Investing September 7, 2017

For Some DB Plan Types IDL, Not LDI, Is the Answer

John Lowell, with October Three, says for two types of DB plans, investment-driven liabilities (IDL) is almost risk free for plan sponsors and provides more meaningful benefits to participants.

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For traditional defined benefit (DB) plans, liability-driven investing (LDI) is used to align the movement of investments with the movement in liability. John Lowell, an Atlanta-based partner with October Three, says this does a good job if done properly.

However, for two types of DB plans, investment-driven liabilities (IDL) is almost risk free for plan sponsors, and at the same time, provides more meaningful benefits to participants, he contends.

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Lowell explains there are two types of plans for which IDL is workable; variable annuity plans and market-return cash balance plans. “In a variable annuity plan, participants have a benefit a lot like with a traditional plan, but what makes it different is the plan establishes what’s called a hurdle rate,” he says. ”Assume the hurdle rate is 6%, in a given year. If assets go up by more than 6%, then plan participants get an increase in benefits related to returns over 6%. Similarly if returns are less than 6% benefits go down in relation to how much returns went below 6%, to the extent allowed by law.”

According to Lowell, essentially what happens for either of these plan types, and what makes IDL fundamentally different from LDI, is rather than locking in a low rate of return, and taking a plan that’s underfunded and making sure it stays that way because it can’t catch up, plan sponsors can generate assets to create a higher rate of return and to the extent they do, will generate higher benefits. With IDL, the plan and participants share risks. “Designed properly, they will wind up with a plan that will become well-funded, and once it is, it is almost risk free for plan sponsors, at the same time providing more meaningful benefits to participants,” he says.

Lowell further explains that with an IDL strategy, unlike an LDI strategy, there is no glidepath or funded status trigger to dictate a change in asset allocation to lock it in; there is nothing to lock in. As an example, he says, “Suppose you are a participant in a cash balance plan. The plan sponsor tells you you’re going to get the same return as the return on trust assets except that for technical reasons, the sponsor will guarantee you have no loss of principal and will cap your upside at a certain percentage. The cumulative rate or return cannot exceed a percentage specified. It depends on how the plan is designed, and that can be changed over time.”

“With IDL, I as a plan sponsor know that growth in liabilities is going to track the growth in assets,” he adds. “I will never get into a situation, if I do things properly, where the plan is not going to 100% funded.”

Lowell says October Three has found that given how pension finance works, using LDI also locks in massive costs, i.e. PBGC premiums, which make companies say they don’t want to offer DB plans anymore. On the other hand, in driving liabilities, plan sponsors are driving downside risks as well as upside rewards. They are almost able to lock in costs, then the whole idea of offering a DB plan as the primary retirement savings vehicle is no longer problematic.

“The sad thing is, not a whole lot of plan sponsors have gone down this road. But, I have not heard of a single plan sponsor that has gone down this road that say they hate it, whereas those with a traditional DB plan want out of it,” Lowell says. “IDL is attractive to unions. What they like is that risk is shared by all rather than only being on the employer, as with a traditional DB plan.”
Compliance September 7, 2017

District Court Approves Class Certification in Deutsche Bank Challenge

The ERISA lawsuit has gained class certification after the plaintiffs successfully established numerosity, typicality and commonality.

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A federal district court judge has granted class certification to a sizable group of Deutsche Bank employees who have filed an Employee Retirement Income Security Act (ERISA) challenge, alleging self-dealing in the company’s retirement plan benefit.

The now class-certified case comes out of the U.S. District Court for the Southern District of New York. The underlying allegations are that Deutsche Bank and other defendants violated their fiduciary duties by offering in the company 401(k) plan proprietary, high-cost investments that profited the bank. This development comes nearly a year after the court rejected defendants’ argument that the lawsuit, filed in December 2015, should be time-barred by ERIA’s various statutes of limitation. The bank otherwise denies the allegations. 

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According to the plaintiffs’ complaint, the Deutsche Bank Matched Savings Plan, as of 2009, had roughly $1.9 billion in assets and offered participants 22 “designated investment alternatives,” 10 of which were “proprietary Deutsche Bank mutual funds.” The core of the complaint’s allegations concerns the inclusion of Deutsche Bank proprietary mutual funds among the plan’s offerings. According to the complaint, “Deutsche Bank earned millions of dollars in investment management fees by retaining [these proprietary mutual funds] in the plan.”

The complaint specifically alleges that the plan included three proprietary index funds that charged excessive fees in relation to other comparable index funds. The complaint also asserts that the plan included actively managed proprietary funds that charged investment management fees two- to five-times higher than “other actively managed funds in the same style,” and “not only did these proprietary funds have higher fees, but they also consistently underperformed as measured by benchmark indices.” Plaintiffs allege that the plan further failed to include the least expensive share class for each of its offered proprietary funds and failed to rationally control recordkeeping costs.

Turning to the class certification matter at hand, the district court has considered plaintiffs’ arguments primarily under Rule 23(b)(1), which permits class certification if prosecuting separate actions by or against individual class members would create a risk of: (A) inconsistent or varying adjudications with respect to individual class members that would establish incompatible standards of conduct for the party opposing the class; or (B) adjudications with respect to individual class members that, as a practical matter, would be dispositive of the interests of the other members not parties to the individual adjudications or would substantially impair or impede their ability to protect their interests.

As the decision lays out, Rule 23 “does not set forth a mere pleading standard.”

“A party must not only be prepared to prove that there are in fact sufficiently numerous parties, common questions of law or fact, typicality of claims or defenses, and adequacy of representation, as required by Rule 23(a) … The party must also satisfy through evidentiary proof at least one of the provisions of Rule 23(b).”

Weighing the requirements of class certification 

Weighing this requirements of class certification, the court observes the parties do not contest the numerosity of the plaintiffs, which is obvious given the large size of the retirement plan under consideration. On the matter of commonality, the court has determined plaintiffs proved it sufficiently, on the logic that “where the same conduct or practice by the same defendant gives rise to the same kind of claims from all class members, there is a common question.”

The decision clarifies: “Plaintiffs raise numerous questions that are capable of classwide resolution, such as whether each defendant was a fiduciary; whether defendants’ process for assembling and monitoring the plan’s menu of investment options, including the proprietary funds, was tainted by a conflict of interest or imprudence and whether defendants acted imprudently by failing to control recordkeeping expenses. Resolution of these questions will generate common answers apt to drive the resolution of defendants’ liability … Defendants argue that plaintiffs cannot show commonality because none of the alleged breaches affected all class members. They note, for instance, that 12,000 class members never invested in a single proprietary fund at any point during the relevant period. Commonality, however, does not mean that all issues must be identical as to each class member. These distinctions among class members may affect the calculation of damages but do not defeat class certification when the underlying harm derives from the same common contention, in this case that the investment lineup made available to all participants violated ERISA.”

The court similarly sides with plaintiffs on the matters of typicality and adequacy of representation.

“Plaintiffs have shown typicality,” the decision states. “Typicality is intended to ensure that maintenance of a class action is economical and [that] the named plaintiff’s claim and the class claims are so interrelated that the interests of the class members will be fairly and adequately protected in their absence. The requirement is met where each class member’s claim arises from the same course of events and each class member makes similar legal arguments to prove the defendant’s liability.”

The decision continues: “Each plaintiff has done one or more of the following: (1) invested in at least one proprietary mutual fund; (2) participated in the plan during the time period when the recordkeeping fees were allegedly excessive; and (3) invested in a proprietary or non-proprietary fund for which cheaper alternatives were allegedly available. This is sufficient to show typicality.”

The full text of the decision, including more detailed consideration of Deutsche Bank’s failed counterarguments against class certification, is available here: MorenovDeutscheBankClassCertification.

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