>>>>In California and elsewhere the retirement planning industry is beginning to wake up to a new ?defined benefit? plan for low- to middle-income workers or, as a legislative aide, Greg Hayes, describes it, an ?IRA in an insurance wrap.?? The concept, if California S.B. 1234 overcomes not insignificant financial and legal hurdles, promises to upend conventional thinking over the utility of 401(k)-type plans for the private-sector workforce.?
It also may create a shift in thinking about fiduciary responsibilities of the employers that sponsor plans. ??
Signed into law on Sept. 28 by Gov. Jerry Brown, the concept was inspired by the aunt of bill sponsor State Sen. Kevin de Le?n.? His aunt still works as a maid in her 70s and without any retirement savings.? Almost simplistic in concept, the program would require employers to automatically enroll the state?s 6.3 million private-sector workers who have no retirement coverage.? Companies with fewer than five employees are exempt.? Unlike IRAs, however, investment decisions for the retirement fund would be made by the investment board managing the program, not the individual participants.? Workers could opt-out, although they would be re-enrolled every two years unless they again opt out.? Companies that fail to enroll eligible employees would be fined up to $750 per employee.? The state of California and employers participating in the program would not be liable for investment results.
Formally known as the California Secure Choice Retirement Savings Trust Act, the program would not cover public sector employees, railway workers or those covered by a Taft-Hartley pension plan.? Private sector employers also could opt out by using vendors, mainly the Fidelitys and Prudentials of the retirement world, who wish to participate in the state?s Retirement Investments Clearinghouse.? Vendors and their financial advisors to the plans and to participants would be covered by existing law.
Before the Secure Choice program can get underway, the new Investment Board for the Secure Choice program must be appointed and undertake a feasibility study on costs and other issues.? The Investment Board would comprise of a mix of state officials and private sector representatives who would serve without pay and be appointed by the Governor and Assembly. ?Another hurdle facing the Investment Board is to secure approval for favorable tax treatment from the Internal Revenue Service and a waiver from the U.S. Department of Labor from ?ERISA.? This means the new savings program is still several years from going into effect, according to Hayes, adding that Assembly representatives had already met in Washington last month with the IRS and DOL to discuss the matter.
While the Investment Board is not explicitly required to act in a fiduciary capacity, there are? expectations that it will, based on the language in the bill and precedent in common law.
First, a ?self-sustaining? trust would be set up under the new law with two funds, identified as program and administrative funds, the former to invest employee contributions and latter to pay costs.? A segregated account within the program fund would likely be established as the Gain and Loss Reserve Account, to help stabilize what would amount to a hoped-for guaranteed return of 3-4 percent for participants each year in the investment portfolio.? Supporters of the new law hope that the reserve account, along with the purchase of insurance contracts, will smooth out volatility in investment returns currently experienced by DC plans and avoid losses during a bear market.?
Having a trust in place, of course, gives rise to a fiduciary duty, even if not explicitly stated in the new law.? Presumably the Investment Board would be the primary fiduciary with portfolio managers acting in a co-fiduciary capacity.? The statutory language of the bill reinforces this premise by using language from the prudent investor standard in imposing duties on the Board to invest ?with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with those matters would use.?
More interesting, though, are some of the statutory provisions that require the imposition of an investment policy statement, its parameters written courtesy of the state General Assembly and, I?m told, borrowed from the state?s 529 plan.? It is an IPS with a decidedly conservative investment cast that will be further defined by the Investment Board.? The list of available asset categories listed in S.B. 1234 includes standard domestic and international equity classes, government-issued debt, REITs, money market funds, insurance contracts, and federally-insured bank products.? However, the equity mix ?shall not exceed 50 percent of the overall asset allocation of the fund,? according to Sec. 10002(e)(3) of the new law.? Nor would the fund be permitted to invest in more exotic investment instruments such as derivatives, options, futures, swaps, caps, floors and collars, which Assembly members nixed, presumably over concerns of over-leveraging by fund managers gone wild.
When asked about the risk of a high inflationary environment, given the portfolio?s conservative tilt, Hayes ? who comes from the financial services industry ? said the whole design of the program is intended to look at investments for the long-term.? Still, the memory of sustained inflationary rates during the 1970s and ?80s is still fresh for some in the investment industry, raising questions as to whether a replay of that environment would prompt the California General Assembly to eventually tinker with the IPS ? even if the insurance contracts and reserves are able to sustain a 3-4 percent annual return.? The return does not factor in inflation, according to Hayes.
All costs to administer the program and manage investments would be limited to no more than 1 percent of the total assets in the investment fund.? Given the potential size of the portfolio ? a legislative report on the bill estimates first-year contributions could reach $6 billion alone ? there would probably be a need for the involvement of numerous money managers.? At this early stage it?s also unclear whether the program fund would have a series of target-date funds or other alternatives based on the investment time horizon of the participant.? This question, too, will have to be resolved by the Investment Board.
The only mention of a fiduciary in the 13-page bill is a clear affirmation in Sec. 100034 that employers ?shall not be a fiduciary, or considered to be a fiduciary,? and not bear responsibility in any way for participation in the Secure Choice program.?
When reviewed by the DOL it?s unclear whether this rejection of a fiduciary obligation for the employer could throw a wrench into the state?s application for regulatory relief from ERISA.? While the California provision is obviously meant to allay concerns over employer liability, the DOL?s earlier draft rule of its own fiduciary rule, intended to apply to IRAs as well as ERISA plans, would appear on its surface to be at odds with S.B. 1234.? That said, the Secure Choice fund would not provide for a conventional brokerage platform where the investments are self-directed.? So the anti-fiduciary argument that is being made against the DOL rule? that the platform universe is too large for fiduciary monitoring ? holds no water here.
California S.B. 1234 also raises the prospect of how state fiduciary law might apply.? The Uniform Management of Public Employee Retirement Systems Act (UMPERSA) would seem to be the most applicable, but for obvious reasons it applies to public pensions.? There is no model act that envisions a public-private hybrid plan.? Further, UMPERSA, like the suite of model prudent investor acts, places the trustee in a position of being liable for certain losses.? Since S.B. 1234 would not hold employers or the state liable in this regard, it is a marked departure from UMPERSA, where the state is usually responsible for making good for losses in the pension system.?
This does not mean the hurdles to adapting UMPERSA are insurmountable.? To the contrary, this model act has suffered from inertia, being adopted only by Maryland and Wyoming.? ??If the new hybrid pension plan becomes the wave of the future, it would not be surprising to see the state Law Commissioners back at the drafting table with a new model act, at the same time that industry observers ponder whether the defined benefit plan ? or some modified version with an insurance wrap ? is indeed back in vogue.
Source: http://www.401kfiduciarynews.com/solving-a-retirement-crisis-its-as-simple-as-1234
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