Group Stinks, an article written by Scott Woolley in Forbes July 13, 2009 issue has proclaimed all group annuity contracts are dogs.  In this time of specialization, it is great to see a writer take on the roll of an ERISA attorney, contract lawyer, investment manager, plan advisor, and consumer rights advocate.

Are there abuses in the small 401(k) market?  Small being defined as plans with less than 100 employees and $5 million in assets.  Absolutely.  Do they take place in plans with assets of $10 million to $250 million?  Rarely.  Based on Larkspur Data Resources, Mr. Woolley would suggest we have 18,000 dumb companies investing $185 billion of plan assets in dog annuities.  His claim is that all of these products are sold by unscrupulous brokers who are motivated only by lavish commissions.

And Scott, please send me the name of the supervising Texas CPA firm so I can avoid their sophisticated analytical capabilities to not understand or ask the right questions before signing a group contract, or any other business contract.  No matter how much oversight provided by the SEC and the State Department of Insurance, you cannot protect companies from making potentially poor business decisions.

I am not defending the high cost and abusive group contracts sold by some companies.  It is the tone and unconstructive generalization about the GACs that prompts me to post this blog. 

In the future I would suggest you interview brokers and advisors who will provide unbiased advice and explain the value of a GAC.  You have received very biased advice from competitors selling against the products.  Not sure if they have any more honorable intentions than brokers selling GACs that provide poor value.

Finally, the advice to employees is sound.  Identify what the true costs are to participate by asking your employer to do a thorough review of the expenses and fund performance.  As a fiduciary, this should be done every year.  Use the DOL Fee Disclosure form and have the broker and insurance company complete the form.  Also, have the broker put in writing they are not receiving any other form of compensation other than what is disclosed on the form.  This should be signed by an officer of the brokerage firm.

The 401(k) plans with outrageous fees do negatively impact future account balances.  Having a naive writer author financial articles with limited business acumen and not seeking independent sound opinions/advice could be equally damaging.

One final comment, “Do not complain to your Benefits Department.”  A company with fewer than 100 employees typically does not have a Benefits Department.  There are plenty of complaining employees.  How about offering to form a committee to thoroughly review all aspects of the company 401(k) plan, if there is not one already in place?  This will lead to better results for the employer and for plan participants.

For those of you who aren’t familiar with the concept, simply stated, dollar cost averaging is consistent investment of  set amount of money in periodic intervals to reduce market risk.  Instead of investing a lump sum trying to time the market, dollar cost averaging spreads out the investments over time and minimizes the negative impact of market fluctuations while taking advantage of the increase in purchase power during down market cycles.

With the above in mind, Precept RPS has consistently included the topic of dollar cost averaging at every employee educational meeting.  However, whenever dollar cost averaging is mentioned or explained, plan participants usually give a look of skepticism or disbelief.  They have a difficult time believing that there’s a potential for investment gain even when the market is substantially down for the year.

To help prove that this concept applies to everyday investors and especially to 401(k) participants who practice dollar cost averaging through payroll deductions, I conducted a little experiment.  I have been tracking 2 mutual funds for the past 11 months, the Schwab S&P 500 Index E Share fund (SWPEX) and the Fidelity Spartan Ext. Market Index Inv fund (FSEMX).  On September 11th, 2008, just prior to the market crash, a share of the Schwab S&P 500 Index fund was $18.98 and a share of the Fidelity Spartan Ext. Market fund was $36.55.  However on July 22nd, 2009, each respective share price was $14.87 and $25.56.  That is a decrease in price of 21.65% and 21.74%!  Yet, as the cliché goes, it’s all about the journey, not the end results.  What if, starting in September 2008 until July 2009, I invested $100 in each fund on the 11th and 22nd day of the month?  How much would I gain or lose?

It may be shocking, but even though the Schwab S&P 500 fund was down about 25% in that time period, through dollar cost averaging, I was up 8.26%.  Similarly, for the Fidelity Spartan Ext. Market fund which was down 28.02% for that time period, I was up 12.78%.  All I did was automatically invest $100 every 11th and 22nd day of the month.  This shows the advantage of practicing dollar cost averaging by increasing your purchasing power during down market and realizing positive returns during the recovery period.

Now, do not use this example as a guarantee that you’ll always realize investment gains.  The purpose of dollar cost averaging is to minimize risk and maximize your potential for investment returns   Instead of guessing when the market is on the rise or fall; this steady approach incurs all the highs and lows in order to balance out the risk.  As we move through this volatile market period, plan participants will realize that dollar cost averaging is applicable in theory and in practice.

For more information:

Dollar Cost Averaging: A Technique that Drastically Reduces Market Risk

Does Dollar Cost Averaging Work?

Target date funds are viable options for plan participants with limited time to research plan fund options or limited investment knowledge to select individual funds.  Target date funds offer a simpler solution of using a glide-path asset allocation strategy which matches up to the participant’s target retirement date.  However, the hearing showed that is much more difficult in practice.  Joseph C. Nagengast, of Target-date Analytics said, “There is some theoretical rationale for employing a glide path throughout the accumulation phase. No credible rationale has ever been proffered for using a glide path in the distribution phase”.  However one point was made clear, there should be no regulations on how one invests in target date funds.  “In the 70-year history of mutual fund regulation, the government has never regulated the investment choices of mutual funds.  Nor should it start now,” said ICI General Counsel Karrie McMillan.  The largest fear of placing restrictions on investment choices for target date funds is that it would cripple the fund manager’s ability to rebound from losses, as well as hinder the fund’s long term objectives.

While the hearing did touch on what’s wrong, many testimonials did mention ways to help improve target date funds.  Nagengast suggested a need to focus on “the name of each fund (that) must bear some relationship to the way the fund is managed, that is, its glide path” and how “the glide path must be designed to provide for a predominance of asset preservation as the target nears and arrives”.  Other suggestions include disqualifying target date funds as a Qualified Default Investment Alternative, offering full disclosure, education programs, and education targeting soon-to-be retiree programs.  In the end, the DOL and SEC will gather all the data to try and address any future regulations.  However, by the sound of it, what was once thought as a doomsday event for target date funds, now seems to be much-ado-about-nothing.

For more information:

Missing the Targets by Steven Syre (Source)

Financial Planners urge Fedl Standard for Target Date Funds by Darrell A Hughes (Source)

U.S. Urged not to Tamper with Target Date Funds by James Pethokoukis (Source)

Target-Dates Useful but Flawed, Witness Tell SEC and DoL by Rebecca Moore (Source)

The hearing is partly a response to the performance of the 2000 – 2010 target date funds. As of 3/31/09, the average 1 year performance for 2000 – 2010 target date funds was down 24.67%. In theory, the composition of the funds should be more conservative the closer to the target retirement date. This hearing will address how and why target date funds have such high average negative returns.

In addition, the hearing is also a follow up from last February where the Department of Labor issued a regulation from last year that allowed target date funds to be used as the qualified default investment option (QDIA) for plans. However, the hearing did not address any “requirements regarding the composition of target-date funds and the appropriate ratio of stocks and bonds as the fund nears its target”. What is to stop a manager from investing 80% in equities and only 20% in bonds for a 2010 target date fund? Hopefully what comes out from the hearings are guidelines for plan sponsors to review their target date funds and see if they fit the plan’s goals.

For more information, please go to http://www.planadviser.com/compliance/article.php/4333

In the final case of our judicial development 2008/2009 series, we will be focusing on the Kennedy vs. Plan Administrators for Dupont Savings & Inv. Plan.

Kennedy v. Plan Administrators for Dupont Savings

Background:

In Kennedy vs. Plan Administrators for DuPont Savings & Inv. Plan, Kari Kennedy, the daughter of William Kennedy and the executor of his estate, tried to recover approximately $400,000 that had been paid to her father’s ex-wife, Liv Kennedy. Mr. and Mrs. Kennedy divorced in 1994, and at that time Liv voluntarily waived her right to receive benefits as part of her property settlement under the Savings and Investment Plan (SIP) sponsored by DuPont. Subsequently, Mr. Kennedy never removed his ex-wife’s name from the beneficiary form on file with DuPont. Once Mr. Kennedy passed away, over seven years later, DuPont distributed his SIP benefits to his ex-wife (the named beneficiary).

In response, Mr. Kennedy’s estate sued, claiming that Liv surrendered her rights under the divorce decree. The District Court entered a summary judgment in favor of William’s estate and ordered DuPont to pay the benefits to the Estate. The case then went before the Fifth Circuit Court of Appeals where they reversed the holding, ruling that Liv’s waiver of the benefits would have amounted to an “illegal diversion of benefits to someone else, in violation of ERISA’s provision against such diversion (or “alienation”). ‘A state court divorce decree,’ the Circuit Court said, ‘is technically not the kind of paper diversion of plan assets that ERISA allows because it was not a Qualified Domestic Relations Order (QDRO), in the phrasing of ERISA.’” It is interesting to note that other Circuit Courts have ruled that a divorce decree could amount to a waiver of benefits even though it isn’t a domestic relations order specified by ERISA,.

Kari Kennedy petitioned the Supreme Court and they agreed to rule on the case.

Result:

The Supreme Court ruled against the estate. The Court first ruled that, under ERISA, a divorcing spouse could waive plan benefits through a divorce decree under state law. The Court, however, disagreed with the Fifth Circuit’s ruling and stated, “we think that the better view is that Mrs. Kennedy’s waiver” was not an alienation or assignment that was illegal under ERISA. The Court held that ERISA provide no exception to a plan administrator’s duty to act in accordance with plan documents. The plan documents allowed DuPont to pay benefits to a participant’s designated beneficiary and specified the manner in which beneficiary designations and changes were to be made. The Court concluded, “William’s designation of Liv as his beneficiary was made in the way required; Liv’s waiver was not.”

Impact:

This case stresses the importance of updated beneficiary information and what constitutes ERISA approved designation or waiver beneficiary designation campaigns to ensure initial appointment by participants and on-going updates. For plans transitioning from paper elections to on-line beneficiary designation, it may be an opportune time to emphasize the importance of this simple but critical enrollment step.

For more information, please read:

http://www.lhdl.com/news/enewsletter_article_detail.cfm?ARTICLE_ID=311 (source)

http://www.scotusblog.com/wp/?s=kennedy+dupont (source)

• Acting solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them
• Carrying out their duties prudently
• Following the plan documents (unless inconsistent with ERISA)
• Diversifying plan investments; and
• Paying only reasonable plan expenses

• Follow your Plan’s Investment Policy Statement
  • An investment policy statement is essential for the proper operation of a plan and the proper fulfillment of the fiduciary duties for selection and monitoring of investments 
• Remember to document everything
  • ERISA is concerned with a prudent process and the best way to demonstrate this is to carefully document your actions and decisions.
• Reinforce basic investment principals
  • Don’t forget about the value of diversification and investing for long term gains
• Remember to keep plan participants informed
  • With the uncertainties in the market, participants probably have a lot of questions regarding their investments. It is very important to communicate with participants. Ask your vendor for some materials that can help explain the current market to plan participants and their options in such volatile times.

Fidelity Bond vs. Fiduciary Liability Insurance by Janelle Sotelo, Account Manager, Precept RPS

In today’s ever-changing world of the retirement plan market, plan sponsors are asking if they need a Fidelity Bond or Fiduciary Insurance or both. The two may sound similar but there are big differences between them.