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Healthcare Reform May Harm Pension Plans

“American Health Care Act” May Drain Money From Retirement Savings

House Republicans introduced the “American Health Care Act” today,  following up on their campaign pledge to “repeal and replace Obamacare.”  I won’t opine on the provisions of the bill since I am not a healthcare  expert.

However, the bill does contain a provision which many retirement professionals believe will be damaging to retirement savings.  The bill eliminates many of the subsidies Obamacare provides for lower-income Americans to pay for health insurance.  To replace the subsidies, the bill provides for “tax credits” Americans may use to partially offset the cost of paying health insurance premiums.  And, since these tax credits will likely not provide for the same level of funding as current Obamacare subsidies, the bill encourages Americans to save for healthcare expenses in Healthcare Savings Accounts, or “HSA’s.”  This is a bad idea for many reasons:

  • First of all, we know that the vast majority of Americans aren’t saving enough for their retirement.  If they are now told they have to also start putting money aside for healthcare expenses, the combined burden may be impossible for most Americans.
  • As you would expect, many Americans can’t fully fund their retirement savings accounts AND their healthcare savings accounts.  So, they have to make a choice. Most retirement professionals agree that providing for current healthcare needs will outweigh the need for “down the road” retirement.  So, retirement savings rates will drop for many Americans so they can (try) to fund their healthcare needs.
  • While HSA’s have been promoted for decades as a way to provide for healthcare expenses, the fact of the matter is that they don’t work.  The vast majority of Americans don’t save the amount of money to cover expenses for “high deductible plans.”  For wealthy Americans, they are a viable option.  But for the majority of Americans HSA/high deductible plans  don’t work and we should stop pretending that they do, or will.

There may be merits to portions of the healthcare bill introduced today, but the inclusion of HSA’s is not one of them.  There is the old adage that “retirement depends on savings”, and “healthcare depends on premiums.”  Let’s keep it that way.

 

 

The Many Virtues of “Benchmarking”

 

Plan sponsors in the public sector use the Request for Proposal (RFP) process as an easy (though time-consuming) and reliable way to obtain market information.   A well-constructed RFP and evaluation process can be invaluable. It permits the plan sponsor to make decisions on plan design, administrative services, investments, fees and participant services on a regular basis. It also helps in fulfilling some, but not all, fiduciary obligations.

As helpful as the RFP process is, it is not the only tool a fiduciary should use to gauge the effectiveness of their defined contribution plan. For one thing, the RFP process is usually conducted once every few years. In the current environment, the market changes nearly daily, so an RFP process every five to seven years simply doesn’t keep up with what is going on in the market. However, it would be inefficient to use an RFP process more frequently because the process itself is time consuming and, depending on local or state bid or procurement rules, entails a lot of extra work to obtain basic information for comparative purposes. So, the RFP process is a necessary and important tool that should be used every five to seven years; but it must not be your only measurement tool.

In between the regular RFP cycle, there are other options that should be used by plan sponsors to be certain they are fulfilling their fiduciary duties. One such tool was discussed in this column last November. A regular “Due Diligence” process is an excellent tool to use every couple of years to supplement the RFP activity. This provides an easy and informative way to obtain information on what other plan sponsors are doing, and how their program compares to your program.  [See article on this topic below or under archives for November, 2016].

Another tool is a simple Benchmarking Study. Information from your most recent RFP and your most recent Due Diligence study can easily be placed into a spreadsheet and updated regularly. The items you would want to benchmark are:

  • Administrative Fees
  • Investment Management Fees
  • Participation
  • Average Deferral Rates or Amounts
  • Auto-Enrollment and Auto-Escalation details
  • Default Options
  • Year Over Year Investment Performance (of Asset Classes) Opposite Benchmarks

Once you have identified the “similarly situated” plan sponsors in your Due Diligence study, it is easy to record and update these critical measures (and others) to demonstrate whether your plan is improving over time compared to benchmarks, or going backwards. Benchmarks can be measurements you pick as objective, and/or are those of similarly situated plans you have identified as part of your peer group. Consistent and accurate measurement of features for your plan, compared to your peer group are very important. If you plan is not improving when compared to your peer group over time, you may have a problem.

Benchmarking key items, and keeping them updated, is an excellent way to demonstrate to participants that you are fulfilling your fiduciary duties by continually monitoring key items and improving your plan. It is easy to lift benchmarking data from the Fund Performance Review prepared by you or your consultant and put it in the Benchmarking Study. The key is to keep the Benchmarking Study simple and current. Be sure to measure the relevant items that you have determined to be important measures of “good plan governance.”

The RFP process, Due Diligence Study, and Benchmarking are all key tools that make fulfilling your fiduciary obligation easier and more effective in the long run.  Don’t make the mistake of just relying on the RFP process alone to fulfill your fiduciary obligations to plan participants and their beneficiaries.

 

 

Due Diligence Study Just as Important as an RFP Process

 

Most public plan sponsors are very diligent about conducting public bids for their defined contribution pension plans on a regular basis. Depending upon local laws or customs, most public plan sponsors conduct a formal Request for Proposal (RFP) every five to seven years.

While the formal public bid process is an important activity for every fiduciary, it is not the only way to fulfill your obligations to plan participants and beneficiaries. Every plan sponsor should conduct a “due diligence” process annually. The purpose of a due diligence study is different from an RFP process in the following ways:

  • A due diligence study compares your plan to other “similarly situated” plans in your geographic area, and to other similar plans on a national basis. This is a “plan sponsor to plan sponsor” comparison, or benchmarking, as opposed to formal responses to an RFP from vendors.
  • Due diligence studies are less formal than an RFP process, and dialogue with other plan sponsors, stakeholders, and vendors is encouraged. The RFP process is more rigid, and therefore more meaningful if it is preceded by a due diligence study. A due diligence study can help educate board members in advance of the more formal RFP process.
  • A well-executed due diligence study can be more enlightening than the RFP process because it permits a direct comparison of plan features, plan design, fees, and services with other similar plans. A formal RFP process tells you what vendors can offer in regard to these services, but it won’t tell you all the “best practices” your fellow plan sponsors are using.
  • Finally, a due diligence study permits other plan sponsors to comment on your particular plan, and to offer observations and experience with the same or similar issues.

You don’t necessarily need to hire a consultant to conduct your own due diligence study. A consultant may guide you in organizing your questions for other plan sponsors, but it is very useful for board members and staff to actually conduct the due diligence interviews on their own. A “peer to peer” discussion with other plan sponsors can be extremely useful. And, the other plan sponsors participating in your study can reciprocate by using your information for their own due diligence study.

And don’t forget vendors. Consult them on “best practices” as well. You will likely find those conversations very enlightening, especially if they are with a vendor who opted not to bid on your program the last time you issued an RFP. I recently had a call from a large public plan sponsor who was disturbed that their last RFP garnered only one response- from their current vendor. All other vendors opted to decline. I asked the plan sponsor if they had conducted a due diligence study before the RFP, and the answer was “no.” After I encouraged a few phone calls to key people in the market, this particular plan sponsor learned of three requirements in their RFP that motivated most vendors to decline. These three requirements could have been easily modified if the plan sponsor had discussions with other similarly situated plan sponsors before drafting the RFP.

There is no mandatory format for a due diligence study. Talk to others and be creative. The important thing is to have an ongoing due diligence process that is conducted annually. If you’ve not done it before, you will be surprised at what you will learn by doing so.

Gregory Seller Consulting, LLC

All rights reserved. May not be reprinted in whole or in part without written permission. Provided for information only and is not legal or investment advice. Plan sponsors should seek their own legal counsel on these issues.

Economic Issues Confront State-Sponsored Retirement Plans for the Private Sector

At last count, 17 states have considered legislation to establish retirement plans for private sector employees that would be operated by state governments. Four states (California, Illinois, Oregon and Massachusetts) have actually enacted legislation creating such plans, subject to a variety of organizational and implementation steps.

There remain a number of regulatory and legal concerns, not the least of which is obtaining an exemption from ERISA (Employee Retirement Security Act of 1974) that otherwise applies to retirement programs established for private sector employers. Without this exemption, operating such plans could create potentially onerous obligations for governments and the taxpayers in the affected states.

While the ERISA exemption has been the primary focus of most public debate on this creation of such plans, there is another looming issue that could be just as significant.

Who Takes the Financial Risk of Operating These Plans?

Thus far, the legislation in the affected states requires that these plans be self-sufficient, and not require any taxpayer subsidy to create and operate plans. While this sounds like a reasonable requirement, the economic facts of creating a new plan are formidable:

  • Record keeping costs are relatively fixed. It costs about the same to maintain a million dollar 401(k) account as it does one with just a few thousand dollars in it. Since most of these plans would be created with no existing assets, the upfront costs of establishing the record keeping and administrative functions could not be borne by the participants unless a significant portion of these costs were deferred or subsidized in the early years. So, the first question is who pays to establish the infrastructure of these plans until they can be “self-supporting”?
  • Since these plans would be created (primarily) to serve very small employers, the operational expenses will be far grater than plans established for medium-sized to larger plan sponsors. Small employers tend to have very manual operations and it could prove difficult to rely on automated systems for contributions, benefit payments and other routine functions of daily plan governance.
  • Small employers do not have the Human Relations (HR) or Benefits Department apparatus that exists in most other companies of even relatively modest size. With no HR or Benefits department in these small employer operations, the state-run system is going to have to assume virtually all the functions of enrollment, monitoring and communication that would otherwise be handled by or shared with the employer.
  • Participant service functions (call centers, etc.) are much more costly for small plans where the employer may have a work force that is not used to self-service benefit arrangements handled on-line. As any retirement vendor will tell you, servicing small and micro-plans is very costly, not only with respect to routine administrative functions, but for participant service functions as well.

It remains to be seen how all of these upfront costs will be paid for if these plans are to be “self-sufficient” when there are no assets to begin with. New plans, without any rollover assets, can take years to accumulate enough in assets to fund operational and communication expenses through a reasonable asset fee.

What About Competition?

No service provider, state-run or otherwise, is immune from the impact of competition. Just because the micro-market is not well served today does not mean it will forever be a “market orphan”.   As other entities (private and public) find creative ways to serve the micro-market, state-run plans will have to determine how they protect plan participants and plan sponsors from the impact of diminished assets that could result from competing plans in the future. In the private sector, this risk is mitigated by the capital a company is prepared to devote to supporting the business. In state-run plans that are “self-supporting”, what happens when costs rise or assets are depleted, or both, due to competition? How can participants be protected from having their fees increase due to a shrinking pool of assets with fixed administrative and operational costs?

Prudent Study and Modeling 

Most legislation appears to require a series of prudent steps in order to implement these plans. The economic issues noted above, and ways to mitigate expense risk to participants will likely be a larger issue than the ERISA exemption. With careful planning and modeling, such solutions may be possible, but they won’t be easy. Not unless someone, like the taxpayer, is ultimately on the hook for the risk.

 

Recent NAGDCA Agenda Shows Creativity Still Alive in Government DC Market

Following my attendance at the 2014 NAGDCA Conference I posted an article about how disappointing it was that the conference agenda contained so little fresh and new.   This year’s Indianapolis conference agenda was much more innovative and refreshing.

My favorite session was titled “The What, Why and How of Structuring Investment Menus: Contrasting Case Studies.” All of the speakers had something significant to contribute. The session was moderated by Richard Davies of AB (AllianceBernstein), and the panelists were Steven Montagna, City of Los Angeles, Jeffrey Cable, Colorado PERA, and Cindy Rehmeier of the Missouri Employees Retirement System (MOSERS).

Different Solutions, But Equally Successful

What I liked best about this session is that it presented three very distinct and different ways of structuring plan investment menus. Each of these plans is very successful, and highly regarded. Yet each one has chosen a different way of designing their investment array, and how they are offered to plan participants.

MOSERS is to be commended for using auto-enrollment and voluntary auto-escalation. Custom asset allocation funds are the default option, and MOSERS has done a great job moving participants from a confusing array of 31 investment options in 2009 to a more streamlined and contemporary design of funds that are segmented into three major categories. The custom target date funds are designed for the majority of participants who don’t want to make investment decisions. A second tier offers a stable income option, and an opportunity to participate in the commingled pool used to fund the defined benefit plan. For active investors, there is a self-directed brokerage option. Auto-enrollment is a tremendous idea more plans should adopt. Unitization of the defined benefit fund as an investment option for the defined contribution plan is an innovative idea. Whether it will catch on with most participants is unknown, and is administratively complex, but it shows creative thinking.

Colorado PERA uses a thoughtful “three tier” approach with an excellent focus on low cost institutional funds. The basic tier includes PERA target date funds, with a second tier offering seven custom asset class funds. These funds permit participants to set their own asset allocations, instead of having someone do it for them in the target date funds. A third tier includes the self-directed brokerage account for participants who think they always know better than anyone else. The Colorado program has devised a simple way for participants to customize their own asset allocations without having to select from expensive retail funds. This creative design serves three different plans (457, 401(k) and a DC Choice plan alternative to the state defined benefit plan).

The City of Los Angeles program is perhaps the most different of all from the “conventional” design of defined contribution plans. For starters, the City of Los Angeles plan does not offer target date funds. Instead, the plan offers five risk-based funds (ultra-conservative, conservative, moderate, aggressive, and ultra-aggressive). All funds are institutionally priced with very low fees.   The second tier offers more savvy investors a choice of seven “white label” funds constructed around asset classes (core bond, core large-cap, etc). This allows participants to design their own custom asset allocation rather than use one of the risk-based asset allocation funds. And, like the other plans there is a self-directed brokerage option for that small percentage of participants who think they always know investments better than anyone else.

Refreshing and Creative

It is very refreshing to see the way each of these plans tailored their investment array to their own participants, without using “easy way out” options like offering only target date funds.   I have long felt that the rush to target date funds was not the panacea many plan sponsors thought they were. There are many plan sponsors who raised their hands in an “alleluia” moment, thinking that target date funds are the ultimate solution for their participants, and that nothing else would come after that. All three of these plan sponsors have “evolved” beyond just offering target date funds, and that is great idea.

Thinking Beyond Target Date Funds

Though target date funds have been widely trumpeted as the best way to “bundle” participants into logical groupings, many of us have always had trouble buying the whole concept of everyone the same age having exactly the same asset allocation needs. To me, it just never made sense. If you take everyone age 50, or whatever age, there is simply no way that everyone in that age group has the same needs. People of the same age have different risk tolerances, different family issues, different sources of future and current income, and different desires for post-retirement income and legacy planning. In my own situation during my working career, I opted out of target date funds and selected managed accounts because I didn’t feel the asset allocation in the target date fund for my age group made any sense for my personal circumstances. I know of many other retirement professionals who did the same thing, many of whom opted for risk-based funds instead of age-based funds.

The Thinking on Target Date Funds is Evolving

There has been much written on this topic over the past ten years or so, and I am glad to see that the defined contribution industry is finally moving beyond target date funds being the “ultimate” solution. I like the City of Los Angeles approach in particular because it doesn’t even pretend that risk tolerance is age-related. The fact that no target date funds are offered is refreshing. It takes a bit of courage to do what Los Angeles did, and I like that. Of course, Los Angeles is my hometown and I readily admit that people in California think a bit differently. The Los Angeles approach may not work well in other places, but I think it is refreshingly honest to have an investment array that emphasizes individual relationship to risk (asset allocation funds) rather than the easier alternative of lumping participants by age group. In that regard, both Colorado PERA and MOSERS offer creative options to the conventional target date fund design. Los Angeles just goes one step further and shows that a highly successful plan with impressive characteristics does not necessarily have to offer target date funds.

Grouping by Zodiac Sign May Make More Sense Than Age Grouping!

While I am not opposed to target date funds, I don’t think they are the great solution many people think they are. You can easily make an argument that asset allocation funds based on your zodiac sign would be better than age! Yes, I think it is plausible that you could design an asset allocation fund suited to Libra’s that is better tailored to their characteristics than a single fund for everyone who is between the ages of 45 and 50! While that is a humorous idea, it makes a point.  And, if a plan sets up funds based on your zodiac sign, it will most certainly be done first in California!

I commend each of these three plan sponsors for thinking “outside the box” in their plan design. I think this is truly one of NAGDCA’s best sessions and it offers three very intriguing ways to think about your plan investment menu. Whether any of these three creative approaches work for you and your participants isn’t the point. The point is that the government defined contribution market is still evolving, thank goodness, and so is the wisdom surrounding the design of the investment menu.

Great Work by the Annual Conference Committee

In addition to the speakers recognized above, I would like to thank the 2015 NAGDCA Annual Conference Committee, chaired by Polly Scott of Wyoming. The other members were Kathleen Wilson, Jim Link, John Bourne, John Eckhardt, Regina Hilbert, Erin Sheridan, and Rey Guillen. Thank your for an informative conference agenda, and in particular, for this very creative and energizing session.

 

“Code of Conduct for Public Pension Service Providers” Should be a Two-Way Street

 

According to a recent article in PLANSPONSOR® (May 6, 2015), the National Conference on Public Employee Retirement Systems (NCPERS) has developed a 10-point voluntary “Code of Conduct” for service providers to public employee pension programs.

According to the article, the plan requires service providers to:

  • Act in a professional and ethical manner at all times in dealings with public plan clients;
  • Act for the benefit of public plan clients;
  • Act with independence and objectivity;
  • Fully disclose to public plan clients conflicts of interest that arise that may impair the ability to act independently or objectively;
  • Act with reasonable care, skill, competence, and diligence when engaging in professional activities;
  • Communicate with public plan clients in a timely and accurate manner;
  • Uphold the applicable law, rules, and regulations governing their sector and profession;
  • Fully disclose to public plan clients all fees and charged for the products or services provided to said client;
  • Not advocate for the diminishment of public defined benefit plans, and;
  • Fully disclose all contributions made to entities enumerated in Schedule A that advocate for the diminishment of public defined benefit plans.

Most public and private pension professionals would certainly agree that most of the points above should be expected of any professional entity operating in the public pension arena. And it should not apply just to “service providers”. It should also apply to the conduct of public retirement systems as well.   Perhaps that was the intention of NCPERS, but if so, it doesn’t say that. To make it clear that both parties are bound by this conduct, some modifications are in order:

  1. Public pension systems also have an obligation to fully disclose the facts, including a more realistic measurement of potential costs to all stakeholders. The public deserves to know what the implications are if the assumed rate of return for the public retirement system fails to materialize.   What would be the impact on the system and on stakeholders? A study by Cheiron for a state retirement system in 2013 calculated that there was only a 40% chance the retirement system would achieve it’s assumed rate of return of 7.5% over the next 20 years. Studies like that need to be conducted by every public retirement system, and the results need to be shared with all stakeholders. Public retirement systems also need to act with “independence and objectivity” in developing alternative plans of action if the assumptions turn out to be wrong. And, those alternatives should be openly debated by all stakeholders.    In January of 2014, The Nelson A. Rockefeller Institute of Government issued a report   titled “Strengthening the Security of Public Sector Defined Benefit Plans”. The report makes a compelling argument that the proper rate for valuing pension liabilities on financial statements is separate from the question of what pension funds assume they will earn on their investments. This report, and others like it argue that the public sector is not doing all it could to fairly and objectively estimate the potential long-term costs of their system. Some retirement systems deal with this better than others, of course. However, there remains a prevailing “circle the wagons” mentality in too many public systems where there is reluctance to deal openly and honestly with stakeholders about the potential cost of funding current benefit obligations.
  1. This brings to the last two points in the “Code of Conduct”. Service providers must:
  • Not advocate for the diminishment of public defined benefit plans, and;
  • Fully disclose all contributions made to entities enumerated in Schedule A that advocate for the diminishment of public defined benefit plans.

Any public entity that relies entirely on taxpayer funds should not try to stifle free speech. Penalizing taxpayers and other stakeholders for engaging in a public debate is just bad government. There is never an acceptable excuse to limit or restrict free speech, yet this is what these two points seem to imply. It could be argued that, in some jurisdictions, it may even be illegal to use a public contract for services to muzzle any discussion about a public entity that could be deemed “diminishing”[1]. I’m not a lawyer, so I will leave that discussion to others.

This is not the first time these types of provisions have been used by public retirement systems and/or boards that oversee public pensions. At least one state government has a clause in their contract with their service provider that prohibits them from saying anything negative about the defined benefit plan, or engaging in any public discussion that may appear threatening to the policies of the Board.

A city in California has a clause in their contract that permits them to fire their vendor if any staff member (including employees who live in that city) speak to the city council about any issues they have with plan governance. In other words, don’t bring any possible missteps to the attention of the elected officials on the city council. If you do, you’re fired and not eligible to bid on the plan again. While it is unlikely that any court would agree that a public entity can prohibit taxpayers from speaking with their public officials, the vendor (in this case) signed the agreement for fear of losing the contract.

There are other examples besides those above. The point that is lost on so many public retirement systems is that any public discussion of retirement plans, funding alternatives, benefits, and yes, even alternative plan designs, is a healthy exercise. Many individuals, companies, and research organizations are, in fact, trying to encourage steps that would shore up these systems and make them more sustainable in the long-term.  Not everyone who shares an opinion is an enemy lurking around the corner. When any pubic entity sees public commentary as an enemy, it diminishes the ability to craft creative solutions to pension system problems.

It is this type of behavior, and the failure to engage in honest and objective discussions of defined benefit plans that is feeding taxpayer angst about public sector pension plans. Voters in cities like San Diego and San Jose may have felt differently about their ballot initiatives if they had confidence in the integrity, objectivity and cost assumptions used by their public pension officials.

Entities that are fully taxpayer supported (by individual and corporate taxpayers alike) are only creating suspicion and mistrust when a code of conduct is “one-sided” and punishes any free speech the system finds “diminishing” (however defined) to the system.

Gregory Seller

Gregory Seller Consulting, LLC

Gregg is an independent consultant specializing in public and private pension advocacy, plan architecture and design, and thought leadership for public pension policy. His practice is fostering debate on improving public and private pensions in the United States, and on the more efficient delivery of secure pension benefits to plan participants.

For more information on this topic and related issues in public plan governance, please go to: www.gregoryseller.com

Provided for information only and is not legal or investment advice. Plan sponsors should seek their own legal counsel on theses and other matters regarding their fiduciary responsibility.

[1] There are several definitions for “diminishment”. One of them is “The act of reducing in size, quantity or quality.” Merriam Webster® defines it as (among others)  “To become or to cause (something) to be less in size, importance, etc.”

Rockefeller Institute Gets it Right

 

In January of 2014, The Nelson A. Rockefeller Institute of Government issued a report titled “Strengthening the Security of Public Sector Defined Benefit Plans”.[1]

The report makes a compelling argument that the proper rate for valuing pension liabilities on financial statements is separate from the question of what pension funds assume they will earn on their investments.

A More Accurate Estimate of Ultimate Cost

Rather than valuing future liabilities based on the “assumed rate of return” declared by the pension system, the report says a fairer picture of the true cost of the plan for all stakeholders would be a discount rate tied to some instrument like high quality municipal bond rates.

It is important to emphasize that this study, and others like it, aren’t opposed to retirement systems setting target or “assumed” rates of future return for investment purposes. The important distinction is that, for financial statements, it would be far more reasonable to use a discount rate from actual market instruments, instead of some “assumed” long term rate in the future.

Nothing to be Afraid of

Unfortunately, many public retirement systems have taken a negative view of this proposal.   The fear seems to be that taxpayers and other stakeholders will be shocked by what they see as the potential long -term cost of the plan, when measured more conservatively. In that regard, the study does not argue for valuing such plans on a “risk free” rate of return, as have some other similar studies. Instead, it advocates for the use of a discount rate on high quality municipal bonds, or something similar.

Administrators of public retirement systems should not fear using such a measurement.   In actuality, it would  help the longer- term health of these plans if there was a more frank and realistic discussion of what the costs of these plans could be, particularly if they are not managed prudently. It would also make politicians less likely to skip or reduce required pension payments since it would highlight the impacts of under-funding more significantly.

Stakeholders deserve a more honest assessment of what these plans will likely cost. Shareholders in a corporation may vote with their feet by selling shares in a company that is not properly managing its pension liabilities. Taxpayers, on the other hand, can’t opt to do the same thing unless they pick up and move to another locality, which can be a costly and impractical proposition.

Being Well Informed is Better Than Ignorance

Since as much as 70% of the benefits from a retirement system can be derived from investment returns, it is of course important to maximize earnings as prudently as possible. However, it is equally important to minimize risk, and to evaluate those risks in the most realistic fashion. Keeping stakeholders in the dark about the true ultimate costs of these plans will only increase the negative feelings and apprehension that has been building against public sector defined benefit plans for the past decade. A more honest and forthright estimate of potential costs will serve to benefit public employees in a number of ways, including making required funding payments and avoiding political tampering with benefits and cost estimates. In the long run, that will not only bolster the financial security of these plans, but also make them more respected for being prudently managed.

I encourage you to read the full report at www.rockinst.org.

Gregory Seller Consulting, LLC

All rights reserved. May not be reprinted in whole or in part without written permission. Provided for information only and is not legal or investment advice. Plan sponsors should seek their own legal and investment advice on this issue.

 

 

 

[1] The Nelson A. Rockefeller Institute of Government is the public policy research arm of the State University of New York. The full report may be accessed at www.rockinst.org

PUBLIC EMPLOYEES TAKE THEIR PLACE AT THE END OF THE LINE

PLANSPONSOR© magazine released their “Plan Sponsors of the Year” awards today in the latest issue. As in past years, the awards bestowed by the magazine showcase the “best in class” approach used by many plan sponsors who take their fiduciary responsibility to employees seriously. The plan sponsors recognized have taken a number of creative actions to improve the retirement prospects for their employees. Among them:

  • Auto-enrollment and auto-escalation
  • Revamped fund line-ups with lower cost and better performing funds
  • Automatic default to Target Date Funds or Managed Accounts
  • Recent competitive bids to ensure that they are offering the best services at the lowest cost in the market, for both recordkeeping, and investment services.

A variety of corporate plans are showcased, each one with an impressive track record for effective plan governance that puts the interests of employees above all else. That is, of course, until you scroll over to see the article on the Public DC award.

Public Employees Come Last

The public DC plan to receive the award has three different record keepers, 83 investment options, dismal usage of default investments, and a somewhat average participation rate. The investment offerings are, for the most part, mediocre and quite expensive for a plan with over $200 million in assets. With 83 investment options, the City has severely diluted its ability to negotiate lower fees from investment providers. There is rampant duplication of fund asset classes, and no clear way for participants to discern what are the least costly and better performing options among the 83 fund array. There is a proliferation of proprietary-investment funds that would never survive an independent competitive fund review in an open and independent public bid process.   The investment providers, sales brokers and unions appear to be running the show, all to the detriment of the plan participants.

An Award for Perseverance Against Adversity Rather Than “Best Practice”

Ironically, the article on the Public DC Plan is really a feature about the efforts of a dedicated employee in the Human Resources (HR) department to “fix” the Plan, over the objections of the DC Board that (apparently) runs the Plan.  Instead of a “best practice” example (which is the theme for the corporate plans recognized) the article champions the efforts of a  HR employee to remake the Plan into something far better for the employees. In that regard, the article is very kind given the history this Plan has for lack of transparency and self-dealing.

To their credit, the City did undertake a public bid process a couple of years ago. Sadly, the public bid was never concluded in a meaningful way for Plan Participants:

  • At least one union objected to any independent review of the Plan, in particular the option endorsed by them (for which they are receiving a fee from that particular provider).
  •  Another vendor undertook a nasty campaign to toss out the entire public bid process. At one point in their letter this vendor says their current contract is “open-ended and the City is not obligated to issue a RFP (Request for Proposal)”. Really? So it is a never-ending contract that should never be reviewed by anyone?

Sadly, the City caved to pressure from investment companies and unions and made no real significant changes. Investment options were cut back from over 100 to 83, but little else (for participants) changed. The real losers were the Plan Participants who, for a City of this size, have a confusing and very expensive program.

Transparency Issues Ignored

There was no attempt to fix the transparency issues for this Plan, during or after the failed bid process. For example, there is no up-front disclosure that two of the three providers pay fees to third party unions or associations in return for an endorsement. There’s nothing inherently wrong with endorsement fees provided the fees are disclosed to Plan Participants (which they are not, at least not easy to find) and that the endorsing entities perform some regular due diligence on why they endorse that particular company. In both instances here there is no documentation that a public bid or independent evaluation has ever taken place to award the endorsement to either vendor. Perhaps there has been, but it is not disclosed to Plan Participants. The City could have easily fixed this by demanding full disclosure from all three vendors. They obviously chose not to.

Public Employees Finish Last, Again

So the bottom line is that the PLANSPONSOR® awards for corporate plans recognize “best practice” fiduciary responsibility where governing boards and committees take action based on the “best interests of plan participants and their beneficiaries”[1]. Sadly, the award for the public sector DC plan focuses on actions by a single employee to (try) to overcome inaction by a governing board that obviously views its constituents as the Plan vendors and unions instead of their employees.

This is not the only City in America to undermine the interests of Plan Participants by failing to successfully conduct regular, independent reviews of all aspects of their program. Fortunately, most other large cities take their responsibility seriously and conduct frequent, independent bids to ensure that all aspects of their program are competitive, contemporary and in the “best interests of plan participants and their beneficiaries”[2].

Maybe next year the Public DC award will be given to this particular City for actually fixing their program. Or, if history repeats itself, the heading of the award for this City might as well be titled “Don’t Let This Happen to You!”

Gregory Seller Consulting, LLC

All rights reserved. May not be reprinted in whole or in part without written permission. Provided for information only and is not legal or investment advice. Plan sponsors should seek their own legal and investment advice on this issue.

 

[1] IRC Sec 457(b)

[2] IRC Sec 457(b)

STABLE VALUE CHARADE: Analysis Shows “Multi-Manager/Multi-Wrap” Scheme a Bad Deal For Participants But A Money Maker for Your Consultant

More and more plan sponsors have moved to create Custom Stable Value Funds for their plans over the past decade, and this has been a tremendous benefit for plan participants. Custom Stable Value Funds offer greater fee transparency, lower fees (in most cases) and avoid the risks inherent in “pooled” arrangements with other plan sponsors over whom you have no control. They also permit the plan sponsor to exercise more control over investment policy and portfolio quality.

Evolution of “Multi-Manager/Multi-Wrap” Stable Value Funds

When most plan sponsors first created their Custom Stable Value Funds, they were usually composed of one investment manager and one “wrap” provider. The “wrap” provider (generally an insurance company) guarantees liquidity for book value benefit payments to plan participants. In some situations the investment manager was also the wrap provider and in other situations the wrap provider was different.

As the assets in Custom Stable Value Funds have grown, there has been a trend to move away from “single -manager/single- wrap provider” arrangements to “multi-manager/multi-wrap provider arrangements.” Some consultants recommend the “multi-manager/multi-wrap” design because they argue that diversification of managers and diversification of wrap providers is better than the “single –manager/single-wrap provider” design. However, a recent analysis of several large Governmental Custom Stable Value Funds calls into question whether the “multi” arrangements have any real benefits for plan participants. To the contrary, the analysis shows that most of these “multi” funds have significantly higher fees and lower yields than their “single” counterparts.

“Multi-Manager/Multi-Wrap” Generally Means “Multi-Layering of Fee Upon Fee”

For our analysis, we examined publicly available information on over two dozen large State, County, and City defined contribution programs. While the sampling was random, it included a diverse number of plans with different vendors, managers, consultants and plan designs.

Without exception, every single “multi-manager/multi-wrap” Custom Stable Value Fund had higher overall fees, and lower overall yields than funds of similar size that used the “single-manager/single-wrap” design.[1]

  •  In some situations the differences were startling:

Two adjoining states have Custom Stable Value Funds. For the one state (let’s call it State ‘A’), the assets in the Custom Stable Value Fund are about $2.0 Billion. For the other state (let’s call it State ‘B’) the assets in the Custom Stable Value Fund are just over $1 Billion, or about half of the asset size of State ‘A’.

A few years ago, at the recommendation of their consultant, State ‘A’ converted from a “single-manager/single-wrap” to a “multi-manager/multi-wrap” arrangement. When the conversion was made, the total fees for the Custom Stable Value Fund maintained by State ‘A’ increased nearly three-fold. According to the fund summary the total fees for investment management, fund oversight, and administrative fees are approximately .44%. Fees are paid to multiple managers, multiple wrap providers, and a separate entity that oversees the “cash buffer” of the fund. The average yield for last year appears to be about 1.80% according to the plan web site.

Conversely, State ‘B’, which has a Custom Stable Value Fund that is half the size of State ‘A’ has total fees (investment management, book value wrapper, and administrative fee) of approximately .20%. The average yield for last year appears to be about 2.60% according to the plan web site.

Investment policy and other primary features are similar, yet the fees for the “multi” arrangement appear to be three times the cost of the “single” arrangement when investment management fees are compared side-by-side with administrative fees removed. To add to the irony, the fund with the higher fees is twice the size of the other fund, which would generally not be the case.

The pattern outlined above was similar for all of the funds examined. A large City and a large County in California (with different vendors and consultants) both converted from “single” to “multi” fund structure for their Custom Stable Value Funds at about the same time. In both situations, overall fees increased two to three times over the prior arrangement, and the net yield to participants plummeted. Other variables such as credit quality and investment policy were similar.

We could not find a single example where a conversion from “single” to “multi” designs lowered fees or improved yields.

The “Diversification” Argument

Consultants who advocate “multi” arrangements cannot argue with the fact that these arrangements are almost always more expensive and incredibly more complex to manage. However, they argue that there are benefits to diversification. If so, then what exactly are those benefits? Where is the data that show some future “benefit” of higher fees and lower yields? Some advocates of “multi’ arrangements speculate about fund-meltdown scenarios in which a “multi” wrap fund may have greater protection, but there are no actual facts of such situations to justify the higher fees. If one of your wrap providers fails, it makes little difference whether you have one wrapper or many – the fact is you have to replace the wrap provider who no longer meets your credit quality guidelines.

“Top of Scale” Fees

One of the most basic flaws of “multi” arrangements is the fact that plan participants lose the advantage of downscaling fees that nearly all fund managers offer. The more money you place with them, the lower your fees. So, when you hire five managers in place of one, you are at the top of the fee scale for all of those managers. That is one reason for the large increase in management fees in “multi” arrangements, and it is a disadvantage that does not go away.

Other Common Myths of the “Multi” Custom Stable Value Fund Design

  • Manager “Style” Specialty

 Managing bonds is not like managing stocks. Stocks are different, and different managers have different specialties. Bonds don’t have characteristics like stocks. Once you determine what percentage of your portfolio you want in AAA Corporates, or Government-backed securities, Treasuries, etc, nearly any large manager can go to the market and very efficiently purchase and manage your “basket” of bonds. Assuming your Investment Policy Statement for the Fund is clear, there’s not much room for “discretionary” choices like there are in stocks. The argument that a collection of bond managers can provide better selection and management than an overall manager is dubious when it comes to the size of the vast majority of Custom Stable Value funds. An exception would be in private placements, but this would not be a fund holding for the vast majority of Governmental defined contribution plans.

  •  “Wrapper” Diversification

Whether you have ten wrap providers or one, the main issue is credit quality and the ability to guarantee book value benefits. It’s easier to monitor and oversee one wrap provider than a variety, many of whom are small and have lesser credit quality than the larger firms. In one recent large plan that was out to bid, one of their wrap providers had already fallen below the minimum credit quality standards and was technically ineligible to be a wrap provider. This fact was pointed out by a potential bidder. Neither the consultant or plan sponsor was aware of that fact. These “multi” arrangements have many moving parts and require a higher level of oversight.

A Bummer for Retirees

 Retirees are still big users of Stable Value Funds. In once recent conversion from “single” to “multi” fund design, the fund yield dropped over .50% on the date of conversion due to higher fees investment management fees and a doubling of wrap fees. Retirees were understandably upset. When fixed yields are already at historic lows, a drop of .50% in yield can mean a big difference in draw-down income for retirees.

High Fees in a Low Interest Rate Environment

In a double-digit interest rate environment, a fee increase from .15% to .40% is not nearly as painful as the same increase in an interest rate environment where the gross yield is hovering around 2%-3%. In the current environment, every penny of fixed income yield makes a difference, so it is hard to justify the hefty fee increases in “multi” arrangements, regardless of the hypothetical arguments on diversification.

For huge Custom Stable Value Funds over $5 Billion, there are some scenarios where a dual or triple manager arrangement may make financial and investment sense. And, for some jumbo funds, one wrap provider may have a limit on the risk they will underwrite. But for the vast majority of Governmental Custom Stable Value Funds, the “multi” arrangements are just a bad deal for the participant, and a fee bonanza for the consultant.

Conflict of Interest Abounds

One of the more disturbing findings in our analysis is that in over half the situations examined, the consultant who recommended the “multi” design is also the manager of the new arrangement. A prudent plan sponsor should never permit that to happen. In a couple of situations, the consultant billings increased two fold after moving to a multi-manager/multi-wrap arrangement. In both situations, participants pay the consultant fees from fund revenue.

As we have discussed before, a plan sponsor should never permit a consultant to benefit from a recommendation he or she makes for a new product or service. To be certain your consultant is recommending a “multi” arrangement for the right reasons (if there really are any) be sure to tell them that they cannot be hired as a manager or provider for any services in any plan design or product structure they recommend.

For more information on this topic see the related article “Does Your Consultant Have a Conflict of Interest?”, February 5, 2014.

Not the Last Word…..

The debate on this issue will continue, of course. However, given the facts of high fees and falling yields in the market, “multi” arrangements will continue to be under pressure to justify this cumbersome and expensive fund design with no clear advantage for plan participants.  If rates continue to fall, it is conceivable that in some of the worst of these arrangements, the fees will outstrip the income to the point where the net yields drop below 1.00%.  The important question for the plan sponsor to ask is who really benefits from a conversion to a “multi-manager/multi-wrap” fund design, and who will suffer?

 

Gregory Seller Consulting, LLC

All rights reserved. May not be reprinted in whole or in part without written permission. Provided for information only and is not legal or investment advice. Plan sponsors should seek their own legal and investment advice on this issue.

 

 

 

[1] One exception being a Custom Stable Value Fund with over $10 billion in assets, for which a comparable fund was not examined.

A Chasm of Good Intentions

September 29, 2014

Having just returned form the 2014 Annual Meeting of NAGDCA (National Association of Government Defined Contribution Administrators) in San Antonio, I am struck by how little has really changed in the government market in the past 35 years.

I have a soft spot in my heart for NAGDCA. I attended both of the original formation meetings in Chicago in 1980 and 1981, and attended the first Annual Meeting in Biloxi, Mississippi in 1982. I also helped create, and served on, the first Industry Board. I’ve attended all the Annual Meetings except two.

While not unique to NAGDCA, it seems that most pension conferences just keep having the same sessions on the “retirement crisis” in America; too many people saving too little. Every year, there’s another public figure, academic or media personality telling us how bad the crisis is. But we know all that. We’ve known that for over three decades.

What we need to focus on is what to do about it.

It’s time to stop diagnosing the problem and focus on the cure:

  1.  Automatic Enrollment and Automatic Escalation

Every government defined contribution plan in American should be compulsory when you are hired. Period.

Employees are free to opt-out, but we know that only a fraction will. Every plan sponsor should be actively implementing this. If your state has garnishment or other laws that prohibit automatic enrollment, you need to focus on changing the law. Go to your state capitol and explain the issue. Be sure your local city council or county commissioners pass a resolution endorsing a change in the law. Get legislative and vendor sponsors, and get your public employee unions on board.

In my nearly 40 years in the public sector pension market, I’ve seen providers and plan sponsors spend hundreds of millions of dollars over decades to improve enrollment. Advertising campaigns, videos, splashy brochures; yet we have barely moved the needle on “voluntary” enrollment. It’s time to stop wasting money on things that don’t work and focus on making automatic enrollment and automatic escalation our number one priority. Don’t take “no” for an answer. We all know that the inertia of automatic enrollment really works in the long run so let’s just get that done for every governmental defined contribution plan in America.

  1. Scrap The Individual Fund Selection Process

If the “people aren’t saving enough” theme is the number one recurring topic at pension conferences, a close second is the “people are poor investors” sessions. Ok, we get it. So let’s do something about it.

Enroll everyone in managed accounts, target date funds, or risk-based asset allocation funds. Discourage participants from individual fund selection. Make them sign a form that they are a “knowledgeable investor” before they pick their own funds in an alternate core line up or brokerage account.

Most of the evidence points to managed accounts as the best way to structure a portfolio that takes into account your defined benefit plan, the pension plan of a participant’s spouse or partner, and other factors such as social security or personal savings. Target date funds can’t and don’t do that. While it is true that portfolios in managed account programs may be similar to those in target date programs, the big difference is that managed accounts put the participant into the fund that is right for them, based on their unique set of circumstances (of which age is only one of the factors). Target date funds can never measure up to that degree of customization. They just aren’t designed to operate that way.

However, if you can’t offer managed accounts for a reasonable fee, then opt for target date funds. They are far from perfect. The “off the shelf” target date funds are often tailored for the corporate 401(k) market, and many are loaded with proprietary funds of the investment manager. Custom target date funds are great for jumbo plans but they carry added fiduciary risk and are really only economically feasible for very large plans. Nonetheless, anything is better than asking your participants to pick from an investment menu of mutual funds. So if you don’t opt to put your participants in managed accounts, target date funds are a good second option.

Risk-based funds are also another option. Given the issues with target date funds (one size fits all for people in a certain age bracket) the risk-based alternative at least permits some degree of customization if the participant has other retirement plans and/or personal savings or a spouse/partner with another retirement plan. However, most participants will need help selecting a risk-based fund so if you can’t easily offer that, then stick with managed accounts or target date funds.

The important thing is to scrap individual fund selection. Only a small minority of participants really do it well, and most plan sponsors spend way too much money and time “monitoring, hiring and firing” specific fund managers for asset classes that most participants don’t understand or use wisely. For the very small percentage of people who are capable of constructing their own portfolio, let them do it in the brokerage account. There’s no need for the plan sponsor to “select or edit” core funds for knowledgeable investors, so just scrap individual funds. Think of the time and money you will save when you end this practice that is really of little long- term value to the bulk of your participants.

       3.  It’s Time to Reallocate Your Plan Governance Dollars

Once you have all of your employees in the plan, and safely tucked into a managed account, target date, or risk-based fund default option, it’s time to spend your consulting fees and investment advisory fees in a more creative manner.

Providing your plan participants with projected future income statements is a great starting place. Ideally, you should include all future sources of retirement income; your defined benefit pension plan, the defined contribution plan, personal savings, retirement income from a spouse/partner and even social security, if applicable. This tool would a far better way to spend plan-level funds instead of wasting money on individual fund selection and monitoring.

Once you no longer have to worry about enrolling participants and helping them select investment options, your plan vendor (record keeper) can devote resources to counseling sessions with participants and their spouse/partner to help them understand their retirement income projection statement. All of those boring and repetitive “enrollment meetings” would be replaced with personal counseling sessions (every two years, at least), where the focus would be on the projected retirement income statement, and not on plan investments or other topics that simply confuse the bulk of participants.

No One Ever Complained About Having Too Much Money in Retirement

 It’s highly unlikely any participant is going to be angry at their employer for making them save too much money for retirement. It’s time we really focus on what actions we can take that truly help our employees. Unfortunately, it takes a bit of courage to step over a chasm of good intentions and make decisions that really have a profound and positive impact on the financial well being of employees. It is far easier to stick with the status quo, even if it isn’t working well.

The deck is stacked against this type of transformative change. The existing infrastructure of the government defined contribution plan market (and to a degree the DB market as well) is loaded in favor of the government and private entities that benefit from the existing and inefficient plan architecture. But this change will occur, because there are leaders in the market, both in the public and private sector who know these are the changes that need to be made. They are prepared to step over the chasm to make these important changes happen, and transformative change will ultimately occur. Your choice is to be a leader, or one of the followers.

Gregory Seller Consulting, LLC

All rights reserved. May not be reprinted in whole or in part without written permission. Provided for information only and is not legal or investment advice.