default investments that would qualify a plan for safe harbor protection.
In “401(k)Plans: Clearer Regulations Could Help Plan Sponsors Choose Investments for Participants,” the Government Accountability Office (GAO) set out to examine which options plan sponsors selected as default investments and why; how plan sponsors monitor their default investment selections; and what challenges, if any, plan sponsors report facing when adopting a default investment for their plan.
GAO finds companies that sponsor a 401(k) plan use a range of qualified default investment alternatives (QDIAs) to automatically enroll employees. From 2009 through 2013, a strong majority of employers used a target-date fund (TDF) as their default, according to data from three annual industry surveys that GAO reviewed.
Fewer plan sponsors reported using the other two default investment types that the Department of Labor (DOL) identified: balanced funds or managed account services. The characteristics plan sponsors looked for when selecting a default investment are asset diversification, ease of participant understanding, limited fiduciary liability, and a fit with participant characteristics.
Some stakeholders also identified positive attributes of each default investment type and mentioned other factors—plan sponsor preferences; plan circumstances; or changes in the plan’s environment, such as a plan merger or court decision—that could influence a plan sponsor’s default investment selection in the future.
The report takes a look at the various factors plan sponsors consider when they monitor default investments, and the results of their monitoring efforts, which hinge on plan-specific considerations.
NEXT: What affects a plan’s ability to monitor investments?
Stakeholders generally said that the type of default investment and a plan’s circumstances—such as the availability of resources and expertise devoted to investment monitoring—can affect the extent of a plan sponsor’s monitoring efforts and the response to monitoring results.
Plan sponsors and stakeholders said that after an extensive default selection process, some plan sponsors may be reluctant to change the default investment regardless of monitoring results. For example, a plan sponsor and service provider may have negotiated a reduction in overall plan investment management fees in exchange for using a provider’s investment as a plan’s default, making it more difficult to change. Plan sponsors cited regulatory uncertainty, liability protection, and the adoption of innovative products as significant challenges when adopting one of the three default investments.
The structure and features of each QDIA type affects how plan sponsors and stakeholders monitor them, the report found. For example, plan sponsors and stakeholders said that quantitative performance data across similar investments varied by QDIA type. Balanced funds and off-the-shelf TDFs have more data with which to compare peer funds and benchmarks than custom TDFs and managed accounts, for example.
Some sponsors noted that the fixed asset allocation of balanced funds facilitated easier point-in-time comparisons of the QDIA’s returns, risks, and costs against other individual balanced funds, a balanced fund peer group, or other relevant benchmarks. The glide path of a TDF, on the other hand, requires more sophisticated performance monitoring of a series of funds.
Often, according to the GAO report, the variation in glide paths among target-date series makes it difficult for the sponsor to identify peer TDFs (or appropriate benchmarks) with similar objectives, asset allocations and risk attributes.
NEXT: Are some investments easier to monitor?
In contrast, plan sponsors with a managed account as the QDIA reported that they monitor only the account provider to ensure that the contracted services are being provided rather than considering investment performance. Plan sponsors are generally unable to compare managed account services across providers because of a lack of consistent performance information.
DOL regulations outline several specific conditions that plan sponsors must adhere to in order to receive relief from liability for any investment losses to participants that occur as a result of the investment. Plan sponsors and stakeholders generally said that the regulations were unclear on several points, such as how sponsors could fulfill the regulatory requirement to factor the ages of participants into their default investment selection; whether each default investment provided the same level of protection; and whether they were allowed to incorporate other retirement features, such as products offering guaranteed retirement income, into a plan’s default investment.
These uncertainties could lead some plan sponsors to make suboptimal choices when selecting a plan’s default investment that could have long-lasting negative effects on participants’ retirement savings
Because QDIAs have played a significant part in boosting worker participation in defined contribution plans since they were first authorized, the report recommends that the DOL assess the challenges of plan sponsors and stakeholders, including the extent to which these challenges can be addressed, and implement corrective actions.
To produce the report, the GAO reviewed relevant federal laws and guidance; analyzed industry survey data on the prevalence of default investment use; analyzed non-generalizable responses from 227 plan sponsors who completed a Web-based questionnaire; and interviewed 96 stakeholders, including service providers, advocacy groups, and research organization representatives, as well as academicians.
“401(k)Plans: Clearer Regulations Could Help Plan Sponsors Choose Investments for Participants” can be accessed here.