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Grading the Pensions Protection Act, 10 Years Later

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Do you remember the Pension Protection Act (PPA)? More than 900 pages of legislation touching seemingly every part of the retirement system. It presented challenges for defined benefits plans. Defined contribution (DC) plans instead saw beneficial provisions, including the permanence of certain provisions of the 2001 Economic Growth Tax Relief Reconciliation Act (EGTRRA) and the creation of safe harbors for using target date funds as defaults and for implementing automatic enrollment.

The PPA heralded a new era for DC plans with the potential to greatly increase workers’ access to retirement income security. But looking at the PPA’s report card, we do not see “straight As” over the last decade.

Many of the provisions took years to enact, and plan sponsors still seem to struggle with them. As the PPA celebrates 10 years, we ask: Was it successful? Did it transform DC plans in the way the industry had hoped? How can we do better?

Callan gives a grade to the performance of nine key PPA provisions over the past decade. We start with the least effective.

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Grading the Pensions Protection Act, 10 Years Later

  1. 1. CALLAN INVESTMENTS INSTITUTE Grading the Pension Protection Act, Ten Years Later Success Stories and Near Misses The end of the year is always a time for nostalgia. Do you remember the Pension Protection Act (PPA)? More than 900 pages of legislation touching seemingly every part of the retirement system. It presented challenges for defined benefits plans. Defined contribution (DC) plans instead saw beneficial provisions, including the permanance of certain provisions of the 2001 Economic Growth Tax Relief Reconciliation Act (EGTRRA) and the creation of safe harbors for using target date funds as defaults and for implementing automatic enrollment. The PPA heralded a new era for DC plans with the potential to greatly increase work- ers’ access to retirement income security. But looking at the PPA’s report card, we do not see “straight As” over the last decade. Many of the provisions took years to enact, and plan sponsors still seem to struggle with them. As the PPA celebrates 10 years, we ask: Was it successful? Did it transform DC plans in the way the industry had hoped? How can we do better? In this DC Spotlight, Callan gives a grade to the performance of nine key PPA provisions over the past decade. We start with the least effective. 9. The PPA’s Fund-Mapping Safe Harbor is arguably its least impactful DC provision, despite appearing promising back in 2006. It afforded much-sought-after ERISA Section 404(c) protection for assets being mapped from one fund to another within the plan, potentially expediting a desirable streamlining of fund lineups. To qualify, the PPA stipulated that balances be reallocated among one or more remaining or new investment options “the stated characteristics of [which]…are…reasonably similar to those of the existing investment options...”1 This fund mapping safe harbor was important because plan sponsors tended to allow “legacy funds”— which either no longer fit the plan or were weak performers—to remain in the lineup out of concern for the fiduciary consequences of removing them and having to map participant assets. This led to fund proliferation and confusion when participants needed to select funds. Spotlight Research December 2015 Knowledge. Experience. Integrity.
  2. 2. 2 Unfortunately, this proliferation continues. Although 15% of plan sponsors said they seek to decrease the number of funds in their plan,2 the opposite is occuring. Excluding target date funds, the aver- age number of funds rose from 11.4 in 2006 to 14.5 in 2015.3 Sponsors are often confused over how to interpret mapping requirements, and are concerned that participants will loudly object if certain beloved funds disappear from the plan—even if those funds are redundant or poor performers. Study Tip: Plan sponsors and consultants should revisit this provision’s potential. In reality, very few participants object when plan funds change—most don’t even notice. For the few that do, offering a self-directed brokerage account is one possible alternative. Grade: C 8. Quarterly Benefits Statements are another low-impact PPA provision. Prior to the PPA, 81% of DC plans already provided them.4 There is little evidence to suggest that such statements positively affect behavior. Recently, the Department of Labor (DOL) has been seeking to require lifetime income pro- jections on benefits statements to encourage higher savings levels, but research shows only a small percentage of people respond to these types of projections.5 Study Tip: Researchers continue to explore ways to motivate saving. The most promising appears to be personalized, just-in-time communication. For example, Shlomo Benartzi of UCLA recommends texting or emailing workers “… a little financial advice every time they are in danger of making a poor financial decision,” such as taking a loan or a withdrawal from the DC plan.6 The ERISA Advisory Council has developed this type of communication to prevent workers from cashing out their retire- ment plans upon termination. Plan sponsors should continue to seek participant communications that go beyond quarterly benefits statements. Grade: B- 7. Vesting comes in seventh. In an attempt to reduce vesting schedules, the PPA required that employer contributions be vested 100% after three years or 20% per year starting with year two. Shorter vesting periods is a laudable goal: the more quickly DC participants are vested in a plan, the less likely they will experience “leakage” as they navigate the retirement system. This is particularly an issue for workers ages 25 to 34, over a quarter of which, the Bureau of Labor Statistics notes, have been with the current employer for 12 months or less.7 The PPA’s vesting requirements can be labeled a modest success. Plans with immediate vesting increased from 34% in 20058 to 45% in 2014.9 Yet plan leakage remains an issue as workers persist in cashing out small balances.11 Study Tip: Plan sponsors should not forget about leakage when considering ways to improve their DC plans. Offering fewer loans, implementing loan origination fees (which may impede loan taking), allow- ing repayment of loans upon termination, and educating workers on the long-term impact of cashing out their plan can all help to reduce plan leakage. Grade: B
  3. 3. 3 6. Investment Advice, courtesy of a prohibited-transaction exemption (PTE), comes in sixth on our list. The PTE was intended to expand the availability of online investment advice while preventing conflicts of interest by advice providers. Indeed, advice has become more prevalent. In 2005, 15% of plan sponsors provided participants with online investment advisory services;11 in 2014, this jumped up to 47%.12 However, usage remains low; the Plan Sponsor Council of America reports that in plans with 5,000 or more participants, average advice utilization by participants is 13%.13 Study Tip: Increasingly, plan sponsors are reexamining advice and guidance solutions beyond retire- ment savings, such as financial wellness options intended to support workers’ overall financial situa- tion. Given the DOL’s upcoming regulation on the definition of a fiduciary—which could impact a wide range of participant interactions—it may be time for plan sponsors to reevaluate the role and scope of advisory solutions. Grade: B 5. Automatic Contribution Escalation’s impact has truly been a mixed bag. The PPA gave it credibility when it made it part of a new non-discrimination-testing safe harbor. Prior to the PPA, just 9% of plans offered automatic contribution escalation14 —today that figure has more than quadrupled to 42%.15 At the same time, the PPA safe harbor hobbled automatic contribution escalation by requiring esca- lated savings to be capped. Many plan sponsors—most of whom have no interest in this non-discrim- ination testing safe harbor—have been loath to allow contributions to escalate to robust levels. This is too bad, as many financial planners suggest saving between 10% and 15% of pay to amass a suf- ficient nest egg. Another reason it does not rank higher on our list: about half of the time it is an opt-in solution,16 which tends to result in low utilization; conversely, utilization tends to be very high when employees must opt out. Study Tip: Given DC participants’ persistently low savings rates—especially under auto enrollment— plan sponsors should consider opt-out automatic contribution escalation. Further, they should con- sider caps as high as 15% of pay; research shows that when participants choose their own caps, they commonly pick 15% or higher. Grade: B 4. Company Stock Diversification takes the fourth spot. This provision compelled plan sponsors to allow immediate diversification of employee contributions invested in employer stock in DC plans, with the ability to diversify out of employer contributions in employer stock after three years. It also required employers to provide participants with a notice describing their diversification rights and “the importance of diversifying investment of retirement account assets.” The decline in company stock prevalence and utilization since 2006 has been striking: then, 34% of plans offered company stock with an average allocation of 22%; now, 26% of plans offer company stock with an average allocation of 12%.17
  4. 4. 4 Study Tip: Plan sponsors should continue to evaluate the role of company stock in the DC plan. In light of the Supreme Court’s 2014 judgment that offering company stock in a DC plan is a fiduciary function, sponsors should consider adopting a process for regularly reviewing company stock, includ- ing incorporating company stock evaluation language into the plan’s investment policy statement. Grade: B 3. Automatic Enrollment significantly benefited from PPA safe harbors, including fiduciary relief from state wage laws, which made implementation a much easier decision for plan sponsors. The data bears this out. Prior to the PPA, 19% of plans had auto-enrollment;18 62% of plans do today.19 Auto-enrollment can powerfully increase plan participation20 but it still isn’t the top PPA success story because it is not often robustly implemented. Default contribution rates of 3–4% remain the norm, and research shows participants are slow to move from such low savings levels. Saving at nominal levels is a sure way to fall short when it comes to retirement income adequacy. Study Tip: Plan sponsors should consider higher default contribution rates under auto-enrollment, as well as tying auto-enrollment with opt-out automatic contribution escalation. Research shows that participant opt-outs are no higher when the default contribution rate is 6% of pay than when it is 3%. To address cost, plan sponsors may need to rethink the company match, e.g., incorporate a stretch match requiring participants to save at higher levels in order to receive the full company contribution. Grade: B+ 2. Target Date Funds take second place. The PPA created qualified default investment alternatives (QDIAs) including balanced funds, managed accounts, and target date funds—the latter is the clear favorite. Today, 75% of plans offer target date funds21 as the default investment alternative for non-par- ticipant directed monies. Not only has prevalence soared, but so has utilization: as a common default under auto-enrollment, the money directed into them has stuck. The average allocation to target date funds has grown from 4.1% in 200622 to more than 25% (and growing) today.23 Study Tip: Target date funds have been a big success in terms of prevalence and utilization, but have not always delivered on performance. During 2008–2009, target date fund losses created head- lines and concerns that participants did not understand their risks. Managers have made concerted efforts to improve diversification and management of their glide paths, but nonetheless, considerable diligence is required of plan sponsors when it comes to evaluating and monitoring target date funds. Risk-adjusted performance ranges widely by manager, and the typical target date fund has failed to outperform the Callan DC Index™ since 2006. Grade: A-
  5. 5. 5 1. EGTRRA Permanence, in our view, is the PPA’s biggest success. In 2001, EGTRRA made a number of DC-beneficial changes to Federal tax laws, including a variety of provisions that increased DC sav- ings opportunities—such as making catch-up contributions available, increasing DC savings limits, and creating Roth contributions. However, EGTRRA had a “sunset” date, which meant its provisions were set to expire in 2011. As a result of EGTRRA permanence, today catch-up contributions are per- mitted in more than 97% of large plans,24 while 62% of plans offer Roth contributions.25 Unfortunately, few participants test the contribution limits: the average savings rate for lower-paid participants is 5.3%, the average for all eligible participants is 6.7%, and only one-fourth of eligible participants have made a catch-up contribution.26 Study Tip: Over time, implementing automatic contribution escalation is bound to help workers reach higher savings levels. Plan sponsors might also consider encouraging catch-up contributions by pro- viding a matching employer contribution (45.7% do),27 or even automatically enrolling workers into catch-up contributions when they turn 50. Grade: A- Conclusion Has the PPA changed DC plans for the better? In many ways, the evidence shows it has—but it also reveals that there is room for improvement. Enthusiasm around auto features is evident, but savings lev- els are not nearly high enough. Opportunities to augment investment outcomes abound for those taking advantage of QDIAs, online advice, and company stock diversification, but the path remains bumpy. While the PPA doesn’t receive an A+ when it comes to DC plans, that is not necessarily because of its provisions. Rather, it is because of the way those provisions have been implemented by plans sponsors and used by plan participants. A fresh look at the advantages of the PPA provisions should be on the New Year’s resolu- tion list for plan sponsors and participants. Authored by Lori Lucas, CFA, Callan’s Defined Contribution Practice Leader. Email institute@callan.com with questions.
  6. 6. 6 Notes: 1 United States. Government Printing Office. (2006). Pension Protection Act of 2006 (Public Law 109-280, Section 621.C). Washington, DC. 2 Callan Associates Inc. (2015). DC Trends Survey. [Survey]. Pg 28. 3 Callan Associates Inc. The Callan DC IndexTM . As of September 30, 2015. Available at https://www.callan.com/tools/dcindex/. 4 Hewitt Associates, LLC. (2005). Survey Findings: Trends and Experiences in 401(k) Plans. [Survey]. Pg 79. 5 Goda, Gopi Shah, Manchester, Colleen Flaherty, Sojourner, Aaron. Do Income Projections Affect Retirement Saving? Center for Retirement Research at Boston College. 2013. No. 13-4. 6 Benartzi, Shlomo, Lehrer, Johan. The Smarter Screener: Surprising Ways to Influence and Improve Online Behaviors. (Portfolio Publishing Ltd, 2015). 7 United States. Department of Labor. Bureau of Labor Statistics. (2014). Employee Tenure in 2014 (USDL-14-1714). [News Release]. 8 Hewitt. Pg 34. 9 The Vanguard Group, Inc. (2015). How America Saves. [Report]. Available at https://institutional.vanguard.com/iam/pdf/HAS15.pdf. 10 A 2014 AonHewitt study found that 43% of participants who terminated employment took a cash distribution. 11 Hewitt. Pg 48-49. Four out of ten sponsors offered outside investment advisory services, and 40% of those offered the service online. 12 Callan. DC Trends Survey. Pg 33. Nearly 80% of sponsors offered outside investment guidance, and 59.8% of those offered the service online. 13 Plan Sponsor Council of America. (2014). 57th Annual Survey of Profit Sharing and 401(k) Plans. [Survey]. 14 Hewitt. Pg 1. 15 Callan. DC Trends Survey. Pg 15. 16 Ibid. 17 Callan. The Callan DC Index. 18 Hewitt. Pg 13. 19 Callan. DC Trends Survey. Pg 3. 20 According to DCIIA’s 2014 Plan Sponsor Survey (available at www.dciia.org), the portion of plans with over 90% participation more than doubled, from 18% prior to the implementation of automatic enrollment to 45% afterwards. 21 Callan. DC Trends Survey. Pg 20. 22 Plan Sponsor Council of America. (2007). 50th Annual Survey of Profit Sharing and 401(k) Plans. [Survey]. 23 Callan. The Callan DC Index. 24 Plan Sponsor Council of America. (2014). 25 Callan. DC Trends Survey. Pg 16. 26 Plan Sponsor Council of America. (2014). 27 Ibid.
  7. 7. Corporate Headquarters Callan Associates 600 Montgomery Street Suite 800 San Francisco, CA 94111 800.227.3288 415.974.5060 www.callan.com Regional Offices Atlanta 800.522.9782 Chicago 800.999.3536 Denver 855.864.3377 New Jersey 800.274.5878 Certain information herein has been compiled by Callan and is based on information provided by a variety of sources believed to be reliable for which Callan has not necessarily verified the accuracy or completeness of or updated. This report is for informational pur- poses only and should not be construed as legal or tax advice on any matter. Any investment decision you make on the basis of this report is your sole responsibility. You should consult with legal and tax advisers before applying any of this information to your particular situation. Reference in this report to any product, service or entity should not be construed as a recommendation, approval, affiliation or endorsement of such product, service or entity by Callan. Past performance is no guarantee of future results. This report may consist of statements of opinion, which are made as of the date they are expressed and are not statements of fact. The Callan Investments Institute (the “Institute”) is, and will be, the sole owner and copyright holder of all material prepared or developed by the Institute. No party has the right to reproduce, revise, resell, disseminate externally, disseminate to subsidiaries or parents, or post on internal web sites any part of any material prepared or developed by the Institute, without the Institute’s permission. Institute clients only have the right to utilize such material internally in their business. About Callan Associates Callan was founded as an employee-owned investment consulting firm in 1973. Ever since, we have empowered institutional clients with creative, customized investment solutions that are uniquely backed by proprietary research, exclusive data, ongoing education and decision support. Today, Callan advises on more than $1.8 trillion in total assets, which makes us among the largest independently owned invest- ment consulting firms in the U.S. We use a client-focused consulting model to serve public and private pension plan sponsors, endowments, foundations, operating funds, smaller investment consulting firms, investment managers, and financial intermediaries. For more information, please visit www.callan.com. About the Callan Investments Institute The Callan Investments Institute, established in 1980, is a source of continuing education for those in the institutional investment community. The Institute conducts conferences and workshops and provides published research, surveys, and newsletters. The Institute strives to present the most timely and relevant research and education available so our clients and our associates stay abreast of important trends in the investments industry. © 2015 Callan Associates Inc.

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