Tax Reform on the Horizon

The Washington Post reported yesterday that Congress has begun meetings on Tax Reform. And, for the grammarians who are reading this, I capitalized tax reform for emphasis, not because we have anything formal yet.

Could we have tax reform? And, if we do, what might it do to the world of benefits and compensation?

Let's focus on my first question first. Could we have tax reform? Of course we could. The better question is will we? I think it is as likely as not. Although some measures say that it has picked up, the economy, in the opinion of your humble (well, I try to be humble most of the time) correspondent, it is still abysmal. Republicans in Congress want to balance the budget, but without raising tax rates. Democrats in Congress and the White House generally want to get the budget closer to being balanced, but would like to do it without cutting back social programs which would require more revenue. More revenue comes from three places:

• Growing the tax base (the two parties do not agree on how to do this)
• Raising tax rates (Republicans say this will not raise revenue and will filibuster such a bill in the Senate and vote it down in the House)
• Decreasing tax expenditures (regular people refer to this as closing loopholes and cutting back on deductions)

The third one seems to be the way to go. I head similar sentiments way back at the beginning of 1985. And, guess what, that was the first year of a President's second term. He was a President who inherited a terrible economy. And, before the mid-term elections, we had the Tax Reform Act of 1986. What did it do, generally? It decreased marginal tax rates, cut the number of marginal rates from a lot (I don't recall how many) to two and eliminated a tremendous number of deductions.

Hmm?

In fact, suppose we look at the first half of the last few two-term President's second terms (I am going to count Nixon as two-term since he was elected a second time).

• Nixon -- ERISA was passed and signed into law shortly before the mid-term election of his second term (actually Ford was President by then and if you don't know why, then either you are very young or have been living under a rock).
• Reagan -- In the first two years of his second term, we got COBRA as well as TRA86, and a plethora of smaller bills. TRA86 as I noted above was signed into law shortly before the mid-term elections.
• Clinton -- This is the apparent anomaly and perhaps we should note that he is a Democrat who was working with a Republican-controlled Congress. We got some smaller bills, but nothing of the magnitude of TRA86 or ERISA. But, even in what was then a booming economy, the first half of Clinton's second term brought us the Taxpayer Relief Act, the Balanced Budget Act, and the ever-memorable Child Support Performance and Incentive Act.
• Bush (43) -- Nearly halfway through his second term, we were greeted with the landmark Pension Protection Act of 2006, shortly before Congress recessed to campaign for the mid-term elections.

Do you detect a pattern here? I know that my readers are very observant, so as they say in the math textbooks, the observation of the pattern is left to the reader.

It could happen. And, if it does, what can I tell you about what it will look like?

• It will be thick. Major legislation that has come out of the Obama White House has been fairly universally thick. Consider that both PPACA and Dodd-Frank weighed in in exess of four full reams of paper apiece. Should we truly get a comprehensive tax reform bill (perhaps it would be called the Comprehensive Reform And Policy ACT ... if you can't work that out, go back to the beginning), I would take the over if five full reams were the betting threshold.
• It will focus on what the media will call loopholes. This is one thing that the two parties can agree on is that there are too many loopholes in the current Internal Revenue Code. It will attempt to simplify, but once it goes to a Conference Committee and each member appeases his or her favorite special interest, simplicity is not going to happen.

When you hear about loopholes in the media, they tend to focus on two things: deductions for corporations that allow what we know to be highly profitable ones to pay no federal income taxes; and deductions for very high earners that are just not available to the rest of us.  Bearing those two things in mind, consider these potential changes:

• Reduction in corporate tax deductions for employer-provided health benefits either by simply limiting the deduction, disallowing the deduction for a far tighter definition of discriminatory plans, or not allowing a deduction with respect to all but preventive health benefits for highly compensated employees. This would be somewhat analogous to the limits that were placed on long-term disability benefits about 25 years ago.
• Reductions in the pay cap and 415 limits (maximum benefits and contributions limits) for qualified retirement plans. Additionally, we could see a reduction in the 402(g) limit, the annual limit on elective deferrals to a 401(k) plan.
• A tighter definition of what constitutes a nondiscriminatory retirement plan thereby reducing the level of deductions attributable to highly compensated employees.
• A reduction in the compensation threshold under Code Section 162(m). This would be a significant appeasement to the major labor unions.
• Tying deductions for executive compensation to the Dodd-Frank Say-on-Pay votes. I went out on a limb on this one, but voting for this would not cost any elected official many votes.

So, that's what I see the style of such a bill to be. Even at Congress's worst, though, that would only fill up 100-200 pages. They would still need almost five reams more for me to be on the winning side of the over-under bet. What's your opinion? If you have one, and I know you do, please comment, be it here, on Twitter, on LinkedIn, or on Facebook. Or, if you don't want to go public, send me an e-mail.

DOL Provides Guidance on TDFs

In February 2013, the Department of Labor (DOL) issued a paper entitled “Target Date Retirement Funds – Tips for ERISA Plan Fiduciaries.” Clearly, this is a signal from DOL that this is an issue for plan sponsors and their plan committees to watch. But, there are other fiduciaries as well and some have a vested interest in a plan sponsor’s choice of target date funds (TDFs). In this article, we’ll examine the DOL paper and some of its implications, but first we provide some background for those who don’t live in this world on a daily basis.

In 1993, Barclay’s Global Investors introduced the first TDF. While there had been some dabbling in risk-based funds, this was the initial plunge into developing a fund targeted at an individual’s intended retirement date. The evolution of TDFs moved along fairly slowly for the next ten years or so, but in 2006, Congress passed and President Bush signed into law the Pension Protection Act (PPA) starting a veritable explosion in TDF usage in 401(k) and other defined contribution (DC) plans.

The impetus was a provision in PPA establishing the qualified default investment alternative (QDIA), the investment that a plan sponsor uses as a default for moneys in participants’ accounts not otherwise designated for investment. The law and its guidance established that QDIAs should be one of these:

•  A fund that takes the participant’s age or retirement date into account
•   An investment service (managed account) that takes the participant’s age or retirement date into account
• A balanced fund
• A money market fund, but this can only be used for the first 120 days

According to the 2012 Janus/Plan Sponsor survey, approximately 75% of all defined contribution plans have chosen target date funds as their QDIAs.

Today, there exist a wealth of TDFs of many shapes and sizes. Virtually all of them have in their name a year (multiple of five) that is intended to represent a participant’s expected retirement age. Often, that is where the similarities end. There are “to” funds and “through” funds so named because they are either intended to take a participant to retirement (the participant is expected to take a distribution when he or she retires) or through retirement (the participant is expected to keep his or her money in the plan and draw it down gradually through retirement). There are proprietary funds (those which are essentially a fund of funds run by the asset management institution that manages the TDF) and there are open-architecture (often custom) TDFs composed of those funds that the asset manager thinks are most appropriate for the fund regardless of the manager of the constituent funds. There are TDFs that are composed largely of actively managed funds (these usually have higher underlying expenses) and TDFs that are composed primarily of passively managed funds (usually having lower underlying expenses).

The DOL paper suggests factors that a plan sponsor should consider in its fiduciary decision to choose a family of target date funds, often as the QDIA. Specifically, the paper points out investment strategies, glide paths (this is the move from a more aggressive equity-heavy strategy far from retirement to a more conservative strategy closer to retirement), and investment-related fees.

Plan sponsors should consider this DOL guidance carefully. While there is nothing in the paper that suggests that a plan sponsor must follow the DOL’s suggested steps, one would certainly think that plan sponsors that do so may relatively well shield themselves from costly losses in litigation. No strategy is foolproof, but if I were on a jury or if I were a judge and I heard that a plan sponsor did exactly what the Department of Labor suggested, such evidence would often compel me.

The paper spells out these eight steps:

• ·         Establish a process to compare and select TDFs
• ·         Establish a process for periodic review
• ·         Understand the fund’s investments and how they will change over time
• ·         Review the fund’s fees and investment expenses
• ·         Ask about the availability and appropriateness of non-proprietary TDFs
• ·         Communicate with your employees
• ·         Use all available sources of information in evaluating and selecting your TDFs
• ·         Document the process

I am going to add two more items to this list. First, a number of defined contribution recordkeepers are affiliated with or owned by asset management firms. Some of them will only take on a new client if their own proprietary TDFs are used as the plan’s QDIA. It may be acceptable to begin by using these proprietary TDFs as the plan’s QDIA, but when you use recordkeepers of this sort, you will certainly have a contract for services for several years. The contract will offer you financial disincentives to change TDFs to those provided by another vendor. It aligns well with the DOL’s advice to not engage in such a contract. Doing so could put you in a poorly-performing family of funds that you cannot switch out of without incurring significant fees (usually passed on to the participants) or in a very expensive family of funds that are subsidizing hidden fees or both.

Second, the DOL’s final piece of advice (of the eight) is to document the process. Documentation of processes is an excellent idea. It’s especially an excellent idea if you follow your own processes. However, a number of companies (see for example, Tussey v ABB) have lost or settled litigation when they did not follow their own documented processes. Not having a documented process is bad, but documenting what you should and will be doing and then doing something else is probably much worse.

Several points that the DOL makes are particularly noteworthy. Consider, for example, a proprietary family of TDFs composed of high-expense actively-managed proprietary funds. While not all TDFs are set up this way, the following is a possible scenario:

• ·         Family of TDFs is composed of high-expense, actively-managed proprietary funds
• ·         The TDFs come with an underlying investment expense
• ·         Each of the underlying funds in the TDF provide a return net of expenses

In this case, the TDF is essentially double-charging the plan participants. Each of the underlying funds has a significant investment expense and, at the same time, the overall fund comes with an additional investment expense. The DOL paper points out how an account balance of $25,000 compounded at 7% per year for 35 years will accumulate to approximately 40% more than the same account balance compounded for 35 years at 6% per year. Put into more practical terms, for a younger employee, the 40% implicit cost of much higher investment fees may be insurmountable.

Finally, the paper points out the importance of defined benefit (DB) plans in selection of TDFs. While it is true that far fewer employees are covered by DB plans than were 25 years ago, a significant number still are. While the paper doesn’t use these words, it makes clear that plan sponsors that also provide broad-based DB plans might consider those defined benefit amounts as a fixed income investment for participants. In such cases, using a more aggressive TDF is likely appropriate.

The DOL paper is not formal guidance. It’s not part of a regulation on fiduciaries. Following the DOL’s advice in this case is not, per se, required. But, a word to the wise: other such pieces of informal guidance have been considered safe harbors by courts. Plan sponsors and their consultants might wish to consider this publication that way as well.

Plaintiff's Bar -- The Good, The Bad, and The Ugly

Collectively, they are known as plaintiff's bar. These are the attorneys who gear their practices toward representing plaintiffs in civil litigation. As I see it, they fall into three categories:

• The group who represent plaintiffs in litigation where the plaintiffs in question have clearly been wronged. While it's not where I am going to focus here, consider, for example, the made-up case where plaintiff goes to a restaurant (think Japanese steak house) where the chefs put on a show for their diners. They toss food. They flip spatulas. I have never seen a diner get hurt in one of these situations. But, in this fictional situation, one chef decides to fling diners' food to them on razor sharp knives. One diner gets up to leave because he is frightened and just as he does, a knife flies astray and hits him blade first in the back, seriously injuring him. The restaurant's insurer says that the diner assumed a risk when he sat down at the hibachi grill. I don't have legal training, but the lay person in me thinks he needed an attorney to right this wrong.
• The group who represent plaintiffs who have probably not been wronged, but where there might be a court that will find for plaintiffs and award massive damages. As an example, consider the spate of cash balance plan lawsuits that were filed. Typically, the issue was age discrimination. Whether or not there actually was age discrimination in designs was a matter of opinion. As a group, actuaries are well-trained to opine on this issue. Being one of these actuaries and being one who knows many others, I've not personally found one yet who thinks that cash balance plans are inherently age discriminatory. But, the attorneys filing the suits know that all they need is one big win and the payoff for them will be huge. I disagree with these attorneys, but it is possible that they are right and I am wrong.
• Finally, there is the group who seek out plaintiffs to file lawsuits where there is never any thought of wrongdoing. All they are doing is hoping that defendants will think it is less expensive to settle the lawsuits than to defend them. Since the attorneys in such situations don't, in my opinion, even care if there is any wrongdoing, I view this as the worst of all situations.

Yes, I have an example for you. As regular readers of this blog know, Dodd-Frank and its older brother Sarbanes-Oxley have imposed significant requirements on issuers of proxies to disclose executive compensation. Most companies have worked hard to ensure that their disclosures are, at a minimum, adequate. A meaningful percentage of them have gone above and beyond in their disclosures providing information to shareholders beyond that which is required and providing excellent supporting rationale for their compensation decisions.

So, what's the litigation here?

A group of attorneys made the startling (well not really) discovery that if you could find a way to stop a company from holding its annual shareholder's meeting that all proverbial hell would break loose. I wrote about this here. What they claim is that disclosure of executive compensation in the proxy is inadequate for the shareholder to make an informed decision regarding say-on-pay or some other vote on which their client could weigh in.

We apologize for this brief commercial interruption before returning you to your regular program. In my profession, I work with a lot of people who do understand compensation. Many of them are also shareholders in companies so that they get to cast their votes on these matters. As part of the small group who could actually make sense of these disclosures, how many of them actually take the time to review the executive compensation disclosures in proxies? A very unscientific review of data that I did on this group (this means that I observed, asked a few people and took a guess) suggests that fewer than 10% of this group actually reviews the executive compensation disclosures carefully enough to opine on its reasonableness. Most institutional shareholders outsource the review and even the firms to whom they outsource such review are working far more from checklists than they are from hard analysis of the data.

So, there's no case, right?

That's not the point. A well-timed lawsuit can cause a company problems. Put yourself in the position of a company and decide how you would react when you learn that plaintiffs have gone to court seeking an injunction to prevent you from holding your annual shareholder's meeting (for those even less legally informed than me, this means that a court would prohibit that meeting from taking place). You are probably left with just a few options, all costly and none foolproof:

• Fight the injunction and hope you win
• Settle to make plaintiffs and their attorneys go away, so to speak
• File significantly enhanced disclosures with the SEC and provide them to shareholders on a timely enough basis

The attorneys for plaintiffs are betting that most companies will choose what's behind door number two. That is, they are betting that companies will opt to settle for an amount of money whereby those attorneys will recover their expenses plus perhaps 35%-40% of the remaining settlement. That makes it profitable litigation for those attorneys.

What should companies do?

There is no great answer, but it seems a good tact to prepare for this sort of litigation.

• Enhance your disclosures proactively. That is, make yourself a less vulnerable target. 
• Have a team internally that understands the issues and that can be mobilized to combat the opposition. This should probably be composed of internal people and have outside counsel in the loop.
• Make your disclosures convincing. Describe how you developed your practices and why they are appropriate for your company in your industry and your geography.

And, yes, there is a fourth thing that you can do that some may think is as useful as the first three: hope you don't get sued.

Communicating Rewards

I haven't had a really good rant on here for a while. Today, I think I am going to change that. The topic is communication of rewards programs. That means benefits of all kinds, compensation, learning and development, work/life programs -- the whole kit and kaboodle. It's all part of rewards, and as a society, our communication of rewards is just plain miserable.

There, I said it. I'll say it again. In the United States today, communication of rewards programs to employees just plain sucks. I didn't say that companies don't try. I didn't say that supervisors don't try. Things have gotten really complicated. Most components of rewards programs today are offered because there is an underlying incentive. Perhaps the incentive is in the Internal Revenue Code. That means that either or both the employer and the employees get a tax break because of this particular rewards element. And, who understands that?

Consider either the communications that you receive or the ones that you send (if you represent the employer side) related to rewards. How do you get the communications of most of these elements? I'm guessing it's one of two way:

• e-mail
• a large packet of material filled mostly with required disclosures

Do you read every e-mail that you get including attachments? I don't. When you receive a large packet of materials describing the new health care plan, do you read the whole thing? I don't.

Once upon a time, but during my working lifetime, changes, especially improvements, to rewards programs were communicated differently. How is that? Someone spoke to us. Yes, a real live person with a real live voice spoke to us. Sometimes it was done in groups, sometimes individually. Often, the person who spoke to us could and would answer questions. Yes, the required disclosures were covered, but their was emphasis placed on what was really important and you knew it.

Let me give you an example. When your employer changes its 401(k) plan, there are pages of required disclosures. Most of those disclosures don't mean anything to you or to me. Everyone is worried about getting sued now, so often, most of everyone doesn't want to tell you anything that isn't prescribed by law. You get all the required information, but little relevant information. Therefore, you don't make optimal use of the new program. Why would you? You don't know the full benefit of the change. You don't know who to ask. And, even if you did, that person might be afraid to tell you.

My plea for the near future: let's go back to real communication.

IRS Releases 2013 Covered Compensation Tables

Here they are.

New Trends in the 401(k) World

Shortly after the passage of the American Taxpayer Relief Act of 2012 (ATRA), Aon Hewitt did a pulse survey of more than 300 large employers (presumably from their client base, but the press release doesn't seem to specify) on 401(k) plans. Here were some of their key findings:

• 49% of respondents currently do not offer Roth provisions
• Of those, 29% are very likely or somewhat likely to add Roth provisions in the next 12 months (this would bring the percentage who do not offer Roth provision down to about 35% of the total)
• Of the new adopters, about 76% will add in-plan conversion (from traditional to Roth) features
• Approximately 53% of companies that currently allow Roth contributions but do not currently offer in-plan conversions will begin to allow them

Personally, I am pleased to see this trend. For the life of me, though, the only good reasons I can see to not offer both of these features are these:

• HR has too many other things on their plate and implementation of these is not a high enough priority to implement in 2013
• The company is particularly paternalistic and worries that because Roth accounts have earlier distributable events than traditional 401(k) accounts that participants will not use them for retirement
• Employees have not asked for them (I think this is not a good excuse because many employees will not have heard of the opportunity)
• Employers have not heard of these changes (shame on them, they should be reading this blog, of course)

The employer-sponsored retirement plan world has changed from one largely of employer responsibility to largely one of employee responsibility. For employees to someday retire, since very few who don't save in employer-sponsored retirement plan save elsewhere, those employees will need to begin saving at young ages and save responsibly and consistently. The more tools they have available to them, the more likely they are to do it, and that is good for our future.

CDHPs -- Perhaps I Was Always Correct

It's been more than one year since I wrote my not exactly seminal piece on Consumer Driven Health Plans (CDHPs). In it, I said that insureds forego lots of important medical care, not because they are making a well-considered consumer decision, but because they simply can't afford it. While I don't think anyone posted in the comment section of my blog, several experts told me privately how misguided my thoughts were. They told me how quality of care is increasing as consumers of medical care make wise choices.

Now we have a study published by the Rand Corporation working with researchers from Towers Watson and the University of Southern California. The way I read it, even if the quality of care, when care is sought, is improving, necessary preventive care is sought less often. In my opinion, it's because of one of these factors:

• Consumers can't afford to pay the costs.
• Consumers have experienced too many situations in CDHPs where they thought a particular test was covered by their plan as part of well care, but either it's not or it's not fully covered.
• Consumers have no idea if they can afford the costs, but dealing with the health plan's "Customer No Service" Department is just too painful.
• Their physician can't figure out whether the test is covered.

From the same study, reading from Figure 4, we see the following reductions in preventive care under CDHPs:

• 3.7% for Glucose Level
• 4.2% for Lipid Profile
• 4.9% for Cervical Cancer
• 2.8% for Mammogram
• 2.9% for Colorectal Cancer

I am not saying here that the CDHPs, in an of themselves cause these declines in preventive care, but there certainly does seem to be a correlation. Personally, I know that I am entitled to one physical per year under the employer-sponsored CDHP in which I participate. Frankly, I've been in a plan of that sort for most of the last 6 or 7 years. Of the tests listed above, some are fully covered by the plan, some are partially covered, and some don't seem to be covered at all. 

I don't recall which one it was, but for one of those tests, when I called the health plan, I was told that reasonable and customary (R&C) costs were covered. After they paid R&C costs, I was left with a $200+ bill.

Is my physician particularly expensive? I don't think so. He is an in-network provider. Am I in a particularly high cost of medical care geography? I'm pretty sure that's not the case. Did I do something wrong? Not that I can tell.

The good news is that I am in a pretty well-paid profession and I can afford my share of the costs of these tests. But, especially in a bad economy, many people can't. 

The evidence tells me that CDHPs are not working the way they are intended to. But, employer costs are coming down. So, we are probably stuck with these plans. Lucky us.