President Obama's administration has clearly embraced automation as a key element of employee benefits policy. The president's 2011 fiscal year budget, for example, included a proposal requiring employers that do not currently offer a retirement plan to provide automatic enrollment in an individual retirement arrangement. Similarly, the new health care law will require large employers to automatically enroll new hires in a health care plan.
Automated programs like these ostensibly improve take-up rates and coverage by recognizing the common inertia that precludes people from making an affirmative decision to enroll in a plan. But an increasingly common investment option for participant-directed retirement plans has recently come under scrutiny by lawmakers.
Target-date funds, also commonly known as "lifecycle" funds, are collective investment products designed to simplify investment by diversifying assets among equities, bonds and cash or cash equivalents with the asset allocation "automatically" becoming more conservative as the target-date (typically an expected retirement year) approaches.
In implementing the automatic enrollment provisions of the Pension Protection Act of 2006, which first codified employers' ability to automatically enroll employees into defined contribution plans, the U.S. Department of Labor permitted the use of target-date funds among the qualified default investment alternatives used when a participant fails to make an investment election. (These prescribed QDIAs relieve fiduciaries of liability as long as certain requirements are met.) Doing so directly contributed to the popularity of these funds within employer-sponsored retirement arrangements - the percentage of plans offering a target-date option grew by one-third from 2007 to 2008 according to the Profit Sharing/401k Council of America.
After the financial market turbulence began in late 2008, many of these funds - like most securities-based funds - lost significant value. Many workers and retirees - like most investors - lost a substantial percentage of their retirement savings. In February 2009, the Senate Special Committee on Aging held a hearing to examine the reliability of retirement plan investments and specifically asked DOL and the Securities and Exchange Commission (SEC) to consider regulations governing target-date funds. These agencies held their own hearing on the subject later in 2009. The DOL is expected to provide imminent guidance in the form of questions and answers for employers and employees.
Employers have engaged regulators on this issue by describing the many considerations that go into the process of selecting target-date funds, including:
- Examination of specific asset allocations;
- Glide paths (i.e., how quickly the funds adjust their asset allocation to reduce exposure to equities as participants approach or go through retirement);
- Applicable fees to sponsors or participants;
- Asset management; and,
- Of course, fund performance.
The employer and service provider community has pointed out that plan fiduciaries - that already have a reasonable selection process in place - should have the freedom to execute it without fear of liability exposure.
Both plan sponsors and service providers oppose heavy-handed mandates, particularly with regard to the target-date funds' glide path. Although the imminent DOL guidance is not expected to include any mandates, plan sponsors and service providers remain concerned that future legislation or regulations could be more aggressive. If mandates are ultimately handed down, the benefits community wants a liability safe harbor as well.
Employers have expressed support for target-date funds in principle, noting that the growing prevalence of these funds in defined contribution plans over the past decade has helped improve diversification and asset allocation, and ultimately retirement outcomes, for many plan participants. In the final analysis, the success of automatic plan arrangements depends on the ability to use effective default investment vehicles.
Regulatory guidance should focus on the appropriateness of existing processes commonly used by fiduciaries to identify and analyze target-date funds, not one-size-fits-all mandates. The Obama administration clearly believes that automation simplifies and improves employees' ability to invest for retirement. The administration should similarly support target-date funds, which improves employees' ability to benefit from automatic arrangements.
