CUNA Regulatory Comment Call
October 25, 2006
Default Investments for Automatic Enrollment in 401(k) Plans
EXECUTIVE SUMMARY
- The U.S. Department of Labor’s (DOL’s) Employee Benefits Security Administration has issued proposed regulations implementing the provisions of the Pension Protection Act of 2006 (Act) that would make it easier for fiduciaries of 401(k) plans and other participant-directed defined contribution (retirement) plans to adopt automatic enrollment and default investment plan design features. This proposal would apply to credit union sponsors of 401(k) plans.
- Under the proposed regulation, a fiduciary would not be liable for any loss as a result of automatically investing a participant’s account in a qualified default investment alternative (QDIA is defined in the proposal), provided certain conditions are met. The fiduciary, however, would remain liable for the selection and monitoring of a QDIA.
- These rules will apply not only in situations involving 401(k) plans with automatic enrollment features, but also in cases where investments are added or eliminated in conjunction with a change in service provider.
- The aim of the Act and the proposal is to boost participation in retirement savings plans. DOL estimates that the proposal will increase aggregate 401(k) plan account balances by between $45 billion and $90 billion.
- DOL anticipates that the proposed regulations will have two major economic consequences. First, default investment will be directed toward higher-return instruments raising average account performance and automatic enrollment provisions will become more common, increasing plan participation. Second, it is possible that the proposed regulation will have additional indirect consequences which could affect future retirement income levels.
- The DOL is required under the Act to finalize the proposed regulations by February 17, 2007. The final regulations will take effect 60 days after they are published in the Federal Register.
- Comments are due to the DOL by November 13, 2006. Please send your comments to CUNA by November 3, 2006. Please feel free to fax your responses to CUNA at 202-638-7052; e-mail them to Deputy General Counsel Mary Dunn at mdunn@cuna.com or to Senior Regulatory Counsel Catherine Orr at corr@cuna.com; or mail them to Mary or Catherine in c/o CUNA's Regulatory Advocacy Department, 601 Pennsylvania Avenue, NW, 6th Floor - South Building, Washington, DC 20004. You may also contact us at 800-356-9655, ext. 6743, if you would like a copy of the proposed rule, or you may access it here.
BACKGROUND
- Under the Employee Retirement Income Security Act of 1974 (ERISA), a plan fiduciary who invests plan assets on behalf of plan participants and beneficiaries may be held liable for investment losses incurred as a result of its investment decisions, if those decisions are found to be imprudent or otherwise in violation of ERISA’s fiduciary standards.
- Under current law, fiduciaries of individual account plans are relieved of this potential liability if the investment is made at the direction of the participant or beneficiary and the plan meets certain other requirements. The Act amended ERISA to extend this relief to investments in default funds on behalf of participants and beneficiaries who fail to provide investment direction. The Act also directed the DOL to publish regulations implementing this relief.
DESCRIPTION OF THE PROPOSAL
Conditions for Fiduciary Relief
- The proposed regulations establish a safe harbor under which a participant or beneficiary who does not provide investment directions with respect to their account will be deemed to have exercised investment control over the account. If certain requirements are met, plan fiduciaries will not be liable for any investment loss resulting from such investment.
- The proposal establishes the following conditions for fiduciary relief:
QDIA
- The assets invested on behalf of the participant or beneficiary must be invested in a QDIA.
- There are five requirements for a QDIA:
(1) A QDIA may not impose financial penalties or otherwise restrict the ability to transfer investments from one investment alternative to any other investment.
(2) A QDIA must either be managed by an investment manager or a registered investment company.
(3) A QDIA must be diversified in order to minimize the risk of large losses.
(4) A QDIA must not invest participant contributions directly in employer securities. (The QDIA may not be nor include employer securities unless held in a mutual fund or other regulated pooled investment vehicle pursuant to stated investment objectives and independent of the plan sponsor. In addition, if the QDIA is a managed account, it may include employer securities acquired as a matching contribution or acquired prior to management of the account by the investment management service.)
(5) In terms of investment characteristics, the QDIA must be either:- An investment fund product or model portfolio that provides “varying degrees of long-term appreciation and capital preservation through a mix of equity and fixed income exposures” based on the participant’s age, target retirement date (which may be the plan’s normal retirement date) or life expectancy, e.g., a life-cycle or target retirement approach. Asset allocation decisions may be based only on age and need not take into account any other participant-specific characteristics. The investment fund product or model portfolio may be a “fund of funds” or a stand-alone vehicle; or
- An investment fund product or model portfolio (a fund of funds or stand-alone vehicle) of diversified exposures with a target level of risk exposure appropriate for the participant population as a whole, e.g., a balanced fund approach. Asset allocation decisions may be based on the demographics of the participant population as a whole (which may change over time, leading the plan fiduciary to change or add to its selection of the QDIA), and need not take into account any participant-specific characteristics; or
- An investment management service under which the investment manager allocates the participant’s account among diversified exposures based on the participant’s age, target retirement date or life expectancy, e.g., an age-based managed account approach. Asset allocation decisions may be based solely on age and need not take into account of any other participant-specific characteristics.
Opportunity to Make Investment Instruction
- Participants and beneficiaries must have been given the opportunity to provide investment direction, but failed to do so.
Notice Requirement
- A notice must be furnished to participants and beneficiaries at least 30 days in advance of the first investment into the QDIA (initial notice), and at least 30 days in advance of each subsequent plan year (annual notice).
- The notice may be furnished in a summary plan description, summary of material modifications, or a separate communication.
- The notice must be written in a manner calculated to be understood by the average plan
participant and explain:
- The circumstances under which assets will be invested in a QDIA.
- The investment objectives, risk and return characteristics, and fees and expenses of the QDIA.
- The rights of the participants and beneficiaries to make transfers out of the QDIA.
- Where participants and beneficiaries may obtain information on the other investment alternatives available under the plan.
QDIA Materials Furnished to Participants and Beneficiaries
- Any materials provided to the plan by the QDIA (e.g., statements, prospectuses, proxy materials) must be provided to participants and beneficiaries.
Frequency of Transfers Out of the QDIA
- Participants and beneficiaries must have the opportunity to make transfers out of the QDIA with the same frequency that transfers are available with respect to other plan investments, but no less frequently than quarterly, and without financial penalty.
Investment Alternatives
- The plan must satisfy the “broad range of investment alternatives” requirement applicable to ERISA 404(c) plans. Generally, this requirement will be satisfied if the plan offers at least three investment alternatives that are diversified and have materially different risk and return characteristics. A plan need not otherwise meet the requirements applicable to 404(c) plans to take advantage of the QDIA relief.
Penalties
- The Act amends ERISA to provide for civil penalties of up to $1,100 a day for each violation.
- Implementing regulations will be developed in a separate rulemaking by DOL.
Remaining Fiduciary Liabilities
- Plan fiduciaries will not be relieved from liability for the general fiduciary duties requiring the prudent selecting and monitoring of funds offered in the plan, including the investment fund selected as the QDIA. The proposed regulations note that an important part of the selection and monitoring process would be consideration of the fees and expenses of a QDIA. Plan fiduciaries that breach their duty could be liable for any resulting investment losses.
- In addition, the general fiduciary duties applicable to investment managers still apply. An investment manager is liable for any breach of its fiduciary duties in connection with its management of a QDIA, including liability for investment losses.
- The prohibited transaction rules under ERISA and liability resulting from the violation of those rules will still apply.
QUESTIONS REGARDING THE PROPOSAL
- 1. DOL generally expects the additional costs that plan sponsors may incur to
meet the conditions of the proposal would be low. Specifically, the annual notice
provision can be satisfied by adding information to existing notices and disclosures,
such as the Summary Plan Description, the annual investment election form, or by
adapting information provided to the plan by the investment manager of a qualified
default investment alternative. The requirement to pass through investment material
to participants and beneficiaries does not impose extensive costs. Would you expect
there to be a significant increased burden to comply with this proposal?
Yes _____ No _____
Do you have suggestions as to how to minimize the administrative cost?
- DOL indicates that the proposed regulation may indirectly prompt some plan
sponsors to shoulder additional costs in terms of increased retirement benefits
paid to employees. For example, it is expected that the proposed regulation, by
promoting the adoption of automatic enrollment programs, will have the indirect
affect of increasing aggregate employer matching contributions by between $700
million and $1.3 billion annually (expressed at 2005 levels). Adverse consequences
are not expected because the adoption of automatic enrollment programs and the
provision of matching contributions generally are at the discretion of the plan
sponsor. Do you agree with this analysis?
Yes _____ No _____
Please explain.
- Will plan sponsors that direct default investments from very low-risk instruments
into higher-performing portfolios make other changes to investment options or undertake
new efforts to inform or influence participants’ investment decisions? Will those plan
sponsors that implement automatic enrollment programs change other provisions of their
plans as well? For example, might they change matching contribution formulas, eligibility
or vesting provisions, loan programs, or distribution policies?
Please explain.
- More than one-half of all participant directed individual account plans recently
reported compliance with ERISA section 404(c)(1) and associated regulations. While
the fiduciary protections afforded by this proposed regulation for default investments
are intended to be similar to those afforded by the regulation under section 404(c)(1)
of ERISA for participants’ active investment elections, it is possible that some
fiduciaries who are covered by the proposed regulation in connection with default
investments will not be covered by the regulation under section 404(c)(1) in connection
with participant directed investments out of default investments. If so, how might the
proposed regulation’s incentives interact with those associated with the existing ERISA
section 404(c) regulation, and to what effect?
Please explain.
- Will employees who make additional contributions as a result of new automatic
enrollment programs reduce their current consumption or other types of current
saving, or some of each? Will they be more or less likely than otherwise similar
participants to retain or roll over their accounts, preserving them into
retirement?
Please explain.
- Section 902 of the Act adds a new ERISA section providing that ERISA will
supersede any state law that would directly or indirectly prohibit or restrict
the inclusion in any plan of an automatic contribution arrangement. DOL has
requested comments on whether and to what extent regulations would be helpful
in addressing the preemption provisions.
Please explain.
- According to the analysis in the proposal (please see Cost-Benefit Assessment on page
56820), average increases in pension income will be larger for individuals with higher
career earnings, but they will be proportionately larger for those with lower career
earnings. Moreover, while average pension incomes will rise in each of the four career
earnings quarterlies, a small minority of individuals in each quartile could lose some
pension income. The proposed regulation may also have macroeconomic consequences, which
are likely to be small but positive. An increase in retirement saving is likely to promote
investment and long-term economic productivity and growth. The increase in retirement
saving will be very small relative to overall market capitalization, and may be offset in
part by reductions in other saving. Based on DOL’s analysis and estimates, the agency is
confident that the proposed regulation will increase aggregate retirement savings and pension
income substantially. The Department therefore concludes that the benefits of this proposed
regulation will exceed its costs by a wide margin. Do you agree with this conclusion?
Yes _____ No _____
Why or why not?
- Other comments?
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Eric Richard • EVP &General Counsel • (202) 508-6742 • erichard@cuna.com Mary Mitchell Dunn • SVP & Deputy General Counsel • (202) 508-6736 • mdunn@cuna.com Jeffrey Bloch • Senior Assistant General Counsel • (202) 508-6732 • jbloch@cuna.com Lilly Thomas • Assistant General Counsel • (202) 508-6733 • lthomas@cuna.com Catherine Orr • Senior Regulatory Counsel • (202) 508-6743 • corr@cuna.com |
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