Compliance June 21, 2016

Empower Suggests Retirement Industry Should Band Together on Policy Issues

Empower will work in conjunction with SPARK to develop an industry-wide forum in which members could build a set of agreed-upon priorities.
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In an address to the Society of Professional Asset-Managers and Record Keepers (SPARK), Empower Retirement President Edmund F. Murphy III called on retirement industry leaders to join forces to form a united coalition when engaging policy makers and regulators on issues of common concern. 

Murphy told the audience that Empower would work in conjunction with SPARK to help promote the development of a proactive policy agenda. The effort would include the development of an industry-wide forum in which members could build a set of agreed-upon priorities and use their collective expertise and experience to help legislators and regulators understand the value and benefits behind various proposals.

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In addition, Murphy outlined a series of goals derived from many years of policy development work led by Great-West Financial President and CEO Robert L. Reynolds:

  • Correcting the tax window: Preserve and expand all existing savings incentives and correct the false “scoring” and 10-year “window” used today by the Treasury Department to account for the cost of savings deferrals;
  • Fixing the access gap: Provide workplace savings to all working Americans—by supporting legislation to facilitate multiple employer plans, “starter” 401(K) plans and auto-IRAs at the federal level;
  • Providing larger—and refundable—tax credits to small employers and savers: Small companies that establish plans must have a greater incentive to do so. The incentive could be extended to part-time, freelance, and contract workers who establish IRAs. Expanded testing safe harbors should be developed for small employers;
  • Requiring auto features: Require the adoption of “full-auto-suite” plan design (with participant opt-out) and establish an industry norm that will achieve deferral rates of 10% or more.
  • Encouraging greater adoption of lifetime income options:  Workers should have a tax incentive to choose guaranteed income options. In addition, plan sponsors should be encouraged to provide lifetime distribution options;
  • Alleviating health care expenses: Allow retirees to make tax-free withdrawals from qualified plans if they are used to cover supplemental health insurance or medical expenses.

Murphy noted that a key attribute of the 2006 Pension Protection Act was the “real sense of collaboration between policy makers and the industry to help the 401(k) in its continuing evolution to better meet the needs of the workforce.” He said, “This is a model we should and must embrace once again.”

Murphy urged retirement industry colleagues to leverage their established credentials as innovators and knowledgeable experts to drive enhancements to the retirement system. He noted that with 90 million Americans in defined contribution plans the retirement industry collectively holds an important position of trust. 

“We know our business better than anybody. We hold the core competencies to drive innovative solutions and better outcomes,” said Murphy. “We will lead the needed improvements to America’s retirement system. It’s our job—and we need to make it our mission.”

Data & Research June 21, 2016

Investment Policy Statements Can Protect Advisers from DOL Scrutiny

In the wake of the DOL rulemaking, a financial advisory firm acts at its peril if it overlooks the prudent investor rule, a new research paper says.
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Concerned about conflicts of interest among financial advisers to retirement savers, in April 2016 the Department of Labor (DOL) finalized a rulemaking that imposes Employee Retirement Income Security Act (ERISA) fiduciary status on any person who provides “investment advice or recommendations” to retirement savers or retirement plans.

A discussion paper written by Max M. Schanzenbach, from Northwestern University – School of Law, and Robert H. Sitkoff, from Harvard Law School, notes that fiduciary status under ERISA imposes not only a duty of loyalty but also a duty of care. As the DOL acknowledged, a financial adviser to a retirement saver will now be subject to “trust law standards of care” in addition to “undivided loyalty.”

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According to the authors, the fiduciary standard of care is governed by the “prudent investor rule,” which is grounded in modern portfolio theory and requires an overall investment strategy having risk and return objectives reasonably suited to the purpose of the investment account. Under the prudent investor rule, no type or kind of investment is categorically permissible or impermissible. Instead, a fiduciary must evaluate the principal’s risk tolerance and investment goals, choose a commensurate level of overall portfolio market risk and expected return, and avoid wasteful diversifiable risk.

Because of the multiplicity of relevant considerations—including the investor’s risk preferences, age and health, family status and obligations, and other asset holdings and sources of income—application of the prudent investor rule is specific to an investor’s particular circumstances, the paper notes. Accordingly, the rule permits a wide variety of investment techniques, including active investment strategies, provided that the result is an overall portfolio with risk and return objectives reasonably suited to the investor. The rule is principles-based rather than prescriptive.

NEXT: Successfully complying with prudent investor rule

Application of the prudent investor rule to financial advisers to retirement savers creates new litigation risk for those advisers. “In the wake of the DOL rulemaking, therefore, a financial advisory firm acts at its peril if it overlooks the prudent investor rule,” the authors write.

However, they contend that compliance with the rule is feasible with the tools already in use by other fiduciaries, such as bank trust departments, that have long been subject to the prudent investor rule. The centerpiece of bank trust department compliance with the prudent investor rule is the “investment policy statement.” Such a statement sets forth the individualized investment program created to match the account’s purpose and risk tolerance with a diversified portfolio having an appropriate balance of risk and expected return.                                

The authors point out that an investment policy statement will normally specify the account’s risk tolerance” as well as its investment goals and return requirements in light of the particular circumstances of the account. An investment policy statement will also normally specify asset allocation guidelines, and facilitates rebalancing to maintain proper diversification.

Finally, the authors note, an investment policy statement also provides a paper trail in the event of an audit, litigation, or a dispute, and it facilitates selection of an appropriate performance benchmark against which to compare the account’s performance.

The discussion paper may be downloaded from here.

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