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Creating Ideal Defined Contribution Plan Takes Strong Will, Firm Focus

December 15, 2010
Related Topics: Defined Benefit Plans, Benefit Design and Communication, Retirement/Pensions, Featured Article, Compensation
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What are the elements of an ideal defined-contribution plan? According to a recent poll of large plan sponsors by Chicago-based Northern Trust Corp., they include automatic features, immediate vesting, a streamlined fund lineup and dearth of loans.
A state-of-the-art plan would also potentially offer investment advice, be unbundled and have target-date funds as its default. Of course, it can be difficult to live up to this ideal.
Indeed, automatic enrollment is featured in only a small majority of plans, auto escalation features and immediate vesting are not the norm, and loans are common. Yet some plans are closer to their ideal than others.
There are plenty of examples regarding how plan sponsors have overcome obstacles—ranging from cost, fiduciary concerns, palatability and simple group dynamics—to optimize their defined-contribution structure.
Whether it is out-of-pocket costs or costs associated with resources, expense can be a key deterrent in getting to the optimal defined-contribution plan. Cost can make plan sponsors reluctant to add advisory services or even automated features.
Ironically, cost can become an issue when plan sponsors consider unbundling their defined-contribution plan to take advantage of institutional structures. For large plans, the use of separate accounts and collective trusts can produce economies of scale that translate into much more attractive pricing for participants.
However, going from a turnkey bundled solution to one with more moving parts requires additional plan sponsor resources. Trust and custody must be negotiated and managed when separate accounts are employed and fund fact sheets may need to be created. Nonetheless, many plans are unbundled and use institutional products.
Plan sponsors who overcome cost issues tend to perform a cost-benefit analysis or seek to neutralize cost through creative solutions. If resource costs are an issue in moving to an institutional structure, for example, these plan sponsors weigh the resource needs against the reduced fees to participants, greater flexibility in managing the plan and increased opportunity set of investment managers and even asset classes (a number of real return funds, for example, are only available in collective trusts), etc.
An example of neutralizing cost through creative solutions can be applied to the addition of automated features. When potentially higher employer matching costs are an issue in adding automatic enrollment, for example, plan sponsors have overcome this hurdle by restructuring the match so that the impact is economically neutral to the company.
Potential fiduciary liability an impediment
Potential increased fiduciary liability is another common deterrent. For example, even though the Pension Protection Act of 2006 explicitly permits plan sponsors to manage custom target date strategies within their plan, some are hesitant about assuming the responsibility of being the funds' investment manager. Nonetheless, a number of plan sponsors have overcome this hurdle and do manage their own custom target date funds.
How? Typically, such plan sponsors take the position that a plan of superior design is proofed against fiduciary liability concerns.
In the case of custom target-date funds, they reason that the ability to have control over their target-date glide path, benefits from the economies of scale of existing funds within the plan, and diversification through a best-in-class set of underlying funds enhances the plan so that fiduciary concerns are offset.
Of course, such plan sponsors must be confident they can implement such plan enhancements successfully, they must have faith in the integrity of their process, and they must be committed to documenting their approach. If not, plan sponsors likely would be better off just outsourcing the custom target-date fund management.
The point of view that a superior plan trumps fiduciary concerns has been instrumental in plan sponsors gaining comfort with the implementation of everything from investment advice to auto features.
Barrier of potential backlash
More than one plan sponsor has been stymied in its pursuit of a best-in-class, defined-contribution plan by concerns about participant backlash. A good example is when sponsors consider streamlining a plan's investment funds with the intention of making the plan easier for participants to use, simpler for the sponsor to monitor and potentially less expensive because of greater economies of scale within the diminished fund lineup.
However, as the plan sponsor faces chopping sacred cows from the plan—funds that are well-liked but redundant and ill-suited for the plan—the resolve to streamline may wane. Plan sponsors that have successfully navigated this type of rocky terrain have done so by focusing on whether participant desires are the same as participant needs.
In this example, some plan sponsors have decided that the majority of participants will benefit from a streamlined approach, but a vocal minority will object. In that case, given that the change is in the best interest of the typical plan participant, the plan sponsor resolves to forge ahead with the streamlining—using bolstered communication support (or a self-directed brokerage window) to address the vocal minority's potential concerns.
The approach of parsing out participant needs from participant desires and then treating any disconnect as a communication issue applies in areas ranging from availability of loans to matching strategies.
Lack of focus as a snag
Perhaps one of the most insidious obstacles to the ideal defined-contribution plan is lack of focus by the plan sponsor. Many plan sponsors can identify features that may improve their defined-contribution plan, but never get around to implementing them.
It may be as simple as not having room on the agenda to address the topic at committee meetings because of other urgent plan issues, or it may be as complex as a group dynamic that tends to focus on tactical rather than strategic initiatives. Automatic contribution escalation is often a good example of this.
Because experience with automatic contribution escalation is still rather limited, it is easy for plan sponsors to procrastinate in making the decision to implement it. It is not that automatic contribution escalation is deemed unnecessary or a poor fit for the plan—it is just that it cannot get traction with the decision-makers.
Plan sponsors that successfully grapple with implementing automatic contribution escalation (or other such strategic initiatives) do so by developing an annual work plan that will allow them to prioritize both tactical and strategic defined-contribution plan decisions. They then hold themselves accountable for addressing the items on the work plan so that they do not get derailed during the course of the year.
Why it matters to reach the ideal
It must certainly be acknowledged that what is ideal for one plan may not be the case for another. Plans may be too small to benefit from unbundling or custom target-date funds, they may not need automated solutions, or they may have a sophisticated participant demographic that is fully capable of navigating greater investment choice.
However, it is also true that some plans fall short of their potential for reasons that can be overcome given the proper approach. Why does it matter?
At a recent Defined Contribution Institutional Investment Association plan sponsor round table, sponsors of large defined-contribution plans were asked what the return on investment to the plan sponsor is for optimizing their defined-contribution plan. One plan sponsor said the company was known for having top benefits packages, another cited recruitment and retention, while a third said they worried that if it didn't have a sound defined-contribution plan, people would “retire on the job” because they couldn't afford to leave.
Perhaps most compelling of all, however, was the plan sponsor who said that if defined-contribution plans weren't well run, there likely would be greater government intervention in the 401(k) system. The incentives, in other words, are many for overcoming the obstacles to an ideal defined-contribution plan.
Workforce Management Online, December 2010 -- Register Now!

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