In the 25 years Steve Klapper has been the corporate payroll and benefits manager for American TV & Appliance, he has received only two questions from employees on benefits information mailed to their homes.
Yet this year, the Madison, Wisconsin-based electronics company will spend about $30,000 printing and mailing benefits information—such as 401(k) summary plan descriptions—to its 1,200 employees, he says.
In this tough economy, American TV & Appliance would much rather use the money to keep or hire an employee, says Klapper, adding that he would prefer to send the information electronically instead of mailing it.
“In this day and age when such a large number of employees are used to receiving information electronically and don’t even know the cost of a postage stamp, the idea we are fulfilling a government requirement for the good of the employee by sending it through the mail is just nonsense,” he says.
Klapper was one of 77 respondents to the U.S. Labor Department’s request for information on sending electronic employee benefit plan information to participants.
While the agency is trying to determine what to do about its current policy on electronic delivery of information, it may not happen before plan sponsors will be required to give an estimated four-page document outlining certain plan and investment fee information to its participants. Without a change in the current electronic delivery, plan sponsors will need to mail this fee information, instead of a less costly delivery via computer.
The Washington, D.C.-based Investment Company Institute said the cost of printing and mailing this particular notice to the 72 million participants in participant-directed retirement accounts ranges from $37.4 million to just under $50 million. Plan sponsors will be required to send this information by May 31, 2012.
“Companies are all focused on ways to cut down on cost, and [electronic disclosure] would be a much more effective way” of giving participants information, says Louis Mazawey, principal and head of the tax group at Groom Law Group in Washington, D.C.
The Labor Department is considering interim e-disclosure guidance and is hopeful it will be issued in late August, one official said. The official did not give more details.
Currently, companies need to get employee consent to send benefit information electronically. The current rule also says employees need to use computers as a significant part of their regular responsibilities to qualify for electronic communication.
Many of the respondents to the agency’s request for information want electronic delivery of information to become the default notification system, where participants would need to opt out to receive paper delivery—similar to how some employees currently opt out of other automatic features, like automatic enrollment.
Plus, many employees are already using the Internet to keep pace with changes in their 401(k) plans. According to the Chicago-based Profit Sharing/401k Council of America’s 2010 annual survey of plans, 91.9 percent of all plans and 96.4 percent of plans with 5,000 or more participants use the Internet for balance inquiries on their retirement accounts.
“Participants are being overwhelmed with information,” says Aliya Wong, executive director of retirement policy for the U.S. Chamber of Commerce. “We have the technology to get them information more effectively and to give them the best experience possible.”
To highlight the more timely concern plan sponsors have in delivering fee information, the U.S. Chamber of Commerce and 15 other industry groups told the department they felt the fee disclosure deadline would happen before a new rule for electronic disclosure could be finalized. In a July letter, this group asked the department to consider using existing relief that allows electronic delivery of quarterly benefit statements to apply to the delivery of fee information.
“Such transitional relief would mitigate disruption to and the cost of plan administration and provide participants and beneficiaries with a more consistent and efficient delivery experience,” the letter said. “Mailing the extensive written disclosures required by the new regulation to participants and beneficiaries who currently engage plans via online access would be wasteful, costly and, for many participants and beneficiaries, unwanted.”
The existing relief, called Field Assistance Bulletin 2006-03, allows participants to opt out of electronic delivery and get paper copies of benefit statements. The group’s July 7 letter added that expanding the provisions of the bulletin to the fee disclosure requirement would protect all participants: Anyone wanting a paper copy would have that option available.
“We think this relief is absolutely necessary for the fee disclosure rule because it is a lot of information, and a much better way to get it to people,” Wong says.
Workforce Management Online, August 2011 — Register Now!
Explaining the Labor Department’s ERISA Regulations
The Labor Department issued an interim final regulation July 16, 2010, which would require certain pension plan service providers to give detailed information on fees and possible conflicts of interest to plan sponsors.
On June 1, the Labor Department formally proposed to extend the effective date of this interim final regulation, known as Section 408(b)(2) of the 1974 Employee Retirement Income Security Act, to Jan. 1, 2012, from July 16, 2011. It is expected the rule will become final in late summer or early fall.
A second regulation, under Section 404(a) of the same federal pension law, was finalized in October 2010. It requires plan sponsors to give participants with self-directed accounts like 401(k)s, specific information on administrative and investment costs. This regulation starts for plan years beginning on or after Nov. 1. The June 1 notice proposed to change this rule’s 60-day transition provision to up to 120 days.
The department said in the June proposal that all these extensions should help service providers and plan sponsors comply with the requirements by these new effective dates.
An interim final rule is different from a final rule in that it asks for public comments and has the potential to change. In the example of the provider disclosure, the Labor Department signaled in February that it would extend the effective date to January 2012. Also, it carries the full weight of a final rule, and those affected are required to comply by its start date. Last, federal departments and agencies are allowed to modify a final rule, like in this case changing the compliance date with the participant disclosure regulation.
Workforce Management Online, July 2011 — Register Now!
Supreme Court Finds Devil’s in the Details of Summary Plan Descriptions
About 27,000 Cigna Corp. employees thought they were getting a sweet deal in 1998 when they read the terms in a summary plan description of their newly converted retirement plan from a traditional defined benefit pension to a cash balance plan.
But the U.S. Supreme Court recently reversed a lower court’s decision involving the company and its workers, saying even though statements made in the summary of the plan documents may be misleading, participants can’t sue companies based on that information. The terms in the plan document are what determine plan benefits.
The case, Cigna Corp. v. Amara, is significant because the high court in its May ruling said summary plan descriptions can’t be held to the same level of reliability as the plan document. While plan sponsors may find a bit of comfort in that, the high court also said the district court could award damages if employees demonstrated they were harmed by inconsistencies in communication.
Employers need to make sure the summaries match what’s in the plan document, experts agree.
“Employers are going to need to be a lot more careful in making sure summary plan descriptions are more thorough,” says Andrew Volk, partner at Seattle-based law firm Hagens Berman.
In 1998, Cigna told its employees through various forms of communications—which included the summary plan description—that the balance in their new plan would be the combination of their benefit under the old plan plus the new benefit earned in the cash balance plan.
But the complete plan document conflicted with the summary plan description, saying participants with earnings through the old plan would get the greater of whichever balance ended up being larger at the end of their employment: their traditional formula benefit as of Jan. 1, 1998, or what they would accumulate under the new cash balance plan.
In 2001, Cigna workers filed a class-action lawsuit in U.S. District Court for the District of Connecticut in Hartford, saying the Philadelphia-based health insurance company gave misleading information through the summary plan description and other communications to employees about the new retirement plan.
The district court and later the U.S. Court of Appeals for the 2nd Circuit in New York City favored the employees’ argument. Just last month in an 8-0 decision, the Supreme Court reversed the lower court rulings, saying that the summary plan description can’t replace the terms found in the actual plan document. The high court also sent the case back to the district court to decide whether participants were actually harmed by the faulty information.
“We believe that, in order to obtain relief … a plan participant or beneficiary must show that the violation injured him or her,” Justice Stephen Breyer wrote in the opinion for the court.
Adam Greetis, a partner at Seyfarth Shaw in Chicago, said plan documents can be complicated, so it’s important to be clear and consistent with the summary that goes out to participants. Drafts of the summary plan description should be compared line by line to make sure there are no mistakes.
“Review documents for consistency,” Greetis said, speaking during a webinar presented by the Human Resources Management Association of Chicago. “Don’t even get near this error.”
Summary plan descriptions are usually distributed when employees enroll and are the road map workers use to understand benefits. By law, these documents need to be updated every five years if changes are made, or every 10 years if there is no change. The plan document, by law, needs to be provided if an employee asks for it.
The high court decision should encourage employers to make sure provisions in the summary plan descriptions match the plan document, says Kim Buckey, practice lead, summary plan description services, for Woburn, Massachusetts-based consulting firm HighRoads.
“It points out the need for accurate communication and to make sure whoever is communicating your plan understands benefits very well and communicates very well,” she says. “Focus on the benefits and what this means to the employee.”
Buckey adds employers might go so far as using employee focus groups, to make sure workers understand the content in a summary plan description before rolling it out.
“This way you can make sure [summary plan descriptions] are understandable and readable,” she says.
Experts agree it is important to tell the truth about benefits. One of Cigna’s communications said the company would not realize any cost savings, when in fact it did save the plan $10 million annually, according to the high court’s opinion.
“When you are trying to communicate with participants, make sure it is balanced, and not selling,” says Bernard Kearse, principal at Atlanta-based consulting firm ERISA Pros. A good summary plan description “will point out exceptions and tell the plan participant to go to the plan document for more information.”
Workforce Management Online, June 2011 — Register Now!
Labor Department Weighs New Definition of Fiduciary
When you try to change a regulation that has been virtually untouched for 35 years, there’s bound to be a lot of feedback.
That is what officials at the Labor Department discovered at a two-day hearing in March on a proposed regulation that would dramatically expand a 1976 rule defining when a person providing investment advice becomes a fiduciary to a retirement plan.
“I’ve been at the Labor Department for more than 20 years, and I’ve never seen something like the lobbying effort I’ve seen here,” says Tim Hauser, the department’s associate solicitor in the plan benefits security division.
While the department is taking a careful look at the more than 200 comments by individuals and organizations as well as reviewing the testimony from 38 people who attended the hearings, it expects the final regulation will be out by the end of the year, Hauser says.
Right now, people who provide advice for a fee must pass a five-part test to be labeled a fiduciary. Their advice must be provided on a regular basis and it must be mutually agreed (between adviser and recipient) that it is the primary information used in making investment decisions.
Under the 1974 Employee Retirement Income Security Act, a fiduciary must act in the best interest of the plan and its participants.
The proposed rule, first published in the Federal Register in October 2010, abolishes the five-part test and says people who meet any one of the five elements can be labeled fiduciaries. The department specifically noted that even one-time advisers would be considered fiduciaries under the proposed rule, as would advisers who give recommendations on how to manage securities and those who provide advice directly to retirement plan participants. The new rule would apply to broker-dealer firms and other providers of advice for individual retirement accounts.
The department’s main complaint is that the current regulation is outdated and doesn’t work, considering the significant changes in the financial industry and the massive shift to defined contribution plans.
“In today’s world, a lot of a plan’s success depends upon investment advice,” says Norman Stein, professor of law at Drexel University, who testified on behalf of the Pension Rights Center. “If people are doing something wrong, they shouldn’t be able to hide behind this ancient regulation.”
But many critics have a wide array of concerns, mainly charging that the change would cast too wide a net and would wind up raising costs for plan sponsors, force providers to exit the business and ultimately not benefit participants.
“Any casual conversation had about investments will make you a fiduciary,” says Kent Mason, partner at Washington-based law firm Davis & Harman. “Advice has to play a significant role in decision-making.”
Mason, who testified on behalf of the American Benefits Council, said there are too many circumstances where accepted practices, like record keepers helping plan sponsors whittle down thousands of investment choices based on the plan sponsor’s investment criteria that would trigger fiduciary status unintentionally. Knocking out this kind of assistance may discourage employers from offering retirement plans, he says.
But the Labor Department’s Hauser says the proposed rule will help plan sponsors, especially small and midsize companies, because the financial experts will be held liable for their advice, not the business owner or their managers who made decisions based on that information.
“Right now employers are right in the bull’s eye,” Hauser says. The proposal allows “other fiduciaries to be held liable and more appropriately held liable.”
But some plan sponsors, like Bob Steen, fiduciary to his company’s ESOP, say the proposal would be “a game changer,” driving up costs and limiting what the plan could pay out to retirees.
“There are people who don’t understand their fiduciary duty, and we have plenty of laws to deal with those folks,” says Steen, CEO at Bridge Community Bank in Mount Vernon, Iowa.
Stock valuation firms would become fiduciaries under the rule. Steen estimates the cost for an appraisal will more than double because these firms will need to buy fiduciary insurance and will pass that cost onto ESOPs.
“It matters that the stock value is as reasonable as it can be because we pay out people based on it,” Steen says, adding the rule shouldn’t apply to ESOPs. “We give our employees recourse if they question any aspect of the stock value.”
Hauser says the labor department is set with its position on valuation firms, but it understands the need for clarity and concern about costs in other areas, and hopes to address many issues brought up in the comments and hearings in the final regulation. He added that if providers who question their fiduciary status can show that their practice is sound, the department has “expansive authority to grant exemptions” to the rule.
“It’s critical we get this right and figure out who should be considered a fiduciary,” he says.
Workforce Management Online, March 2011 — Register Now!
Wage and Hour Lawsuits Top Employer Litigation Concerns
Richard Wilcox was a technician for Alternative Entertainment Inc., a satellite equipment company based in Madison, Wisconsin. In October 2009, Wilcox led a class-action lawsuit with about 2,000 Michigan and Wisconsin employees, claiming the company paid employees on a per-job rate, without additional pay for overtime, and didn’t properly deduct wages for alleged faulty work.
Wilcox’s employer argued otherwise, but to avoid the expense of going to court and other factors, Alternative Entertainment settled with the plaintiffs this month for a little more than $2 million.
“We hope that this settlement, along with the other cases against employers in the cable and satellite TV industry, will cause employers to review their pay policies to make sure they are in compliance with federal and state laws,” says William Parsons, a shareholder from Madison-based law firm Hawks Quindel which represented the plaintiffs.
Wage and hour lawsuits like this one are skyrocketing, and settlements are consistently high, says Gerald Maatman Jr., co-chair of law firm Seyfarth Shaw’s class-action defense group.
In 2010, 6,761 wage and hour lawsuits were filed, which was a 10 percent increase from 2009 and a 67 percent increase from 2005 when there were 4,039 lawsuits, according to the Administrative Office of the United States Courts. Meanwhile, the top 10 wage and hour settlements totaled $336.5 million in 2010, down slightly from the total of $363 million in 2009, according to the Chicago-based law firm’s latest Workplace Class Action Litigation Report.
“This is the tort of the day,” Maatman says, adding that wage and hour lawsuits should be an employer’s top concern. “Every year the number of cases goes up. Who knows when we are going to get to the top of the bell curve.”
The Fair Labor Standards Act of 1938 sets certain standards in today’s workplace, such as minimum wage and overtime pay, and is intended to protect workers from unfair employer practices. Even with the 2004 amendment to the law, employer attorneys say it is still easy for employers to be out of compliance.
“It is Depression-era legislation that was enacted to address industry workforce problems that don’t exist today,” says Sean Scullen, a partner at Quarles & Brady in Milwaukee. “It hasn’t kept pace with the modernization of the workplace, and employers are not in compliance as a result.”
The number of wage and hour class-action lawsuits is increasing because of several factors, lawyers agree. First, unlike technical lawsuits involving pension law, experts aren’t always necessary, and lawsuits can be brought by one client with a single allegation, Maatman says. Secondly, after years of limited federal resources to enforce the federal law, the Obama administration has stepped up its actions. Third, many unemployed workers have found it easier to report violations after they’ve been let go from the company where the problem occurred.
“Once they’ve lost their job they lose that inhibition,” Parsons says.
Many employers are conducting audits to make sure wage and hour policies are firmly in place, says Mark Batten, partner and co-chair of Proskauer Rose’s class- and collective-action practice group in Boston. Companies typically wouldn’t want to talk about their practices because of the ease in filing wage and hour lawsuits, employer lawyers agree.
“Rampant litigation is forcing employers to wake up. Employers are changing policies and are paying more attention, doing more audits than they used to,” Batten says. “Audits are unavoidable. It’s the only way [employers] really know they’re doing the right thing.”
Employers need to look at and document many factors, including how they count hours worked and calculate overtime, classify employees and their work environment, and other recordkeeping policies to minimize their exposure to wage and hour claims.
Lawyers say that employers who have reporting mechanisms in place for employees to state problems are less likely to face any trouble in court.
“Almost every [employee] handbook has a reporting mechanism for sexual harassment,” Scullen says. “It’s not hard to create a similar mechanism for raising concerns” about wage and hour issues.
Courts are beginning to offer guidance for employers. Last year, a federal judge in the Western District of New York dismissed a case against Black & Decker, where the employee claimed his supervisor told him not to record his overtime hours. The court said the company had written policies and training information instructing employees to accurately record all time worked. The case was dismissed.
“This is the type of case that gives hope to employers,” Maatman says. “It lays out a road map for what employers can do in terms of complaint procedures.”
Workforce Management Online, March 2011 — Register Now!
Labor Department Pushes Intensified Scrutiny of Employee Stock Ownership Plan Fiduciaries
Darlene Brown has been a trustee to her company’s employee stock ownership plan since 1997. The company’s chief financial officer, Brown is one of nearly 800 employees and retirees who, through their retirement plan, own 100 percent of Parametrix, an Auburn, Washington-based consulting firm specializing in environmental services.
So far, Brown thinks she is on track to retire in 14 years with the savings from this plan combined with the assets she has accumulated in the company’s 401(k) plan. But a recent proposal from the Department of Labor that changes a 35-year-old regulation redefining fiduciaries to plans has Brown concerned that the potential cost of the employee stock ownership plan, also known as an ESOP, will dramatically increase, in turn hurting her ability to save enough to retire on time.
“If I used the average for our accounts this would mean $31 per account each year,” if the cost to appraise the plan doubles, Brown says. “This $31 could have gone to purchase stock in the company which has generally grown, so it is not the amount of money, but the opportunity for growing the account that is diminished by these annual expenses.”
Brown adds Parametrix has “no plans to change our ESOP, although this proposed regulation scares us in terms of increasing the cost to our plan.”
ESOPs are defined contribution retirement plans, where the assets are primarily company stock. Because ESOPs are required by law to invest mostly in company stock, participants share ownership of the business that is equal to the proportion of stock in the plan.
There are about 11,500 ESOPs in the United States covering 10 million employees with $901 billion in assets, according to the ESOP Association. It’s hard to get the exact number of ESOPs because most are privately held, and although it’s required to have company stock appraised annually, plan trustees aren’t required to file that information publicly.
Currently, ESOP trustees are the primary fiduciaries and can be held liable if they knowingly participate in certain kinds of transactions, including signing off on bad valuations of the company stock. In general, advisers to all kinds of retirement plans become fiduciaries primarily when they get paid for guidance.
The proposed rule extends fiduciary liability to ESOP valuation firms and significantly strengthens the Labor Department’s ability to file lawsuits against them for faulty appraisals.
“This (proposed) regulation helps us more fairly allocate the responsibility and hold accountable the person who really is the responsible party if a fiduciary breach occurs,” said Assistant Secretary of Labor for the Employee Benefits Security Administration Phyllis Borzi in a conference call to reporters. “We want fiduciaries to have good, solid, quality advice that’s consistent with the duties of prudence and loyalty.
“If it dries up the schlocky advice, I don’t have a problem with that.”
The Department of Labor says the proposed regulation is designed to clarify which adviser roles carry fiduciary responsibility under federal law. The department’s main complaint is that the current rule is old and doesn’t work considering the significant changes in the financial industry as well as the massive shift to defined contribution plans.
“These rules have really become a barrier for the department’s ability to protect participants and beneficiaries,” Borzi says.
But the proposed rule, as it relates to ESOPs, may do more harm than good, says Michael Keeling, president of the Washington, D.C.-based ESOP Association.
Keeling and other ESOP experts agree that making valuation firms fiduciaries will reduce the number of firms willing to perform the service. The risk to the firm will be too high and firms can turn to other lines of business, such as estate valuation, which don’t require any fiduciary responsibility, Keeling says.
“There are opportunities for people valuing privately held stock other than valuing ESOPs,” Keeling says. “The impact will be a hindrance on ESOP creation and operation.”
Keeling predicts a domino effect. Valuation firms that remain in the ESOP business will need fiduciary insurance, and that cost will be passed onto their clients.
Columbia Financial Advisors Inc., one of the nation’s largest business valuation firms, is analyzing the cost of purchasing fiduciary insurance, says Kathryn Daly, principal. Because they are still working on that figure, Daly couldn’t say exactly how much costs would rise, but said because of the risk involved, it wouldn’t be a surprise to see ESOP valuations double.
Some firms may not think the new risk is worth it, she says.
“I think the qualified ESOP appraisal firms will exit the market,” Daly says. “Who is left will be the firms not as qualified. If our costs go up, it will make the cost of putting an ESOP in a smaller company cost-prohibitive.”
Parametrix pays about $25,000 annually for Portland, Oregon-based Columbia Financial Advisors to appraise its company stock, Brown says. Valuation fees are included in the expenses of the plan, so if that cost goes up, there is less money for each plan participant.
“It would not deflate the value of the stock but would impact overall account balances,” Brown says.
Dave Fitz-Gerald, chief financial officer and ESOP trustee at manufacturer Carris Reels Inc. in Proctor, Vermont, agrees, adding the proposed rule may end up hurting the participants the Labor Department is trying to protect.
“As a 100 percent employee-owned company, the more the company spends, the less it is worth,” he says. “The more we spend on administering benefits the less we spend on other things like payroll and benefits.”
Karl Huish, chief retirement specialist with investment consulting firm Loring Ward of San Jose, California, says the Labor Department needs to update fiduciary requirements for ESOP valuation firms so it can better protect beneficiaries, but it should also provide guidance to valuation firms to help avoid making bad appraisals.
“It’s going to be tricky,” Huish says. “All these (ESOP) companies are so different. How you create guidelines that help and not hurt (valuation firms) is going to take some careful thought.”
Under the proposed rule, certain providers that give advice only once would become fiduciaries to plans. The Labor Department needs the ability to go after these providers, because oftentimes their advice is crucial to the future benefit participants will receive, Borzi says.
“Certain decisions are only going to go forward based on what that appraiser says and yet we have no claim against the appraiser,” Borzi says.
ESOP experts agreed there are bad valuation firms in the community. Daly said she hopes the Labor Department holds hearings on the proposed regulation and suggested that requiring trustees to pass a certification test might be a more appropriate way to protect participants without significantly adding more costs.
“We want to keep the system working for all of us, even the Labor Department,” Daly says.
The Labor Department will take comments on the proposed regulation until January 20.
Workforce Management Online, November 2010 — Register Now!
Weighing Retirement Calculator Options
With all the uncertainty about retirement readiness, figuring out how much employees have accumulated for retirement is becoming a big deal.
The Profit Sharing/401k Council of America’s (PSCA) September survey of 931 plans with 8.6 million participants showed 30.7 percent of plans offer some type of retirement calculator. That’s up 8.6 percentage points from 2005.
It’s part of a push plan sponsors are making to ensure employees are better educated during these uncertain times, says the PSCA’s president, David Wray.
“Participants come to the (defined contribution) system very unprepared,” Wray says. “Companies have definitely stepped up education assistance to participants, and this is one way they are doing it.”
Experts say coming up with an exact retirement nest egg is very difficult considering all of the variables needing to be combined. And while retirement calculators are giving many users a good start in figuring out their financial needs, several experts say these programs need to better address key planning issues.
Certain factors, such as rates of return on investments, life expectancy and Social Security estimates, could be handled better so users can get a more accurate picture of their finances.
John Turner, director of the Pension Policy Center and author of several studies on publicly available retirement calculators, says these sites should send users to the Social Security Administration’s website to calculate their benefits based on their own earnings history. Social Security is one of the key factors in determining a total retirement package, and many of the free sites Turner studied use a worker’s most recent earnings to determine Social Security benefits.
Using the most recent Social Security earnings could be really off for younger workers because it doesn’t account for earnings growth over time, says Kirk Kreikemeier, actuary and director for a retirement calculator study conducted by the Society of Actuaries. Going to the Social Security website would be “a fairly simple step that would go a very long way in getting people to get the proper estimate,” Kreikemeier says.
But when a user goes to a secondary site, they might not return to the retirement calculator provider’s website, says Stuart Ritter, vice president and financial planner for T. Rowe Price. While it’s true users could spend more time inputting better, more detailed information like Social Security, most calculator providers don’t want to risk losing a user because of lost interest or lack of time.
“Some people want a quick, ballpark answer,” Ritter says. “A lot of people don’t want to take an additional step.”
Turner’s research shows many calculators ask users to figure a rate of return on their investments. Several sites allow people to enter whatever they want, including annual return rates of 20 percent. The percentage that people input is used to calculate the lump sum, and there have never been multiple consecutive years where a 20 percent return on investment would be considered the norm, Turner says.
“Unsophisticated users typically overestimate rate of returns,” Turner says. “It’s possible they could do much worse than what they put down.”
And many calculators assume people will live until 95—even though the average U.S. life expectancy is about 78 years—so the life expectancy component of the retirement equation gets skewed as well, Kreikemeier says.
Turner and Kreikemeier prefer calculators that use a Monte Carlo approach to return on investments. While it’s known for its swanky gambling casinos, the term “Monte Carlo” is also a mathematical tool that implements a random sampling of numbers to get an approximate answer. In this application, Monte Carlo assumes no one can predict future markets, so it takes into account thousands of different scenarios, including previous historic bull and bear markets to come up with a possible average rate of return.
T. Rowe Price has used the Monte Carlo approach since 1999. The program explains the technique, but doesn’t detail rates of return. Users go through five main steps, answering questions including age, annual income, expected retirement date and other possible sources of retirement income—including Social Security. The data are compiled, and the user receives a results page showing a projected monthly estimate of assets and a projected monthly amount that might be needed. Users can readjust specific factors and get a second set of results.
Turner says Monte Carlo is a large part of the retirement equation because it considers probable ranges of return, and not a straight average rate. More online calculators are starting to incorporate this method, he adds.
“If you put in a fixed rate, say 7 percent, it seems like a reasonable average but it’s possible you could do much worse than that,” Turner says. “The Monte Carlo approach recognizes that.”
Turner adds that while improvement is needed, online calculators have come a long way and are a good starting point for many workers.
“I’m hoping to be helpful in improving calculators,” Turner says. “I recognize calculators face really difficult issues.”
Workforce Management Online, October 2010 — Register Now!
Financial Reform Postpones a Key Stable-Value Decision
Stable-value funds have typically been the go-to investment for retirement participants needing predictable returns. But while some providers are trying to improve the product, the newly passed financial reform bill has postponed the investment’s fate for more than a year while federal agencies determine whether stable-value funds should be classified as swaps. Swaps are derivatives where there is a contract between two parties; that contract’s value is based on something else, most often an underlying asset.
One of the major reasons for this sweeping financial bill was to better regulate this kind of transaction and to increase transparency to avoid another market meltdown.
Known as one of the largest overhauls of the financial system since the Great Depression, the Wall Street Reform and Consumer Protection Act, passed by Congress and signed by President Barack Obama on Wednesday, July 21, asks the Securities and Exchange Commission and Commodity Futures Trading Commission to study whether stable-value funds should be defined as swaps. The agencies have within 15 months to start the project.
If the agencies classify stable-value funds as swaps, then they need to determine whether the funds should be exempt from the law. Current stable-value contracts are automatically excused.
The decision, at least for now, to keep stable contracts intact is a relief, says Matt Gleason, head of stable value for Dwight Asset Management Co. Earlier versions of the bill threatened the existence of the investment, he says.
“Ultimately they’ll get it right,” Gleason says. “There might be additional regulation to improve transparency.”
Stable-value products, which make up about 25 percent of defined-contribution assets, are fixed-income products. The investments are protected, or “wrapped,” by a bank or insurer’s investment guarantee that agrees to pay the book value of the investment if the market value tanks.
It’s a very popular investment because it provides investors a guaranteed return that is higher than money market funds. The Hueler Stable Value Pooled Index showed a 3.07 percent one-year return as of April, compared with the 0.52 percent return for the Lipper Money Market average over the same period. The Stable Value Investment Association says that on average, about half of all 401(k) plans offer the investment and participants invest 15 to 20 percent of their assets in these accounts.
The wrap is a negotiated contract meant to hedge the risk of the bond investment. Earlier versions of the bill had many industry experts concerned that the broad definition of swaps would include the wrap portion of the stable-value investment.
Although legislators’ intent was to protect consumers from other risky swaps investments, experts say the actual language of the bill would have put wrap providers on both sides of a deal—advocating for the highest price in selling the wrap, yet as fiduciary of the plan, negotiating the best wrap price possible for participants. And without the wrap, the stable-value fund would simply be another fixed-income investment. “You can’t be a fiduciary on both sides of the deal. It’s engaging in a prohibited transaction,” says Diann Howland, vice president of legislative affairs for the American Benefits Council.
In addition to the study, the bill creates stricter financial regulation and transaction rules and is aimed at preventing another financial crisis. Despite positive returns for stable value when most other investment classes fell in 2008, wrap providers were slammed by the instability of the market and participants wanting book values.
Overall, the average yield for the investment declined, reaching 3.12 percent in 2009, compared with nearly 5 percent in 2007, according to Hueler Analytics Stable Value Pooled Fund Index. This steady downward trend started the dominoes tumbling. Funds increasingly relied on wrap contracts, and as a result, providers started re-evaluating their liabilities and began moving out of the business.
With fewer than a dozen wrap providers today, pricing for contracts is at a premium, hovering at about 25 basis points, compared with about 9 basis points prior to the financial collapse, says Marko Komarynsky, director of fixed-income manager research for Towers Watson & Co. But shifts are under way, benefiting the asset class as well as participants, Komarynsky says.
To ensure a higher-quality product, wrap providers are demanding more conservative investments, with more subsector restrictions than in the past, says Gleason of Dwight Asset Management. The company manages $45 billion in stable-value products.
To help reduce exposure for wrap providers, Dwight has come up with a new five-year term insurance contract. Under the contract, wrap providers would be responsible for a specific guarantee, and then would be able to renegotiate the terms in five years. Most contracts today are evergreen, meaning there are no predetermined maturity dates. Since this wasn’t working out for providers, Gleason says Dwight came up with this remedy.
“Clearly there are a number of issues in stable value,” Gleason says. “We’re trying to be a thoughtful leader in this asset space.”
Stable value certainly has a place in diversifying portfolios, but plan sponsors need to be aware of its underlying investments and wrap contract terms, Komarynsky says. A recent MetLife stable-value study showed a third of plan sponsors are not sure whether certain events would trigger market-value payments.
“It was such a boring topic a few years ago,” Komarynsky says, “But now, unless you are on top of it, you are really behind the game.”
Workforce Management Online, July 2010 — Register Now!
More Workers Checking In on Pension Plans
Defined-contribution participants aren’t the only ones asking whether they will have enough money for retirement, one consulting group has found.
Mercer reported a 40 percent increase in defined-benefit participants asking for their estimated end benefit in 2009 versus 2008, says Andrew Yerre, defined-benefit business leader in the company’s U.S. outsourcing division. The Mercer unit, which consults on domestic outsourcing and investment issues, is the defined-benefit administrator for 73 clients with 260 defined-benefit plans covering 1.3 million people, says Bruce Lee, principal and spokesman. Last year, 80,000 people asked the company to calculate their estimated benefits, he added.
“The drop in the markets prompted a lot of people to look at employer-sponsored benefits,” Yerre says.
A new annual funding notice is probably another cause for the bump in requests, Yerre says. Before an overhaul to pension law in 2006, participants received arcane and heavily detailed summary annual reports on the status of their defined-benefit plans.
Because of the new law, participants now receive an annual funding notice in addition to the report. This notice simplifies the financial information found in the report, highlighting the funded status or health of the plan as well as its liabilities. The notice doesn’t give participants specific details about their per- sonal estimated end benefit, but it does outline how to request that information.
The annual funding notice has been in effect only since 2008, so this is the first time Mercer has looked at the number of participant requests for information, Lee says. Interestingly, more than half the requests came from participants younger than 55, he adds.
Mercer is encouraging participants to look at their pension as part of all their retirement resources, as well as estimated health care costs, Yerre says. Defined-contribution plans are the main source of people’s retirement savings, so the responsibility of whether a participant has enough for retirement is shifting to the individual; pension plans are playing a more minor role. Meanwhile, workers need to be aware that retiree health care expenses are no longer typically covered by employers and factor them into their retirement strategy, Yerre says.
“People need to understand their total retirement picture,” Yerre says. “The key is looking at all sources of income.”
Workforce Management, June 2010, p. 8 — Subscribe Now!
Investment Help Pays Off, Study Finds
People who use professional help to manage their 401(k) plans get higher returns than those who try to figure it out themselves. And, retirement plan participants who use help have risk levels and asset allocations that better fit their needs, a recent study shows.
The study—“Help in Defined-Contribution Plans: Is It Working and for Whom?”—focused on three of the fastest-growing types of professional help: target-date funds, managed accounts and online advice. The joint effort by Hewitt Associates and investment advisor Financial Engines showed that participants using help had a median annual return of 1.86 percent more than those who made their own investment choices.
The study examined the behavior of 400,000 participants in seven large plans with more than $20 billion in assets from 2006 to 2008. Only 25.3 percent of these participants used some kind of help.
That’s a lot of people making either too risky or too conservative investment choices on their own, says Pam Hess, Hewitt’s director of retirement research.
“It is amazing how a small shift can have significant meaning,” Hess says.
For example, a 25-year-old investing $10,000 in a retirement plan would see a 103 percent increase to $105,800 by age 65 when using investment help. If this young worker doesn’t use help, he could expect to earn about $52,100, the study reported.
Especially in volatile times, it’s important that participants use the right kind of help according to their needs and age. While younger workers may use target-date funds when entering the workforce, it might be a better idea to switch to managed accounts once workers get to their 40s, Hess says. Many people need help figuring this out.
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During the three years studied, participants with appropriate risk levels underperformed in only one instance—when compared with low-risk partici- pant investors in the bear market of 2008. Otherwise, appropriately risked investors performed better or the same in every other market condition.
The study showed target-date fund users had the shortest work tenure and were on average 38 years old, with a $6,300 account balance. Managed account users had 12½ years of service, were on average 49 years old and had $45,000.
Online users worked fewer years and were younger than managed account users but had higher account balances of nearly $70,000. By comparison, non-help users averaged 45 years old, had similar tenures to online users, but had significantly lower average balance of nearly $43,000.
Employers need to have various kinds of professional investment help available for the different needs of their workforces. Older workers nearing retirement should be given special attention to avoid last-minute mistakes. “Having a personal plan is critical at that point,” Hess says. “If you get it wrong, you can’t retire. There is a big downside.”
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Meanwhile, though it’s unclear why many participants don’t use professional investment advice, the Labor Department is expected to issue soon a proposed regulation on investment advice given to plan participants. Late last year, a Bush administration rule on mutual fund companies giving investment advice was pulled, with the intent of a broader, more plan participant-friendly regulation to be issued early this year.
“I am hopeful sponsors feel more at ease with fiduciary responsibilities around” offering investment advice, Hess says.
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Workforce Management, May 2010, p. 12 — Subscribe Now!