Risk and the legislative framework: A complex interaction
For plan sponsors — whether defined benefit (DB) or defined contribution (DC) — here’s a basic truth: what happens in Washington, D.C. is apt to have an impact on you, your plans and your plan participants. And whenever we talk about the regulatory environment, the story includes complex interactions, unintended consequences and multiple stakeholders — all of which can create additional risk.
Need examples? Easy. The Pension Protection Act of 2006 (PPA), ongoing changes to Financial Accounting Standards and increasing Pension Benefit Guaranty Corporation premiums all have had an impact on DB plan sponsors. Not always for the better.
Sometimes seemingly innocent bits of wording can have a very long tail. Back in the 1990s, for instance, the Treasury Department offered an example of what plan sponsors could use as the default saving rate for participants auto-enrolled in DC plans. The number they came up with was 3%. That was supposed to be just an example, but everyone latched onto it. Today we still see that savings rate widely used as the default rate, and, though it is a good start, it’s pretty clear people need to save more.
To be sure, there have been times when regulators have done plan sponsors a favor. Not that long ago, DC plan sponsors who wanted to do the right thing and help their participants invest their retirement savings for growth were afraid to do so – they feared lawsuits or other actions should funds decline. Thus, sponsors would often use a “safe” option like a stable value fund or a money market fund as the default investment. So, in effect, the fiduciary’s own risk management practices were creating greater risk to plan participants, whose accounts weren’t growing as they should.
This is where plan sponsors should remember PPA’s safe harbors, specifically designed to help clarify regulators’ expectations on the selection of qualified default investment alternatives (QDIAs). This allows them greater flexibility and protection in selecting investment options for plan participants, specifically permitting sponsors to pick diversified options like target date funds or managed accounts as the default. Additionally, last October the U.S. Treasury Department made it easier for DC plan sponsors to adopt deferred annuities within a target date fund (TDF), one of the most popular QDIA options. The introduction of QDIAs was a positive change for fiduciaries and participants alike due to the added flexibilty, and we expect to continue to see innovation in this area. Such an approach may work in other situations, too, although safe harbors do have their own pitfalls: If they become viewed as the only safe approach, that can be a barrier to the development of other approaches that may make more sense.
Yet, these changes are just the start of what’s needed to help plan sponsors help their participants meet their retirement savings goals. We need to be thinking about regulations and rules that make the retirement system more efficient and help manage risks in a transparent, clear manner for fiduciaries and participants alike. Many retirees are nearing or at retirement age and face a retirement that may last decades. We need to make sure the regulatory process supports those retirements, because Social Security alone won’t work.
Rules and regulations are a necessary part of the retirement plan landscape that will only continue to evolve over time. We all need to work to ensure those current (and future) rules really achieve their goals of making the pursuit of preparing for retirement safer and more secure.