Compliance January 15, 2015

Little Plan Sponsor Reaction to No Presumption of Prudence

A survey finds the majority of DC plan sponsors that offer company stock as an investment option have no plans to make changes to the offer, despite a more complex company stock environment.
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Following a U.S. Supreme Court decision that fiduciaries of employee stock ownership plans (ESOPs) are not entitled to any special presumption of prudence under the Employee Retirement Income Security Act (ERISA), 72.7% of defined contribution (DC) plan sponsors that offer company stock indicated they anticipate no changes to their offerings this year.

According to the 2015 Defined Contribution (DC) Trends Survey by the Callan Investments Institute, 9.1% said they will regularly review company stock in investment committee meetings, while another 9.1% said they will eliminate company stock as a plan option. The same percentage said they are waiting to make a decision pending the outcome of ongoing stock drop lawsuits.

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Lori Lucas, executive vice president and defined contribution practice leader at Callan Associates in Chicago, tells PLANADVISER she expected the number of plan sponsors taking a “wait-and-see” approach to be higher. She also expected that more plan sponsors would investigate outsourcing the oversight of their company stock, but only 4.5% said they would.

The survey found 4.5% of plan sponsors intend to freeze their company stock investment offering this year, and the same percentage said they will change language in their investment policy statement.

Lucas concedes that it is hard to determine the best reaction to the decision because the court was not entirely clear about what actions plan sponsors should take. The question of what the trustee of a retirement plan that offers employer stock as an investment option is supposed to do with inside information that the stock price may be overvalued was prevalent in the high court’s discussion of the case. The court also considered whether fiduciaries of ESOPs have a presumption of prudence that plan participants cannot overcome in a lawsuit unless they plausibly allege plan fiduciaries abused their discretion by remaining invested in employer stock. The court laid out points to consider in a court’s analysis in situations in which the complaint alleges a fiduciary was imprudent in failing to act on the basis of inside information.

The Supreme Court remanded the case to the 6th U.S. Circuit Court of Appeals to consider whether allegations that a fiduciary should have recognized on the basis of publicly available information that the market was overvaluing or undervaluing the stock are generally implausible and thus insufficient to state a claim. The pleading standard requires that to state a claim for breach of the duty of prudence, a complaint must plausibly allege an alternative action that the defendant could have taken, that would have been legal, and that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it.

“The company stock environment is clearly more complex,” Lucas notes.

The Callan survey found that in 2014, all plan sponsors that offer company stock reported taking some action to limit their liability. The most common action was to communicate diversification principles to plan participants (54.5%), which is required by the Pension Protection Act (PPA) of 2006. Plan sponsors also frequently cited hardwiring company stock into the plan document (40.9%) and offering tools to improve participants’ diversification out of company stock (36.4%). Callan noted that hardwiring company stock into the plan has been a common defense in stock-drop lawsuits; however, this is likely to change following the Supreme Court’s June 2014 ruling.

Data & Research January 15, 2015

A New Landscape of TDFs in Retirement Plans

About one in 10 plan sponsors replaced their target-date fund/balanced fund manager in 2014.
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Last year was a busy year for target-date fund (TDF) decisions and changes within defined contribution (DC) plans, a survey finds.

According to the 2015 Defined Contribution (DC) Trends Survey by the Callan Investments Institute, about one in 10 plan sponsors replaced their target-date fund/balanced fund manager in 2014, and the proportion of plans that offer their recordkeeper’s proprietary TDF declined precipitously, from 47.5% in 2013, to 28.7% in 2014. Plan sponsors expect this number will decrease even further in 2015 (to 23.6%).

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Lori Lucas, executive vice president and Defined Contribution Practice leader at Callan Associates in Chicago, said the change in the TDF landscape was what stood out to her in the survey findings. “I was not surprised by the change away from recordkeeper’s proprietary funds, but was surprised by how many DC plans are using custom target-date funds,” she tells PLANADVISER.

According to the survey, plans with custom target-date funds increased materially, from 11.5% in 2013 to 22.3% in 2014. Lucas says Callan did expect an increase in plans using custom TDFs, but were surprised by the size of the increase.

The survey also found the proportion of plans with indexed TDFs remained steady between 2013 and 2014 at around 42%, and TDFs continue to trump other options as the most prevalent choice of default investment fund for participant-directed monies (74.6%). This year, fees now outrank performance as a criterion for selecting or retaining a TDF. Fees had ranked third between 2009 and 2013, but are now in second place, behind portfolio construction.

Lucas says she found it interesting that although 12% of plan sponsors said they had replaced their TDF managers, none said they expected to do so in 2015. “It seems to me like the Department of Labor’s [DOL] tips for TDFs raises the bar; it sets up the expectation by the DOL that a plan’s TDF will fit the demographics of participants and the plan, and that plan sponsors would have documented this,” she says. Lucas also notes that TDFs have evolved considerably over the years—glide paths have evolved, some are more aggressive now after becoming more conservative after the recession. “These are all merits for reevaluating TDFs and having a documented process.” Lucas adds that plan advisers can prompt plan sponsors to benchmark their TDFs and guide them in the process.

Lucas says there were a couple of disappointing findings in the survey. Callan expected to see more of a shift in the DC plan fee landscape. “Last year, we saw a lot of activity in fee analysis and recordkeeper searches,” she says. “We thought more [plan sponsors] were moving to out-of-pocket fees—those taken directly out of participants’ accounts—and moving away from revenue sharing, but the survey results didn’t show this,” she notes. The survey shows plan sponsors are changing the way fees are paid, but it is not clear from the findings how they are doing this.

The survey found fewer plan sponsors calculated or benchmarked plan fees in 2014 than in 2013, and fewer reduced plan fees after conducting a fee evaluation. More than twice as many plan sponsors changed the way fees are paid in 2014 as in 2013. More plan sponsors did not know what portion of their funds pay revenue sharing this year versus last (8.3% in 2014 versus 2.6% in 2013). More plan sponsors also changed the way fees are communicated to participants.

More than half of plan sponsors are somewhat or very likely to conduct a fee study in 2015. Furthermore, 46.7% of plan sponsors are somewhat or very likely to switch certain funds to lower-fee share classes and 44.3% intend to renegotiate recordkeeper fees in the coming year.

Lucas says there is still work for plan sponsors to do related to fees. Asked if there was a policy for fees, just 21% of plan sponsors surveyed indicated they do have a written fee policy as part of an investment policy statement (IPS), and 15% have one in a separate document. Only 5% plan to formalize a fee policy in 2015. “It is a good idea for investment committees to document a fee policy and the way fees are paid. The bar is high given all the transparency requirements and lawsuits,” she says. Advisers can help plan sponsors with a fee policy.

 

Other “good news/not so good news” findings, according to Lucas, relate to automatic enrollment. Automatic enrollment usage increased for the fourth year in a row to reach 61.7% of plans. But, Lucas notes, implementation of auto enrollment is not necessarily ideal. Plan sponsors continue to offer automatic enrollment primarily to new hires, with only 12.5% also including existing employees. Lucas says the main reason plan sponsors cited for not implementing auto enrollment for all employees was cost. “It is such an effective tool for getting people into the plan, that when a plan sponsor offers a matching contribution, it increases their plan costs. So, to make it more affordable, they just focus on new hires,” she explains.

A second reason plan sponsors give for offering auto enrollment only to new hires is the expected pushback from current employees. Lucas says they overestimate the amount of pushback they’ll receive. “They think employees that have been receiving a paycheck for a while will react negatively to a decrease in that paycheck, but our experience indicates this is not true.”

Another issue with auto enrollment implementation revealed by the survey: only one-third of plans offer both automatic enrollment and automatic contribution escalation. In addition, defaults for automatic enrollment range from 1% to 10%, with an average of 4.3%, and plans with opt-out automatic contribution escalation most frequently have an annual increase rate of 1% with a cap of 6%. Lucas notes that a default 3% deferral is still the most common among plans, and escalating by 1% each year up to 6% is not the best formula for retirement readiness. “Most in the industry recommend saving 10% to 15% of pay; we didn’t see much movement towards that,” she says.

One thing Lucas thinks plan sponsors should think about is what response they will have to new money market regulations. Few plan sponsors are making changes to their investment fund lineup despite the Securities and Exchange Commission’s recent amendments to money market regulations. “We received kind of a muted response from plan sponsors, but it may be an area where they’re taking a wait-and-see approach,” she says. Forty-three percent of respondents indicated they are still evaluating what the new regulations mean for them. “The regulations not only affect money market funds but funds that use money market funds as underlying investments,” Lucas notes.

Other findings from the 2015 DC Trends Survey include:

  • Sixty percent of plan sponsors conducted an investment structure evaluation within the past year;
  • Many plan sponsors increased the proportion of index funds in the plan (27.3%). This trend should continue in 2015;
  • More than three-quarters of plans (77.3%) now offer some kind of institutional structure—either collective trusts, separate accounts, or unitized private label funds;
  • Most DC plan sponsors do not offer a retirement income solution and are unlikely to do so in 2015. When they do offer one, it tends to be via access to their defined benefit plan;
  • Many plan sponsors provide a retirement income projection to participants, and communicating about retirement income adequacy is a high priority. However, few sponsors use retirement income adequacy to measure the success of their plan; and
  • In 2015, participant communication, fund/manager due diligence, compliance, and plan fees are high priorities.

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