Monday, March 31, 2008

CT Small Business 401(k)/Retirement Plans -SB652

The reality of the small plan retirement marketplace is that many retirement plan alternatives (both plan structures and service providers) exist, but they can be far from optimal for many businesses. Their characteristics often impede a plan sponsor’s desire to establish them or a participant’s ability to maximize their retirement security through them. The proposed State of CT defined contribution plan could provide a meaningfully superior alternative in the small plan market. It would offer both a “real” competitive advantage to small businesses adopters in CT as well as benefit all small plan sponsors and participants by forcing existing plan providers to “up their game” against a highly visible retirement plan alternative with a strong investment structure.

Since the passage of ERISA legislation over 25 years ago there has been a monumental shift in the country’s retirement system away from defined benefit plans toward defined contribution plans. This shift in retirement responsibility to the individual has been accompanied by substantial technological changes in both retirement plan administration and asset management. Technology, product and process changes have created stunning efficiencies, to the point where the cost to manage and administer marginal increments of retirement assets is probably quite close to zero. Unfortunately, these cost and efficiency advances have been arbitraged primarily to the benefit of sponsors and participants in the larger plan market where the scale and resource has been available to expedite realization of these benefits.

Plan sponsors and their participants in the small plan market are facing their new and highly complex retirement planning and savings responsibilities using a complex patchwork of retirement plan vehicles and an inefficient market of retirement plan providers with legacy fee structures and investment products that can severely undermine their best efforts. The current proportion to which small plans are disadvantaged is hard to quantify because of service bundling, investment subsidization and obscure fee disclosures but a reasonable estimate could be in the range of from .5% to over 2.5%. This includes both the impacts of higher fees and the opportunity cost of investment limitations. Some, though not all, of this inherent difference is artificial, unnecessary and unfair. It continues to exist because of structural inefficiencies in the retirement plan market that small retirement plans can't easily overcome.

Market efficiency is implied by some groups simply based on the fact that there are a multitude of retirement providers trolling the small business community for clients. However, the notion that the mere presence of multiple competitors forces retirement market efficiency presumes that buyers are fully informed, have sufficient experience and resources and the pertinent information to make optimal retirement plan decisions. This assumption couldn’t be further from reality! Despite what ERISA demands of them, plan sponsors, particularly small businesses, often know very little about retirement plan administration and generally assign a higher priority to other business demands that require their time and capital.

Our experience suggests that it is nearly impossible for retirement plan sponsors without specific skills and background to meet the substantial fiduciary burden to acquire, understand and validate all the information that is necessary to prudently evaluate competing service packages as required of them by ERISA. Consequentially, small market plan sponsors, without the resources to hire unbiased experts, often either rely on other far simpler decision making heuristics or potentially conflicted, non fiduciary outside resources. In most cases, they simply avoid the decision to implement a retirement plan all together.

Structural inefficiency in the retirement plan market is propagated by information asymmetry and conflicts of interest.

Plan sponsors often don’t fully understand their fiduciary responsibilities given the highly technical and legal nature of the regulations that bind them. For instance, ERISA imposes obligations on plans and their fiduciaries to “act with the care, skill, prudence and due diligence under the circumstances then prevailing that a reasonably prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of like character and with like aims.” Trying to derive actionable practice from relativist language like this would be inconceivable for the inexperienced.

Plan fiduciaries must act prudently and solely in the interest of plan participants and their beneficiaries in establishing fees and appropriate services with retirement plan providers. The practices of product bundling, asset-based fees and the utilization of revenue sharing and internal investment subsidies to offset retirement plan provider’s costs of administration has made it very difficult for plan sponsors to fully understand fee structures. This lack of transparency makes an objective evaluation of competing products and services at best expensive and often impossible for unassisted retirement plan sponsors.

Perhaps the most impenetrable exercise for plan fiduciaries is determining which investments to make available to plan participants. The small business employer is responsible for prudently selecting and monitoring investment options made available in the plan. Plan sponsors generally do not possess the specialized skills and information required to appropriately evaluate the quality and potential of investment products offered to them.

Finally principal-agency conflicts infect many small market retirement products which are designed to maximize the vendor’s revenue rather than the best interests of the plan sponsor or participant.

In complex markets, like the retirement plan market, which require specialist knowledge, the arbitrage process, whereby information and efficiency gets broadly incorporated into products and prices, takes years and years. This has not fully occurred in the small retirement plan market. In an inefficient market, prices, products and services do not represent the best value.

In an inefficient market, the proposed State of CT defined contribution program could offer a number of valuable benefits to small retirement plans:

•deliver certain of the technological and structural benefits of administrative and asset management scale,
•deliver a productive, cost effective and well, diversified set of investment options including ongoing monitoring for effectively zero marginal cost
•provide the flexibility and greater benefit of a 401(k) plan in terms of its higher deferral opportunity, potential loan provisions, flexible vesting schedule, a Roth option and no required employer contributions in some cases as required by other simpler plan alternatives,
•provide a well known “brand” that would be attractive to sponsors who would avoid the decision to adopt a plan based on other issues.

The State of CT has a vested interest in helping it small business base become more competitive and its workers as well prepared for retirement as possible. The proposed State sponsored retirement plan could be a unique step in shifting industry dynamics to afford all future retirees, regardless of their employer size, the best opportunity that can make available under current laws, to maximize their retirement security.

Continuing to ignore or subsidize segments of the retirement plan industry operating in an inefficient market is unproductive. Plan sponsor inertia and diverse businesses needs for a range of retirement solutions will ensure that market opportunities will continue to support a wide range of retirement plan employers in the State. The State should move ahead with the proposal based on the fact that it could expand retirement plan coverage in the small employer market.

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