Auto-enrollment bonanza ahead

WASHINGTON — The Labor Department's proposed investment default regulation for participant-directed defined contribution plans could boost sponsors' use of automatic enrollment by 50% and pump billions into the plans.

The proposed regulation, issued Sept. 26, is the first to deal with default options. It provides sponsors a safe harbor from fiduciary liability if their default options are balanced funds, lifecycle funds based on the targeted retirement date of the participant, or managed accounts. Until now, no such safe harbor existed, so fiduciaries could be sued no matter what default option they chose.

David L. Wray, president of the Profit Sharing/401(k) Council of America, Chicago, said even under the proposed rules, "it is still a fiduciary decision by employers to choose the best option for the default," which might not necessarily be one of the types the new rules list.

"The DOL gave direction on what people should be comfortable in doing, but didn't say people couldn't do something else as a fiduciary if they feel justified in doing it. The DOL didn't say ‘use only these three choices.'"

The Labor Department's list of default options excludes two that had been widely used in the past — stable value and money market funds.

Michael Weddell, retirement consultant at Watson Wyatt Worldwide, Southfield, Mich., predicts "a mass exodus from using money market and stable value funds as a default."

"I think it (the new rule) will hurt stable value providers" in the short term, Mr. Weddell said. "But the fact that the work force is getting older will help (them), because as people's retirement horizon shortens, they'll shift to less risky investments."

Clifford York, director-retirement plans, BP America Inc., Houston, which does not offer automatic enrollment now for its $9.1 billion 401(k) plan, said BP "could move in that direction" if the proposal is adopted.

"We are still concerned with preservation of principal," Mr. York added. "Just because regulations provide additional latitude doesn't mean employers will move from a short-term investment fund."

The BP plan has an 85% participation rate, he added.

The regulation is expected to take effect after Nov. 13, the end of the public comment period, depending on whether the comments lead to changes in the rule.

The Labor Department estimates $45 billion to $90 billion will go into 401(k) or other participant-directed defined contribution plans as a result of the new rule. The estimate is based on a projection over the career spans of all types of workers, from new entrants in the work force to those nearing retirement, and discounted to 2005 dollars.

In all, 401(k) plans have some $2 trillion in assets, Mr. Wray said.

Messrs. Wray and Weddell didn't have an estimate of how much money might go into such plans because of a new default rule.

"In 2005, 16.9% of sponsors offered automatic enrollment, up from 10% the year before — and this was without the (new rule)," Mr. Wray said. "That number will be higher in 2006 without the changes," about 20%. "With the change, you will see a dramatic increase."

Mr. Wray thinks 50% of plans might offer automatic enrollment in the next three years; Mr. Weddell thinks 30%.

Mr. Wray said the proposed rules are "a big deal."

"Employers are going to be stepping up and taking over responsibility for making decisions. It is a big change."

The two major impediments to automatic enrollment have been removed, Mr. Wray said. "With the (recently enacted) Pension Protection Act, the wage garnishment conflict has been removed, and with DOL (proposed) regulations, the uncertainty of the default investment has also been removed," Mr. Wray said.

"As a result to these two government actions, a significant number of plan sponsors will add automatic enrollment to 401(k) plans," he said.

"A lot of companies were holding up a decision to go to automatic enrollment, waiting for clarification on what would be an appropriate default option. … Companies doing automatic enrollment (without the Labor Department guidance) were being pretty bold. They were doing it without a lot of direction."

Mr. Wray noted the new rules allow for unforeseen future innovation in investment funds that could be used as default investments.

"Some clarification will be needed for mapping money out of previous defaults into a new default," Mr. Wray said. "We will have to wait and see how regulators clarify that. We raised the issue. Whether they will do anything about it, I don't know."

The guidelines require that plan sponsors notify participants of the automatic enrollment and details about the default investment, enabling them to either opt out of the plan or change their allocations.