"Access" Points

On Friday, the Department of Labor, as part of the White House’s Middle Class Task Force, formally unveiled a couple of initiatives.

The “new” one—and the one likely to capture the attention of the retirement plan community over the next several weeks—deals with investment advice for participants (see “DoL Proposes New Advice Rule”).

At a high level, the DoL has taken a major step back from the position it took in the final regulations on the subject put together—by the DoL—in 2008 before being halted, and then withdrawn last November by the new Administration (see “IMHO: Executive Order”). They also, IMHO, seem to have taken a step back from the admonitions of the Pension Protection Act of 2006 (PPA) to draft regulations that would craft an exemption to ERISA’s prohibited transaction rules that have long barred the ability to be compensated for advice on a basis that might vary according to the recommendations of the adviser1.

Withdrawal “Symptoms”

Now, many (including, apparently, some that signed that legislation) have always had an issue (to put it mildly) with this particular provision of the PPA, which they fear opens the door to “conflicted” advice (see “IMHO: Irreconcilable Differences”). Of course, proponents of the PPA’s interpretation have argued that part of the DoL’s charge was to build compliance and disclosure structures that would prevent that result. However, that apparently wasn’t possible—at least for the current DoL, which, after halting the publication of the rules and putting it back out for comment, decided last fall to withdraw its proposal “in response to concerns raised in public comment letters questioning the adequacy of the final class exemption's conditions to mitigate the potential for investment adviser self-dealing2.”

Let me be clear: I’m not faulting the DoL for essentially adopting the position that the solution that they had crafted under the leadership of one Administration was not workable under another. Greed is a corrupting force, and even the most able, honest, and forthright adviser could, on any given day, be tempted to offer advice that better fits his or her own needs than that of a participant (we also know that there are plenty of advisers out there who are neither able, honest, nor forthright). Let’s face it—the folks most in need of investment advice are most assuredly also the least likely to read (or to understand) the disclosures that are supposed to put them on notice that the advice they are about to receive could be tainted (note that, even with those opportunities muted by the new regulations, the proposed disclosure form runs FIVE pages). In large part, IMHO, requiring that compensation for investment advice be “level”—as the newly proposed regulations do—is no more than a return to the status quo.

That, of course, is also its limitation. After all, while the new regulations were touted as a means of “increasing access” to “high quality investment advice,” I think it’s fair to say that the practical result is an emphasis on “high quality” (read “not from a source whose compensation varies according to the advice provided”) rather than “access,” because I’m hard-pressed to see how the new regulations will do much to engender a real expansion of advice offerings3.

Shifting Gears

Mitigating the impact of this shift in position—and, make no mistake, it is a shift—is the reality that there are many more fee-based advisers serving this space today than there were even as recently as 2006. Perhaps some of these were motivated by the ability to offer participant advice, but I see little connection between that movement and these particular regulations. Another reality is that a growing number of participants are simply being defaulted into investment options without the “intervention” of the participant, much less an advised participant.

Additionally, the proposed regulations contain new restrictions on the design and deployment of the computer model (the selection must be made by a plan fiduciary unaffiliated with the adviser), and some intriguing questions about the applicability of specific investment theories4, as well as a determination that it is not only the adviser, but the adviser’s firm whose compensation impact must be considered. However well-intentioned, these new elements will almost certainly impede, rather than accelerate, the availability of these tools.

While the DoL made an effort to estimate the impact advice can have5, we have no such estimates on the impact of potentially conflicted counsel. Presumably, those conflicts could put participants in the clutches of a “Madoff wanna be,” but, frankly, I’m hard-pressed to understand the difference between the recommendations potentially incentivized by the personal interest of an adviser versus those of a plumber, real estate agent, used car salesman, or lawyer (though perhaps a rigid adherence to ERISA’s prohibited transaction rules provides the requisite justification).

No one—certainly not this writer—is in favor of promoting advice that isn’t good for participants. Ultimately, keeping the door closed on potentially conflicted advice may be the safest and most prudent course, though one might be inclined to think that the structures already in place (the selection of an adviser is a fiduciary duty, after all, and providing investment advice for a fee is a fiduciary act) would keep the worst at bay—and that new proposals could be crafted to weed out the rest. Or one might be inclined to insulate the participant from even potentially “good” advice, because that advice might also serve the adviser’s personal interest.

Regardless, the Labor Department has laid out a new course on how participant advice can be offered, and how advisers can be compensated for that service. They have asked for input on that new direction6—and I sincerely hope they get it.

—Nevin E. Adams, JD


1 “A final rule and related class exemption published in January 2009 were withdrawn in November 2010 in response to concerns raised in public comment letters questioning the adequacy of the final class exemption's conditions to mitigate the potential for investment adviser self-dealing.”

2 Not to be cynical about it, but those concerns were expressed by just 28 individuals/institutions (which the DoL has published at http://www.dol.gov/ebsa/regs/cmt-investmentadvicefinalrule.html). More accurately, there weren’t (even) 28 expressions of concern about the regulations themselves. Many, as you might suspect, were simply pointing out areas of needed clarification; several were just pointing out the need for final regulations, noting that the lack of certainty about the rules had created a legislative limbo in which nobody was doing anything, or at least anything different, regarding the provision of investment advice. That said, apparently somewhere in that relatively modest number of comments lay arguments compelling enough to persuade the Labor Department that there was no way to thread that particular needle.

3 The DoL would presumably take issue with my conclusion, since the regulations repeat the assumption associated with the prior—but very different—version that this approach would “extend investment advice to 21 million previously unadvised participants and beneficiaries.”

4 This may well be the “battleground” of commentators over the next several weeks. The DoL solicits comments “on the conditions applicable to investment advice arrangements that use computer models.” This is a far-ranging section of the proposed regulations, ranging everywhere from “what investment theories are generally accepted” and should this regulation not only specify them, but “require their application.” I suspect at some level that some may draw comfort from this apparent effort to bind in not only what process is appropriate for these models, but what inputs. One can’t help but wonder, however, if those findings might at some point be extrapolated (implicitly or explicitly) to other applications.

5 There are some interesting acknowledgements in the proposed regulation: that there is no requirement to “offer, provide, or otherwise make available any investment advice to a participant or beneficiary”; that in scoping the impact of the regulations, the DoL assumed that, on average, participants and beneficiaries who are advised make investment errors at one-half the rate of those who are not.

6 Written comments on the new investment advice proposal should be addressed to the Office of Regulations and Interpretation, Employee Benefits Security Administration, Room N-5665, U.S. Department of Labor, 200 Constitution Ave. NW, Washington, D.C. 20210, Attn: 2010 Investment Advice Proposed Rule. The public also may submit comments electronically by e-mail: e-ORI@dol.gov or through the federal e-rulemaking portal at http://www.regulations.gov.

Promises Premises

It was hard not to be struck this past week by that Pew Center on the States report titled “The Trillion Dollar Gap.”

That title was a reference to the apparent chasm between the potential obligations of the assorted pension and retiree health-care programs of the 50 states, and the money set aside to pay for them (see “States Face $1 Trillion Retirement Benefits Funding Gap”). In some respects, the portrayal was better than it might have been: For one thing, the analysis was based on plan year-ends that predated the Q4 2008 meltdown, and it focused only on state programs, rather than the assortment of local government programs.

On the other hand, it suffered—as many of these reviews do—from a lack of context. It combined the obligations represented by retiree health and pensions—and, while both surely are financial obligations, they are driven by different factors. More importantly, most of the public sector has, until very recently, treated retiree-health obligations as a pay-as-you-go obligation—just as the corporate sector did until the mid-1990s, when accounting rule changes mandated a different approach (one that, in short order, pretty much eviscerated the notion of retiree health-care coverage in that sector, certainly on a prospective basis). Thus, while the obligations are real, it’s hard to escape a certain “gotcha” sense in a report that presents a crisis so soon after the accounting rules have shifted so dramatically1.

“Bad” Timing

The news couldn’t come at a worse time for public pension programs. In recent months we’ve been treated to a series of stories of well-heeled attorneys and politicians effectively “scamming” the system by exchanging a modest amount of service for huge pension payoffs and the publication of $100,000 Pension Club lists in California (with searchable capabilities, no less), alongside the intimations that the insidiously titled “private placement agents” have been lining their pockets with ill-gotten gains from the public treasuries.

This at a time when the perception is that public-sector workers are paid “better”2, that the public sector accounts for most of the jobs “saved and/or created” by stimulus spending—oh, AND that “they” get the kind of pension and post-employment health-care coverage that most private-sector employers long ago eschewed. These concerns will certainly be exacerbated by the Pew study—which, lest we overlook the point, reminds us that “[u]ltimately, taxpayers could face higher taxes or cuts in essential public services.” However, IMHO, what goads the public most about the current situation is a sense that these decisions are taking place with “our” money.

Of course, reports of a “crisis” in underfunded pension plans is hardly an unusual occurrence—indeed, they are as regular as the market’s cycle itself (see “‘Over’ Blown”). Crooks, like Willie Sutton, are inexorably drawn to big piles of money—and promises that can be made today, but not fulfilled until later, are mother’s milk for the political class.

And, while the Pew report acknowledges that “many state officials grasp the depth of the funding challenges for their public sector retirement benefit systems and the need to respond,” it also cautions that “the pressure in an election year to channel money to competing priorities such as education may tempt lawmakers to neglect the problem.”

Still, at a time when it is clear (to me, anyway) that the nation could stand a good shot of fiscal prudence, and while all government expenditures seem fair game for review, it’s worth remembering the following about those public pensions to put those concerns in context:

(1) The median annual (national) pension is less than $20,000. There are abuses, but those are the exception, not the rule. Most aren’t getting rich off these payments.
(2) Most of the funding for those retirement benefits still comes from investment income, not contributions (from taxpayers).
(3) To some extent—and, in some cases, to a great extent—the funding problems presented are the result of changes in accounting rules, not a sign of mismanagement.
(4) Many public-sector workers contribute to those pension plans—putting their savings at risk, as well as their pensions, when the funds are mismanaged.
(5) Many public-sector workers contribute to those public pension plans at rates—and sometimes mandated rates—that are well above the average 401(k) deferral rates in the private sector.

Taxpayers—and that certainly includes public-sector workers—clearly have a stake in the management of these programs and the financial obligations they entail. For the very most part, those responsible for the systems reviewed in the Pew study have been good stewards of what they’ve been given. However, actions have consequences, and the impact of decisions delayed can compound over time. All too often, politicians have intercepted/redirected funds that should have fulfilled those commitments to causes more exigent to their current political or financial realities. As the Pew study reminds us, we must continue to be cognizant of the costs of those obligations. But more importantly, IMHO, we must be more mindful of the promises made—because they can become promises we have to keep.

- Nevin E. Adams, JD


1 Even on the pension side, while acknowledging that, in aggregate, the state systems were 84% funded (and, while that was before the worst of the market slide, it’s still an incredibly good number, IMHO—do YOU have 84% of the value of your mortgage sitting in your bank account?), the report’s authors couldn’t resist reminding us just how much money was represented by that remaining 16% (about $452 billion, in aggregate).

2 Care should be taken in drawing conclusions on pay levels since such “average” comparisons inevitably gloss over the realities of pay differences legitimately based on education, job title, and tenure.

Safety “Knot”

Two weeks ago, the Department of Labor and the U.S. Treasury turned to the retirement plan community for some input on how to “enhance retirement security for workers in employer-sponsored retirement plans through lifetime annuities or other arrangements that provide a stream of income after retiring.”

Now, part of what the DoL is trying to figure out (see Feds Call for Lifetime Income Product Public Comment) is why the take-up rate on annuities (technically “lifetime annuities or other arrangements that provide a stream of income after retiring”) is so dismal—not just because many see them as a superior way to ensure that “stream of income,” but because some are hoping that, if it can be made more available as a distribution option (perhaps even a default distribution option), more participants will take advantage of it.

There are good reasons for the inquiry. We all know that most participants with a non-retirement-related distributable event (such as a job termination) tend to have relatively small balances; that all too often they take that small balance as a cash distribution—and spend it (what’s left after taxes and penalties, anyway). We also know that many, perhaps most, defined contribution plans don’t provide an annuity distribution option. Not that it would likely matter, since defined benefit plan participants who, unlike their DC cousins, are frequently given that option routinely reject it in favor of a lump-sum option (when offered). Therefore, it doesn’t take much imagination to realize that merely having the option available won’t be enough to impact participant behaviors (and trust me, even as a default, when it comes to getting that distribution check, I suspect participants won’t be as pliant as they have been with other automatic design features).

Participants have, it seems, learned to distrust annuities. Stories abound of individuals who have been bamboozled by unscrupulous advisers (and sometimes by annuity providers themselves)—in terms of product, promise, and fees. While the concept of an annuity—giving your money to a firm that will, some years hence, provide you with a specific income stream—is relatively straightforward, the realities are anything but. The here-and-now money being surrendered inevitably seems larger than the promised income stream, and unless you have an actuarial bent, it’s nigh impossible to figure out how badly you’re being ripped off1—assuming that the firm you hand that money over to is still financially viable 20 years out. Moreover, the disclosures attendant with those purchases—certainly on the retail level—are enough to make you long for the brevity, simplicity, and coherence of a mutual fund prospectus. Sure, you can lose your shirt at the craps table, but at least you’ll have some fun doing it.

From an employer standpoint, the current reluctance is, IMHO, even easier to understand. First off, there are all the same issues and concerns that the participant has with regard to the complexity of the product and “disclosures” (and I use the term loosely)—and the ever-present sense that they are getting ripped off (though, at an institutional level, perhaps less so). Take all that, add to it the already-daunting obligations of a plan fiduciary, and extend those not only past employment, but potentially past the lifetime of the participant himself. While the Labor Department has made several efforts to ameliorate those concerns, they can’t really afford to let the fiduciary totally off the hook for making a prudent decision in choosing a provider/product—but let’s face it, whatever stance the DoL may take, litigators may well choose to apply a less stringent standard. However much that plan fiduciary would like to help the participant make the right choice(s), it’s hard to imagine why they would want—or be expected to want—to assume that kind of potential liability today, much less decades into the future.

So, what’s to be done? We are, in essence if not reality, talking about a structure that will allow workers to buy their own personal pension, and, IMHO, the questions that need to be answered aren’t really all that hard to understand.

People want a safe repository where their savings can be comfortably entrusted at the proper time, and from which a secure, predictable stream of lifetime income can eventually be drawn. That comfort will, in turn, require that it be relatively easy to communicate (and understand), and—like any retirement investment—that fees can be disclosed (and understood). It would be a program that, hopefully, plan sponsors can facilitate without becoming co-signers of the obligation. One, it should be said, that won’t put those savings at risk during the interim by imprudent speculation (as the private sector sometimes does) or misappropriation for other purposes (as politicians are wont to do). And one that, IMHO, remains a voluntary choice, not one imposed on participants (if you want to wipe out voluntary retirement savings, just tell people they won’t be able to get their money “out” EXCEPT as an annuity distribution).

Indeed, in my mind, the question about a retirement income solution isn’t so much about why plan sponsors have been reluctant to offer these options at present—and why even fewer participants take it—because I think that, once we give people the right kind of choice, they’ll make it.

- Nevin E. Adams, JD


The Labor Department’s request for information is online HERE


1 Another great rip-off fear: that you’ll hand over your life savings assuming that you’ll get it all back over the rest of your life, only to die prematurely and leave nothing to your heirs, is a very real concern (and one that never seems to be counterbalanced in most participants minds by the notion that you could live longer than anticipated and draw more than was put into your account.

Goal Lines

That report, published by Towers Watson (see “Towers Watson Finds DB Plans Outperformed DC Plans” at ), compared the differences in investment results between 401(k) plans and defined benefit (DB) plans—and, in a contest that you’d surely have trouble getting decent odds on in Vegas, defined benefit plans fared better.

That shouldn’t—and probably didn’t—surprise anyone, IMHO. Defined benefit plans have a lot of things going for them that 401(k)s don’t. First, most DB plans have someone in an official capacity paying attention to them. They are obligations of the employer, after all, and they have a direct—and increasingly visible—impact on the bottom line. Second, in view of the first consideration, those responsible for that bottom line impact of the DB plan generally have the good sense to engage the services of experts to help them make the right decisions. Finally, and perhaps most importantly when it comes to making investment decisions, DB plans have the benefit of time—and in many cases, a nearly indefinite time horizon—upon which to base and fund their commitments. They have, in football parlance, a solid ground game, well-honed defensive line, a quarterback who is getting solid play-making support from the sidelines, and control of the clock.

401(k) plans, on the other hand, rely on the investment prowess of an untrained, and in most cases, wholly uneducated participant-investor. A “quarterback,” if you will, who effectively strolls out on the field, drops back and—well, sometimes they just fall on the ball, sometimes they try to run with it (for a short distance, anyway) and, yes, sometimes they just—in pure “Hail Mary” fashion—hurl the ball downfield and hope for the best.

Little wonder that, in the time periods that were the focus of the Towers Watson update, DB plans did better. In fact, after fees were taken into account, Towers Watson estimated that DB plans outperformed 401(k) plans by roughly one percentage point in 2008, though both types of plans lost value.

That said, when you look at the full Towers Watson analysis, the result is more nuanced. Over the decade and change it has been conducting this analysis, Towers Watson noted that DB plans do better (on a relative basis to 401(k)s) when the markets are bearish—and yet, 401(k) results, with all their faults and shortcomings, tend to fare better (at least at a plan average) when the bulls are in charge.

In fact, the Towers Watson report draws the following conclusion:

“After stronger performances by DB plans during the 2000-2002 bear market, 401(k) plans outperformed DB plans from 2003 through 2005, as measured by plan-level medians. DB plans and DC plans realized equal returns in 2006, with 401(k) plans taking the lead again in 2007. But, over the 13-year period, which captures both bull and bear cycles, DB plans outperformed 401(k)s by an average of 23 basis points.”

Read that last sentence again. That’s right—despite all their advantages, over one of the most tumultuous market cycles in memory (1995 to 2007), DB plans did better than their 401(k) brethren—by just 23 basis points.

Now, there are issues whenever you try to come up with something like an “average”(1) result in any evaluation, much less an “average” 401(k) plan investment result. For example, that “average” 401(k) plan might have a group of participants that gravitate toward more-conservative investments counter-weighted with a group of “shoot-the-moon” gamblers, yielding an “average” return that winds up being pretty diversified at the group level(2). Moreover, some of the plans in the Towers Watson evaluation had both a DB and a DC program and, at least in theory, participants covered by both programs might—and certainly should—invest differently than those with only a DC plan to rely on.

The bottom line: The presentation of a DB “average,” regardless of the care taken in presenting the data, may be something of a stretch; but, IMHO, while there may be an arithmetic “average” for 401(k) plan returns, it sheds little light on what is really going on at the level where such decisions matter—the not-so-average individual participant.

And, as many Super Bowl losers can attest, it isn’t about how many yards you gain on the ground, how many interceptions you’ve thrown, or how many sacks—it’s the score on the board at the end of the game that counts.

—Nevin E. Adams, JD

The Towers Watson study is online at http://www.towerswatson.com/research/845

(1) For another perspective on averages, see “IMHO: The Mean-ing of Average”

(2) The Towers Watson analysis noted that, over time, 401(k) plans do, in fact, have a wider distribution of returns than DB plans, and that, with the exceptions of 2002 and 2003, 401(k) plans had a wider distribution of investment returns in all years in the analysis.