Law gave structure to evolving regulations, but there's room for improvement
Without the Pension Protection Act, retirement plan participants would be less equipped for retirement than they are today as the retirement industry makes the transition to defined contribution from defined benefit plans.
That's the consensus of DC plan experts who also say there's plenty of room for improvement, which they believe can be achieved primarily through greater efforts by sponsors rather than by new laws or regulations.
“The big thing for the defined contribution industry was the building of some structure around automatic enrollment, automatic escalation and target-date funds (through qualified default investment alternatives),” said Lew Minsky, executive director of the Defined Contribution Institutional Investment Association.
Without the PPA, participants likely would have “less well-diversified portfolios, lower participation rates and lower contributions rates,” he said.
Although there “was definitely movement” among sponsors to automatically enroll participants prior to the passage of the PPA, “adoption rates were spotty at best,” Mr. Minsky said. “The Pension Protection Act put forward a workable framework. It gave sponsors comfort and led to widespread adoption.”
Mr. Minsky and other DC industry members said sponsors must move away from offering a 3% initial deferral rate — a common industry practice — to a higher initial rate. They also must be willing, he added, to go beyond the 10% contribution cap on auto features — auto-enrollment plus auto-escalation — covered by Department of Labor non-discrimination rules.
Too many participants view a sponsor's initial deferral rate as an endorsement, and don't raise their contributions. Sponsors practice an “unfortunate overreliance” on safe-harbor rules, he added.
“We don't need a legislative change” to increase participant contributions, he said. “The industry needs to get beyond the misperceptions. We can get there within the existing legislative and regulatory structures.”
Helped deal with shift
The PPA helped sponsors deal with the “shift of defined contribution from a supplement to the cornerstone of workplace-based retirement,” said Anne Lester, managing director at J.P. Morgan Asset Management (JPM), New York, who is the portfolio manager and head of retirement solutions.
PPA's importance to the DC industry will have greater impact in the next decade as participants rely more on defined contribution than traditional pension plans, she said. “Many pre-retirees still have some defined benefit plans,” she said. “Right now, we are on the cusp of a big generational change from defined benefit to defined contribution.”
Future DC plan improvements will depend more on sponsor initiatives than on new laws or regulations, she said. “One real challenge” is the sponsors' fear that employees will complain about or reject plan design changes such as auto features — a concern J.P. Morgan Asset Management has found to be unwarranted.
In a 2015 study, for example, “fear of employee pushback appears to be a deterrent to adoption automatic features, (but) research shows those fears are overstated,” said a J.P. Morgan Asset Management (JPM) report describing the survey results.
“I can't believe it's been 10 years,” said Ann Combs, a Vanguard Inc. principal and head of the firm's government relations office, who was the Department of Labor's assistant secretary for employee benefits security from 2001 to 2006.
“I don't think we anticipated how much the industry would change,” said Ms. Combs, adding the degree of growth for target-date funds has been a surprise.
Ms. Combs said two key DC issues — auto-enrollment and QDIAs — were aided by the debate over the PPA that focused primarily on defined benefit plans. ”They were under the radar,” she said. “They weren't pulled apart or picked apart” in the legislative process because “the political battle was over defined benefit plans.”
Among plans for which Vanguard is record keeper, 41% offered auto-enrollment in 2015 vs. 10% in 2006, according its latest analysis of DC plan clients.
Also, 90% of clients offered target-date funds in 2015 vs. 43% in 2006. Among plans offering target-date funds, 70% of participants invested in this option last year vs. 22% in 2006.
Establishment of QDIA
Consultant Michael Webb said the biggest impact of PPA was the establishment of qualified default investment alternatives that has led to significant growth of target-date funds. Balanced funds and managed accounts are the other QDIAs.
Before PPA, the “primary defaults were fixed income or stable value,” said Mr. Webb, a New York-based vice president for Cammack Retirement Group Inc.
The PPA's impact on target-date fund investing is illustrated by Callan Associates Inc.'s quarterly DC index. For the first quarter of 2006, target-date funds represented 4.7% of participants' asset allocations; by the end of 2015, target-date funds accounted for 25.3%.
Mr. Webb said sponsors need to build upon the opportunities created by the PPA.
“Auto enrollment has had a dramatic impact for new hires,” he said. “You can argue that contributions are too small, but something is better than nothing. For new employees, the important thing is to start saving in the first place.”
Mr. Webb said sponsors must encourage, nudge or even push participants to expand their contributions beyond the initial auto-enrollment default rate. Sponsors should employ auto-escalation and, if necessary, automatic re-enrollment, he said.
Auto-enrollment “adds participants who would not have enrolled,” said Jeri Savage, partner in charge of defined contribution research for Rocaton Investment Advisors LLC, Norwalk, Conn.
She said there's room for improvement among plans offering a 3% initial deferral rate. “We know some participants would save more, but because the sponsor started at 3%, they see this as an endorsement,” she said.
When she talks to clients about starting the auto-enrollment deferral rate at 6%, “some agree, but some push back because there is a concern about the cost,” Ms. Savage said.
Because many sponsors still automatically enroll only new hires, Ms. Savage recommends re-enrolling everyone to improve their asset allocations and allowing participants to opt out.
ERISA attorney Marcia Wagner said the PPA created a safe harbor for an investment trend that has recently accelerated — robo-advisers, the online services that provide automated portfolio management advice.
“Robo-advisers is a big deal,” said Ms. Wagner, managing director of the Wagner Law Group, Boston. “Robo-advisers could not have arrived without the statutory safe harbor” of the Pension Protection Act.
This article originally appeared in the August 8, 2016 print issue as, "A real boon for defined contribution".