DC Plans Need a Framework for Managing Operational Risks

When a retirement plan faces challenges, plan sponsors tend to focus on shortcomings in oversight of investment, market or longevity risks. But, Segal Marco Advisers says, as public sector defined contribution (DC) plans continue to grow in size and complexity, sponsors need to look closer at operational risk: the risk of loss resulting from external events or failed internal processes.

A public sector letter from Segal Marco, “Operational Risk Is the Achilles’ Heel of Defined Contribution Plans,” offers a framework for identifying and managing these risks. Julian Regan, public sector market leader and senior vice president with Segal Marco in Boston, says even though the insight is given for public sector DC plans, it could apply to corporate DC plans, as well.

Regan offers examples of external events or failed internal processes:

• The DC plan’s third-party administrator (TPA) fails to stop participants from contributing to the plan after they’ve reached the statutory contribution limit. “The Internal Revenue Service [IRS] has a communication piece that listed this as the No. 1 compliance failure,” Regan says.
• The plan is supposed to make required minimum distributions (RMDs) to participants, but the recordkeeper doesn’t identify some participants who are supposed to receive them. According to Regan, if the IRS discovers this during an audit, the plan will have to go through a correction process with the agency.
• In the industry over the years, there have been cases of lost or stolen participant data, Regan notes. “Unintentionally mishandling specific personal information such as Social Security numbers has been and can be an issue,” he says. “Plan sponsors can handle this through risk management and controls.”
• A DC plan may not have been checking fees, and the asset-weighted expenses participants are paying—the total of investment management and administrative expenses—are excessive. Regan says this may not have been neglected purposely, but plan sponsors may be unaware of pricing available. This can open them up to legal suits, as has been occurring for a number of years. “Undertaking risk assessments or benchmarking relative to peer plans reduces the probability of that outcome,” he says.

The Segal Marco Advisors article says plan sponsors may be able to manage their operational risk by adopting a framework that includes:

• A governance structure that enables assignment of risk-management roles, responsibilities and reporting requirements documented in policies, contracts and job descriptions;
• A manageable program for conducting operational audits and risk assessments;
• A documented approach to managing data security risks;
• Periodic peer reviews, benchmarking and request for proposals process reviews to evaluate investment-related expenses and fees, disclosure practices and investment structure design;
• A comprehensive investment policy that provides a framework for program design, decisionmaking, monitoring and performance measurement; and
• Key performance and risk measures that establish thresholds across plan functions, including telephone customer service and website availability.

  What the framework looks like