Employers Advised to Re-Evaluate Retirement Plan Costs
Original post benefitnews.com
Even with fee disclosure rules in place, it is hard for plan sponsors to discern the fairness of the fee structures in their retirement plans.
The TIAA Institute has taken issue with the fairness of per capita administrative service fees. In a recent report, the Institute says that plan sponsors need to look harder at the fee structures of their plans because what may seem fair might actually be penalizing the lowest paid or shortest term workers.
“When people started charging per head fees, people claimed it was fair. It doesn’t meet an economic standard of fairness. It is simple and transparent but definitely not fair,” says David Richardson, senior economist with the TIAA Institute and author of a recent research paper on assessing fee fairness.
It is up to plan sponsors to “do that classical weighing of efficiency vs. fairness and what it means. A per head fee is transparent but it is not a fair thing to do. … These per head fees are a clever way to charge expensive fees to younger, shorter tenure workers. I find it worrisome,” he says.
This has always been an issue but all of the fees were wrapped up in an all-inclusive fee that paid for investment, administrative and other services. Once the government began requiring an unbundling of fees, “we started seeing all of these things,” he says.
Historically, fees were charged on a percentage of assets basis, which was fair, he says.
He uses Social Security as an example of why a per-head fee is not equitable. Currently, Social Security charges administrative costs as a percentage of income taken in. If it decided to charge all 325 million people in the Social Security Administration system a flat $50 fee, “every man, woman and child, firm or disabled, would be charged the same because we are providing that service,” Richardson says. “I don’t think anybody would consider that to be fair but that is what flat fee advocates are claiming in a retirement plan.”
He doesn’t believe fee issues will go away anytime soon, saying that he believes the overwhelming majority of vendors in the market are honest but many of the regulations are geared to those who may not be.
“So, the government has to be proactive, not reactive on this. The tendency is to say if people have more information, they are better informed. That is not necessarily true,” he says. “A lot of people have a hard time understanding that information. It is tough. When they are saying we need more and more disclosure, more and more information is not just helpful. Sometimes it is just noise to people.”
So when deciding how to assess the effectiveness of a plan administrative fee structure, TIAA Institute says plan sponsors must follow four standards: adequacy, meaning that total fees collected must cover the cost of features and services provided to plan participants; transparency, meaning that everyone can easily find information about the fee structure and how the fees are used to cover the cost of plan features and services; administrative ease, meaning the fee structure is not too complicated or costly for either the plan sponsors or plan vendors; and fairness, which ensures that administrative fee structures must provide horizontal and vertical equity.
Horizontal equity means that “participants with similar levels of assets pay similar levels of fees”; and vertical equity means that “participants with higher levels of assets pay at least the same proportion in fees as those with lower asset balances,” according to TIAA Institute.
The Institute says that an administrative fee structure charging a flat pro rata fee can meet all four standards.
“This fee structure will be transparent, can easily satisfy adequacy, and is simple to administer. The pro rata fee will be fair because similar participants pay the same level of fees and higher asset participants pay the same proportion of fees as low asset participants,” TIAA Institute finds.
“Our goal is to help plan sponsors make the best decision for their plan and their plan participants,” Richardson says.
He also cautions ERISA plans to keep these four standards in mind because not doing so could violate the “spirit of non-discrimination rules,” he adds. “It tilts benefits in favor of key and highly paid employees.”
Why planning for retirement matters
Planning for retirement is a bit of a numbers game. It's not just about deciding when you plan to retire, but also estimating how many years you plan to live in retirement. You also have to figure in the cost of healthcare during retirement which could include long-term care.
According to numbers from the National Retirement Planning Coalition, there's been a significant increase in the life of a 65-year-old over the past generation.
In 1980, the average life expectancy for a 65-year-old man was 79.1 years and for a female it was 83.3 years. In 2010, that number increased by over 3 years.
While 3 years may seem small, it can have a financial impact on those living in retirement.
An example from the from the National Retirement Planning Coalition shows a 21 percent increase.
$50,000 of annual expenses in retirement
- 14 years in retirement = $700,000
- 17 years in retirement = $850,000
The example above does not include the cost of healthcare in retirement which can drive up the cost. The Insured Retirement Institute (IRI) and Health View Services estimate the cumulative health care expenses for a 65-year-old man in 201 was $370,000 and for a woman $417,000. That does not include the cost of long-term care.
The majority of workers today depend on individual account plans, defined contribution plans and individual retirement accounts to save for retirement.
The fast-fading days of retiree health coverage
Employers are trying out all kinds of approaches to better manage retiree health costs, though the day will eventually come when just a handful will offer such benefits to the over-65 set.
That’s the conclusion the Kaiser Family Foundation reached in what is essentially a status report titled “Retiree Health Benefits at the Crossroads.”
Companies once offered retiree benefits as a way of retaining workers but have been chipping away at them for years. One of the more recent companies to make the move was Northrop Grumman, which earlier this month told employees it would use a broker to help them choose from a variety of Medicare supplemental options. That's just one of a number of avenues employers are taking.
As Kaiser noted, “several major trends stand out in particular, namely, growing interest in shifting to a defined contribution approach and in facilitating access to non-group coverage for Medicare-eligible retirees, and consideration by employers of using new federal/state marketplaces as a possible pathway to non-group coverage for their pre-65 retiree population.”
The report noted that the number of companies offering coverage of any type to retirees has dwindled, from 66 percent in 1988 to 28 percent last year.
It said even employers that plan to continue providing coverage of retirees are exploring ways to reduce the corporate dollars dedicated to the task.
Though fewer in number, retiree health benefit plans remain an important source of supplemental coverage for roughly 15 million Medicare beneficiaries and a primary source of coverage for more than two million pre-65 retirees in the public and private sectors, Kaiser noted.
The landmark changes brought to health care by the Patient Protection and Affordable Care Act, and the constant revisions of the law, have left employers off balance when it comes to cost-containment measures, Kaiser said. But there are other factors at play that further complicate planning.
For instance, Kaiser says, a consistent push to boost the Medicare eligibility age to 67 could result in companies having to cover their older workers for another two years. That can add up for those with large and experienced workforces.
“In an earlier study, Kaiser Family Foundation and Actuarial Research Corporation modeled the effects of raising the Medicare eligibility in a single year (2014), finding that employer retiree plan costs were estimated to increase by $4.5 billion in 2014 if the Medicare eligibility age is raised to 67. In addition, public and private employers offering retiree health benefits would be required to account for the higher costs in their financial statements as soon as the change is enacted,” Kaiser said in its report.
Options identified by Kaiser for reducing the cost of pre-65 retiree health coverage include “strategies to avoid or minimize the impact of the excise tax (a.k.a. the Cadillac tax) on high-cost plans included in the ACA. Although the tax applies to plans for active employees, as well as pre-65 and Medicare-eligible retirees, there is a focus on pre-65 coverage because of its relatively higher cost. And even though the tax takes effect under the PPACA in 2018, employers must begin to account for any material impact the tax may have on their retiree health programs in today’s financial statements.”
Kaiser also said shifting pre-65 retirees to private and public exchanges, moving to a defined contribution plan, and changing plan design to shift costs to employees are all receiving more attention.
Also, employers are increasingly choosing to trim the cost of drug programs away from plans that provide coverage to Medicare-eligible retirees.
Kaiser concludes that company-sponsored health coverage for retirees will inevitably recede from the benefits landscape.
“Over the next few decades, these trends suggest that employer-sponsored supplemental coverage is likely to be structured differently and play a smaller macro role in retirement security than it has in the past and than it does today. Relatively fewer workers will have such coverage available in the future, to be sure.”
Originally posted April 14, 2014 by Dan Cook on www.benefitspro.com.
Losing by Winning, Case Offers Harsh Reminder Concerning Preventable Expenses
The circumstances behind a recent court decision were typical, and their consequences painfully predictable. Although the plan administrator “won,” that victory does not reflect the huge—and entirely unnecessary—cost to the plan sponsor in terms of overhead and legal fees.
Herring v. Campbell was a fight over who would receive the retirement benefits accrued by John Wayne Hunter, a participant in an ERISA-governed plan. When Mr. Hunter died, he left behind a $300,000 account balance. Although he had properly designated a beneficiary (his wife), she died before he did. And because he had never designated a new beneficiary, it fell to the plan administrator to choose between the two parties who claimed Mr. Hunter’s benefits.
The plan document included a fairly typical list of default beneficiaries. These were, in order of priority, Mr. Hunter’s surviving spouse, his children, his parents, his brothers and sisters, and his estate. Mr. Hunter left no spouse, no natural or adopted children, and no parents. He was, however, survived by two stepsons and six siblings. The plan administrator therefore had to decide which of these two groups was entitled to split Mr. Hunter’s money. If the stepsons were his “children” under the plan, they would be his beneficiaries. If not, then his siblings would receive the benefit.
The plan’s ambiguity as to the definition of this single word (children) caused the administrator and sponsor to be dragged into court. The litigation lasted several years, leading all the way to the United States Court of Appeals for the Fifth Circuit—just one step short of the Supreme Court.
None of this was necessary. Here were the entirely preventable steps in this matter:
- First, the administrator considered and rejected the stepsons' (weak) claim that they were entitled to the $300,000 under the Texas probate law doctrine of "equitable adoption." She instead distributed the account, in equal shares, to Mr. Hunter's siblings.
- The stepsons appealed the decision. The plan administrator reviewed the appeal and again denied their claim.
- The stepsons then moved their claim to federal court, and the trial judge ruled in their favor.
- The plan administrator filed a motion for reconsideration, which the trial-court judge denied.
- The administrator was therefore forced to file her own appeal in the Fifth Circuit, where a three-judge panel reversed the district court's ruling, bringing the matter full circle.
The fact that the second-highest court in the land vindicated the administrator’s decision is of little comfort to the administrator, who spent years on an entirely pointless legal battle in which she had no real stake. Nor was being right on the law any comfort to the plan sponsor, which had to pay the (presumably massive) legal fees and court costs in both the federal district court and the Fifth Circuit.
In other words, the interesting legal issues in this case (for example, the proper standard for reviewing a plan administrator’s decision when the plan document is silent about something) are beside the point. Rather, the lesson is that the entire conflict could have been avoided by simply stating, in the plan document, that stepchildren either are or are not “children” for purposes of determining a beneficiary when a participant dies without designating one.
Plan sponsors should review their plans’ default beneficiary provisions and see what— entirely preventable—dangers might lurk there.
Lawrence Jenab, Partner Spencer Fane Britt & Browne LLP