Lost at Sea December 2020 Popular ERISA Safe Harbor Features May Expose DC Participants to Increased Levels of Risk and Retirement Income Insecurity
Lost at Sea December 2020 Popular ERISA safe harbor features may expose DC participants to increased levels of risk and retirement income insecurity.
S.S. LOST AT SEA
Authors: Dan Long, QPFC, AIF® Relationship Manager, Retirement Solutions, DoubleLine Nick Dalgety, CFP® Head of National Accounts, DoubleLine Andy Larson, CPC Director of Retirement Education, Retirement Learning Center
DoubleLine partnered with Retirement Learning Center to publish this content.
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Summary The primary goal of Employee Retirement Income Security Act A lack of attention to participant goals and risk (ERISA) plans is to help participants secure retirement income. planning is linked to 404(c), QDIAs and auto enroll/ However, too many participants in defined contribution (DC) escalate features. plans lack retirement income goals and fail to properly evaluate investment risk. This lack of DC participant planning and risk Promulgated in October 1992 and broadly impacting DC plans assessment can be traced to the ubiquitous 404(c) and qualified ever since, 404(c) allows DC participants to make their own default investment alternative (QDIA) safe harbors. investment decisions while relieving plan sponsors of the liability associated with those decisions. At the time, everyone got what Under these influential safe harbors, DC participants are often they wanted – what could possibly go wrong? inattentive to the key aspects of their retirement income planning and investment risk management. Inattention to Next, with the Pension Protection Act (PPA) of 2006, other these critical risk decisions creates a riskier and virtually aimless changes to QDIA and auto-enrollment/auto-escalate rules approach to DC plan investing. increased participation and deferral rates by automating the enrollment, deferral and investment election process. Again, We believe it’s time for DC stakeholders – plan sponsors, these were very positive developments for DC plans – what advisers, service providers and the government – to take steps could possibly go wrong? to directly address these risks. These safe harbors foster a lack of DC participant attention to key elements of retirement planning – specifically, setting retirement income goals, and understanding and taking the appropriate level of risk. Participants are really not to blame for this hands-off attitude as the powerful and persistent messaging In this paper we explore the following considerations: is very clear:
• DC participants are often inattentive to • Do nothing, and you will be enrolled in the plan. retirement goal setting and risk assessment. • Do nothing, and your contribution rate will be decided. • Education rather than advice is primarily offered to help participants set planning • Do nothing, and your contribution goals and address investment risks. rate will increase each year. • Common DC messaging promotes a “do • Do nothing, and your equity allocation nothing” approach among DC participants. will be selected for you.
• QDIAs – overwhelmingly in the form of QDIA defaults put the investing cart before the horse and can target-date funds (TDFs) – might not be lead to investments that are selected before the precursors of a suitable for many participants. good investment strategy are in place: • Solutions are available to enhance retirement income planning and mitigate investment risk. • Do nothing, and don’t develop holistic retirement income goals. • Do nothing, and don’t establish a risk tolerance for losses. Participants are Lost at Sea when they are under the • Do nothing, and don’t establish an influence of a combination of safe harbor rules like investment time horizon. 404(c) and QDIA, along with automatic plan provisions and target date funds. • Do nothing, and don’t establish a target rate of return.
2 Lost at Sea Popular ERISA safe harbor features may expose DC participants to increased levels of risk and retirement income insecurity.
PPA introduced the 408(g) Fiduciary Adviser For example, TDF QDIAs don’t take into account an individual’s retirement income goals, other assets or pensions, or saving An often-overlooked advice provision of the PPA was the habits, all of which have a significant impact on investment risk introduction of an ERISA fiduciary exclusively for plan decisions. As a result, TDF QDIAs have the potential to expose participants. This “Fourth Fiduciary” is unique as it need not DC participants to unplanned and even unnecessary investment replace existing service providers or investment options, nor risks. Regardless, DC plans continue to use equity-heavy TDFs is the 408(g) Fiduciary Adviser subject to co-fiduciary liability with automatic enrollment, investment defaults, and the rules. protections of 404(c) and QDIA safe harbor rules. While lauded for their many positive impacts, 404(c) and Jason Zweig from The Wall Street Journal said it plainly when he QDIA safe harbor rules actually foster an environment where wrote in August 2019 about TDFs, “These funds aren’t wimpy.”1 DC participants pay little attention to the key elements of While these higher risks might be advantageous to a portion retirement planning such as setting retirement income goals of investors, TDFs might not be the right default choice for all and understanding appropriate levels of risk. Because the DC participants at all times given their higher levels of equity 404(c) safe harbor only requires DC plan sponsors to provide risk. Equity-heavy TDF QDIAs might serve younger participants participants “education” to help make investment decisions, well by providing them a simplified approach and oversight for actual investment “advice” is rarely offered to assess planning relatively smaller account balances. risks – particularly advice held to an ERISA fiduciary standard. However, despite many creative themes and tools, few in the However, this lack of attention to the investment planning financial industry would defend the education model as effective process becomes more problematic as a participant ages. in helping DC participants make appropriate short- and long- Certainly by their mid-40s, participants should be taking a term investment decisions. more-careful and holistic look at their investment decisions as they begin to build multiple retirement accounts and develop Decades of education under the 404(c) safe harbor have more complex financial planning needs. Instead, while primarily provided only modest levels of investment understanding to designed to be a total portfolio solution, too many participants DC participants. Research continues to show that too many mix and match TDFs with other TDFs and other funds that are participants don’t understand investment risks when making available on the core menu. asset allocation decisions and too few participants make retirement income planning decisions. Also, and potentially Morningstar summarizes in a 2019 report, “Plan sponsors the most critical issue, too many participants fail to adequately should encourage participants not interested in using a evaluate the investment risks of a plan’s selected QDIA. target-date fund in its entirety to use a type of in-plan advice solution, such as advice or managed accounts.”2 The QDIA has grown beyond its original intent and has become almost synonymous with target-date An overly simplified approach to retirement planning, anda funds. propensity for higher equity allocations, illustrates the critical need for TDFs to be coupled with more professional investment As originally envisioned, the QDIA was intended to be the advice, especially advice providers held to an ERISA fiduciary investment default if a DC participant failed to make an standard. investment election. QDIA defaults are now predominately TDFs, and it is estimated TDFs will comprise over 50% of all DC plan assets in the near future. Despite the popularity of TDFs, we believe their one-size-fits-all approach does not suit all participants in all situations.
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Conclusion Another unique element of the 408(g) model is that it can be delivered through a registered investment adviser, a broker- Future retirees will likely rely on DC plans for a substantial amount dealer, a trust department of a bank or an insurance company. of their retirement income. However, while well intended, the As such, 408(g) Fiduciary Advisers are well positioned to work 404(c), auto enroll/escalate features and QDIA rules have had with DC plan sponsors to support the growth of financial the unintended consequence of encouraging participants to wellness programs – and respond to the need for a wide range pay less attention to the key aspects of retirement planning of account consolidation and product types such as insurance, and investment risk management. The simplified “do nothing” annuities and banking services. approach with default investments – while good at driving participation and deferral rates – has resulted in misaligned 408(g) Fiduciary Adviser Fact Check levels of investment risk in DC plans and a lack of overall A DC plan sponsor can hire a 408(g) Fiduciary Adviser and: retirement income planning by participants. • provide participants with holistic investment Therefore, the ultimate test for DC plans remains: advice held to an ERISA fiduciary standard; • Can DC plans deliver adequate retirement income • retain the plan’s 3(38) fiduciary; to participants given their current structure? • retain the plan’s financial adviser and recordkeeper; • Or will DC plan participants remain lost at sea, heavily influenced by ERISA safe harbors, and • continue to offer the existing investment menu without proper planning and goals to help manage including TDF, SDA and annuity providers; investment and retirement income risk? • continue to deliver financial wellness We are optimistic. The retirement industry has been and remains and 404(c) education programs; remarkably adept at evolving to meet the needs of participants. • support the integration of Health Savings Accounts (HSAs); We believe the industry is evolving to address these concerns. In fact, solutions to address the unique problems created by • and support participants in implementing these safe harbor rules are already available and can readily be emergency savings accounts. adapted to current business models. Next, clearly not all DC participants will utilize an investment First, we believe participants should have broader access to professional. However, plan sponsors can support participants investment professionals held to an ERISA fiduciary standard. without professional investment guidance indirectly through The ERISA standard is a high bar and we believe it offers the changes in the plan-level asset evaluation and selection process. best opportunity for effective planning and investment decision- Specifically, additional risk screens are warranted that will help making. Plan sponsors generally retain investment professionals limit the potential for large losses. In addition, we believe more held to the ERISA standard – why not provide participants with alternative asset classes, customized-model portfolio options the same level of support? and annuities have the potential to help participants manage volatile or down market conditions. To this end, DC plan sponsors, advisers and providers should strongly consider the only ERISA fiduciary focused exclusively These types of changes can go a long way in transforming a for plan participants – the 408(g) Fiduciary Adviser. DC plan from a supplemental arrangement into a true pension arrangement, one that delivers consistent and secure retirement While providing participants an investment professional held to income. Our hope is this paper will encourage these and other a high ERISA fiduciary standard, a 408(g) Fiduciary Adviser does ideas and that it will create thoughtful discussions among all DC not need to supplant nor replace any plan service provider or plan stakeholders. investment option. Uniquely, it can be used in conjunction with any existing or new plan offerings. DC plan sponsors are also not liable for the advice given to participants by a 408(g) Fiduciary Adviser, provided the sponsors follow a prudent selection and monitoring process.
4 Lost at Sea Popular ERISA safe harbor features may expose DC participants to increased levels of risk and retirement income insecurity.
Risk Management Ideas for DC Plans
1. Complete an Advice Availability Worksheet 4. Offer In-Plan Annuity Options Plan sponsors and consultants can estimate the level of assets The Setting Every Community Up for Retirement Enhancement invested through various advice arrangements by using the Act (SECURE) of December 2019 provided DC plan sponsors Advice Availability Worksheet. DC plan participant advice additional safeguards in the annuity-provider selection process. options include: In addition, several recordkeeping and advisory firms have already embraced annuities in the portfolios they build for DC • Managed accounts plan participants. • Packaged collective investment trusts (CITs) As an individual offering or as part of a customized portfolio, • Tradable models annuities can play a growing role in DC plans and mitigate participant investment and retirement income security risk. • Robo-advisers • Self-directed accounts (SDAs) with an 5. Expand the use of Risk-Centric Screens With Plan-Level investment adviser representative (IAR) Investment Selection • 408(g) Fiduciary Adviser By shifting the DC investment menu selection process toa more risk-centered scoring approach, DC plan officials and An example is provided in Appendix A. advisers can help participants outside of advice arrangements to better mitigate the risk of large losses. Risk-based assessment 2. Perform an Advice RFP approaches can be applied to more-traditional DC menu asset Executing an advice request-for-proposal (RFP) process is the first classes such as TDFs and core menu options, as well as any new step in offering advice. Because identifying and vetting advice products such as annuities and customized models. providers might be a new experience for many plan sponsors, it An example is provided in Appendix C. is prudent to perform a thorough and insightful RFP process that is clearly documented, and the rationale for the final decision articulated and archived in plan records. Sample advice RFP considerations are provided in Appendix B.
3. Deploy the 408(g) Fiduciary Adviser Model It is our view that the 408(g) Fiduciary Adviser model is the preferable advice solution for DC plans. As noted previously, the 408(g) Fiduciary Adviser role is unique because their focus is exclusively the participant and the Fiduciary Adviser need not replace existing service providers and investment options. The 408(g) Fiduciary Adviser is also not subject to the co- fiduciary liability rules while providing other important flexibility to advice providers and being well suited to support the growth of financial wellness programs. Please contact DoubleLine for more information about additional 408(g) tools and resources that can benefit your plan or practice.
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Appendix A: Advice Availability Worksheet One step to expanding the availability of DC plan participant advice is to complete anAdvice Availability Worksheet using the sample worksheet below. DC plan sponsors and consultants can use the worksheet to ascertain the level of plan assets invested through any available participant-level advice solutions. If in-plan advice utilization is low, then changes to plan design and participant communication strategies might be warrantedto reduce the plan’s advice friction and better mitigate participant investment risk. This simple worksheet gives plan sponsors and their consultants a manageable participant advice metric to discuss within their DC plans.
Sample Advice Availability Worksheet:
Assets Accounts
Plan Totals: $10,000,000 500 Insert data points Assets/Accounts with advice: Tradable Models: Provider: $0 0 Insert data points 408(g) Fiduciary Adviser: Provider: $0 0 Insert data points SDBA with IAR: Provider: ABC Fiduciaries $100,000 1 Insert data points Provider: $0 0 Insert data points Provider: $0 0 Insert data points Packaged CITs:
Provider: $0 0 Insert data points
Robo-advisor Provider: $0 0 Insert data points
Managed Account
Provider: XYZ Advisers $400,000 4 Insert data points Other: Provider: $0 0 Insert data points Total advice assets/accounts: $500,000 5 Total assets without advice: $9,500,000 495 Total participant level advice: 5% of assets 1% of accounts
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Appendix B: Sample Advice RFP Questions Experience and Qualifications Service • (FAB-2007-1) Describe the adviser’s regulation in accordance • (FAB-2007-1) Incumbents only – Have there been any with applicable federal and/or state securities law. changes in the information that served as the basis for • How long has the firm provided ERISA fiduciary-level advice? initial selection of the investment adviser, including whether the adviser continues to meet applicable federal and state • What are current assets under management? securities laws requirements? • How many plan sponsors utilize your services? • (FAB-2007-1) Incumbents only – Is the investment advice • How many plan sponsors dropped your service in the prior provider complying with the contractual provisions of the 12 months and why? engagement? • How many participants utilize the advice? • (FAB-2007-1) Is the advice being furnished to participant • What percent of all participants in your plans utilize the and beneficiaries based upon generally accepted investment advice? theories? • What are the training, background and licensure of • (FAB-2007-1) How will you help gather participant comments individuals providing the advice? and complaints about the quality of the furnished advice? • What differentiates you from other advice providers? • Is advice offered under the 408(g) Fiduciary Adviser provisions? If not, explain the type of ERISA advice provided. • What is the educational/marketing process used to alert Fees and Documentation participants to the availability of the service? • (FAB-2007-1) – What is the utilization of the service of the • Explain the marketing campaign and timeline. investment advice services by the participant in relation to • How frequently are participant meetings conducted? the cost of the services of the plan? • Describe the participant experience over a 12-month period. • What are the fees and how are they paid? • Describe your process to accumulate and integrate all • Provide a copy of the service agreement for legal review. household financial accounts. • Provide copies of errors and omissions (E&O) and fidelity • Describe your data security process. bond coverage. • Have you experienced data breaches in the last 24 months? If yes, describe your remediation process. DOL Field Assistance Bulletin (FAB) 2007-1 offers assistance • Under your model, who executes trades? when selecting a 408(g) Fiduciary Adviser3 • Will the advice work with our current TDF and core lineup? • Will the advice help determine if annuities are prudent in asset allocation decisions? • Will the advice help manage emergency savings accounts or other liquidity requirements? • Will the advice help with HSA coordination? • Will the advice be provided at the household level across participant accounts in and out of plan?
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Appendix C – Sample Riskalyze Scoring Chart – Traditional and Nontraditional DC Options
By applying a multivehicle scoring and comparison approach across traditional and newly available options, DC plan sponsors and their advisers can research a broader investment universe than traditionally available. While looking to manage any unnecessary risks present in investment menus, plan sponsors and consultants can quickly view the risk and return characteristics of all of their options, regardless of custodian or investment vehicle type. While advisers and their clients have access to a variety of tools, we used Riskalyze for illustrative purposes. Riskalyze’s technology compares individual investment options, TDFs, model portfolios and annuities. As seen in the sample fund menu below, many of the traditional options available in DC plans today can have higher risk profiles as seen in their higher Risk Number and a lower GPA, both of which are simplified numbers that redact multiple risk and return metrics. Evaluating all available DC investment options through this risk-focused lens can lead DC officials to reconsider the prevalence of higher-risk options in DC menus.
Copyright © 2019 Riskalyze, Inc. All rights reserved. For educational purposes only. Riskalyze does not make investment recommendations or provide investment advice. The information provided does not constitute investment advice, is provided solely for informational purposes and does not constitute an offer to buy or sell a security.Financial advisers must determine whether particular investments are appropriate for their clients. The above list is accurate as of Aug. 24, 2020. The Risk Number is calculated using correlation and volatility data from 2008 to present and average returns calculated using actual price history from June 2004-present or inception. We calculate the annualized return number as (final price / initial price) ^ (1 / number of years) - 1. The Riskalyze GPA™ is a quantitative expression of the efficiency of an investment, strategy or portfolio with respect to how much return is realized or expected per unit of risk.
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Author Biographies
Daniel M. Long, QPFC, AIF W. Andrew Larson, CPC Relationship Manager, Retirement Solutions Director of Retirement Education DoubleLine Retirement Learning Center
Mr. Long joined DoubleLine in 2018. He is responsible for With 35 years of experience in the financial services industry, retirement solutions client relationship management. Mr. Mr. Larson is a respected authority, frequent lecturer and Long’s responsibilities have involved working with plan author on industry topics. His background includes managing sponsors, consultants and service providers to successfully and consulting with major recordkeeping platforms, extensive operate retirement plans for employees. He has more than two product design for plan sponsors and advanced sales support for decades of experience in the retirement plan industry. Prior intermediaries who work with plans. As a retirement industry to DoubleLine, Mr. Long held retirement solutions roles with executive, Mr. Larson ran the recordkeeping and consulting Goldman Sachs, RSM McGladrey, Transamerica, Neuberger practice for Universal Pensions Inc. (UPI), and headed the BISYS Berman, ADP and PaineWebber. He has been a speaker at Corporate University. He has served as an adjunct professor for various industry conferences and currently serves on a local the Central Lakes College system in Minnesota and provides not-for-profit board with ASPPA. Mr. Long holds a BS in Business expert witness services on numerous industry topics. Andy is Management from Cornell University and an MBA from the coauthor of the Retirement Learning Center book “Retirement Northwestern Kellogg Graduate School of Management. He is a Resource Guide: Essential ERISA Education & Best Practices Qualified Plan Financial Consultant. for Financial Advisors.” He is a graduate of the University of St. Thomas in St. Paul, Minnesota, and maintains a Certified Pension Consultant (CPC) designation from the American Society of Pension Professionals and Actuaries.
DoubleLine partnered with Retirement Learning Center to publish this content. Nick Dalgety, CFP® Head of National Accounts DoubleLine
Mr. Dalgety joined DoubleLine in 2013 and is responsible for managing our National Accounts and Retirement teams. He has more than 20 years of experience in the financial service industry. Prior to DoubleLine, Mr. Dalgety was a Vice President with Goldman Sachs. Within that role, he worked with financial intermediaries on manager selection, asset allocation decisions and practice management. Mr. Dalgety later worked as a Financial Adviser to high net worth clients and business owners. He has been a speaker at various industry conferences and has served on the Scenemakers Board for the Goodman Theater in Chicago, Illinois. Mr. Dalgety holds a BBA in Finance from the University of Iowa. He is a CFP® certificant and holds the Series 7 and 63 Licenses.
9 Lost at Sea Popular ERISA safe harbor features may expose DC participants to increased levels of risk and retirement income insecurity.
Investing involves risk. Principal loss is possible. Dan Long is a registered represenative of Foreside Fund Services, LLC.
Citations 1 “The Funds That Make You Buy Low and Sell High,” The Wall Street Journal, Aug. 30, 2019 2 “Don’t Mix Target-Date Funds With Other Products: Morningstar,” ThinkAdvisor, Aug. 30, 2019 3 “Field Assistance Bulletin No. 2007-01,” U.S. Department of Labor, February 2007 (https://www.dol.gov/sites/dolgov/files/ebsa/employers-and-advisers/guidance/field-assistance-bulletins/2007-01.pdf)
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