Retiring Traditional Plans

Inquiring minds want to know: “Why have businesses taken advantage of options to reduce expenses in defined benefit plans, where the corporation picks up the tab, but made no effort to take advantage of opportunities to reduce costs in the defined contribution plans, where employees bear the cost?”

The kicker is that some of those inquiring minds are sitting in the Department of Labor (DOL), and they just might add teeth to that rhetoric.

Keith Dressel, VP at Paramus, N.J.-based Morgan Stanley, told Chain Store Age that the DOL has begun to consider this question, and he predicted employee investment plans could become a “regulatory environment within the next two or three years.”

Defined benefit plans, such as pension plans, have been on the decline, while defined contribution plans, such as 401(k) investments, have become the norm for most companies. Historically, both types of plans relied on public mutual funds (MFs) as investment vehicles.

However, as the size of corporate retirement plans have achieved considerable mass, MFs have become less efficient because whether a company invested $1 million or $50 million, administrative fees remained the same. There are no price breaks for economies of scale after the $1 million threshold.

“The majority of large corporations have eliminated MFs from their defined benefit plans because of the administration fees associated with a public mutual fund,” said Dressel. “It’s certainly a prevalent trend, and independent consultants have advised companies with large plans to move from MFs to separately managed accounts (SMAs), with one company’s plan as the investor, or collective investment trusts (CITs), where multiple companies are investing.”

Defined contribution plans have also gained potential leverage as they have grown in popularity and value, but fewer companies have taken advantage of transitioning defined contribution plans away from MFs to SMAs.

“When 401(k)s were first offered, they were expensive to administer and had very low balances,” explained David Napolitano, senior VP, Morgan Stanley. “The only logical vehicle for investments were public MFs. Over time, 401(k) balances have become much larger, so the investments can be handled at a much lower cost using SMAs, or synthetic mutual funds as they are also called.”

For instance, a plan with an average balance of $20,000 and total assets of $20 million might be charged 1.9% to administer MF investments, according to Napolitano. But with SMAs, that fee could be reduced 50 basis points to 1.4% and save the participants half a percent.

“Even with a fairly priced MF that charges fees of 1.2% to 1.3%, we could buy that cost down at least a quarter of 1% with SMAs,” he noted. “On a $100 million plan, the savings would be $250,000—and that saved money could be used for a variety of benefits.”

In one case, a Morgan Stanley client with a $300 million plan and 5,000 employees in the New Jersey, New York, Pennsylvania triad used the savings from converting its plan from MF investments to SMAs to establish an education program that would help its associates make more informed decisions. Even after implementing the investment-guidance program, the company saved $600,000.

“Obviously the savings depend on the dynamics of each company, how many employees it has and their geographic area,” noted Dressel. “However, adding an education program brings real value to an employee benefits plan.”

Another productive use of monies saved, suggested Napolitano, could be to issue bonuses that would stimulate opportunities for increased investments.

“There can be a problem when highly compensated executives are more motivated to invest than the non-highly compensated associates,” he explained. “It becomes a problem when an executive wants to put the maximum amount in his 401(k) but because non-highly compensated associates aren’t participating, the executives are limited in the amount they can put away. A company could use the money it saved after converting the plan to SMAs to make bonus contributions on behalf of the non-highly compensated group, which in turn would stimulate opportunity for maximum contributions in the highly compensated group.”

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