Report Lays Out Causes and Consequences of ERISA Lawsuits

The rise in lawsuits is prompting more sponsors to turn to lower-cost index funds—and could prevent them from offering lifetime income products.

Lawsuits against 401(k) plans have been on the rise in the past two years, according to a report, “401(k) Lawsuits: What Are the Causes and Consequences,” issued by the Center for Retirement Research at Boston College. In 2016 and 2017, there were 107 lawsuits filed, the highest since 2008 and 2009, when 169 lawsuits were filed.

The Center says it is important to understand the causes and potential consequences of these lawsuits, since 73% of workers in 2016 were offered a workplace retirement plan, up from a mere 12% in 1983—and 401(k) plans now hold over $5 trillion in assets.

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Rather than spell out specific guidance on how plan fiduciaries should act, the Department of Labor (DOL) has historically emphasized enforcement over regulation and guidance, the Center says. This “means that fiduciaries are often left to guess what practices comply with ERISA [the Employee Retirement Income Security Act] and may only become aware of an alleged violation from a DOL investigation or lawsuit,” the Center says.

There are three main reasons for lawsuits, including inappropriate investment choices, excessive fees and self-dealing, the Center says. The DOL only says that fiduciaries should exercise a prudent process when selecting investments “so as to minimize the risk of large losses.” Lawsuits arise when funds persistently deliver poor performance compared to their benchmarks. Another issue arises when fiduciaries include the employer’s own stock in the 401(k) plan and it performs badly. However, in Dudenhoeffer v. Fifth Third Bancorp in 2014, the Supreme Court ruled that absent “special circumstances,” fiduciaries cannot be held liable for failing to predict the future performance of the employer’s stock, thereby setting a tough standard for plaintiffs to succeed.

Excessive fees are another reason for 401(k) lawsuits. Here, too, the DOL says fiduciaries should employ a prudent process, select funds that charge no more than a reasonable fee and periodically assess whether that fee is still reasonable by comparing the fees to funds with similar risk/return and asset class characteristics. However, in addition to this, the Center says, the fiduciary must ensure it has taken steps to select  the lowest-cost share class of a given fund. One way they can open themselves up to a lawsuit is by selecting a retail share class when an otherwise identical but lower-cost institutional share class is available.

Fiduciaries must also ensure that administrative fees, which include recordkeeping fees, are reasonable. They can do this by leveraging the plan’s size to negotiate lower administrative costs, ensuring that the plan’s recordkeeping fees do not subsidize services other than the retirement plan and asking the recordkeeper to offer transparency into the fees they charge.

In the case of self-dealing, this is when a fiduciary acts in their own best interest, rather than in the best interest of the plan and its participants. More than 40 financial firms’ 401(k) plans have been associated with lawsuits alleging self-dealing, i.e. choosing their own investment funds that had poor performance potential, excessive fees, or both. Since 2015, excessive fees and self-dealing lawsuits have dominated the lawsuits brought against 401(k) plans.

Consequences of litigation

As a result of these lawsuits, many retirement plans have gravitated to low-cost passive mutual fund options, which also track very closely to their benchmarks. In 2016, 24.9% of equity mutual fund assets were in index funds, a dramatic rise from 9.9% in 2001, data from the Investment Company Institute (ICI) shows.

Plans have also dropped specialty asset class funds, such as industry-specific equity funds, commodities-based funds and narrow-niche fixed income funds, as these potentially charge higher fees and carry highest investment risks.

Fiduciaries have also been demanding better fee disclosure from service providers, and this has resulted in lower fees. Additional ICI data shows that the average mutual fund fees as a percentage of assets for 401(k) participants has declined from 0.77% in 2000 to 0.48% in 2016.

However, one downside, the Center says, is that fiduciaries may stay clear of new innovations out of fiduciary fear, such as investment vehicles that provide lifetime income streams. “After all, offering an annuity option would involve more complexity than passive investments, and, thus, higher fees, and would require the plan to choose a provider, which itself entails more risk,” the Center says. Policymakers can counter this with more clarification on how plans can offer drawdown products while protecting themselves from litigation.

The full brief can be downloaded here.

Will Student Debt Repayment Support Become Table Stakes?

Student debt hurts the financial well-being of an overwhelming portion of respondents to a new survey—with the scourge of student debt cutting across generations and economic status.

Student loan education, repayment and refinancing specialist CommonBond hosted a panel discussion about the topic of “the missing benefit,” by which it means payroll integrated student loan repayment and refinancing support for employees.

Journalists and financial industry professionals were invited in by the firm to hear speakers, including Heather Coughlin, U.S. solutions leader for financial wellness at Mercer, along with Naz Vahid, managing director and law firm group head at Citi Private Bank, and Tara Malone, vice president of employee benefits for Young & Rubicam Group. The panel spoke broadly about the student loan debt challenges facing workers across the United States, and they all agreed that both employers and employees will benefit from greater uptake in student loan repayment benefits.

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According to the panel, the total amount of U.S. student loan debt has topped $1.4 trillion, including nearly $75 billion in “parent PLUS loans” taken out by individuals on behalf of their kids. In terms of workforce percentages, fully 72% of workers say they have outstanding student loans or had successfully finished repaying loans while working. While it’s probably not a surprise to hear that 59% of those ages 22 to 44 currently carry student debt, it is perhaps more startling to see that 21% of workers older than 45 currently have student debt. Other stats show 10% of individuals have both their own student debt and that of a friend or family member that they are responsible for, while 21% plan to take out debt in the next five years to help finance someone else’s education.

“These numbers show that student loan debt repayment is a universal workforce challenge,” Coughlin stressed, citing her own statistics from within the Mercer book of business. “It is not just an issue for Millennials.”

Nor is it only in lower-earning jobs and industries that individuals struggle to repay student debt. From her perspective working with law firm clients, Vahid suggested it is not uncommon to hear about younger married couples with more than $1 million in combined student loan debt. According to Common Bond’s survey data, twice as many people with student debt than without are worried about their personal finances, and across all generations, financial worries drop drastically for those people who do not have student debt.

Sharing her perspective as an active HR corporate professional, Malone suggested the impact of student debt is so pervasive and damaging that workers aren’t opting into traditional financial wellness benefits that highlight saving for the future. Sixty-one percent of survey respondents who say they worry about their finances regularly also say student debt has delayed or prevented them from saving for retirement.

Plugging for its own services, which include helping employers establish payroll integrated student debt repayment benefits, CommonBond experts suggested most financial wellness programs, as they have been rolled out so far, are tailored to workers without student debt. As CommonBond VP of Partnerships Leigh Gross pointed out, approximately four in five HR leaders reached for the survey indicate they are planning to make improvements to their employee benefit offerings within the next three years, but they are failing to take into account those with student debt.

“For workers ages 22 to 34, student debt significantly outranks retirement as the top financial concern,” he noted. “Those without student debt had a much different perspective. Retirement and health care were cited as their biggest financial stresses—as they should be.”

As the experts explained, there is something of a disconnection between what employers view as the most progressive and valued benefits, versus what employees want to see. Employers are proud of their offering of “general financial planning” and of “tuition reimbursement.” Yet employees across all age groups and industries with student debt consistently rank student loan repayment support ahead of tuition reimbursement and financial planning as a preferred benefit.

The speakers all indicated that offering student loan repayment is a tremendous way to improve the loyalty and employment longevity of Millennials—and to attract new talent of all generations in competitive industries. Currently only about 5% of employers in the U.S. offer any type of student loan repayment benefit, but Coughlin suggested Mercer believes this type of benefit “could soon become table stakes.” Tied to proper education and the availability of 529 college savings plans, the offering of student loan repayment support can help individuals as much or more than any other single benefit, she concluded. 

“More than 86% of employees who have student debt for themselves or others, or are planning to take out loans in the next five years, said they would be more inclined to stay at their current company if their employer provided monthly student loan repayment support,” Gross noted. “Additionally, 85% of those said they would commit to staying at least three years or more. Another 41% said they would stay at least until their loans were paid off.”

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