Compliance October 13, 2014

Appellate Court Upholds DC to DB Transfer Elimination

October 13, 2014 (PLANSPONSOR.com) – Another federal appeals court has ruled employers may eliminate retirement plan transfer provisions allowing employees to move assets from a defined contribution plan to a defined benefit plan.
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The 9th U.S. Circuit Court of Appeals ruled that eliminating this type of transfer provision does not violate the Employee Retirement Income Security Act (ERISA)’s anti-cutback rules, which prohibit any amendment to an employee benefit plan that would reduce a participant’s “accrued benefit.” This matches up with an earlier 1st U.S. Circuit Court of Appeals ruling in Tasker v. DHL Retirement Savings Plan, also involving shipping company DHL Holdings, which permitted the elimination of related transfer provisions under ERISA.

The current case, Andersen v. DHL Retirement Pension Plan, comes on appeal from the U.S. District Court for the Western District of Washington, which also upheld the employer’s right to eliminate the DC [defined contribution] to DB [defined benefit] transfer provision. In a decision handed down in 2012, the District Court noted that the Department of Treasury has ultimate authority in determining overlapping provisions of ERISA’s anti-cutback rule and the Internal Revenue Code (IRC), and has disseminated a regulation that directly addresses the transfer right at the center of the case. That regulation says plainly that “a plan may be amended to eliminate provisions permitting the transfer of benefits between and among defined contribution plans and defined benefit plans.”

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Plaintiffs in Andersen v. DHL were former employees of Airborne Express Inc. who participated in both Airborne’s defined benefit pension plan and its defined contribution plan. Case documents show that the defined benefit pension plan was a floor-offset plan. That is, its benefits were calculated on the basis of a participant’s final average compensation and years of service, with an offset for any account balance in the defined contribution plan. Before the challenged amendment, participants could transfer the funds from their defined contribution plan accounts to the defined benefit plan’s general pool before the participant’s benefits were calculated. When Airborne was purchased by DHL, executive management merged the two companies’ retirement plans, amending the Airborne benefit plan to eliminate participants’ right to transfer funds into the defined benefit plan. 

Participants’ motivation for transferring DC balances into the DB plan was to reduce an offset of the guaranteed benefit. If, for example, a participant was entitled to receive $5,000 in monthly benefits under the DB but had a balance in the DC plan that would equate to a $3,000 monthly annuity, he would receive a monthly benefit of $2,000 from the defined benefit plan. If his balance in the defined contribution plan would equate to a $6,000 monthly annuity, he would receive nothing from the defined benefit plan.

The 9th Circuit agreed with precedent set by the 1st Circuit (as well as two district courts) that the amendment did not violate the anti-cutback rule. According to the text of the 9th Circuit decision, “the panel deferred to [the U.S. Treasury] insofar as it interpreted Treasury Regulation A–2, which provides that, without violating the anti-cutback rule, a plan may be amended to eliminate provisions permitting the transfer of benefits between and among defined contribution plans and defined benefit plans.”

The 9th Circuit also asked the Treasury to weigh in, via amicus brief, on whether DHL’s “elimination of Plaintiffs’ right to transfer their account balances from the defined contribution plan to the defined benefit plan violate[d] the anti-cutback rule …, where the result of the elimination of the transfer option was significantly to decrease the periodic benefits paid from the defined benefit plan and in total.” The government subsequently filed a brief answering that question in the negative and recommending that the panel affirm the District Court.

The 9th Circuit goes on to note that “although the result reached here is disturbing given the negative impact on Plaintiffs’ periodic retirement benefits,” the actuarial assumptions used to calculate participants’ accrued benefits in the plans did not change with the plan amendment and have not been challenged.

Benefits October 13, 2014

Passive Investing May Not Optimize Participant Outcomes

October 13, 2014 (PLANSPONSOR.com) – Does choosing only low-cost, passive investments for retirement plan fund menus optimize the outcomes for participants?
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Not according to recently released research from American Funds. “We see plan sponsors are really focused on passive management and think that’s a safe fiduciary choice,” Mark Steburg, senior vice president in American Funds’ retirement plan services business, tells PLANSPONSOR. “But, plan sponsors are also concerned about participant outcomes.”

Steburg points out there are only a few levers plans sponsors can pull to affect participants’ retirement readiness—automatic plan features and professionally managed investments, such as target-date funds (TDFs), are two of those levers. But, he contends, the retirement plan industry is not thinking enough about the how the right active managers can really help participants maximize investment returns. “For a participant in a retirement plan more than 40 years, as much as 70% of their accumulated account balance is investment returns, so selecting the right active managers can really help,” Steburg says. “We found the best active managers have performed well consistently over time.”

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In a comprehensive study, American Funds sought to identify active manager traits associated with a track record of outpacing indexes over long periods. It studied 20 years of active large-cap equity fund returns over various rolling periods. According to Steve Deschenes, director of product development at American Funds, and author of the study, “The Active Advantage: More from the Core,” the research looked at a range of screens from the simple and intuitive to the mathematical and complex. “We found two relatively intuitive screens came out as the most powerful—expense ratio and manager ownership in the fund,” he tells PLANSPONSOR.

The study used data provided by Morningstar to examine 3,037 actively managed funds over a 20-year period ending in January 2014. Focusing on funds whose expense ratios were in the lowest quartile and firms whose manager ownership was in the highest quartile reduced those 3,037 funds to just 105—85 actively managed large-cap domestic equity and 20 actively managed large-cap international equity, all of which outpaced the broad market averages over that period. Deschenes notes that American Funds was proud to find 100% of its funds qualified for both screens.

The research also looked at two scenarios, one for an investor in the retirement savings accumulation phase and another for an investor in the decumulation phase. In the first, a lump-sum $100,000 was invested in two portfolios in January 1994 with a 50/50 allocation to U.S. and international large-cap equities. One portfolio was all exchange-traded funds (ETFs), while the other was composed entirely of actively managed funds in both the highest ownership and lowest-cost quartiles of the Morningstar universe. Twenty years later, the actively managed portfolio would have grown to $551,409—31% more than the ETF portfolio.

The second scenario began with a $500,000 nest egg and made annual withdrawals of 5%, increasing that amount by 3% each year to account for inflation. Over 20 years, the actively managed portfolio would have generated 57% more wealth than the portfolio invested in ETFs.

Passive strategies and ETFs have attracted retirement plan investors because of their low costs, but Deschenes says cost is not the only criteria of value; plan sponsors have to look at performance. In addition, he says in the study report, low-cost investing is not the exclusive province of passive strategies. American Funds believes low-cost investing is part of the reason some active managers have outpaced indexes frequently. “Plan sponsors should choose managers that will give a higher likelihood of more retirement income for participants,” he adds. 

Deschenes also notes that manager ownership in a fund correlates to how much managers’ interests are aligned with investors. He says ownership information has been available since 2005, when the Securities and Exchange Commission (SEC) required all managers to reveal ownership in the funds they manage. Information is available on the Morningstar database, and Morningstar incorporates ownership in its annual stewardship survey.

Deschenes recommends plan sponsors work with their consultants or advisers to review their plans’ investment lineups and add low expense ratio and manager ownership to the list of criteria for actively managed fund in their investment policy statements (IPS). Another thing plan sponsors need to manage closely is perceived risk of the investment options in their plans, “and active management has the opportunity to improve volatility via a smoother ride,” he contends.

Even in choosing or creating TDFs, all index is not the answer, Steburg adds, there are low-cost active managers that can have a huge impact on participants’ retirement readiness.

“It’s all about participant outcomes and helping them retire on time with sufficient income,” he says. “Quality active management is crucial lever for plan sponsors to pull to achieve outcomes. Plan sponsors can use our research to help them choose the right active managers.”

The study report is available on the American Funds website.

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