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Ten Important Questions That Every Plan Sponsor Should Be Asking
1. Have you checked the diversification of your investment selection over the last several years?
If not the tilt may be toward Growth and Large Cap with other categories being completely ignored.
2. Do you have an Investment Policy Statement?
9. Do you know the Total Cost of your plan? To you? To your participants?
Discussion points for the Ten Important Questions:
1. It is the obligation of the plan's fiduciary(ies) to provide an adequately diverse selection of investments to plan participants. This legal requirement is further enhanced by plans that state they will comply with IRC 404(c). An adequately diverse investment selection can best be described by using the Morningstar Style Box. These nine asset categories need to be represented adequately in the funds offered by the plan to participants. There is a trend of plans offering funds from the upper right boxes (ie. Large Cap Blend and Large Cap Growth), while ignoring the other 7 categories. Commonly accepted "adequate diversification" would be to cover a minimum of 6-7 of the categories.
A further problem is the issue of multiple funds from the same category. It is not unusual for a plan to find, upon review, itself with 4-5 funds offered from the same category. This presents another problem, as the funds most likely have a high degree of overlap (ie. investing in the same underlying stocks), sometimes exceeding 50%. Participants can find themselves in 3-4 funds, mistakenly believing they are adequately diversified, that all invest in the same stocks. This issue is best addressed by offering only 1 fund per category (perhaps two in the "blend" category) which will force diversification among participants.
In summary, a well diversified plan will have at least 7 Morningstar Categories represented, a fixed income fund, a foreign stock fund, a guaranteed account, and potentially three asset allocation funds.
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2. An Investment Policy Statement (IPS) is the mission statement for the plan. A well drafted IPS contains the following: the asset categories that will be represented, how many funds per category will be allowed, how funds will be selected for each category, how funds will be monitored/reviewed for each category, how funds will be replaced when they fail the monitor/review criteria, how often the Plan Committee will meet to perform these activities, and how participants will be notified of any changes.
The over-riding concern with having an IPS is that it shows proper Due Diligence on the part of the plan fiduciaries. Due Diligence is defined as the prudent monitoring of the plan's investment choices. Prudent monitoring is simply having the measurable criteria spelled out in such a way that it is apparent that the plan is being served well by the fiduciaries.
In summary, an IPS is an audit item, is fairly easy to draft, and should be used by EVERY qualified retirement plan out there. The reality is that less than 50% of plans will have an IPS, with even fewer actively monitoring their plan's investments by the one they may have in place.
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3. Now that points one and two have you thinking about some of the basics in working with the investments in the plan, you then need to think about how the investments you offer are adequately diversified by fund family. One of the ways smaller vendors and mutual fund companies will offset costs (to remain competitive) is to require a certain percentage of the funds offered to participants be their own. This automatically builds in a bias towards one fund family. While bias will always exist to some extent, it is the job of a prudent fiduciary to limit it as much as possible. Obviously, requiring up to 70% of the fund choices to come from a single fund family is not in the best interests of the plan participants. Vendors with proprietary requirements should be avoided, or should be required to provide an option removing the proprietary requirement, for this reason.
A side note would also include sub-advised funds in this discussion as well. Sub-advised funds have most of the characteristics of a proprietary fund and there are some very good arguments for avoiding them as well.
The larger issue with this point is that the Plan Committee should have access to experts in the selection of funds in the plan. There are several subjective and objective measuring criteria that should be tracked in this process. Using professionals to supply this data and provide guidance will limit the chance for error tremendously. A few of the better vendors and brokers will supply this guidance on all of the funds provided in the program. A plan that intends to follow the written specifications of their IPS is required to have this data supplied to them on an annual basis. Without this data, it is impossible for a plan sponsor to adequately review the investments and make judgments as required by the IPS.
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4. This point is directed at the plan's demographics. With the typical employee population having several age groups and risk tolerances represented, it is vital for a plan to be able to measure the level of participation and interaction the participants have with the plan.
Contribution patterns (the amount each age group is saving), interaction with the plan (web hits, VRU hits, call center hits, etc.), and the number of requests for specific advice can tell a fairly complete story about the needs of the group.
Once the needs have been identified, a plan sponsor can direct how the resources of the vendor can best address them. The obvious point here is that the plan sponsor should choose a vendor that has the ability to track this vital data and then respond to it.
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5. Education material should be changed every 18-24 months to maintain interest and excitement in the plan. New tools are constantly being developed as well as new requirements for plan sponsors. If the material is old and stale, there is definitely a need to find a new vendor or require the current vendor to provide updated material.
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6. Once an employee is enrolled and becomes a participant, it then becomes necessary to begin providing education on a regular schedule. The point here is that participants gain very little by sitting through enrollment meetings each year, but desire educational topics to make them better investors. Semi-annual education meetings should be offered to every plan sponsor on a variety of topics. Make sure the vendor is offering this, or look for a new one. Section 404(c) provides some Safe Harbor protection to plan sponsors that do provide educational material and meetings.
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7. The federal and state governments seem to continuously tweak the rules for Qualified Plans. Recently, there have been required changes via GUST and EGTRRA. There will be more changes in 2003. Some vendors or Third Party Administrators do not provide adequate guidance on how to implement and communicate these changes, so it is necessary to inquire as to the comfort level of the plan sponsor regarding these changes. Is the plan sponsor confident his/her plan meets the new requirements and are they taking advantage of them?
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8. The 401(k) Plan is typically only a portion of a participant's overall financial plan. The best plans make available the tools to help the participant consider their entire financial landscape. Items like Internet-based tools, professional planners, and printed material help out with this need tremendously. Some plans will offer all three, but most should at least offer Internet and printed resources to their participants. If a participant can see how their 401(k) fits into their overall financial picture, they gain a new level of appreciation for the benefit their employer is offering them.
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9. Total Cost is often hard to determine to the average plan sponsor. A lot of the plans that have grown to $3-5 million in assets began as a Group Annuity (GA) plan. GA plans have implicit (hidden) costs built in that plan sponsors routinely do not realize are there (or at least how large the cost is).
When measuring the Total Cost of the plan, you must consider the four general categories:
- The weighted expense ratios charged by the underlying investments,
- The asset charge (wrap fee), if any, charged by the vendor,
- The per participant charge levied by the vendor, and
- The flat base fees charged by the vendor.
Often, the actual cost of the plan will be a surprise to the plan sponsor. Several vendors choose to play "hide the pea" with their costs by burying wrap charges in the expense ratios, not identifying TPA fees in proposals, not identifying extra charges for non-proprietary funds, or failing to list the routine charges a plan will incur as standard fees.
A good broker will typically spreadsheet these costs out to be sure nothing is missing prior to presenting any products to the plan sponsor.
Additionally, it is imperative to identify which costs will be borne by the participants, and which costs will be paid by the sponsor. Never forget that the decision-makers typically have higher account balances and that high asset charges (either wrap fees or expense ratios) will affect them more than other participants
10. This point is an overall comment on the first nine points. "Best Practices" and "Prudent Man Rules" are required to operate a Qualified Plan effectively and in the best interests of the plan participants. The best plans have a methodical structure they follow to ensure this. Regularly scheduled Plan Committee meetings, Annual Investment reviews, participant surveys, etc. should be organized by the broker and vendor to make the plan sponsor's job easier (and to "force" the plan sponsor to do the correct things). Most plan sponsors do not have a structure to their approach to the retirement plan, and providing one differentiates the broker and the vendor.
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