More plans loosen rules on diversifying company stock

Reacting to corporate scandals of recent years, 16% of defined contribution plan sponsors made their company stock diversification rules less restrictive in 2004, up from only 1% the year before, a survey by Pensions & Investments and Deloitte Consulting LLC, Wilton, Conn., shows.

"When the 2003 survey was taken, the news about company stock scandals (such as Enron Corp. and WorldCom Inc., now MCI Inc.) had just broken and plan sponsors hadn't had much time to react. By 2004, they took action," said Leslie Smith, a principal at Deloitte.

The corporate fraud scandals resulted in the firms' 401(k) participants losing large amounts of money invested in company stock when the price of those stocks plummeted.

Defined contribution plan sponsors also got tough on under-performing and scandal-tainted mutual funds last year.

The number of plan sponsors that replaced a mutual fund last year because of poor performance rose to 37%, from 29% in 2003, while the number of sponsors that said they have never dropped a fund because of performance fell to 25% from 32%.

Some 12% of respondents dropped a mutual fund because of the mutual fund trading scandals that were revealed beginning in 2003, and 5% said they had considered doing so.

In addition, 86% of plan sponsors said they used funds from multiple fund families in 2004, an eight percentage point rise from 2003.

Investment strategies were clearly a main focus last year.

Sixty-four percent of respondents said they use internal investment committees, an increase of 25 percentage points over 2003, and 45% reported using outside investment consultants, a 10-point increase.

"The message is that companies are focusing on investments and the need to have an investment process in place," said Ms. Smith.

Some 26% of respondents replaced their core funds, keeping the same number of funds, while 22% increased the number of core funds available.

Also, 10% of plan sponsors added lifestyle and target retirement date funds to their plans' investment lineups.

While only 7% of respondents offered managed accounts as an investment option in 2004, 9% said they are considering adding the feature in the future.

Also, 92% of plan sponsors reported they were satisfied with their plan's investment options, which Ms. Smith said is surprising, given the number of plan sponsors who changed managers last year. She added that plan sponsors might have interpreted the question to mean were they satisfied with their investment lineup after they had made changes.

Fees on short-term trades were levied in 2004 for the first time by 27% of respondents; another 23% had policies that don't involve fees to stop short-term trading.

"Plans are putting trading restrictions in place because they don't want participants to do short-term trading, as a reaction to the mutual fund trading scandals," said Ms. Smith.

In another area, 88% of plan sponsors said they have a clear understanding of the total plan/participant fees being charged — consistent with the 2003 survey. But only 57% said they have a clear understanding of all the revenue-sharing arrangements that the record keeper has with the mutual funds included in the plan. Only 52% of respondents said they have a clear understanding of what it costs the provider to administer the plan.

"Plan sponsors need to understand the fees being charged on services and what's going on behind the scenes," said Ms. Smith. "When decisions are made about what investments will be in the plan, it's important for plan sponsors to understand all the fees involved and what the revenue-sharing arrangements are."

She believes that when asked if they understand total fees, plan sponsors "think it's just what they pay the bill for, and that they understand it. When you get down to the questions on revenue sharing and total costs to the provider, many sponsors realize that they don't understand that."

Some 15% of plans offered automatic enrollment last year, a slight decline from the 14% that reported offering it in 2003, but an additional 14% of sponsors said they were considering adding automatic enrollment to their plans, up from 10% a year earlier.

There was a major shift in responses when sponsors were asked why they instituted automatic enrollment, with 42% saying that encouraging retirement savings was the leading motivation in 2004. That's up from the 26% saying that in 2003, when the major reason was to increase overall participation.

"The days of thinking participation rates in the 70% range are good are gone," said Ms. Smith. "Plan sponsors want those numbers to be higher."

However, "a big consideration of companies is the cost of automatic enrollment. While they want to get everyone in the plan, it costs more to do it and give a match," she said.

Lifestyle or balanced funds were the default option in 34% of the DC plans with automatic enrollment, up from 30% in 2004. Short-term investments (stable value and money market) were the most common, used by 58%.

According to the report, 15% of plan sponsors that made a matching contribution did it in company stock in 2004, down from 17% in 2003.

"This is not something they can do lightly," said Ms. Smith. "It's a big cash flow consideration for these plans."

Some 426 plan sponsors responded to the survey, conducted last August and September. Responding employers had an average of about 12,000 employees; however, the distribution was skewed by several very large employers. Nearly one-third — 31% — of the respondents reported between 1,001 and 5,000 employees.