It’s All In The Fine Print: Will Your Fiduciary Insurance Cover You When You Need It?

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Carol Buckmann is an attorney who has practiced in the employee benefits field for over 30 years. This post was originally published at Pensions & Benefits Law.

Will that insurer your company has been paying premiums to for all of these years stand behind you if you are sued for ERISA violations?  Have you just been relying on a broker to give you the coverage you need?

I previously wrote about a decision in which CIGNA’s insurer was permitted to deny coverage for fiduciary breach due to a fraud exclusion in its policy.   We have since had another decision from an appeals court in Louisiana in which fiduciaries being sued by the U.S. Department of Labor were denied coverage under each of three separate policies they thought would provide them with legal defense costs and cover any awards assessed against them.  Again, the reason was buried in the policy fine print, which even the brokers didn’t seem to understand, if the facts set out in the decision are any indication.

The facts boil down to the following:  Plaintiffs had three policies: a D&O policy, fiduciary liability insurance and excess fiduciary coverage.  They were sued by the DOL following a formal investigation for selling stock to an ESOP at an inflated price, but the court ruled that the policies didn’t cover the plaintiffs for the following reasons:

  • The policies didn’t cover actions taken before the effective date.
  • The D&O policy didn’t cover ERISA claims at all.
  • Plaintiffs failed to give notice of the claims during the policy period, where the claim was specifically defined as including an investigation by the Department of Labor or the Pension Benefit Guaranty Corporation.
  • The excess coverage didn’t kick in until the policy limits in the basic policies had been reached (which was not possible given the court’s other rulings.)

The plaintiffs were also told that they couldn’t amend their complaint to include the brokers who they claimed were supposed to be providing them with specific coverage, but failed to do so.

No one wants to wade through the details of these policies, but those who fail to have them reviewed by legal counsel may be in for rude surprises later on.  We regularly speak with very competent  employee benefits professionals who confuse the required ERISA bonding coverage (which provides recovery to the plan, not the fiduciaries) with fiduciary liability insurance, or who think D&O policies cover their ERISA plan committee actions (many such policies either don’t cover ERISA claims at all, or don’t cover lower level committee members).  We frequently are told that a plan sponsor maintains fiduciary liability insurance, only to be sent the ERISA bond when we ask to see a copy of the policy.  In many of those cases, we have to deliver the bad news that the fiduciaries have no personal coverage at all.

Clearly, the time to review coverage and obtain any required endorsements is not when the accusations of fiduciary breach are raised.  Just a few among the points to be considered in a thorough review of coverage are the following:

  • Your broker is not a lawyer.  Don’t rely on her to interpret legal clauses in your policy. Get a qualified independent review.
  • Don’t assume that employer indemnification obligations are a substitute for coverage or will cover any gaps in coverage.  There will be legal constraints (for example, under state corporate law) on the company’s ability to provide full indemnification and the commitment may become worthless in the event of bankruptcy or other financial distress.
  • Understand the exclusions in your policy and find out whether endorsements are available to eliminate some of them.
  • Consider whether your policy limits should be increased.  Courts seem to be awarding ever increasing damages in fiduciary breach cases.
  • Understand and follow the notice requirements in your policies.

 

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All Teachers Deserve Adequate Retirement Benefits. It’s Harder Than You Think To Get Them

Chad Aldeman is an associate partner at Bellwether Education Partners and a former policy advisor at the U.S. Department of Education. This post was originally published on TeacherPensions.org.

How many teachers should be eligible for adequate retirement benefits?

My answer is all of them: For every year they work, teachers should accumulate benefits toward a secure retirement.

A reasonable person might say only those who stay for at least three or five years. That would require teachers to show some amount of commitment to the profession, and it would reward teachers for getting through the most challenging early years.

But that’s not the way current teacher retirement systems are designed. Most states require teachers to stay 20, 25, or even 30 years before they qualify for adequate retirement benefits. (The Urban Institute’s Rich Johnson and I calculated these “break-even” points across the country. Find info on your particular state here.)

In other words, today’s teacher pension systems only provide adequate benefits to teachers with extreme longevity. You don’t have to take my word for it. The California State Teachers’ Retirement System (CalSTRS) hired Nari Rhee and William B. Fornia to study whether California teachers were better off under the existing pension system or alternative retirement plans.

The chart below comes directly from their paper. It shows how benefits accumulate for newly hired, 25-year-old females under the current pension system (blue line), a defined contribution plan (red line), a defined contribution plan with no employer contributions (dotted blue line), and a cash balance plan (dotted green line). There are legitimate questions about whether these are perfectly fair comparisons—Rhee and Fornia ignore the large debts accumulated under traditional pension plans—but even in this analysis, it’s clear that the pension system is the most back-loaded benefit structure. Some teachers do better under this arrangement, but most don’t. Depending on the comparison, this group of teachers must stay two or three decades before the pension system offers a better deal.

Rhee and Fornia make a valid point that not all teachers enter the profession at age 25, and their paper also includes the graph below showing the actual distribution of California teachers by the age at which they began teaching. The most common entry ages are 23 and 24, just after candidates complete college (California requires most new teachers to go through a Master’s program before earning a license). The median entry age for current teachers is 29 (meaning half of all teachers enter at age 29 or younger), and the average is 33.

Rhee and Fornia’s point here is that people who begin teaching at older ages have shorter break-even points, and that teachers with shorter break-even points are more likely to benefit. This has a kernel of truth but obscures some key points.

First, it is true pension plans are better for workers who begin their careers at later ages. Pensions are based on a worker’s salary when she leaves the profession, and they don’t adjust for inflation during the interim. If a 35-year-old leaves teaching this year, she may qualify for a pension, but it will be based on her current salary right now. By the time she finally becomes eligible to begin drawing her pension, say in the year 2046, every $1 in pension wealth will be worth far less than it is today. Teachers who go straight from teaching into retirement don’t have this problem.

Consequently, it’s also true that teachers who begin their careers at later ages are comparatively better off than teachers who began at younger ages. They don’t have to wait as long, so the break-even points fall from 31 years for a 25-year-old entrant to just 7 years for a 45-year-old entrant.

But their argument starts to suffer when compared to teacher mobility patterns. Like other states, California sees much higher turnover in early-career teachers than mid- or late-career teachers. The result is that, even for a 45-year-old teacher with a relatively short break-even period of 7 years, only about half will actually reach that point.

The table below pulls together these two data points for teachers of various ages. The middle row illustrates how long the teacher would be required to stay until her pension would finally be worth more than a cash balance plan (Rhee and Fornia calculate slightly shorter break-even points for their defined contribution plans). The last column uses the state’s turnover assumptions to estimate how many California teachers will remain long enough to break even. Remember, the median teacher in California began teaching at age 29. The table below suggests this typical teacher would have had a break-even point of more than 25 years, and the state assumes that only 40.6 percent of this group of teachers will make it that far. Across the entire workforce, the majority of California teachers would be better off in a cash balance plan than the state’s current pension plan.

Age at which the teacher begins teaching How many years does it take for the teacher to break even on her pension plan? What percentage of teachers like her will break even?

25

31

34.6

30

25

40.6

35

19

43.7

40

13

46.6

45

7

54.2

California is a bit of an outlier here compared to other states—it’s a big state and seems to have lower teacher turnover than other states—but it’s still worth asking if this system is working well enough for all teachers. Rhee and Fornia’s main point seems to be that, once you exclude short- and medium-term workers,  the remaining teachers tend to do pretty well under the current system. But that excludes lots of people!

I personally don’t think that’s the right way to look at things. I think it’s worth fighting for retirement systems that treat ALL teachers fairly and equitably. After all, teachers might not know how long they’ll stay in the profession. They might not like teaching as much as they thought, or life might take them on another path. And once we account for this uncertainty, the break-even points become less about raw numbers (do I have to stay 19 or 22 years?) and more about probability (what’s my realistic chance of teaching in this state for 31 years?). Looked at from that perspective, it becomes harder and harder to support pension systems with such extreme back-loading.

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The Pension vs. 401k Debate Harms Teachers

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This post originally appeared on TeacherPensions.org.

Each year, around 150,000 new teachers are hired to work in American public schools. Those teachers might not pay much attention to their retirement except to note that they’re enrolled in their state’s pension plan. A “pension plan” sounds good, safe, and secure, much better than “risky” 401k plans typically offered in the private sector.

This is a dangerous and flawed misperception. Of the 150,000 new teachers, slightly more than half won’t stick around long enough to qualify for the pension they were promised. They’ll get their own contributions back, but in most states, they won’t earn any interest on those contributions, and they won’t be eligible for any of the sizable contributions their employers made on their behalf.

These teachers are worse off than if they had been in a 401k plan. The federal government has laws governing private-sector retirement plans to ensure that workers start earning retirement benefits early in their careers, but those laws do not cover state and local governments. Teachers are left exposed to the whims of state legislators, and during tight budget times, states cut benefits for new teachers. Today, nearly every state makes teachers wait longer to qualify for their pension than private-sector workers wait for employer benefits from 401k plans. Four states require seven- or eight-year waiting periods (called “vesting” requirements) and 15 states, including populous ones like Illinois, Maryland, New Jersey, and New York, withhold all employer contributions for teachers until 10 years of service. In these states, teachers could work up to nine years without any form of employer-provided retirement savings. This would be illegal in the private sector.

Teachers are often told they’re trading lower salaries while they work for higher job security and more generous benefits. But that trade only works well for teachers who actually stick around until retirement. Most don’t. Most teachers get the worst of both worlds—they earn lower salaries while they work and they forfeit thousands of dollars in lost retirement savings when they leave. Check out our report, Hidden Penalties, to see how many teachers are affected in your state and how much they’re losing.

 

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Some Risk Is Good For Defined Benefit Plans, Says Study

Safe investments are good. But investments that are too safe also carry potential risks for beneficiaries. A study by two Iowa University professors suggests that defined benefit plan sponsors should expand their investment choices to riskier assets and go beyond liability-driven strategies that rely on fixed-income assets.

“Employees have some desire to have a fair risk-return trade-off,” said Wei Li, one of the authors of the study. “They would prefer to have some risk exposure.”

Alicia McElhaney reported on the Iowa University study in this article printed in Institutional Investor:

The research contradicts the view held by some defined benefit plan sponsors that given their fixed-income-like payouts, they should engage in liability-driven investment strategies, which rely on fixed-income assets to secure returns.

According to the research, this isn’t exactly beneficial for employees. Here’s why: many employees rely on their pension funds completely for retirement savings, according to the research. Regardless of how their plan sponsors invest, these employees are taking on some risk because their pensions could be wiped out if their employers file for bankruptcy. And while the Pension Benefit Guaranty Corp. (PBGC) provides insurance for pension funds, retirees are only insured up to a ceiling, the paper noted. For higher-paid employees expecting to retire with large pensions, a bankruptcy could spell trouble.

[…]

There is, perhaps, a better way to distribute the risk fairly according to the paper: defined contribution plans. These plans make up 48.6 percent of pension assets in the seven major pension fund markets, according to Willis Towers Watson, and are steadily increasing their market share. Assets under management at these defined contribution plans increased by 5.6 percent over the past 10 years, while they grew by 3.1 percent at defined benefit plans during the same time frame, the report shows.

“A more efficient contract would let employees to shoulder all the pension investment risk while keeping them insulated from firm-specific risks,” according to the paper. “Interestingly, this arrangement resembles what a defined contribution plan offers. Our analysis shows that such an arrangement may substantially reduce firms’ pension funding costs.”

The More You Know: For Participants, Retirement Confidence Comes From Engagement, Education

Credit: BlackRock DC Pulse Survey
Credit: BlackRock DC Pulse Survey

Barely a majority of 401(k) participants are confident about their retirement readiness, and many were unsure of their investment options and how much they should be saving, according to a new survey from BlackRock.

Further, education and engagement can serve as wellsprings of confidence for unsure participants.

PlanAdviser has the cliffnotes:

BlackRock’s DC Pulse Survey of 1,003 DC plan participants found 28% reported feeling “unsure” about whether they are on track for retirement.  The survey revealed people “unsure” about their retirement prospects are much more likely than those “on track” to admit that “I don’t know as much as I should about investing for my retirement” (66% vs. 38%, respectively) and “I don’t know how much money I need to save in order to fund the retirement I want” (68% vs. 32%, respectively).

“Unsure” participants also are less likely to be taking proactive steps to improve their knowledge.

[…]

According to BlackRock’s analysis, the link between a basic understanding of key retirement planning principles and retirement confidence holds true for people at all income levels—suggesting that such confidence is not simply a function of greater financial resources.

“Unfortunately, many individuals who consider themselves ‘off track’ face financial realities requiring support beyond their DC plan,” says Anne Ackerley, head of BlackRock’s U.S. & Canada Defined Contribution Group. “But the good news is that people who are unsure about their retirement standing may be able to build their confidence with relative ease by working in the near term to close critical knowledge and saving gaps.”

BlackRock’s findings on engagement:

The survey also found that across the board, “unsure” individuals are less likely than “on track” participants to engage with their DC plan. Those “unsure” were less likely than those “on track” to say they take full advantage of retirement savings guidance provided by their employer (43% vs. 67%, respectively) and also less likely to have increased their contribution in the past 12 months (35% vs. 47%). They also reported less engagement in evaluating their investment options (25% vs. 38%) and were less likely to report that they evaluate their investment options at least quarterly (29% vs. 50%).

“Our survey shows that plan engagement is a key vehicle for boosting retirement confidence—and that’s a critical message for plan participants and sponsors alike,” says Ackerley. “Individuals need to take greater advantage of the tools already available to them through their plan. And plan sponsors can feel confident that adding more and better tools for their DC participants is a worthy effort—because a robust, participant-focused DC plan really does have the power to make a difference.”

Inside Knowledge: An Advisor’s Take on What Makes A Great Retirement Plan Advisor

Three out of four plan sponsors hire the services of an advisor for their plan, according to the Retirement Advisor Council. And they’re looking for more from their advisor than ever before.

What makes an advisor stand out?

Mark Davis, Senior Vice President of CAPTRUST Financial Advisors, offers his insight in a column published in the Summer issue of the Journal of Pension Benefits.

We picked out some key excerpts, below.

On plan design:

Going forward, in many states, we may well see a growth in usage of state-sponsored plans or mandatory IRA solutions for the smallest of employers. In order to justify the cost of using a company-sponsored plan, advisors will need to know the details of sophisticated plan designs or partner with TPAs who do. Advisors who want to serve larger plans need to show their ability to think strategically and recommend that their clients act tactically to accomplish plan goals.

On participant engagement:

It is the advisor’s job to help make sure the benefit is attractive to and valued by participants. I think it is a plan advisor’s job to help sponsors to leverage every bit of participant support they can get from their plan’s primary retirement services vendors. What is the sponsor, or more importantly, the participant already paying for as part of their fees? Can the advisor help the sponsor strategically use services like auto-enrollment, managed accounts, or advice services? It takes a lot of experience and access to volumes of data to be able to answer these questions. For example, most of the major vendors in the marketplace offer only one choice of managed account alternative and, in some cases, it is a proprietary solution. How can a fiduciary make a prudent choice to select an investment alternative from a universe of one choice?

On investment management:

An advisor’s investment process also needs to be different—and better—than what plan sponsors can do on their own. Gone are the days when a mass produced report from Morningstar, Fi360, or another vendor can just be used to paper a file.

[…]

Advisors need to have a thorough understanding of the various types of investments used by defined contribution plans, and how they can be mixed and matched in menus. They need to understand the basics of behavioral finance—especially the risk of “choice overload” and its potential impact on participation and participant actions.

Advisors need to be able to understand the broad range of qualified default investment alternatives available in the marketplace and be fluent in the differences, particularly between target date funds.

Leaders on my investment team count over 80 distinct target date solutions today, each with their own assumptions, approaches, strengths, and weaknesses.

An advisor needs to be equally comfortable with risk and age-based solutions. Advisors should be able to demonstrate that they have no agenda in the active versus passive investment debate.

401(k) Nepotism: Menu-Setters Show Favoritism Towards Own Funds, Says Study

Do 401(k) service providers show favoritism towards their own mutual funds when setting investment menus?

This is the question that three researchers – Clemens Sialm, Irina Stefanescu and Veronika Pool – sought to answer in a new paper published in the Journal of Finance.

The short answer, according to the paper, is that setting a 401(k) menu is not a purely meritocratic process: plan sponsors are influenced by service providers to include propriety funds on menus, and poor-performing affiliated funds are less likely to be removed from menus. These under-performing funds then continue to perform poorly.

The authors find that affiliated funds are less likely to be removed from investment menus than unaffiliated funds regardless of past performance; but the disparity widens for the poorest-performing affiliated funds. From the paper:

The figures show that affiliated funds are less likely to be deleted from a 401(k) plan than unaffiliated funds regardless of past performance. More importantly, the difference in deletion rates widens significantly for poorly performing funds. For example, funds in the lowest performance decile in Panel A have a probability of deletion of 25.5% for unaffiliated funds but of only 13.7% for affiliated funds. Indeed, the deletion rate of affiliated funds in the lowest performance decile is lower than the deletion rates of affiliated funds in deciles two through four.

Overall, the difference in deletion rates between affiliated and unaffiliated funds is statistically significant for the nine lowest performance deciles.

The researchers bring up a solid rebuttal to their own thesis: what if service providers aren’t simply displaying favoritism; what if providers actually have more favorable, superior information on their own funds?

So, the authors investigated:

While our evidence on favoritism is consistent with adverse incentives, plan sponsors and service providers may also have superior information about the affiliated funds. It is therefore possible that they show a preference for these funds not because they are necessarily biased toward them, but rather due to favorable information that they possess about these funds. To investigate this possibility, we examine future fund performance. For instance, if, despite lackluster past performance, the decision to keep poorly performing affiliated funds on the menu is information-driven, then these funds should perform better in the future. We find that this is not the case: affiliated funds that rank poorly based on past performance but are not deleted from the menu do not perform well in the subsequent year. We estimate that, on average, they underperform by approximately 3.96% annually on a risk- and style-adjusted basis. These results suggest that the menu bias we document in this paper has important implications for employees’ income in retirement.

The full paper – which presents its arguments in significantly more depth than presented in this post – can be read in full here.

 

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California Legislature Passes State-Run Retirement Plan Proposal for Private Workers

The California legislature last week sent a bill to Gov. Jerry Brown’s desk that would require all businesses with more than 5 employees to either offer a retirement plan or enroll their employees in the state-run Secure Choice plan.

[Read the bill here].

More from the LA Times:

Secure Choice would be structured as an individual retirement account but operate much like a 401(k), with a small percentage of every paycheck automatically diverted into the program unless workers take action to opt out.

Workers could take their accounts with them when they change jobs and would face a penalty for withdrawing money before retirement. It has not yet been decided whether the deductions will be made pretax like a traditional IRA or post-tax.

Once the bill is signed into law, there will be a significant buffer period before employees can be enrolled. More details from the LA Times:

State officials said it will take months, if not more than a year, to work out all the details before the plan can begin enrolling employees.

The Secure Choice program will be overseen by a state board, but most of the work of administering the program — sending account statements, tracking worker contributions and investing money for the program — will be handled by private companies. The board will have to choose those contractors before the program can start enrolling workers.

Once the program starts, it will take as long as three years for all workers to be covered. SB 1234 calls for companies with more than 100 employees to enroll workers within a year of the program’s launch. Smaller employers will have as much as two additional years, depending on their size, to get their workers signed up.

A trade group representing some investment managers penned a letter to Gov. Brown urging him not to sign the bill.

Meanwhile, the New York Times’ editorial board last week endorsed California’s Secure Choice plan was a “better way to retire”.

DOL Eases Way For State-Run Retirement Plans For Private Workers

The Department of Labor this week announced a series of proposals and regulatory clarifications regarding state-run retirement plans for private workers — including a key clarification regarding state plans and ERISA.

Among the announcements was a proposal to let large cities operate retirement plans for private workers, if there is no statewide plan. From On Wall Street:

The department also proposed an addition to the rule allowing cities to create similar retirement savings plans if they are in a state that lacks a statewide retirement savings program for private sector employees. Under the proposal, the initiative would be limited to cities with populations at least equal to the least populous state, Wyoming, which has about 582,000, according to the U.S. Census.

More than 30 cities had populations greater than that of Wyoming, according to census data.

The department is soliciting comments from the public on the proposal.

Other key notes from Employee Benefit Adviser:

The Labor Department’s new rule aims to expand Americans’ access to tax-advantaged retirement savings plans, by clarifying the regulatory rules that would govern state-run plans.

In order to qualify as a non-ERISA plan, a state-run program would have to be established and administered by the state; provide a limited role for employers; and be voluntary for employees.

State governments had requested regulatory clarification, according to Perez, which he addressed during the call.

“This regulation does not prevent a state from establishing an ERISA plan. There is nothing to stop a state from doing that,” Perez says. “The eight states to which I am referring to, have chosen a different route. Their concern as expressed to me was: How can we establish this voluntary plan in such a way that will not run afoul of ERISA?”

Chevron Beats 401(k) Fee Lawsuit

A federal judge threw out a class action suit challenging allegedly excessive fees in Chevron’s 401(k) plan this week.

[Read the complaint here.]

The ruling is noteworthy because of the influx of fee-related lawsuits that have hit 401(k) plans in recent months.

Bloomberg BNA breaks down the ruling:

In addition to challenging aspects of Chevron’s 401(k) plan under ERISA’s fiduciary duty of prudence—a common claim in ERISA litigation—the lawsuit also contended that the Chevron plan fiduciaries violated the statute’s duty of loyalty. Judge Phyllis J. Hamilton of the U.S. District Court for the Northern District of California rejected this alternative theory of liability after finding no allegations that any fiduciary actions were aimed at benefiting parties other than the plan’s participants.

Hamilton also dismissed the idea that a 401(k) plan can face liability for failing to offer a stable value fund—as opposed to a money market fund—as an option for preserving capital. According to Hamilton, offering a money market fund “as one of an array of mainstream investment options along the risk/reward spectrum” satisfies ERISA’s prudence requirement.

The lawsuit also accused Chevron of offering high-fee investments when it should have used its leverage as a $19 billion plan to negotiate lower fees and investigate alternative arrangements such as collective trusts and separate accounts. Hamilton disagreed, saying that ERISA plan fiduciaries “have latitude to value investment features other than price.” Further, allegations of high fees, without accompanying allegations of a flawed investment selection process, don’t state a claim for fiduciary breach, the judge wrote.

Does the ruling “raise the bar” for plaintiffs in these cases? BenefitsPro discusses implications:

Typically, there is a “low bar” for plaintiffs’ claims to survive a motion to have a case dismissed, noted Carol Buckmann in a blog post, an ERISA attorney that counsels plan sponsors and a founding partner of New York City-based Cohen and Buckmann.

But in the Chevron decision, Judge Hamilton seems to have raised that low bar. On the issue of whether plan participants paid unreasonable recordkeeping fees via revenue-sharing agreements, she ruled that that “are no facts alleged showing what recordkeeping fees Vanguard charges, so it is not clear on what basis plaintiffs are asserting that the fees were excessive,” according to the decision.

Regarding the bar that plaintiffs’ allegations must exceed to survive a motion to dismiss, Hamilton wrote: “A complaint that lacks allegations relating directly to the methods employed by the ERISA fiduciary may survive a motion to dismiss only ‘if the court, based on circumstantial factual allegations, may reasonably infer from what is alleged that the process was flawed’.” Hamilton was quoting a 2012 appellate decision in St. Vincent v. Morgan Stanley Investment Management Co.