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Implications of the Pension Reform Bill

by Lee

Yesterday's Wall Street Journal included an article (subscription required) about the Pension Reform Bill that is about to be enacted by Congress. The bill includes several implications for asset managers, some of which were highlighted by the Journal:

1) The bill encourages employers to automatically enroll their employees into 401(k) plans unless the employee opts out. As kasina wrote in its Driving Enrollment and Contribution in DC Plans whitepaper, automatic enrollment is an important and under-promoted tool for firms to drive contributions. In fact, only 5% of automatically enrolled employees opt out of the plan or decrease contribution levels. However, investment selection proves especially critical in automatic enrollment implementation due to the overwhelming inertia of employees when it comes to changing the defaults. For example, one top provider sees 90% of automatically enrolled participants failing to diversify beyond the initial investment vehicle(s) in its plans. This inertia ties into the second implication of the reform bill, described below.

2) The bill makes it easier for companies to use different kinds of funds as a default option for employees who don't make an investment choice, such as life-cycle or target-date funds. These products provide participants with an investment vehicle that offers better diversification while often simultaneously generating higher management fees for providers. The changes in this legislation are likely to continue to spur the growth in the number of these structured products.

3) A third implication of the legislation is that the set of rules temporarily allowing people to contribute more money to IRAs and other plans that were set to expire after 2010 are made permanent. This change will not only allow more funds to continue flowing into the industry, but provides needed clarity for future planning (among investors, advisors, and fund companies).

4) Finally, the bill allows asset management firms to provide investment advice to their 401(k) clients. Despite a slew of possible conflicts of interest, Congress has ruled that potentially conflicted advice is better than no advice at all. At the same time, the bill shifts liability from providers to plan sponsors. It will be interesting to see, however, how many firms embrace this new paradigm and offer advice. Many providers have offered options to plan sponsors to hire non-partisan, third-party advisors to help counsel employees, but few have, especially among smaller plans. While the letter of the new law makes it extremely difficult for investors to blame providers offering advice for the poor performance of their portfolio, this doesn't mean that participants won't sue. Knowing this industry and its compliance-wary attitude, I would bet that most plan providers are likely to err on the side of caution when giving advice. I think that the firms with experience offering advice and guidance, such as traditionally-direct players T. Rowe Price and Vanguard, are well positioned to boost their DC business by taking advantage of these legislative changes.