PHOENIX - The nation's retirement system is in desperate need of an overhaul, and the mutual fund industry is likely to play a vital role in that renovation.
That was the message that Ann L. Combs, assistant secretary of the Employee Benefits Security Office, brought from the White House to the Investment Company Institute's 2006 Mutual Funds and Investment Management Conference, held here recently.
In her address to the conference's 1,600 attendees, Combs outlined elements of President Bush's massive pension reform initiative, how the migration from defined benefit plans to defined contribution plans might impact mutual funds, and how, as enforcer of ERISA guidelines, her office regulates one of the fund industry's key customers, retirement plan sponsors.
For example, Combs explained, in the wake of the collapse of Enron's retirement plan, where thousands of employees lost millions of dollars vested solely in company stock, the Bush administration proposed legislation that would allow corporate plan participants to diversify out of company stock after three years into mutual funds. That proposal didn't survive, but has resurfaced as a key element of the pension reform bill currently under consideration in Congress.
The administration is also bullish on greater access to investment advice for participants in employer-sponsored defined contribution plans, another element of pension reform legislation, and is a key supporter of the Securities and Exchange Commission's initiative toward "plain-English" disclosure documents for retirement plans.
And, finally, Combs indicated that the administration is focused on solving a dilemma confronting the single employer defined benefit system, where many old-line corporations are either finding it impossible to meet their contribution obligations, or have gone through Chapter 11 and had those obligations shed to the Pension Benefit Guarantee Corp., the Federal insurer for defined benefit plans that's currently shouldered with a $23 billion deficit. Those two forces have combined to severely diminish benefits and left many people with a short investment horizon to make up what they've lost.
While it might be cold comfort to those folks, the pension reform bill includes language that would strengthen existing pension funding rules, improve disclosure that employers must make regarding contributions to plans, as well as keep them from making additional contribution promises during collective bargaining sessions until shortfalls are accounted for and fulfilled.
"We feel passionately about fixing this system. It is clearly broken," said Combs, whose agency oversees approximately 700,000 pension plans with nearly $7 trillion in assets and another six million health and welfare benefit plans.
Although weaker than the President intended, versions of the pension reform bill have passed both Houses and are being debated by lawmakers with an eye on an April 15 resolution deadline, which, not coincidentally, is also the quarterly deadline for corporations to fulfill their pension obligations.
"It is the natural forcing event that you often need in Washington to get people to make tough decisions," Combs remarked. "But the President will not sign a bill that is weaker than current law."
But while the pension reform debate is undoubtedly of great significance to the nation's future both socially and economically, particularly in light of the strains that 79 million Baby Boomers are expected to place on the Social Security system, the relevancy of defined benefit plans would seem outside of the universe of mutual funds.
Think again, Combs said.
"Defined benefit plan reform may not seem to be in your bailiwick, but it's important for you to understand how your customers are trying to manage the retirement benefits they offer their employees," she said. "They're going through a lot of changes."
For starters, more and more big corporations, like IBM most recently, are migrating away from costly defined benefit plans to more inexpensive defined contribution plans. A new study shows that 37% of the nation's chief executives are planning such a switch (see related story, page 6). But as companies lean more heavily on 401(k)s and the like, they're also increasing contributions to upwards of 6% of an employee's annual salary, deliberating whether to add an automatic enrollment feature and increasing the matching amount they submit.
"They are trying to do things that will likely lead to more assets in the 401(k) environment, which are typically invested in mutual funds," Combs said, noting that more than half of the 54 million households invested in mutual funds do so through employee retirement plans.
Combs warned, however, that signs of growing pains between the two camps are beginning to emerge. Plan sponsors, for instance, are becoming increasingly sensitive to mutual fund fees.
"Plan sponsors are thinking, Why am I paying retail?' and they're pushing back," said Combs, who expects that retirement plan sponsors will soon have the clout to negotiate fees.
They're already pressing for greater transparency. As a result, Combs' office is weighing whether regulatory action might be necessary to ensure that plan fiduciaries receive an accurate fee breakdown from intermediaries, as well as disclosure around revenue-sharing relationships an intermediary might have with other parties, such as pension consultants. Her office is also examining heightened fee disclosure to plan participants, "so they have the information they need to compare investment options, more clearly understand net returns and make better asset allocation decisions."
And, finally, the regulator is scrutinizing Form 5500, an annual, publicly available report that retirement plans file with the Department of Labor and the IRS that gives a comprehensive description of each employer's retirement plan. Combs' office would like to greatly increase and improve the specificity of its fee disclosure section.
"Be prepared. Your customers are going to come to you and say, I need to file this information with the government. You better tell me what's going on,'" she said.
Some plan sponsors, in fact, are so concerned about fee structures that they've begun exploring alternatives to mutual funds, such as old-fashioned bank trusts, or perhaps even a foray into exchange-traded funds.
"So there's a challenge out there for you to make sure that your customers understand the value of mutual funds - the diversification, the low costs. Transparency and fees [are also] going to be important if you're going to remain the dominant investing source for the industry," Combs explained.
Another factor that would surely bring the two camps closer is language within the House version of the pension reform bill that would allow mutual funds and other investment managers to offer defined contribution plan participants investment advice. Since 1974, ERISA has considered such advice a conflict of interest because commission-hungry investment advisors might steer plan participants toward their own funds or perhaps even higher-cost funds.
The House version would allow that advice in exchange for the investment advisor assuming fiduciary responsibility for that plan-specific advice, as currently required under ERISA. The Investment Advisors Act of 1940 is much more lenient, as it requires advisors to act in the best interest of investors generally. Requiring advisors to make decisions under stricter ERISA guidelines would put a greater fiduciary liability on advisors, but would also take employers off the hook.
"Employers would remain responsible for selecting an advisor but not the advice they give," said Combs, who also wants to eliminate duplicative rules between ERISA and the '40 Act. "That should create greater demand for the advice product, because employers have been concerned that they would be held legally responsible."
The Senate version of the bill opposes such an arrangement. It would rather see advice limited to independent advisors. ERISA guidelines, however, already allow for independent investment advice, Combs noted, so that bill would not go beyond existing law.
"[Lawmakers] feel very strongly on both sides of this. It's a member-level issue, and I don't know how it is going to turn out," Combs added. "[But] we need to do a better job of explaining the safeguards that are in place."
In other regulatory news, Combs said her office is working on a rule that would relieve employers of their fiduciary liability should they choose to offer automatic enrollment in a defined contribution plan. Research has overwhelmingly showed that participation in defined contribution plans increases when automatic enrollment is an option, but employers have shied away from the idea over fears that they might get sued for placing employees in a default plan that tanks. And skittish employers that do utilize a default plan oftentimes place employees in ultra-conservative money market accounts.
"We're looking at lifecycle funds, target-date funds [and] funds that balance fixed-income and equity products," she said.
In addition, the regulator is also considering including a professional management option, a new trend in benefits where an outside firm is hired to manage the individual account, either through options that are available in the plan or by pursuing outside products.
"That is on a fast track, and we hope to get it out this year," Combs said. "That's fast track in government."
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