GuidePost - Vol. 2, Issue 3 2006

The GRABot BAG
by Sherrie E. Grabot, CEO

August 2006
Pension Protection Act of 2006

On August 17th, President Bush signed the Pension Protection Act of 2006 into law. He described it as "the most sweeping reform of America's pension laws in 30 years," and observers across a wide political spectrum all agree. So how will the view change from our corner of the pension landscape?

First off, forget about the name. This Act will really do more for defined-contribution plans than traditional pensions. Sure, the bulk of its 900 pages are devoted to shoring up these plans, especially under-funded, "at-risk" pensions, with new funding and disclosure rules. But many experts believe the new law will actually have the opposite effect. Fewer companies every year still offer traditional pensions, and tougher rules will only drive more of them to get out of the pension business. The shift toward 401(k) as the mainstay of most Americans' retirement security will only accelerate.

Hence, the rest of the legislation delivers many important changes in 401(k) law: locking in increases in contribution limits, encouraging widespread auto-enrollment with a safe-harbor provision, adding sensible requirements for matching contributions and vesting schedules - and, (drum roll please), allowing plan providers to offer investment advice. Taken all together, a better name might have been the "401(k) Empowerment Act of 2006."

Automatic results
The part of the Act that's most in the news seems to be auto-enrollment. As well it should be. As we've pointed out before, the more the retirement system shifts toward reliance on 401(k), the more important full participation becomes. A new study shows just how far we still have to go: while average balances edged up 3% between 2004 and 2005, participation rates actually dropped by 1%, to 64.4%. But in plans with auto enrollment, rates were 22% higher than in those without it.

Imagine participation rates moving up above 80% - nationwide. The new law makes that possible, without any changes in employee behavior, just by changing the rules. Now that's news.

Take our advice. Maybe.
What we're most interested in, however, is the section on investment advice. It is rather nebulous, but appears to allow asset managers to give investment advice. That is, paid "fiduciary advisors" can recommend specific investments in which they have an interest. However, either their compensation has to be unaffected by their advice (flat fees), or the advice must be based on a computerized model approved by an "independent expert" (as yet undefined).

The real details won't be known until the DOL fills in all the missing regulations by January 1. Or possibly afterward, as interpretive bulletins and case law continue to clear things up. For now, here's what the future seems to hold for advice providers.

The end of the liability era
It's been almost ten years since the DOL first issued a prohibited transaction exemption allowing investment advice to be bundled with a 401(k) plan. (It was issued to what later became GuidedChoice, if you're counting.) Back then the deal-breaker issue for advice was always fiduciary liability. Over the years the liability issue has gradually receded, so that at best it's not much more than a checkmark in the due diligence process.

Fiduciary liability will always be with us. But now it should be less of a concern for plan sponsors who want to offer advice. While the details of allowable advice services may still need clarification, the broad intent of the law is very clear: giving employees the tools they need to save effectively - from investment advice to auto enrollment - is now a major priority. This should help the prudent choice of an advice provider to become much more of a routine decision.

Buy or build?
Another clear fact is that the bundled advice business is still not for the faint of heart. The rules are very complex, and are likely to be more so when the details of compensation and "independent experts" get ironed out. So who will rise to the opportunity?

The very largest providers may move forward to build their own advice capabilities. They have the scale to make it worthwhile, and some like to do things in-house anyway. The majority, however, will recognize that the effort is just too complicated and demanding to justify the cost, especially considering the restrictions on self-interest. The market for specialists in participant advice, therefore, is likely to grow as most providers choose to buy rather than build.

Objectively speaking
Finally, it's clear that real objectivity will still be a big deal. Whatever the rules for compensation turn out to be, and whatever the standards for computer models and independent verification, the new legislation puts a high value on objectivity. Criticism of this law as a green light for (perhaps unintentional) self-dealing is, I think, unfounded. If anything, third-party objectivity looks like it will be a valuable asset, with a seal of approval from some to-be-determined qualification process. Which means the future looks bright for advice providers.

So on an early analysis, hats off to the Congress for (as one report put it) kicking "401(k)s in maximum overdrive. making workplace savings easier, smarter, and more lucrative" for the average American. But hold on to those hats for a while, because there may be some bumps in the road while the details get worked out. And stay tuned to GuidePost, where we'll try to make sense of all the latest developments.

~~ Sherrie

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