You Run a Business -- Why Do You Choose to be in the Benefit Plan Business, Too?

You've been successful in the business world. You've made your way up through the ranks. Suddenly, because your title starts with the word "chief", you find yourself on the company's Benefits (or some other similar name) Committee.

You're an accidental fiduciary. You have no benefits training. You've never studied ERISA. In some cases, you've never heard of ERISA. What are you doing in this role and why?

Perhaps there is not a single person on your committee with a strong grounding in ERISA issues. But, you know that in order to compete for employees, you have to provide your employees with some benefits. It's likely that some or all of those benefit plans are covered by ERISA. And, ERISA coverage brings with it a myriad of rules and requirements.

Oh no, now I have you panicking. What should you do?

Let's consider one of the most common benefit plan offerings in 2015, the 401(k) plan. What is your committee responsible for? Do you know?

While one could argue that the list might be slightly different, here is a pretty decent summary:

• Plan design
• Selection of plan investment options
• Compliance (with laws, regulations, and other requirements)
• Plan administration
• Communication to participants and education of those participants

That's a lot to swallow. Look around your committee. Presumably, since the committee has responsibility for all of those elements, at the very least, you can find people in the room who, between them, have expertise in all of those areas,

You can't? 

Do you really want the responsibility that comes with being a member of that committee when you have just realized that the expertise to handle the committee's roles doesn't reside on the committee?

You have choices, or at least you might. You could resign from the committee. Frankly, that usually doesn't go over well.

You could engage an expert. Suppose you could find an individual who could function in the role that a committee Chair would play in a perfect world. We're likely talking about someone who doesn't work for your company. This person will bring you peace of mind and essentially serve as the quarterback for the committee. He or she won't have a vote, but will guide you through the processes so that 

• Your plan is well-designed for your population and budgets, 
• It has investment options for plan participants that are prudently chosen and monitored according to an Investment Policy Statement (sometimes called an IPS), 
• It gets and stays in compliance with applicable rules, 
• Is administered properly and the firm that administers it is well-monitored, and
• Is communicated to participants in a clear fashion that properly educates those participants as to the benefits of plan participation.

That sounds great, doesn't it?

If you don't currently have such a quarterback for your committee, perhaps you should. I can help you find one.

Prudence in Light of a Credit Downgrade

Paraphrased somewhat, ERISA tells us that a plan fiduciary should handle plan assets in the way that a prudent man would. Historically, many have found that to mean some or all of these:

• Don't take wild risks
• Generally invest in higher-quality fixed income instruments
• In tougher times, take the flight to quality as the returns that you may be giving up will more than be made up for by the comfort of knowing how safe those assets are

But, wait! The flight to quality, often seen as a movement to invest in US Treasuries, is producing negative returns that will likely get more negative as interest rates rise due to debt downgrade. But, you knew that was going to happen, didn't you?

So, did you pull your plan assets out of US Treasuries? If you didn't, was that prudent?

I don't know.

Think about it. Tell me what you think.

Choosing Your DC Fund Lineup

How do you choose your defined contribution (DC) fund lineup? Do you follow best practices? Do you know what best practices are? More importantly, does your plan have an investment policy, and if it does, do you follow it?

I took an informal poll of some people on DC plan committees. Here are the questions that I asked them:

1. Does your plan have an investment policy statement?
2. If it does, do you follow it?
3. Would an impartial, outside arbiter say that you were following it?

The answers that I got surprised me, but perhaps I shouldn't have been surprised. To question #1, 14 people said yes, 5 thought they had one, and 1 didn't think they had one. To question #2, of the 14 who said yes on question #1, 9 answered yes, 4 were non-committal, and 1 said no. To question #3, of the 4 non-committal to question #2, all said no, and of the 9 who answered yest to question #2, 8 said no.

Perhaps the Department of Labor (DOL) would be an impartial arbiter. Perhaps a judge or jury would be an impartial arbiter. Only 1 in 20 thought they would get a seal of approval from such a person or group. That's pretty frightening, and the fact that I told each person that I questioned that my tallying of votes would be with tick marks only got some honest answers. Even in retrospect, I know the results of my poll, but I couldn't tell you who answered how. And, even if I could, I wouldn't. I won't tell you company names, industry classifications, or even the blood types of my respondents.

I took some time to reflect on this poll -- actually, I didn't take very much time. But, I did think about it. From my experience, here are some areas where I think that plan committees fall might short in following their written investment policy.

• They are too slow to 'fire' a fund. If a fund has a good name or historically has performed well, but then has a significant period of time where it inexplicably underperforms, committees are slow to replace it.
• They bow to pressure from recordkeepers to use proprietary funds because of the 'credits' that they get for it (lower recordkeeping fees because of a larger offset).
• They don't look closely at style changes/style drifts in funds. Oversimplified, if the investment policy says to offer one mid-cap value fund and one mid-cap growth fund and the value fund has gradually drifted to growth, committees are slow to replace the no longer value fund.
• They don't follow the investment policy when choosing target date funds (this one deserves a longer write-up than just a bullet point).

So, what's the problem with target date funds (TDFs)? They are not inherently bad, but especially after PPA (2006) established the concept of a qualified default investment alternative (QDIA) for which TDFs fit the bill perfectly, they became the next big money maker for everyone who could find an angle. For proprietary TDFs, most are just funds of proprietary funds, but the level of fees is a bit higher than it would be for someone who just invested in the proprietary funds and rebalanced periodically themselves. I guess what the participant is paying extra for is the discipline of rebalancing.

If you decide to have TDFs in your plan lineup, but don't want to use proprietary funds, there are plenty of people out there who will design TDFs for you. They will tell you that they will choose from among only the best performers in each asset class to create these custom TDFs. And, for that, they will often charge you a pretty penny. This, of course, will be in addition to the fees that participants get charged. From what I have observed, most of the providers who are offering this service don't have the discipline that the proprietary TDFs do. They may not rebalance quite on schedule. They may make bets on the market that are probably inappropriate.

At the end of the day, though, when you, as a committee member, are evaluating candidates to be the TDFs for your plan lineup, do you consider the plan's investment policy statement? Will you change TDFs if they are underperforming? For that matter, what does it mean for a TDF to underperform? Does your plan's investment policy statement tell you? Do you have a way of monitoring whether the TDF is staying true to its stated style, its stated goals? If you do have that way, do you use it?

In theory, TDFs are a wonderful idea. In practice, however, in my opinion, generally, they remain flawed. Some are better than others. And, they do tend to avoid haphazard practices such as market timing, but I have not seen one yet that some smart, unbiased person couldn't poke holes in. Does this mean that you, as a fiduciary, are in trouble once you put a family of TDFs in your fund lineup? It could, but it doesn't have to. Make sure your investment policy statement is clear with regard to TDF selection and TDF monitoring. Then, follow that policy statement, and document it. Did you read that part? Document that you have followed the investment policy statement.

On The Dynamics of Investment Committee Decisions

In a September 2010 survey conducted by Vanguard, more than 80% of investment committee members surveyed said that the knowledge level of their committee was above average and more than 60% said their committee seldom makes a mistake.

Wow!

I could spend hours now harping on the US educational system as the reason for this (grade inflation where a 'C' meaning average is only given to the worst performing students, but that's for another day and another blog). This is amazing, though ... or is it?

Let's consider why, and then we'll look at a potential solution. Who chooses committee members? The CFO? The Treasurer? Someone similarly situated? The Committee Chair? No matter which one of those it is, it's probably one of them. Who do they choose for the committee? In most cases, they probably choose people that they view as being a lot like them -- their proteges, for example. If that's the case, then a lot of the people on the committee will have gotten a lot of their knowledge from the same place.

Hmm! That's not good. That means that they may have similar biases. They may be serving on this committee chaired by their boss.

Hmm! That's not good. Through peer pressure, group dynamics, inertia, and many other dynamics, people tend to think that their group's ideas are the best, especially if their group builds consensus. Building consensus  generally is good, but what happens if the consensus is wrong? What happens if the consensus is under-(or un)-informed? What happens if the Committee Chair steers the committee toward his or her bias?

I know. This never happens on your committee, but you do know that it happens on most other committees. In fact, I've attended committee meetings where this happens. Sometimes, it produces good results, but all too frequently, it produces bad results based on what the committee thinks were outstanding decisions.

Let's put this in a defined benefit plan context. In order to properly invest defined benefit assets, the committee needs to understand both the assets and the liabilities. (Not doing so increases risk for the enterprise.) Yet, in my experience, very few committee members understand both sides of the equation (plan assets and plan liabilities). These people have other jobs. This is not their area of expertise. That being said, there are plenty of committees and committee members out there who just don't care. They have their committee comprised of some of the smartest people they know (including them, of course). Because they are smart, they will make the right decisions.

Consider an analogue. Suppose WeFlyHigh Airlines was considering which type of airplane to buy to add to their fleet. Should they buy the newest Boeing jumbo jet or the competing Airbus. Do you think they would have the Investment Committee members making that decision? Why not? They are smart people. Surely, they would make the right decision, wouldn't they? No, those decisions are usually made, or at least informed, by true experts. Shouldn't these committees also be informed by experts?

I promised you a solution, didn't I? And perhaps I've already shown my cards.

Hire an expert. Don't bring them on full time. But, this is why consultants exist, isn't it?

How should you choose your consultant? Look for these criteria:

• As part of their engagement, the consultant will educate the committee.
• The consultant understands the asset side and the liability side.
• As part of the liability side, the consultant understands the subtle changes to the liability profile that plan design changes and employee population shifts can cause.
• The consultant has a track record of making changes to the thinking of the committee.
• The consultant will challenge the decisions of the committee.
• The consultant can demonstrate a track record of giving different advice for different plans because those plans had different characteristics and were sponsored by different companies with different goals.
• The consultant freely admits that they are serving in the role of fiduciary.

I expect I'll write more on this topic. In the meantime, I'd love your comments.

Life on an Investment Committee

Nevin Adams, editor-in-chief of Plan Sponsor and its News Dash publication writes a great little "IMHO" piece about being on a plan's investment committee. To sum up:

• If you are on an ERISA plan's Investment Committee, you are an ERISA fiduciary
• Once you are an ERISA fiduciary, you have a personal liability
• On the Investment Committee, you are responsible not only for your own decisions, but the decisions of others

You can read Nevin's article here: http://www.plansponsor.com/IMHO__Liability_Driven.aspx

There are several court cases out there right now that rely on this theory. Unfortunately, I am temporarily precluded from writing about the most interesting of the bunch of them.