Best Practices for 401k fiduciaries (PCI by vcl99353


									 Best Practices for 401(k) Fiduciaries

Wes Schantz & Jim Edwards
Corporate Retirement Plan Fiduciary Services
100 Gateway Drive, Suite 300
Bethlehem, PA 18017
(610) 865-2600 Phone
(610) 865-2408 Fax

Table of Contents

            Section             Contents

               I                   Overview
               II           Role of a Plan Fiduciary
              III              Plan Governance
              IV          Investment Policy Statement
              V       Plan Fee and Expense Benchmarking
              VI                   Questions


Session Overview

Fiduciary best practices is a growing concern among plan sponsors, retirement plan
      itt   t t         d
committees, trustees and corporate boards due to the current economic environment,
                                  t b d d t th                t        i     i        t
market volatility, participant-related lawsuits, declining retirement account values,
poor investment returns, proposed legislative 401(k) fee disclosures, and the
heightened sensitivity of fiduciary responsibilities given recent media attention
surrounding 401(k) savings plans.

Current Environment

              P      d F Di l         (On Hold)
  • 408(b)(2) Proposed Fee Disclosure (O H ld)

  • Current Litigation
     • LaRue v. DeWolff, Boberg & Associates
     • Hecker v. Deere & Co.

  • Nearly $2 trillion in retirement account balances lost

  • Fiduciary Best Practices
      • Formalize polices and procedures
      • Plan benchmarking (Fees, Services, etc.)
      • Investment monitoring

Who is Plan Fiduciary?

                          i discretion in administering and managing a plan or
  A person or persons using di    ti i d i i t i          d      i      l
  controlling the plan’s assets.

      • Neither title nor office controls the legal designation of fiduciary.

      • Members of an Investment Committee are fiduciaries.

Plan Fiduciaries

  Three types of Investment Fiduciaries:

      • Investment Stewards – person or persons maintaining legal
        responsibility for managing investment related decisions (ex: trustees
        and investment committee members).

      • Investment Advisor – a professional who is responsible for managing
        continuous investment decisions (ex: Registered Investment Advisor).

      • Investment Managers – a professional who is responsible for making
        investment decisions; selects the individual securities (stocks and bonds)
        to implement a specific investment objective (ex: mutual fund managers
        and separate account managers).

Role of a Plan Fiduciary

  • Act solely in the interest of plan participants and beneficiaries (duty of
    l lt )

  • Hold and deal with plan assets for the exclusive purpose of providing plan
                      y g                p                     g     p
    benefits and defraying reasonable expenses of administering the plan
    (exclusive benefit rule).

  • Act with the care, prudence, skill, and diligence that a prudent person acting
    in like capacity under similar circumstances would act (prudent person rule).

            •   Act in accordance with plan documents.
            •   Attend investment committee meeting(s).
            •   M i t i investment committee minutes/notes.
                Maintain i     t    t      itt    i t / t
            •   Diversify plan investments unless it’s clearly imprudent to do so.
            •   Act in accordance with Investment Policy Statement.
            •   Monitor and control plan expenses (including investment fees).

Role of a Plan Fiduciary

  Fiduciary Best Practices:

  • Understand standards, laws and plan trust provisions.

  • Maintain written investment policy statement.

  • Diversify assets to specific risk/return profiles of participants.

  • Formalize and document the process for selection of investments.

  • Proactively monitor plan investments and service providers.

    Provide i di        i ti       d d ti t l             ti i t
  • P id periodic communications and education to plan participants.

  • Maintain written contracts with full disclosure of vendor fees and services.

Role of a Plan Fiduciary

  404(c) Requirements (In General):

  1. Employer notification –

      •   The plan intends to comply with 404(c) and participants have control.

  2. Investment choices –

      •   The plan must offer at least three “core” investments.

  3. Transfer Flexibility –

      •                                                    quarterly.
          Participants can transfer between funds at least quarterly

  4. Investment information –

      •       id      i i       i h ffi i i               i f     i
          Provide participants with sufficient investment information.

Role of a Plan Fiduciary

  Common Areas of Concern for Plan Sponsors:

  1.    having h i         i        d               ff i l             h l
  1 Not h i the time, experience, and resources to effectively manage the plan.

  2. Not proactively monitoring plan investments.

  3. Not having an Investment Policy Statement as a roadmap.

  4. Not following the provisions of an IPS when one exists.

  5. Not monitoring plan expenses and plan performance.

                     g          g                              plan
  6. Not understanding or knowing what constitutes “reasonable p fees”.

  7. Not communicating with plan participants or documenting the process.

Plan Governance

 “Governance is how plan fiduciaries organize themselves to manage the legal
                                       p           providing p
   and financial risks associated with plans while p       g plan
   participants with promised benefits”

         Governance is:         Good governance is      Th end product is a:
                                                        The d     d i
          • The way in                                   – Clear mission
            which people are     • Have an
            organized within       appropriate
                                   structure             – Developed skill
            a company to                                   and resource
            manage th i
            responsibilities     – Following the
                                   right policies and    – Delegation of
          – Managing the           processes               responsibilities
            legal and
            financial risks      – Document all          – Accountability and
            associated with a      decisions
            retirement plan

 Plan Governance

Formalize Committee:

    • By laws

    • Board appoints Committee

         i lC       i         b
    • Typical Committee members
            o Knowledgeable chairman
            o Finance executives
                u a esou ce executives
            o Human resource e ecut ves
            o Internal legal counsel
            o Investment advisor
            o Permanent positions vs. term positions

    • Important considerations for Committee
        • Education
                      g                 y p
        • Acknowledgement of fiduciary responsibilities
        • Fiduciary liability insurance

Plan Governance

Committee Responsibilities:

   • Selecting and monitoring plan investments.

        • Important decision items:

            o What asset classes are appropriate for employee demographics?

            o Number of investment options?

            o How to select most appropriate options from available universe?

            o Qualified Default Investment Alternative (QDIA)?

            o How to establish the investment monitoring criteria (IPS)?

Investment Policy Statement – Overview

The importance of an Investment Policy Statement:

        • Provides the framework for all investment related decisions,

        • Provides a roadmap for your investment due diligence process,

        • Prudent process for selecting and monitoring investments,

        • Provides documentation for IRS or DOL audit,

        • ERISA does not require an IPS (although it is prudent to maintain).

        According to the Deloitte Consulting Annual 401(k) Benchmarking Survey
        approximately 83% of plan sponsors maintain a formal investment policy

Investment Policy Statement – Framework

  • Identify plan fiduciaries and their responsibilities.

  • Identify acceptable/suitable asset classes.

  • Identify investment structures.

  • Identify specific criteria for selecting and monitoring investments.

  • Identify default investment alternative (QDIA)

  • Identify specific criteria for replacing investments.

  • Provide for a procedure to account for and control plan investment expenses.

Investment Policy Statement – Plan Fiduciaries

    Plan T t
  • Pl Trustees

  • Plan Administrators

  • Committee Members

  • Registered Investment Advisors

Investment Policy Statement – Suitable Asset Classes

  • Stable Value / Money Market

  • Fixed Income

  • Balanced / Asset Allocation (Target Retirement Date)

  • Large Cap Stocks

  • Mid Cap Stocks

  • Small Cap Stocks

  • International Stocks

  • Specialty Options

Investment Policy Statement – Investment Structures

  • Mutual Funds

  • Separately Managed Accounts (sub-advised)

  • Collective Trusts

  • Individual Securities (Self Direct Brokerage)

Investment Policy Statement – Selection and Monitoring Criteria

  • Quantitative analysis:

      o   Consistency of style.
      o   Define appropriate “index” and “peer group” for each investment option.
      o                          g     p group                year period.
          Median or better ranking vs. peer g p over 3 and 5 y p
      o   Consistently out-perform defined benchmark over 3 or 5 year periods.
      o   Reasonable expense structure vs. peer group.

    Qualitative l i
  • Q lit ti analysis:

      o   Stability and culture of organization.
      o      p p          p y p           p
          People, philosophy, process, reputation.
      o   Disciplined approach.
      o   Legal and SEC proceedings.

Investment Policy Statement – Reporting

  • Establish frequency for performance reporting / monitoring.

  • Performance report should coordinate/integrate with IPS monitoring criteria.

  • Performance “scorecard” for evaluating plan investments.

  • Summary of performance for plan investment options.

  • Recommendations for investment changes (if applicable).

  • Market commentary, plan asset allocation and participant trends.

      According to the Deloitte Consulting Annual 401(k) Benchmarking Survey
      approximately 58% of plan sponsors monitor fund performance quarterly.

Investment Policy Statement – Reporting

  Example of an IPS integrated performance report “Executive Summary”:
               • “Executive Summary indicates watch list status.
                  Executive Summary”

                                                                                                                                   Fund Performance
                                                                                       Correlation to        Perf. Relative to Benchmark       Perf. Relative to Peer Median
                                                                             Manager       Style                                                                                Fund       Peer    Watch List
             Fund Name & Index                 Asset Class    Fund Assets    Tenure     (R-Squared)      3 Year               5 Year           3 Year               5 Year     Expense    Median    Status
 PIMCO Total Return Admin                          F.I.      $1,360,888.68    21.7        80.03%        O. Perform           O. Perform          5%                   3%       0.74%       0.99%    Maintain
 Idx: Lehman Brothers Aggregate

 Dodge & Cox Stock                                LCV        $758,445.80      13.9        93.62%        U. Perform           U. Perform         87%                  69%       0.52%       1.27%   Watch List
 Idx: Russell 1000 Value

 Fidelity Spartan 500 Index Advantage             LCC        $4,253,320.13     4.0       100.00%        U. Perform           U. Perform         37%                  43%       0.07%       1.27%    Maintain
 Idx: S&P 500

 American F d G th F d of A
 A     i                         i
           Funds Grth Fund f America R4           LCG        $1,494,597.70
                                                             $1 494 597 70    12 1
                                                                              12.1        96 57%
                                                                                          96.57%        U P f
                                                                                                        U. Perform           O. Perform
                                                                                                                             O P f              34%                  13%       0.64%
                                                                                                                                                                               0 64%       1 37%
                                                                                                                                                                                           1.37%    Maintain
                                                                                                                                                                                                    M i t i
 Idx: Russell 1000 Growth

 Thornburg Core Growth R5                         MCG         $58,873.53       8.0        91.17%        U. Perform           O. Perform         75%                  40%       0.97%       1.49%    Maintain
 Idx: Russell Mid Growth

 Diversified Mid Cap Value Fund                   MCV         $53,208.87       3.8        97.55%        O. Perform           U. Perform         42%                  24%       0.90%       1.37%    Maintain
 Idx: Russell Mid Value

 Neuberger Berman Genesis Tr                      SCC        $634 984 72
                                                             $634,984.72       8.1
                                                                               81         88 60%
                                                                                          88.60%        O.
                                                                                                        O Perform            O Perform
                                                                                                                             O.                  7%                   5%       1 12%
                                                                                                                                                                               1.12%       1 42%
                                                                                                                                                                                           1.42%    Maintain
 Idx: Russell 2000

 American Funds EuroPacific Growth R4             INTL       $552,784.62      11.5        96.34%        O. Perform           O. Perform         13%                   7%       0.81%       1.48%    Maintain

 Cohen & Steers Realty Shares                     R.E.       $120,910.08       9.8        98.99%        O. Perform           O. Perform         17%                   5%       0.95%       1.42%    Maintain
 DJ US Real Estate TR USD

 *If not marked, Fund is in good standing with regulators.

Investment Policy Statement – Replacement Methodology

  • Replacement criteria:

      o Fails to meet performance monitoring criteria.

      o Manager or management change and legal actions.

      o Style drift, change in investment objective.

  • Replacement methodology:

      o Map to like investment.

      o Freeze new contributions and add new investment.

      o Must give advance notice to participants.

Investment Policy Statement – QDIA

           Qualified D f l I           Al      i
  • QDIA – Q lifi d Default Investment Alternative –

       •   Balanced funds
       •         y          g
           Life cycle or target retirement date funds
       •   Managed accounts
       •   Capital preservation products – 120 day rule

    Grandfathered i defaulted         i into “stable l ” th t bl      l
  • G df th d prior d f lt d monies i t “ t bl value” if the stable value
    product meets the appropriate definition under PPA.

  • Notice Requirements:
      • Initial (30 days prior to investment).
      • Annual (prior to plan year).

Plan Fee and Expense Benchmarking

 •   2008 401(k) fee survey of plan sponsors performed by Chatham Partners
      – 79% of plan sponsors participating in survey report that understanding
               p               p
         their plan costs is important
      – 77% of sponsors say that current disclosure levels are sufficient BUT
           • 58% are confident they understand their plan costs
           • 34% have compared their fees to their providers
                           t    d di l                h i
           • 38% suggest vendors disclose revenue sharing
           • 42% report that their plan fees are transparent

Plan Fee and Expense Benchmarking

The below illustrates the flow of fees from participant accounts to retirement plan service providers

                                         FUND COMPANY
                     Management Fee                                      Sub-Advisory Fee
                                         Investment management                                    SUBADVISORS

                                                                       Investment                 Investment decisions
                                             Administrative:           Admin Fee
                                         trading, accounting, fund
                                            board expenses, etc.
        FUND                             12b(1) fees - advertising,
       EXPENSE          12b(1) Fee       shareholder services, etc.,        12b(1) Fees
                                         which are rebated back to                             RECORDKEEPERS
        RATIO                            recordkeepers because no
                                             broker is involved
                                                                                                     Plan services,
                                                                                               recordkeeping, proprietary
                     Other Fund Fees   Additional revenue sharing:     Other Revenue Sharing          ,             ,
                                                                                               revenue, commissions, etc.
                                            i df       hi h
                                       Negotiated fee which can vary
                                         among plan recordkeepers
                                        based on contract with fund
                                          management company

Plan Fee and Expense Benchmarking

 •   The absence of billed plan sponsor fees has allowed many to view
     administrative services as “free”

 •   “Proprietary” options typically pay more revenue sharing

 •   “Proprietary” options allow service provider to receive revenue two ways
     1) investment management, and 2) revenue share

 •   Asset based revenue sharing creates a windfall for vendors as assets rise
     absent renegotiation of services and/or changes in investments

Plan Fee and Expense Benchmarking

 •   Administration, employee education and communication costs plus
     transaction-based fees
     transaction based

 •   Plan fees are generally paid via:
      • Hard dollar plan sponsor paid fees (i e per participant fees)
      • Asset based fees / revenue sharing

 •   Plan benchmarking important considerations:
      • Determine corporate philosophy on expense sharing
      • Number of participants
      • Number of corporate locations
      • Average account balance
      • Complexity of plan design and administration
      • Employee education and communications

Plan Fee and Expense Benchmarking

  Case Study:

  • Plan assets with service provider:        $150 million

  • Net cash flow:                            $8 million

  • Participants:                             1,750

  • Current service provider platform:        Proprietary mutual funds

  • Service level:                            Medium to low

  • Last completed RFP:                       4 years ago

  • Satisfaction with current vendor:         Good

Plan Fee and Expense Benchmarking

Total Expense Composite Summary:

                                               Current      Lowest        Highest         Peer
                                               Vendor        Peer           Peer        Average
Annualized fund expenses
                     p                               ,
                                                 $960,000    $454,000
                                                                  ,              ,
                                                                            $721,000           ,
ERISA account                                          $0           $0    ($140,000)     ($30,000)
Implicit billed fees                              $46,000            $0            $0            $0
                                 Total Fees    $1,006,000    $454,000       $581,000      $626,000
                           % of total assets       0.67%
                                                   0 67%        0 30%
                                                                0.30%         0 39%
                                                                              0.39%         0.42%
                                                                                            0 42%
                                 % savings            0%         -55%          -42%          -38%

Plan Fee and Expense Benchmarking

Record keeper Revenue Sources:

                                               C     t    Lowest
                                                          L     t     Highest
                                                                      Hi h t         P
                                               Vendor      Peer        Peer        Average
Investment Fees                                $568,512     $88,258   $256,964      $172,611
            Revenue from proprietary funds         $325         $50       $147            $99
Recordkeeping Fees
           Revenue from proprietary funds      $333,888    $75,182     $252,350     $163,766
       Revenue from non-proprietary funds       $23,372   $129,000      $65,595      $97,298
                              Billed fees       $46,000         $0           $0           $0
                          ERISA account t            $0         $0    ($140,000)
                                                                      ($140 000)    ($30 000)
                     Total Recordkeeping       $403,260   $204,182     $177,945     $231,064

           Admin service fee per participant       $230       $117        $102          $132
                Cost above / (below) $150           $80       ($33)       ($48)         ($18)
                    Total revenue collected        $555       $167        $249          $231
                        % less than current          0%       -70%        -55%          -58%

Plan Fee and Expense Benchmarking

“Hypothetical” impact on participant accounts:

                                                Current         Lowest        Highest       Peer
                                                Vendor           Peer          Peer        Average
Average account balance                           $85 714
                                                  $85,714         $85 714
                                                                  $85,714       $85 714
                                                                                $85,714      $85 714
Average annual ee/er contribution                  $4,571          $4,571        $4,571       $4,571
Gross rate of return                                   7%              7%            7%           7%
Total annualized plan expenses                      0.67%          0.30%          0.39%        0.42%
Net investment return                               6.33%          6.70%          6.61%        6.58%
Average yrs to retirement                              20              20            20           20
                      Future value of account   $477,760        $506,892      $500,032      $497,624
Effects of cost savings                                  $0       $29,132       $22,272       $19,864
Total value created                                      $0   $50,980,506   $38,975,432   $34,761,763

Plan Fee and Expense Benchmarking

Investment analysis:

                                Current     Lowest   Highest    Peer
                                Vendor       Peer     Peer     Average
Quartile ranking
3 yr                              26          15       14        15
5 yr                              22          10       13        12
% of fund below market median
3 yr                              5%         0%        0%        0%
5 yr                              5%         0%        0%        0%

Plan Fee and Expense Benchmarking

 Summary/Wrap up:

 •   Understand
      – What you are currently paying
      – How your fees compare to current market practices for similarly situated
          • Service fees
          • Investment expenses
          • Transaction-based fees (loans, withdrawals, etc.)
          • Total plan fees

 •   Consider
      – Benchmarking plan fees every 3 years
          • RFP or RFI process



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