Irreconcilable Differences

Last week, the Department of Labor took another step toward finishing another piece of unfinished business.

It did so by proposing regulations necessary to implement (in confidence, anyway) the provisions of the Pension Protection Act (PPA) dealing with investment advice offered to participants under the auspices of a fiduciary adviser.

For the most part, the proposals (see “EBSA Clarifies Investment Advice Regulations”) seem fairly unobtrusive—if not downright “squishy” (more on that in another column). And, like the recent proposals on fee disclosure (see “IMHO: No One (Else) To Blame”), most of the 129-page document is spent outlining the details of the proposal’s cost/benefit analysis ($10 billion, in case you were wondering—$14 billion in benefits versus $4 billion in implementation/compliance costs). So, if you were having trouble working up the courage to wade through the PDF, take heart—the meat is found in the first 35 pages (with the occasional reference to a glossary at the back).

I was about halfway through the document (yes, the whole thing), when the response from Congressman George Miller (D-California) hit my inbox. Now, I wasn’t surprised to find that Miller, Chairman of the House Education and Labor Committee, took issue with the proposal; it’s an election year, after all. But Miller didn’t just criticize the proposal, or say that it didn’t go far enough, as he has on issues like fee disclosure (see “Miller Fee Bill Cruises through House Committee”). No, he called the proposal “nothing less than a boon for Wall Street and corporate executives” and urged the DoL to “immediately withdraw these harmful proposals.” And then he took a final swipe, noting that, “[i]n its final months in office, this administration has developed a disgraceful pattern of sneaking in last-minute regulatory changes at the behest of special interests” (see “Miller Slams DoL Advice Proposal”).

Setting aside for a moment the contents of the proposal, it’s not like the DoL just rolled out of bed and decided to create some guidelines for investment advice. The PPA set out a lot of new rules and plan design opportunities and then—prudently, IMHO—left fleshing out the details on things like participant notices and, yes, fiduciary adviser investment advice to the ministrations of the Department of Labor. Legislation that, admittedly, is now two years old—but one can hardly argue credibly that the DoL hasn’t been kept busy trying to fulfill the “to do” list created by the PPA.

The reality is that the investment advice provisions of the PPA were among its most controversial —that they even made the final cut was something of a miracle or mistake, depending on your perspective; that the areas of gray left were so abundant perhaps an implicit acknowledgement of the inability to balance two very opposite views. Doubtless there were (are?) those who hoped those provisions would simply atrophy on the vine for want of attention.

Of course, the heart of the controversy lies in the potential, if not inherent, conflicts of interest that arise when advisers offer advice on investments that provide compensation to those same advisers. Some, of course, believe that those conflicts can never be surmounted, or at least that they cannot be surmounted by every adviser every time. Others believe that the problem can be overcome by a combination of process structure, disclosure, and oversight.

Whether or not the PPA’s broad outline—or last week’s DoL proposal—is sufficient to provide the latter will remain a point of debate, IMHO—except for those who will never reconcile themselves to the notion.

- Nevin E. Adams, JD

Crisis of Confidence

I’m old enough to have been a driver (albeit a young one) the last time we had a “real” gas crisis (the one where the issue was not being able to buy gas, not just being able to afford to buy gas).

I can still remember the national sense of frustration when a bunch of crackpots in Iran held 52 Americans hostage for 444 days; the concerns when the USSR, using language startlingly similar to that employed during the recent invasion of Georgia, strolled into Afghanistan—and, yes, I can still remember what a “real” recession felt like (the one where we actually had a 5% drop in GDP).

I also remember the “response” of our leaders in Washington at the time. Now, it’s easy to sit on the sidelines and judge those who actually have to make the tough decisions, but I think it’s fair to say that a common sentiment was that we were “getting what we deserved.” America had too long strutted the world stage imposing its values on others, some said—this was just the ghosts of Vietnam and Watergate coming home to roost. We were told that we were suffering from a crisis of confidence, a “national malaise.” It was, some said, simply time we, as a nation, learned to make do with less.

Fortunately, IMHO, not everyone accepted that assessment as a foregone conclusion. The turnaround wasn’t overnight, and it wasn’t easy. But it began with a leader who saw America’s best days still ahead, who was willing to call to mind that “shining city on the hill.” Frankly, it began when people began to believe they could solve the problems confronting them, rather than being victims of circumstance.

Now, I wouldn’t for a moment suggest that the current economy isn’t struggling. Like you, I feel the anger every time I pull up to the pump—that I get excited at the prospect of paying (slightly) less than $4/gallon is troubling, in and of itself. Like yours, no doubt, my 401(k) portfolio has seen (much) better days, and I have every reason to expect that I’ll be paying twice as much to heat my home this winter as I did a year ago.

Unfortunately, it seems that there is today a growing chorus of “it’s all our own fault” and a willingness, if not an eagerness—at least on the part of some—to once again effectively throw in the towel. Not just on the economy, mind you, or gas prices, but on the employer-sponsored retirement system.

Encouraging Words

It was encouraging, therefore, to see this week’s report from Fidelity that suggested that deferrals were up, albeit slightly, even while balances were down over the past year. It was even more encouraging that participants who had been deferring into the same plan year over year saw a more significant increase (see “Fidelity Database Shows Participants More Inclined To Save”), while statistics on participant loans (down slightly) and hardship withdrawals (up slightly) suggest that participants are, in large part, not only staying the course, but upping their ante.

Our industry has long cautioned against the consequences of not preparing adequately for retirement, but those June 30 participant statements were almost certainly a shock to participants who had been acting on those admonitions. Certainly there were some (perhaps many) who, as the averages in the Fidelity study suggest, saw their entire quarter’s contributions apparently “disappear” into the ether, swept under by the market’s maelstrom. That will, no doubt, fan concerns about how “safe” your 401(k) (or 403(b) or 457) plan is.

Without question, changes will be required. The three-legged stool, to the extent it ever existed, is a thing of the past for most workers (see "Saving While You Still Work"). We may well have to rethink our notion of retirement—though I’m not sure that notion will wind up being much different than the one our parents are already living. And yes, I think the federal government may well be part of the solution—but I don’t think most Americans want government to be THE solution.

The Fidelity survey offers hope—a reassurance that we can make (and are making) a difference; that we don’t necessarily have to lower our expectations of people. We could always do more—and perhaps better—of course. We need to keep exploring the reasons people hesitate to save, or don’t save enough. We need to continue to find solutions, like target-date funds, that make it easy to do the right things when it comes to retirement savings. We need to be willing to be open and honest not only about the goals and risks of these programs, but about their costs. We need to continue to encourage employers of all sizes to remain committed to these programs.

And, yes, we need to do all of that with an appreciation of the importance of our mission—and confidence in the abilities of ourselves and our profession to succeed.

- Nevin E. Adams, JD

What WIll Participants Do?

At the moment, the industry is scrambling to respond to the DoL’s call for comments on the proposed participant fee disclosure regulations by September 8 (see "Know Way".

I think, based on the conversations I have had to date, that most of those comments will be positive on the scope of the disclosures, and fretful about the timeframe for implementation. Most seem to think that the DoL’s measured approach will be matched by a (more) reasonable timeframe for implementation that that contained in the proposal. Of course, there’s pressure from other sides - Congressman George Miller, who has not only held hearings on the subject, but introduced legislation regarding fee disclosures, is grumbling that the DoL’s version doesn’t go far enough. He’ll no doubt be joined by the voices of unbundled solutions who may well feel that they are disadvantaged by the current proposal’s terms.

The ‘debate” over participant fee disclosure has generally focused on one of two concerns – the physical impossibility (or at least impracticality) of doing it – and concerns about what participants would do once they had that information. Those concerns have similarly run the gamut, everything from “we’d spend all this money for no reason” to worries that participants would be so shell-shocked by the size of those fees (or the realization that there WERE fees) that they would opt out of retirement plan savings altogether. The Department of Labor’s recent proposal on the subject will surely serve to mute the debate on whether we should disclose those fees, but what we don’t really know yet is – what will participants do?

How Much Ado?

The DoL clearly (and explicitly) expects that participants will make better investment decisions. In fact, it’s made some effort to quantify the financial impact of those decisions as part of its proposal (see IMHO: No One (Else) to Blame). However, no one – apparently not even the DoL – actually expects that all participants will pay attention (in its estimation of the impact of the regulations, the DoL projects that less than a third of participants will benefit from a time reduction in looking for the information – presumably the rest aren’t paying attention).

Most participants won’t be helped much by the disclosures, IMHO. That’s not a criticism of the effort – but let’s face it, we’re talking in large part about the kind of disclosure that has long been available through mutual fund prospectuses. Does anyone really believe that most participants will comprehend the fine print of those disclosures any better than they currently grasp that same kind of detail in their mutual fund prospectus? Seriously – look at the model comparative chart . I’m not saying this is rocket science, but even in the DoL’s proffered example, you have models of clarity like “$20 annual service fee assessed for accounts holding less than $10,000. May be waived in certain circumstances.” (All of which would make this “model” participant wonder – are we talking about my individual 401(k) account or the plan – my account in total, or my account holdings in that particular fund? And are MY circumstances “certain?”)

Some Improvements, But…

Now, there is the improvement in frequency and convenience of delivery of this information. But while there’s surely something to be said for that, it also has a downside - the sheer volume of materials we’ll now be producing to provide this information. While the DoL took some pains in its proposal to leverage existing mediums, they nonetheless estimated that the annual disclosure would represent an additional 13 pages of disclosure for non-404(c) compliant plans. Surely there has to be a better way!

Perhaps I’m being too harsh in my assessment of the mathematical acumen of participants, or their interest in pursuing the clarity the proposed regulations purport to offer. And, like it or not, those kind of fee structures, complexities and exceptions have long been standard in what passes for disclosure in the mutual fund industry. The specific disclosure of dollar amounts charged against participant accounts called for by the proposed regulations will be helpful information, IMHO – but that’s generally only a small part of the costs participants are bearing.

Where we are may, in fact, be where we need to begin, in terms of helping participants better understand and appreciate the significance of their retirement savings decisions.

But if we’re expecting a significant response to this kind, and this much, information on the part of participants – well, I wouldn’t hold my breath.

- Nevin E. Adams, JD

No One to Blame

Like most of you, I have found the soaring price of gasoline to be enormously frustrating. Not that we haven’t dealt with this kind of thing before—but in the past, there generally seemed to be a reasonable explanation, whether it be a deliberate shift by OPEC, refineries shut down by a hurricane, or some kind of political turmoil in some far-off nation. This time, we have a series of potential “culprits”—the new economies in India and China, government taxes, greedy oil companies, irresponsible automobile manufacturers, unresponsive legislators, and, more recently, underinflated tires, and even speculative pension fund investments. It seems like everyone—and no one—is to blame for our current predicament (and, as painful as the current situation is, just wait until winter).

Some politicians have already picked up on the shift—and, with luck, their August recess will help them better understand just how angry the American people are about the situation. I wouldn’t for a minute suggest that our current energy pricing issues can be talked into submission—but it is intriguing how just talking about actually doing something in the short term has already served to bring down oil prices.

Talking Points

There are similar motivations at work in the DoL’s recent fee disclosure proposal (see “Know” Way). Not that speculation has (yet) been accused of driving up 401(k) fees—but the DoL specifically states that the proposal’s required disclosures “…[are] expected to result in the payment of lower fees for many participants.”

I’ll get to how much lower in a minute, but it’s worth considering just exactly how much it may cost us to achieve those savings—in no small part because most of the 103-page document that brought that proposal to light is consumed with outlining the various costs and benefits projected to result from the new rules. Suffice it to say, it’s going to be expensive. In fact, under Executive Order 12866, the DoL has determined that this action is “significant” because “it is likely to have an effect on the economy of more than $100 million in any one year.”

How much more? The present value of the costs over a 10-year period is projected to be more than $750 million. On the other hand, the present value of the projected benefits is expected to be about $6.9 billion.

The Costs

So far, so good. But only until you begin to explore the assumptions behind those numbers. First, there’s the cost of getting started. Because the DoL says that “plans may employ service providers for making disclosures and that these service providers are likely to spread fixed and start-up costs across many plan clients,” it applies an hourly legal review rate of $113, and assumes that every participant-directed plan will employ legal services upfront to review the regulation for 30 minutes. That adds up to $24 million, according to the DoL.

The DoL also assumes that each plan will spend 30 minutes of clerical time (at an hourly rate of $26) preparing the disclosures at a cost of $5.7 million. The DoL also assumes that it will take 15 minutes of legal time and 30 minutes of that clerical resource to review and update plan-related information; extrapolates those numbers across 59,000 new start-up plans, as well as 378,000 currently operating ($17.2 million); and assumes that costs associated with additional recordkeeping and of producing actual dollar disclosures will cost $26.5 million in year one, and $9.3 million in subsequent years, based on some 2001 GAO projections. They also incorporate average costs for individual plans to consolidate fee information from various providers (one hour per plan at $60/hour) for another $26 million in 2009 costs, and another $35 million that year to send all these disclosures out to participants (the DoL assumes it will take clerical staff an additional two minutes, and that 38% of disclosures will be sent electronically). Oh—and then there’s the cost of distributing the materials. The DoL assumes that the annual disclosure will be 13 pages for plans not already providing disclosures similar to section 404(c) disclosures, and an extra three pages for those who are. All told (making allowances again for 38% to be made electronically), that adds up to another $8.2 million in 2009. All in all, the DoL projects that their proposal will cost the industry $127 million (and change) in 2009—about $335/plan, if you buy into the DoL assumptions. It gets less expensive each year, but in its least expensive year (2018), it would cost nearly $53 million in today’s dollars, albeit spread across the entire participant-directed plan universe.

The Benefits

While there are certainly assumptions worth questioning on the cost side, the benefit side is where, IMHO, things get really “squishy.” The DoL starts by attributing $307 million in benefits (over a 10-year period) because participants will actually behave differently, now that they have different and/or easier-to-understand information (and assuming that they do, as the DoL assumes, pay 11 basis points more than they should). I think the former assumption is far too generous in terms of extrapolating participant response. On the other hand, the latter—that, on average, they pay just 11 basis points more than they should—strikes me as conservative.

The DoL also thinks that around 29% of participants (the number an EBRI study says acted on information they received from their retirement plans) will spend time researching their options, and will thus benefit from the increased clarity of the disclosures. How much? Well, EBRI claims these participants spent 19 hours per year, on average, researching retirement—and the DoL thinks that the new disclosures would save 90 minutes/year for non-404c compliant programs, and an hour/year for the rest. That adds up to 19 million hours—and, assuming an hourly rate of $31 (the value of a leisure hour), participants would save about $608 million in 2009.

Now, of course, nobody is writing a check for that savings in time—and whether it will save that many people that much time is still anybody’s guess (the DoL has solicited comments on both). But those “soft” cost savings of time combined with the savings attributed to changes in behavior wind up, in the DoL’s projections, to provide nearly $7 billion (yes, that’s a “b”) in savings over the 10-year period.

What’s Next?

Personally, I think the projected costs are too conservative, and the projected benefits far too optimistic, based on my experience working with retirement plan participants. That the gap between the two is narrower than projected, however, doesn’t mean there isn’t a gap, and surely shouldn’t suggest that there isn’t a net benefit to be found in the regulations proposed—or in a later, better version.

We may feel stuck between a rock and a hard place when it comes to fuel prices. But the Department of Labor has clearly laid out the basic requirements and, by my reckoning, made at least some attempt to leverage existing mediums and materials to mitigate the effort and expense. Their assumptions may be “wrong,” but we know what they are, and what they are based on. Their proposed timetable for implementation may be unrealistic, but we have a chance to express those concerns.

And if we don’t take advantage of that opportunity—if we let “others” take the lead in framing the final result—then, IMHO, we have no one to blame for the results but ourselves.

- Nevin E. Adams, JD

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Editor’s Note: the Employee Benefits Security Administration (EBSA) encourages interested persons to submit their comments electronically by e-mail to e-ORI@dol.gov (enter into subject
line: Participant Fee Disclosure Project) or by using the Federal eRulemaking portal at http://www.regulations.gov.

Persons submitting comments electronically are encouraged not to submit paper copies. Persons interested in submitting paper copies should send or deliver their comments to the Office of Regulations and Interpretations, Employee Benefits Security Administration, Attn: Participant Fee Disclosure Project, Room N-5655, U.S. Department of Labor, 200 Constitution Avenue, NW., Washington, DC 20210.

All comments will be available to the public, without charge, online at http://www.regulations.gov and http://www.dol.gov/ebsa and at the Public Disclosure Room, N-1513, Employee Benefits Security Administration, U.S. Department of Labor, 200 Constitution Avenue, NW., Washington, DC 20210.