(b)lines Ask the Experts – Different Investment Policies for DB and DC Plans

“The investment policies and due diligence monitoring processes for each plan are quite different. Since both are retirement plans to which the hospital contributes, shouldn’t the policies and procedures be uniform?”  

Michael A. Webb, vice president, Cammack Retirement Group, answers:

At first glance, one would think all retirement plans, whether defined benefit or defined contribution in nature, would have a similar policy for selection and monitoring of investments. However, there are some key differences between the plan types from an investment perspective that contravene a uniform policy/process including, but not limited to, the following:

• Direction of investments – In defined benefit plans, investments are directed by the employer. In defined contribution plans, such as your 403(b) plan, investments are generally directed by employees. Thus, investment changes can be made to the defined benefit plan can be made with little employee relation impact, whereas changes to investment options in defined contribution plans create employee disruption issues which must be addresses via communication. For example, if you change investments in a defined benefit plan every quarter, it would likely be a non-event for employees, but if you did this in your 403(b) plan every quarter, it would likely be a major issue! Thus, in many defined contribution plans, plan sponsors may time investment changes to they can be grouped together for communication purposes, rather than frequently changing single investments.
• Investment modeling – In defined benefit plans,  investment allocations are modeled based on the concept of the efficient frontier, which is a set of optimal portfolios that offers the highest expected return for a defined level of risk or the lowest risk for a given level of expected return. In defined contribution plans the employer is not making the investment allocation, but merely choosing investments from which participants will determine allocations. Thus, the focus shifts from an efficient frontier concept to assembling an investment array which provides  participants the maximum opportunity to accumulate sufficient retirement savings given the varying degrees of investment knowledge of participants (e.g. by making target-date funds available to participants with limited or zero investment knowledge so they do not need to make an allocation decision).

Thus, investing defined benefit pension assets can be quite different than choosing investments for a 403(b) defined contribution plan. It is for this reason that the Experts advise training for all 403(b) plan fiduciaries, even if they have background in pension or endowment investing.