AdvisorOne partnered with fi360 for the 2012 Article Competition. Here, the winner, Gregory Kasten, presents fiduciary best practices for actuarial implementation that can consistently improve 401(k) participant outcomes.
Great strides have been made over the past two decades to upgrade fiduciary best practices and the standard of care in the investment business. Our industry has seen the creation and widespread acceptance of groups like fi360, Committee for the Fiduciary Standard and CEFEX, and the publication of the Prudent Practices Handbook. Since passage in 1974, ERISA has always required a duty of loyalty and prudent expert standard of care. We are now seeing these duties fulfilled on a much more widespread basis. However, if our industry is to thrive, these necessary procedures must produce tangible results for the end user—the client. Tangible results are ultimately more important than simply avoiding prohibited transactions and fee transparency. For an ERISA plan, the most tangible result of all is the successful retirement of most plan participants.
The purpose of this article is not to launch into a prolonged debate about market efficiency. I hope most observers would agree that in the aggregate, the stock market cannot outperform itself. Clearly, after fees, the aggregate net investment performance of investors in the market must be below the market itself, so alpha is negative for the entire group. When investment professionals talk about alpha as their main value proposition, they have placed themselves in the untenable situation of promising an outcome that, at least across all advisors as a group, cannot exist.
This alpha value proposition view is widespread. A study by Jefferson National found almost 76% of advisors thought they added alpha. Not only does adding alpha not exist in any widespread basis, real-world alpha is actually negative in the aggregate. The fiduciary business model must have solid principles and deliver tangible results to the vast majority of clients, not just a few exceptions.
The current environment mixes market fluctuation, economic uncertainty, fee compression, DOL investigations, threat of participant lawsuits and an ever-changing regulatory landscape. The fiduciary standards under ERISA are very high. Plan sponsors have an affirmative duty to be prudent experts and to discharge all of their duties in the sole and exclusive best interest of plan participants. This creates an ideal time for plan sponsors to step back, reassess their current practices and work with an advisor dedicated to understanding ERISA and retirement planning.
Preventing something adverse from happening is mostly an intangible value. This is particularly true in small ERISA plans that have never seen a participant lawsuit, so preventing one seems hard to quantify from a value perspective. Important practices include holding regular committee meetings and calling special ones when necessary, such as significant investment news affecting the plan’s lineup. Decisions should be documented even when the decision is to do nothing. It is important to memorialize the process that you went through to reach that decision. Likewise, it is also very important to maintain a well-drafted investment policy statement. Plan sponsors need to be aware that the investment policy statement and committee minutes are regularly requested items in a DOL audit.
There is no law that requires plan sponsors to offer advice, or even education, to their plan participants. To reduce plan sponsor risk, the advisor should create a record showing everything offered to help participants achieve a secure retirement. Offering education, offering low-cost investment options and providing robust advice programs are some very important ways that you, as a plan fiduciary advisor, can help your participants along their path.
With that said, we also know that most education programs produce little impact on participants’ outcome. Inertia is simply too great. According to the most recent EBRI study, only two in 10 workers stated that they would be very likely to take advantage of such a service if it were available at a modest cost. Further, the study found that those who chose to take advantage of investment advice generally did not benefit from it because most did not implement the recommendations. Of the subset indicating they were likely to seek advice, only two in 10 said they would implement all of the recommendations they received as long as they trusted the source. Thus a minuscule 4% of all the employees (of the two in 10 receiving advice, only two in 10 will act on it) will both take advantage of the service and fully implement the advice.
Managing the Upcoming Fee Discussion
There is no doubt that for years most plan sponsors and participants have not understood what their plan costs. Understanding fees—and ensuring that they are reasonable—is something that the DOL has spent years focusing on. The market environment, combined with the litigation environment, has put fees on the forefront of plan sponsors’ minds.
Plan sponsors are now encouraged to look at not only out-of-pocket or visible recordkeeping fees, but also generally hidden investment costs and wrap fees that go along with having a fund lineup. The legal standard here is reasonableness. There is no legal requirement that plan sponsors find the lowest fee. Instead, reasonableness should be assessed in light of the services received and outcomes delivered. Plans can have different needs based on complexity, number of participants, etc. Services should be evaluated in light of the needs of that particular plan.