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Home Government Affairs Retirement Security 401(k) Plans

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Defined Benefit Pension Plan Funding Levels and Investment Advice Rules

Hearing on
Defined Benefit Pension Plan Funding Levels and Investment Advice Rules
Committee on Ways and Means
United States House of Representatives

October 1, 2009

Table of Contents

Executive Summary
I. Introduction
II. Investment Advice
A. The Need for Advice
B. Pension Protection Act of 2006 and Implementing Regulations
III. Improving Disclosure
A. Why Disclosure Reform is Needed
B. Deparment of Labor Proposals to Address Disclosure Gaps
C. Congressional Proposals to Enhance Disclsoure

The Investment Company Institute, the national association of U.S. investment companies,1 which companies manage more than 40 percent of all 401(k) and IRA assets, is pleased to submit this statement.

Executive Summary

In the nearly 30 years that it has existed, the 401(k) plan has become a powerful engine for providing retirement security to millions of American workers who participate in plans. The system would work even better, however, if more participants had increased access to investment advice and if ERISA rules both assured that participants receive disclosure concerning key information about all investment options in their plans, and set out clearly the information employers need to consider about plan service arrangements.

The need to expand access to investment advice is clear. Access to a financial adviser is much more common for investors outside retirement plans than for those saving in 401(k) plans, despite the amount of assets in those plans, and the importance of those savings to plan participants. The current financial crisis, which has made many Americans want to take stock of their financial picture, underscores the need for robust investment advice services for those savers. The Pension Protection Act of 2006 (PPA), which we supported, created a new exemption to expand access to advice to allow plan and IRA savers to obtain advice from companies familiar to those savers — the companies providing services or investments to the plan or IRA. Congress included strict conditions and protections, including that the advice be unbiased and offered under fully transparent arrangements and from someone who accepts ERISA’s full fiduciary responsibility.

After a long regulatory process, the Department of Labor under the Bush Administration adopted a regulation to implement the exemption and resolve ambiguities about the meaning of the PPA statutory language. While the Institute believes these regulations reasonably implemented the PPA provision in a manner that provides clarity and makes it possible for plans and providers to offer new investment advice programs, we understand the Obama administration’s desire to take a fresh look and issue a new proposal for notice and comment. We urge DOL in its regulatory process and Congress in its consideration of investment advice to encourage the appropriate expansion of avenues for investment advice and preserve pre-PPA guidance that allows various forms of advice and education programs on which many plans now successfully rely. We do not support the advice provisions in H.R. 2989, the “401(k) Fair Disclosure and Pension Security Act of 2009,” because the bill would not only repeal the PPA statutory exemption but would require significant revision of pre-PPA programs, which have been operated successfully.

The Institute strongly supports efforts to enhance existing rules providing for disclosure to participants and employers. The Obama administration has said it will complete two regulatory projects that will close gaps in its disclosure regime, and we support those projects. Two bills referred to this Committee for consideration (H.R. 2779 and H.R. 2989) would address the same disclosure gaps in defined contribution plans. As the Ways and Means Committee looks at the bills and considers whether legislation is necessary in light of DOL’s proposals, we urge that the Committee be guided by the following principles:

  • Participants in all self-directed plans need simple, straightforward disclosure focusing on key information, including information on fees and expenses, which allows comparisons among a plan’s investment options. Comparability of fees is best achieved through use of percentages or basis points or through a representative example (such as the dollar amount of fees for each $1,000 invested).
  • The disclosure should cover all investment products available in plans, including providing comparable disclosure for products that provide a fixed or promised return.
  • Employers should get clear information that allows them to fulfill their fiduciary duties.
  • Plan fiduciaries are responsible for determining the investments that are appropriate for participants and Congress should not upend ERISA’s framework. It is not appropriate for the government to pick investment options for private 401(k) plans.
  • The disclosure rules should be precise and clear so that service providers and plan fiduciaries know what disclosure is required of them. These rules also should be designed to prompt correction of minor or inadvertent errors.

I. Introduction

The success of the defined contribution plan system is evidenced by wide employer and participant adoption and participant feedback. Latest available official Department of Labor data indicate that in 2006, there were 645,971 private-sector defined contribution plans with more than 65 million active participants.2 Institute research on Americans’ attitudes towards 401(k) plans tells us that Americans strongly support the current 401(k) system and greatly value the tax incentives 401(k)s provide.3 Almost nine in 10 households surveyed rejected the idea that the government, and not individuals, should make investment decisions for retirement accounts. Even households without 401(k) or IRA savings see value in the 401(k) system and do not want drastic changes. Reports indicate that, despite the bear market of late 2008 and early 2009, 401(k) participants are staying the course and not abandoning their plans.4

Defined contribution plans could be improved, and the Institute has offered a number of suggestions for changes that, in our view, would strengthen the system by which employers and workers have entrusted and will continue to entrust trillions of dollars of retirement savings to these plans.5 This statement addresses two ways to better serve those saving for retirement in 401(k) plans: expanding access to quality investment advice, and ensuring that plan fiduciaries and participants have the information they need to make the decisions charged to them under their plans.

II. Investment Advice

A. The Need for Advice

While the need for increased opportunities for investment advice to participants is clear, relatively few participants have access to or use investment advice today. According to the Profit Sharing/401k Counsel’s annual survey, about half of all plans offered investment advice to participants in 2008, and only 28% of participants utilized advice when it was offered.6 While pre-PPA programs have been effective in reaching some plans and some participants, more work is needed to create cost-effective advice solutions that would encourage adoption by employers and utilization by participants. Although the PPA exemption adopted in 2006 held great promise for encouraging more advice programs in plans, the absence of clear rules for using the exemption has deterred new offerings of advice.

Compare the relatively low offering and utilization of advice in 401(k) plans with what mutual fund investors outside 401(k) plans and IRA savers experience. Among households holding fund shares outside plans, 77 percent owned shares through professional financial advisers in 2008.7 Among households owning traditional IRAs in 2008 who took a withdrawal in tax-year 2007, 59 percent consulted a professional financial adviser to determine the amount to withdraw in tax-year 2007.8 A survey the Institute conducted in 2007 of recent retirees about how they used their defined contribution proceeds at retirement showed that respondents pursued a range of outcomes reflecting their own personal needs, in many cases rolling some or all of their account balances over to IRAs.9 In making their distribution decision, retirees with a choice of options often consulted multiple sources of information. Forty-two percent indicated they sought advice from a professional financial adviser that they found on their own.

The recent financial crisis, which has made many Americans want to take stock of their financial picture, underscores the need for clarity in making advice more broadly available to participants. Investment advice services can help participants in ERISA plans and IRAs understand the long-term nature of retirement savings and assemble and maintain a diversified portfolio. During the financial crisis, many participants sought help and reassurance from their 401(k) providers. One Institute member with a large recordkeeping business reported to us that participant calls increased 60 percent, and website visits increased by 65 percent, during the market volatility in late 2008. Another large retirement service provider reported that the volume of calls during the most volatile period (late September and early October 2008) spiked to over 100,000 calls per day.10 Without clear rules from DOL, it is difficult for 401(k) providers to offer real assistance to nervous participants. Obtaining clarity on the rules that govern investment advice under the PPA exemption would allow providers to better serve participants when they reach out for reassurance.

B. Pension Protection Act of 2006 and Implementing Regulations

In 2006, Congress enacted the Pension Protection Act to expand access to investment advice for plan and IRA savers by allowing the companies they are already familiar with – those providing services or investments to the plan or IRA – to provide advice programs under strict conditions and protections. These conditions require that the advice be unbiased, in that either the adviser’s compensation does not vary depending on the participant’s investment choices, or the advice is rendered through an unbiased computer model. Additional safeguards require that (1) the adviser must agree to be subject to ERISA’s strict fiduciary duty and acknowledge fiduciary status in writing; (2) the advice program must be audited annually by an independent auditor for compliance with the conditions of the exemption; (3) computer model advice must be pursuant to a model certified by an independent expert; (4) the fiduciary adviser must provide robust disclosure of fees, material affiliations and conflicts of interest, past performance, use of participant information, and more; and (5) the fiduciary adviser must maintain records demonstrating compliance with the exemption for six years.

The PPA required DOL to issue regulations implementing a number of the investment advice provisions. In addition, there were a number of textual ambiguities in the statutory language that needed clarification. After a regulatory process extending over thirteen months, which included two requests for information, a Field Assistance Bulletin, two public hearings, and notice and comment on proposed regulations, DOL issued final regulations at the end of Bush administration.

While the final regulations did not include most of the changes that the Institute had requested in its comments to DOL, we believe that the final regulations reasonably implement the PPA exemption in a manner that will encourage plans and providers to offer investment advice programs to assist participants and beneficiaries of ERISA plans and IRA investors in managing their accounts.

We appreciate, however, that the Obama administration wishes to take a fresh look at these rules to assure itself that the rules are appropriate and in the public interest. Assistant Secretary Phyllis Borzi has stated DOL will issue a new proposal so that interested parties can comment.11 In its efforts, DOL should adopt policies that promote the provision of investment advice and preserve pre-PPA guidance that allows various forms of advice and education programs on which many plans now successfully rely. This pre-PPA guidance either provides an exemption with conditions that protect participants and beneficiaries or finds that if an arrangement operates as described in the guidance, there would be no prohibited transaction requiring exemptive relief.

Congress should follow the same principle: adopt policies that expand, not reduce, the number of participants with access to investment advice. For this reason, we do not support the advice provisions in H.R. 2989, the “401(k) Fair Disclosure and Pension Security Act of 2009,” because the bill would not only repeal the PPA statutory exemption but would require significant revision of pre-PPA programs. These programs have operated successfully and there is no need to subject arrangements that do not involve prohibited transactions or those under prohibited transaction exemptions to additional conditions that add unnecessary cost and might cause plans or providers to no longer offer the programs.

III. Improving Disclosure

A. Why Disclosure Reform is Needed

The Institute has long supported meaningful and effective disclosure to 401(k) participants and employers, as Institute President Paul Stevens testified before this Committee two years ago.12 We stated then and continue to believe that initiatives to strengthen the 401(k) disclosure regime should focus on the decisions that plan participants and employers must make and the information they need to make those decisions.

In addition to supporting disclosure reform, we have sought to shed light through our research on 401(k) fees and the factors that drive fees. A recently completed and detailed survey of 130 plans of various sizes by the ICI and Deloitte Consulting LLP found that the median fee (including investments and recordkeeping) across all plans surveyed was 0.72 percent (or 72 basis points) as a percentage of total assets,13 significantly less than some critics of 401(k) plans have claimed.14 While fees vary across the market, 90 percent of all plans surveyed had an all-in fee of 1.72 percent or less.

The research showed that a plan’s number of participants and average account size (which together constitute the total plan size) are the two most significant drivers of the plan’s overall cost. Other factors that correlated with a lower total fee included higher participant and employer contribution rates, lower allocation of assets in equity-oriented asset classes; use of auto-enrollment; fewer plan sponsor business locations reducing the servicing complexity; and other plan sponsor business relationships with the service provider (e.g., defined benefit plan or health and welfare plan). The factors that were not significant drivers of fees include the type of provider the plan utilized (insurance company, mutual fund company, bank, third party administrator) and the extent to which investments of the 401(k) provider were utilized.

Examining mutual fund assets, ICI research shows that 401(k) investors concentrate their assets in lower-cost mutual funds. The average asset-weighted total expense ratio incurred by 401(k) investors in stock mutual funds was 0.72 percent in 2008, about half the 1.44 percent simple average for all stock funds and substantially less than the industry-wide asset-weighted average of 0.84 percent.15

Disclosure reform should address two gaps in the current 401(k) disclosure rules, the first relating to participant disclosure, and the second to that received by the employer (plan sponsor). First, unlike current DOL participant disclosure rules, which cover only certain plans and do not require disclosure about all investment products, participants in all self-directed plans should receive key information about all products. Second, disclosure reform should clarify the information that service providers must disclose to an employer on services and fees. The Institute supports disclosure of payments a service provider receives directly from plan assets and indirectly from third parties in connection with providing services to the plan. Where the service provider’s services include access to a menu of investment options, employers should receive from that provider information about the plan’s investments, including information about fees.

B. Department of Labor Proposals to Address Disclosure Gaps

The Department of Labor has two proposed regulations that will address both of these gaps. The first proposal will require that all participants in 401(k) plans receive basic and comparable information, including fees, on all the investment options available to them.16 Participants would also receive at enrollment a description of any fees that they may pay in addition to the costs of the plan’s investments. DOL’s proposal uses a layered approach to ensure each participant receives key information, with more detail available online and upon request for those participants who want it.

Participants would receive, at enrollment and annually thereafter, a chart listing each investment on the plan’s menu and comparing each investment’s type (i.e. large cap, international equity, etc.), 1-, 5-, and 10-year historical performance compared against a benchmark, and fees. DOL’s proposal includes a model comparative chart plans can use. Participants would be referred to a website for more information on each investment, including the investment’s strategies and risks, the identity of the investment issuer or provider, portfolio turnover, and the assets held in the portfolio. More detailed documents, like a copy of a prospectus or similar document, would be available upon request. Participants’ quarterly statements would display any administrative fees deducted from their accounts during the quarter.

The second DOL proposal would require plan service providers to disclose to employers the services that they provide and the direct compensation they receive from the plan and employee accounts.17 Service providers also must disclose in detailed fashion all indirect compensation, broadly defined to include anything of value paid from any source other than the plan, employer, or the recordkeeper. This would include finder’s fees, soft dollar payments, float, brokerage and other transaction-based fees, and payments that an affiliate of the recordkeeper receives in connection with the plan. In addition to fee disclosures, the regulation will require comprehensive “conflict of interest” disclosure to employers. Under these new disclosure regulations, a plan fiduciary will be able to assess all of the compensation paid to a 401(k) plan service provider before any contract is entered into. Violations of the new disclosure scheme are enforced by tough penalties on the service provider.

These projects were not completed by the Bush Administration, and Assistant Secretary Borzi has announced she intends to finalize them.18 The Institute strongly supports these initiatives and has urged DOL to complete these projects as quickly as possible.

C. Congressional Proposals to Enhance Disclosure

This Committee has been referred for consideration two bills intended to close the disclosure gaps described earlier: H.R. 2779, the “Defined Contribution Plan Fee Transparency Act of 2009” and H.R. 2989, the “401(k) Fair Disclosure and Pension Security Act of 2009.” As noted earlier, H.R. 2989 also contains extensive reworking of the rules for providing investment advice to participants. In analyzing these proposals, and considering whether legislation is necessary in light of the Department of Labor’s proposals, we urge the Committee to apply the following principles.

Participants in all self-directed plans need simple, straightforward disclosure focusing on key information, including information on fees and expenses, which allows comparisons among a plan’s investment options. This key information includes an investment option’s investment objective, risks, historical performance, and fees. Comparability is particularly important with respect to fees. Mutual fund investors have for years had access to a simple, standardized measure of fees – the expense ratio – as well as a representative example showing what the expense ratio means in dollar terms for a typical investment. H.R. 2989 requires plan fiduciaries to translate asset-based investment fees into dollars on a quarterly basis. Because contributions and distributions are continually being made into and out of 401(k) accounts, creating systems that could provide this disclosure could be very expensive, and in addition, the requirement complicates comparing among the plan’s investment options. For example, if a participant has 90% of his or her account invested in a fund with a 0.40% (40 basis point) expense ratio and 10% invested in a fund with a 1.00% (100 basis point) expense ratio, the participant presented with the dollar amounts of fees for each investment might think the first fund is relatively expensive and the second is cheaper. The best way to achieve comparability is through use of percentages or basis points or through a representative example (such as the dollar amount of fees for each $1,000 invested).

The disclosure should cover all investment products available in plans, including providing comparable disclosure for products that provide a fixed or promised return. All of the current legislative and regulatory proposals would cover all products. Both legislative approaches include a provision requiring regulations to ensure comparable disclosure for insurance and other products that provide a fixed return (like annuities). However, H.R. 2779 appropriately makes the issuance of these regulations mandatory; H.R. 2989’s provision is optional for DOL.

Employers should get clear information that allows them to fulfill fiduciary duties. Employers should receive information from service providers on the services that will be delivered, the fees that will be charged, and whether and to what extent the service provider receives compensation from third parties in connection with providing services to the plan. These payments from third parties, sometimes inaccurately referred to as “revenue sharing” but which are really cost sharing, often are used to defray the expenses of plan administration. We support requiring their disclosure by service providers.

We do not support provisions in H.R. 2779 and H.R. 2989 that force providers to disclose fees in various service categories even if there are no separate charges for the services and the services are not available on a standalone basis. This approach favors one business model – firms that just bundle together recordkeeping and other administrative services – over another business model – firms that offer recordkeeping and administration as well as investment management services, by imposing additional disclosure burdens on the full-service model. More importantly, employers need information that they can use, and this presents them with information – an unbundled number for a service that is not offered separately – the usefulness of which is unclear and which could create liability concerns for employers and service providers.

If Congress should determine nevertheless to require providers to allocate fees among categories even when services are not separately available, it must recognize the difficulties (and liability risks) of disclosing a fee for a service that is not offered separately and allow service providers to allocate in a manner that is reasonable and in good faith. At a minimum, the legislation should provide for safe harbor methods a service provider could, but would not be required to, use for the allocation. This would offer certainty for providers that want to rely on a pre-approved allocation method but offer flexibility for providers to develop and use other reasonable methods. Finally, disclosure should provide flexibility in the form of disclosure (percentage of assets, total dollars, amount per transaction) so that providers can disclose fees accurately in the manner in which they are charged.

Congress should leave to plan fiduciaries the responsibility of determining the investments that are appropriate for participants. H.R. 2989 sets a dangerous precedent by effectively requiring plans to include an indexed investment option meeting specific requirements. This goes far beyond disclosure. It is not appropriate for the government to begin to pick investment options for private 401(k) plans. Decisions about the investment menu of a 401(k) plan are best made by plan fiduciaries who can consider all options available now or in the future in designing plan offerings that will enhance employees’ retirement security.

The disclosure rules should be precise so that service providers and plan fiduciaries know what disclosure is required of them and do not need to interpret the law broadly to avoid penalties. Unless the rules are clear, the resulting disclosure will be confusing to plan fiduciaries and participants and unnecessarily costly to prepare. H.R. 2779 is more clearly written and therefore avoids a number of difficult interpretive issues presented by H.R. 2989. For example, H.R. 2989 defines a 401(k) plan’s services subject to the bill so broadly that it could cover service providers to the plan’s investments. As a result, service providers to investment products like mutual funds and insurance contracts (such as accountants, printers, and custodians), who have no direct relationship with a plan, could suddenly be subjected to detailed fee disclosure for one class of investors, the cost of which will be passed on to retirement plan savers investing through a workplace savings plan. In addition, this suggests that plans must have a personalized contract with each investment product in which it invests, which violates the basic securities law principle that all mutual fund shareholders must be treated equally.

In addition, because of the difficult compliance burdens that the disclosures in H.R. 2779 and H.R. 2989 would require, the bills should include provisions that allow one service provider to rely on information provided by another entity unless the provider knows or should know that the information is inaccurate or incomplete, and that allow inadvertent errors to be corrected within a reasonable time without penalty. Provisions along these lines, which are contained in H.R. 2779, will enhance compliance and correction of minor or inadvertent errors.

As the Institute said when it last testified before this Committee, we applaud the Committee for examining how we can make the 401(k) system even more effective in providing retirement security. We look forward to continuing to work with this Committee and its staff on these issues.

endnotes

1 The Investment Company Institute is the national association of U.S. investment companies, including mutual funds, closed-end funds, exchange-traded funds (ETFs), and unit investment trusts (UITs). ICI seeks to encourage adherence to high ethical standards, promote public understanding, and otherwise advance the interests of funds, their shareholders, directors, and advisers. Members of ICI manage total assets of $11.02 trillion and serve over 93 million shareholders.

2 See U.S. Department of Labor, Employee Benefits Security Administration, Private Pension Plan Bulletin: Abstract of 2006 Form 5500 Annual Reports (Dec. 2008), available at  http://www.dol.gov/ebsa/PDF/2006pensionplanbulletin.pdf. The bulk of these plans were 401(k) plans, with 465,653 plans and more than 58 million active participants.

3 The Institute surveyed 3,000 U.S. households. The survey was conducted in late October through December 2008—that is, during some of the most jarring days in the history of our financial markets. See Investment Company Institute, Retirement Saving in Wake of Financial Market Volatility (Dec. 2008), available at http://www.ici.org/pdf/ppr_08_ret_saving.pdf.

4 See, e.g., Vanguard, How America Saves 2009, A Report on Vanguard 2008 Defined Contribution Plan Data, available at https://institutional.vanguard.com/iam/pdf/HAS09.pdf; Vanguard Research Commentary, “Participants calmer than you’d think amid market turmoil,” (Dec. 2, 2008), available at  https://institutional.vanguard.com/VGApp/iip/site/institutional/researchcommentary/article?File=NewsPartCalm; Fidelity, “Participants Continue to Stay the Course Amidst Market Downturn,” available at  http://content.members.fidelity.com/Inside_Fidelity/fullStory/1,,7669,00.html; The Principal, Retirement Trends Report, The Total View 2009, available at http://www.principal.com/about/news/totalview.htm.

5 In recent testimony to the Education and Labor Committee, ICI recommended seven policy improvements that could be made to strengthen the U.S. retirement system. See Testimony of Paul Schott Stevens, Hearing on “Strengthening Worker Retirement Security,” House Education and Labor Committee (Feb. 24, 2009), available at http://www.ici.org/policy/ici_testimony/09_house_401k_tmny.

6 See Profit Sharing /401k Council of America, 52nd Annual Survey Reflecting 2008 Plan Experience (2009).

7 Investment Company Institute, 2009 Investment Company Fact Book, 49th Edition, available at http://www.ici.org/pdf/2009_factbook.pdf.

8 Holden and Schrass, The Role of IRAs in U.S. Households' Saving for Retirement, 2008, ICI Fundamentals, vol 18, no. 1(Jan. 2009), available at www.ici.org/pdf/fm-v18n1.pdf.

9 Sabelhaus, Bogdan, and Holden, Defined Contribution Plan Distribution Choices at Retirement: A Survey of Employees Retiring Between 2002 and 2007, Investment Company Institute Research Series (Fall 2008), available at www.ici.org/pdf/rpt_08_dcdd.pdf.

10 See  http://content.members.fidelity.com/Inside_Fidelity/fullStory/1,,7669,00.html.

11 See “Labor Department moving ahead on advice proposal, Borzi says,” Pensions and Investments (Sept. 23, 2009), available at  http://www.pionline.com/article/20090923/DAILYREG/909239990.

12 See  http://www.ici.org/policy/regulation/products/mutual/07_house_401k_tmny.

13 Deloitte Consulting and Investment Company Institute, Defined Contribution / 401(k) Fee Study (Spring 2009), available at http://www.ici.org/pdf/rpt_09_dc_401k_fee_study.pdf .

14 This figure represents the median fee for the 130 plans in the survey. The survey used a sampling technique known as nonproportional quotas. Knowing that the universe of 401(k) plans includes more than 450,000 plans, and that smaller plans are harder to find, the survey was specifically targeted across the spectrum of asset sizes and stayed in the field until specific quotas for plans of different sizes were filled. Although the plans are intended to be representative, the median fee should not be projected to the entire population of U.S. 401(k) plans. Weighting the reported fees in the 130 plans by the actual distribution of participants in all 401(k) plans results in a total fee of 0.86 percent. See the Study for more information on the plans surveyed.

15 Holden and Hadley, The Economics of Providing 401(k) Plans: Services, Fees, and Expenses, 2008, ICI Fundamentals, vol. 18, no. 6 (August 2009), available at http://www.ici.org/pdf/fm-v18n6.pdf. While the Deloitte/ICI study described above covers all plan costs, this research only covers mutual funds held in 401(k) plans because ICI does not have the information necessary to study other investments.

16 See 73 Fed. Reg. 43014 (July 23, 2008).

17 See 72 Fed. Reg. 70988 (Dec. 13, 2007).

18 “Lifting the fog: Face to Face with Phyllis C. Borzi,” Pensions and Investments (Sept. 7, 2009), available at  http://www.pionline.com/article/20090907/FACETOFACE/309079996.


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