Even More on the Troubling Framework of the Retirement Plan Industry

In my last two columns, I related how my registered investment advisory firm took over the investment responsibilities for a 401(k) plan as the investment manager as defined in section 3(38) of the Employee Retirement Income Security Act of 1974. As a result, the plan's new recordkeeper--a well-known insurance company--found out that it wouldn't have the power to select and monitor (and replace as necessary) the plan's investment options. This, no doubt, was a disappointment, because it wouldn't be able to add its lucrative proprietary stable-value fund to the plan's investment menu.

An insurance company (or, for that matter, a mutual fund family or any other such provider) recordkeeper offers its services in order to access vast captive audiences of participants in retirement plans so that it (preferably) can more easily and efficiently sell its own products or (less preferably) the products of others (through revenue-sharing and in other ways).

While it’s true that a recordkeeper makes money from the critical recordkeeping services it provides to a plan, the real money is made in three other ways: (1) on the investment options it provides for retirement plans, (2) on the insurance and other financial products it sells onsite through its licensed commissioned insurance salespeople, and (3) on the insurance and other financial products it sells through its website that’s invariably provided to plan participants.

In this month’s column, I’d like to focus on the third area where insurance company recordkeepers make money off plan participants: the insurance and other nonplan financial products they sell through their website, which is linked to plan participants. This kind of linkage is made possible by a recordkeeper tapping the database it has on plan participants. This information--which often includes email addresses, home addresses, phone numbers, and more--has become a new area of litigation by the plaintiff’s bar on behalf of plan participants who don’t want their private information to be used in that way.

An insurance company recordkeeper--first, foremost, and always--exists to sell insurance products. It is therefore a capitalistic profit-seeker. There is nothing wrong with this. After all, such a recordkeeper (or any business) exists to maximize revenues and profits. The problem, however, is that in the ERISA regulatory environment, fees and costs can (legally) slip through the cracks. This happens as a matter of course given the way in which such fees and costs (legally) fail to be disclosed. Relatively few plan sponsors (even supposedly sophisticated ones) that are, after all, fiduciaries understand what this means and how it can hurt participants in the plans they sponsor--not to mention the precious business assets they needlessly waste by making contributions on behalf of participants in overpriced and underdiversified investment options.

From the get-go, then, an insurance company’s inherent nature as a revenue-maximizing entity must be recognized for what it is. This is important to understand because ERISA fiduciary duties exist solely to protect participants (and their beneficiaries). What’s little understood, though, is that when plan fiduciaries live up to these duties, they are also protected from lawsuits that can waste corporate assets. That’s why I’ve always maintained that when plan fiduciaries actually fulfill their duties properly, they not only get it right for their participants but also get it right for themselves.

It's also important to understand the raison d'etre of a recordkeeper's website. Because an insurance company recordkeeper exists solely to sell insurance products, its website is packed with content that will support that primary goal. In my view, though, a recordkeeper's website will subtly sabotage the efforts made by a fiduciary, such as an ERISA section 3(38) investment manager, to protect plan participants. The recordkeeper in such circumstances would say that it has lots of good things on its website, such as information and educational "tools." For example, the insurance company in the example I have provided describes its "Pre-retirement Counseling" services in its response to the RFP issued by the plan sponsor--and helpfully provided by the insurance company--in this way:

“Participants who retire or terminate from the plan have the following options:

• Taking a full or partial distribution
• Annuity payout (variable and/or fixed)
• Life annuity
• Life annuity and fixed period annuity
• Variable life annuity
• Joint and survivor annuity
• Joint and survivor annuity with a 'pop-up' provision
• Systematic withdrawal
• Leaving funds invested in the employer plan, if permitted
• Rolling funds into a rollover IRA"

Note the heavy emphasis in the foregoing bullet points on annuities, which otherwise may (or may not) provide truly helpful information. Under the guise of providing “information” and “education,” the insurance company still cannot help itself: It’s always selling, selling, selling insurance products.

When plan participants retire, they’re faced with perhaps the most important financial decision they will ever make: what to do with--how to invest--their hard-earned savings that have accumulated over a lifetime.

Will the plan sponsor allow such participants to wander around a (nonfiduciary) recordkeeper’s website and--completely unbeknownst to the participant--step on a land mine, such as purchasing high-priced, proprietary insurance company annuity products whose fees will claim a significant portion of the participant’s lifetime savings right up-front?

That act can undo all the good work that was accomplished by the plan sponsor (and fiduciary investment manager) when it put in place a great retirement plan with investment options that are (reasonably) low-priced, as well as broadly and deeply diversified to reduce risk.

At this critical juncture, when a participant needs independent advice that should be provided in its sole interest, will a plan sponsor allow an insurance company to offer that participant a conflicted and therefore suboptimal retirement solution, one not subject to any sort of ERISA, ERISA-like, or RIA fiduciary standard, a solution that instead is within the insurance company’s sole interest? Will the plan sponsor allow participants to conveniently access the insurance company’s website to give the company an easy opportunity to favor its own financial products over all others in the marketplace in response to participant inquiries on what to do about their retirements?

To the extent that the insurance company’s message isn’t a direct one (that is, through personal one-on-one education on-site at the plan sponsor), it becomes subtly indirect (through the insurance company’s website) by establishing a source of impartial “educational” information which, when it comes to making additional investments while still working or new ones when retiring, results in participants turning to the insurance company--that trusted educational advisor that has been bombarding them with “helpful” information for years.

One of the tools offered to plan sponsors by the insurance company recordkeeper described here is a communication and education strategy provided by a “communications consultant” appointed by the insurance company. Here’s how the insurance company describes, in part, this strategy in its response to the RFP issued by the plan sponsor:

“The plan sponsor will be assigned a communications consultant to work collaboratively with the sponsor, the assigned account executive and the on-site representatives to develop an overall participant communication and education strategy through the insurance company’s planning process. This proven method leverages the following disciplined approach:

"The insurance company’s Participant Retirement Program shapes the entire participant experience, so every interaction that employees have with the insurance company is designed to promote positive retirement outcomes. The program is delivered in person, online, in print and over the phone. A sample communication strategy, campaign overview and calendar are included with this submission.

Individuals learn best when they are able to choose the tools that match their learning preferences. Therefore, the insurance company provides one-on-one guidance, on-site seminars, informative print and web content and online resources.”

Whatever the form of the communication going out from the insurance company to plan participants, you can bet that it will have a convenient link to the insurance company’s website and all the wonders offered therein.

W. Scott Simon is an expert on the Uniform Prudent Investor Act, Restatement (Third) of Trusts, and Title I of ERISA. He provides services as a consultant and expert witness on fiduciary investment issues in depositions, arbitrations, and trials, as well as written opinions, which are described here. Simon also serves as a discretionary fiduciary investment advisor to retirement plans at Retirement Wellness Group. For more information, email Simon at wssimon@rwg-retirement.com or wssimon@fiduciary-experts.com. The views expressed in these articles do not necessarily reflect the views of Morningstar.