Client Service May 10, 2016

After 10 Years of PPA, Blueprint for ‘DC 3.0’ Has Emerged

While there is still a lot of room for improvement in the U.S. retirement planning system, one DC industry executive suggests the “blueprint for success” has been drawn out. 
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As leader of Franklin Templeton Investments’ U.S. large market institutional defined contribution (DC) business, Drew Carrington spends a lot of time discussing and analyzing regulatory happenings under the Employee Retirement Income Security Act (ERISA).

Like others who have spent a significant portion of their careers creating and maintaining tax-qualified retirement plans, Carrington says he’s been thinking a lot lately about the legacy of the Pension Protection Act (PPA), which officially turns 10-years old later in 2016.

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“While the DOL’s fiduciary rule gets the most headlines these days, the PPA is still having a major day-to-day impact on the retirement planning space,” he says, “driving employers towards automation and making them more mindful about their ethical and practical responsibilities for preparing their employees for a successful retirement.” What has made the PPA an even more powerful driver of change in recent years, Carrington adds, is the explosion in use of data technology within the retirement planning context. Recordkeeping and investment firms alike are making big efforts to distinguish themselves from the competition through technology partnerships and the rollout of proprietary planning tools. 

“Not only can a new hire or existing employee be swept into an age-appropriate and risk-balanced portfolio that will answer challenging investment questions for them—recordkeepers can increasingly access and leverage external data pertaining to the individual’s unique retirement outlook, allowing for more holistic investment decisions,” Carrington says. “When I am discussing all of this I like to explain to people that we are, I believe, on the cusp of realizing DC 3.0.”

Under this nomenclature, DC 1.0 is “what we had before the Pension Protection Act, with increasingly large and clumsy plans,” Carrington explains. “Then came PPA, which streamlined and automated enrollment and investment menus, making DC 2.0. Finally, we’re at a stage where we can leverage new technologies to bring true customization down to the plan participant level and truly take advantage of all the other features that are available. That is DC 3.0.”

NEXT: DC 3.0 more than just marketing 

Carrington adds that DC 3.0 is also “much more holistic, with the ability to consider everything from anticipated Social Security and pension income to one-time windfalls from home equity, inherited assets or a spouse’s separate retirement accounts. The top providers are already pushing in this direction.”

According to Carrington, there’s an important reason behind defining and advocating for the new set of best practices that are increasingly being employed by top plan providers and consultants, whether as “DC 3.0” or under any other name.

“Given the efforts states are undertaking to attempt to establish their own plans, it is incumbent on industry professionals to advocate for what we know already works,” he says. “This includes all of the great features that were brought about by the PPA, such as auto-enrollment, auto-escalation, more aggressive qualified default investment alternatives, and other elements.”

Carrington predicts that the states which are moving ahead on offering government-backed DC accounts or auto-enrollment individual retirement accounts (IRAs) will continue to move down this path, “but they’ll very soon run into the same problems well-established DC plans, employers and the market providers are already facing.”

“When you look into the mechanics of many of these plans the states are looking to offer, there’s little reason to think they will be able to widely improve retirement readiness,” Carrington says. “Even with auto-escalation, we know that enrolling people at 3% or even 6% of salary is not enough, especially when there is no matching payment coming from the employer, which is likely to be the case here.”

Client Service May 9, 2016

Clients Need to Know All Choices When Making Fee Decisions

There is more focus on fiduciary decisions about retirement plan fees due to increasing litigation.
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Retirement plan fee litigation has heightened plan sponsors’ interest in their fiduciary responsibilities regarding fees, noted Michael Sasso, partner and co-founder of Portfolio Evaluations, Inc.

So far, the litigation has targeted large-market plan sponsors, but Sasso feels it will naturally trickle down to smaller plans, he told attendees of the Plan Sponsor Council of America (PSCA) 69th Annual Conference.

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Michael Olah, managing principal at Michael J. Olah & Associates LLC, added that he has heard a lot of talk that retirement plan sponsors are not going to settle lawsuits anymore and will force trial. “The risk to the industry is that opinions will come down as judgements which will become precedent,” he said.

Olah expects litigation may be coming about why large plans pay less than small plans—why providers are not leveraging technology to reduce administrative fees. He also said the Department of Labor’s (DOL’s) fiduciary rule may spark litigation about adviser fees, especially if plan participants share in the cost. And, Olah anticipates more target-date fund (TDF) legislation coming out of the fee focus, especially about the use of recordkeeper’s proprietary TDFs or TDFs that use only one fund family.

Retirement plan sponsors need to know what choices they have in pricing models and how to pay for plan fees in order to make the best decisions. Jean Martone, director of the Retirement Plans Group at Portfolio Evaluations, Inc., explains there is a “bundled” pricing model in which the retirement plan provider collects all revenue sharing from the plan’s investment options, and a targeted required revenue for it to keep to pay for costs may be recommended to the plan sponsor. She said the pros of this model is the provider will assume the risk in down markets and not charge the plan sponsor, and the plan sponsor will not incur hard dollar fees if the revenue target is not met due to participant behavior.

However, Martone noted that there is a move away from this pricing model to other models. With a “basis point” model, the plan provider sets a revenue requirement as a percentage of plan assets. With a “per participant” model, the provider sets a per participant fee. With these models, the plan sponsor gets any excess revenue generated and has the option to use this to create an account to help with eligible plan expenses or to rebate the excess to plan participants. “This is the shift in the industry,” she said.

NEXT: Paying for plan administration, and fee equalization

Once a pricing model is selected or determined, the plan sponsor must consider how to pay for plan administration costs. Still the most common method, according to Martone is to use revenue sharing, but there is a movement to try to eliminate revenue sharing now because historically, the cost to participants has been unequal—some are invested in higher expense funds and some in lower or no expense funds. “Plan sponsors are trying to find funds with no revenue sharing, but that is difficult to do, so there may be some combination of revenue sharing and a charge to participants to pay for plan costs.

If they are able to eliminate revenue sharing, plan sponsors can charge participants a basis point or flat fee, or the plan sponsor can pay all plan costs itself. The latter option is not very common, but it is being discussed more, according to Martone.

Martone noted that DOL rules require that fees be reasonable for services provided. Some plan sponsors use databases to benchmark their fees, but if they do, they should understand the methodology and make sure the database is updated regularly, Martone said. Another way to benchmark fees is to issue a request for information (RFI). “Look at all fees—loan origination, loan maintenance, mailing of notices, etc.,” she added. Best practice is to perform periodic reviews that are properly documented.

Investment fees are the largest component of 401(k) costs, so plan sponsors should make sure the fees are reasonable given the size of assets in the investments.

Martone pointed out that the Employee Retirement Income Security Act (ERISA) contains no provisions specifically addressing how plan fees may be allocated across plan participants; however, the DOL says the decision is a fiduciary duty and plan sponsors must react prudently.

There has been a move to fee equalization, which Martone said is defined differently by different providers. “If you want everyone to pay the same fee, the best way is to eliminate revenue sharing and use basis points or a per-participant fee,” she told conference attendees. “But, the plan may have a great fund that still uses revenue sharing.”

Plan sponsors should make sure fee transparency provided by service providers deliver the necessary information to determine the starting point; discuss what equalization methods are available from the recordkeeper; work with the recordkeeper and/or a consultant to frame the communication to plan participants; and document every decision.

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