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.

The Values of Shortfall and Surplus

You can look at it in lots of different contexts -- gambling, savings, personal finance, defined benefit plans. Which is bigger, the negative value of a 10% shortfall or the positive value of a 10% surplus? Of course, they are the same, 10% of something, but are they really?

From a personal finance standpoint, if you have a 10% surplus -- that is, 10% more money socked away than you need to meet your current obligations -- that is nice. But, if you have a 10% shortfall, that is really painful. The surplus gets you some comfort or some discretionary spending. The shortfall, on the other hand, increases your cost of money.

In defined benefit plans, it may be worse. And, the value of increasing surplus gets smaller and smaller (somewhat simplistically) as the surplus grows, but not so with the negative value of shortfall. Let's consider a fairly simple example. I'm going to assume that your defined benefit plan has a funding target of $100 million and assets of one of $80, 90, 100, 110, or 120 million. In other words, you have a Funding Target Attainment Percentage (funded status or FTAP) of one of 80%, 90%, 100%, 110%, or 120%. Let's ignore the Target Normal Cost and determine the one-year cost of paying down that unfunded liability (assume an effective interest rate of 5.00%).

At 80%, it's about $3.45 million. At 90%, it's about $1.73 million. At 100%, 110%, or 120%, it's $0. From a one-year funding standpoint, the negative value of shortfall is meaningful, but the positive value of surplus is not.

Suppose you are planning to terminate your plan. Absent the additional cost of annuities (insurance companies need to build in margin to manage their risks and to turn a profit), the surplus is generally worth about 15 cents on the dollar (less if you use it for a replacement plan), but the shortfall has a negative value of $1 on the dollar, unless you are going to get the PBGC to take over your plan.

Why do we care about all this? Until your plan gets into a restricted status (<80% funded) or an at-risk status (<60% funded), all oversimplified, each dollar of underfunding has the same negative value. But, overfunding has less positive value. So, when you are looking at your investment policy for your plan, when it is already fully funded, you should simply be looking to develop a strategy to keep the surplus there, but taking risks to grow the surplus is probably not prudent. It is only when a plan is underfunded that risk-taking may make sense. Again, absent the negatives that fall to a plan once it crosses below that 60% or 80% threshold, every dollar upside has the same value as every dollar downside. So, where a sponsor of an overfunded plan should be risk averse, the sponsor of an underfunded plan should be largely risk neutral. Frankly, the only scenario in which a sponsor should have a preference for risk is one where they are so poorly funded and the company's finances are so bad that they are making a bet with two possible outcomes: 1) the risk pays off and as a result the company is able to stay in business, or 2) the risk goes bad, and the PBGC takes over the plan.

Think about it. Then, think about your plan's investment policy. Does it make sense? Do you need help?