The Canadian Source Of Employee Pension Fund Investment And Benefits Plan Management

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September 2007

New Thinking Required On Fiduciary Responsibility

Sponsors of Defined Contribution employee retirement plans in the U.S. may require some new thinking about their obligations in terms of employee participation and investment selection, says a research paper from Alliance Bernstein.

In ‘Evolving Fiduciary Duty Standards For Defined Contribution Plan Sponsors,’ by Laurence E. Cranch, executive vice-president and general counsel, and Daniel A. Notta, senior vice-president and senior retirement plan counsel, the authors say under the Employment Income Security Act of 1974 (ERISA), plan sponsors are fiduciaries with respect to their DC plan participants. This means that they must act prudently and look to the best interests of these participants.

However, the authors contend that changes such as the improving knowledge regarding optimal methods for the long-term investment of retirement assets held in DC plans have significantly affected the evolution of plan sponsor fiduciary duties.

The primary changes contributing to this evolution include:

These developments will significantly change the standards by which plan sponsors will be measured in terms of how their DC plans encourage appropriate levels of participation by all employees and determine the investment selections, including default options for employees who do not make their own selections.

new thinking fiduciary responsibility

Proper Role

There is a change in perspective under way regarding the proper role of plan sponsors in increasing employee participation rates and contribution levels, and in facilitating appropriate investment selection. Past common practices, many of which persist today, were put in place primarily to avoid perceived litigation risk, says the research paper. This prompted most plan sponsors to try to distance themselves from employee contribution and investment decisions.

The accepted view seems to have been that providing employees with this framework for saving and investing was sufficient to satisfy a plan sponsor’s fiduciary duties. However, as has become abundantly clear, the results of this approach have been far from ideal for many employees. Many are not participating at all and, as a result of poor investment decisions, most are not accumulating anywhere near enough to fund their retirement.

The consequences of these past practices prompted a sweeping change in thinking about what should be done with respect to DC plan participation and investment selection.

In terms of participation rates, the advisability of adopting automatic enrollment has become well-accepted by regulators and industry experts. In addition, plan sponsors are being encouraged to couple automatic enrollment with automatic increases in contribution levels, so that employees gradually increase their contribution rates as their salaries increase.

With respect to investment selection, research has shown that target-date retirement funds, life cycle funds, or managed investment portfolios that include a mix of asset classes weighted heavily toward equities in the initial years and adjusted along a ‘glide path’ to gradually include more fixed income investments as an individual approaches retirement, represent the best current thinking for individuals participating in DC plans. This conclusion has been given explicit support in provisions contained in the new U.S. Pension Protection Act which extends liability protection to target-date retirement products that are used as default options by plan sponsors.

The authors ask, however, “Does this also mean that fiduciary duty standards have evolved, to the point where plan sponsors arguably are required to make some or all of these changes?” These are difficult and sensitive legal issues that require careful analysis. “We are not suggesting that plan sponsors have been violating their fiduciary duties with past widely accepted practices. We are suggesting, however, that the catalysts are in place for a rapid evolution in fiduciary standards in this area, and plan sponsors would be well-advised to consider and adapt to this evolution.”

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