IMHO: Underlying Assumptions

One of those reports was on target-date funds, the other on potential conflicts of interest.  As seems to be its custom in such reports, the GAO communicates its conclusion in the titles: “Key Information on Target Date Funds as Default Investments Should Be Provided to Plan Sponsors and Participants” and “Improved Regulation Could Better Protect Participants from Conflicts of Interest”—and, IMHO, there’s little controversy in those statements.  

The reports themselves offer a great informational primer on target-date fund designs and issues (you’d be surprised how many plan sponsors still don’t quite grasp the concept of “glide path”) as well as the fee structures and revenue-sharing components that underlie the 401(k) retirement savings system.  Both reports acknowledge that efforts are already under way to remedy the shortfalls the reports identified in both, while at the same time promoting solutions to those shortfalls that may not be cost/impact-justified.  

As you peruse the target-date fund report (see “GAO Urges More Help with TDFs for Plan Sponsors”), you’re struck once again by the wide variety of answers to the question, “What is an appropriate asset allocation for participants at retirement age?” much less the assumptions that underpin it.  One might well expect to find different assumptions regarding the markets, investment classes, and how the latter will respond to the former over the course of decades—and, in fact, these assumptions lie at the core of the target-date fund glide path and design.  One might well expect (though many apparently didn’t) that those differences of opinion would translate into very real differences in asset allocation, even at retirement age.    

There are, however, assumptions imbedded in these TDF approaches that, IMHO, are not nearly as well-communicated and/or understood by plan sponsors; assumptions that are predicated on certain participant behaviors that, in the words of the GAO report, “may not match what many participants actually do.”  There is the assumption about what participants will do at the target date—either transfer those assets to another vehicle or retain their investment in the TDF.   

This, of course, is the essence of the “to versus through” debate that has, since the 2008 financial crisis, drawn increasing scrutiny, if only because, IMHO, most plan sponsors (and plan participants) assumed that their target-date fund investment was designed to take them TO that date, not beyond it.  Of course, that assumption bears within it another assumption: that the participant has managed to achieve a certain level of savings accumulation.  Many haven’t, of course, and this knowledge underlies the assumption of those who employ the “through” approach to TDF designs, assuming that a longer equity exposure will serve to shore up that shortfall.  Which, by the way, is another assumption imbedded in the “through” designs—that the participant will leave the money invested in that TDF (if not the plan itself) past their projected date of retirement. 

Moreover, even the “to” TDF camp tends to assume that participants will buy an annuity at retirement, though they frequently don’t.   

The GAO report noted that each of the eight TDF managers it contacted “considered contribution rates in establishing its asset allocation strategy,” noting that “some explicitly noted that these assumptions did not match the general pattern of contribution rates.”  It will surprise few to learn that their assumptions were generally higher, but that they “hoped that rates will increase as workers adjust to DC plans serving as the sole employer-based retirement account,” according to the GAO report. 

And, of course, since a growing number of participants were defaulted into TDFs to begin with, nobody has any real idea if they will behave the way participants have historically or not. 

That said, the GAO has recommended that the Employee Benefits Security Administration (EBSA) (1) amend the QDIA regulations such that fiduciaries are required to document whether factors beyond age or retirement date are relevant, (2) provide guidance to plan fiduciaries on the limitations of benchmarks on those funds, and (3) expand participant TDF disclosures to provide information regarding the assumptions concerning participant contribution and withdrawal intentions.  EBSA was at least open to the first two (though not commenting directly, since they are currently in the process of recrafting those regulations), though it resisted the last as being a “very complicated and subjective undertaking which could affect a plan sponsor’s decision to offer any target date fund option(s),” according to EBSA’s response to the GAO report. 

But, IMHO, if that gives a plan sponsor pause in offering a particular option—well, perhaps it should. 

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See also “IMHO:  When You Assume…” 

The GAO target-date fund report is at http://www.gao.gov/new.items/d11118.pdf