From the May 2003 issue of Treasury & Risk magazine

Seek Directions

The run of stock market losses and the explosion in 401(k) litigation has had a curious effect on plan sponsors: Instead of heading for the bunkers, the response one might anticipate, many companies are choosing to help employees find their way through the financial upheaval. Why? Because in the long run, most are being told it is the best insurance against a whole host of possible rotten outcomes--probably the worst of which from a societal perspective is employees not saving in their 401(k)s at all. "Individuals are making poor decisions that could have a material impact on their retirement security," says Jeff Maggioncalda, president and CEO of Financial Engines, an independent advice provider based in Palo Alto, Calif. "Although there are still some sponsors who believe that it's risky to offer advice, the growing consensus is that it is far more risky to have tens of millions of individuals making poor decisions that could substantially diminish their financial security in the future."

A Gray Workforce

Most employees would probably be shocked to think that companies care whether they have enough for retirement. But the alternative to a healthy nest egg is hanging on to a job well after you've lost the energy or interest to perform it, and companies know well that isn't the road to productivity or innovation. Add to that the problems in Social Security and the impending retirement of the Baby Boom contingent, and a frightening image is conjured up. "What kind of workforce are you going to have if people can't retire?" asks Bill Arnone, a human capital specialist at Ernst & Young. "You don't want to retain workers who mentally retired two years ago and are hanging on because they can't afford not to. It's a massive human capital dilemma."

For companies, advice looks like one way to revive workers' enthusiasm for 401(k) plans and the promise of a comfortable retirement. David Wray, president of the Profit Sharing/401(k) Council of America (PSCA), likens the stock market's collapse to "a bucket of cold water" thrown on defined-contribution plan participants.

What a far cry from only five years ago, when many workers were beginning to think that retirement at 55 wasn't out of the question. A few years ago, "the attitude from participants was, 'Get out of my way, give me more choice,'" Wray says. In the 1990s, many employees stuffed their contributions into high growth, high tech funds.

Corporate America's first response to the interest in 401(k) plans was to educate. They provided brochures and booklets, informative Web sites and seminars. But when faced with all this information, participants often felt overwhelmed. "You can give them education until you're blue in the face and they say, 'How should I invest?'" says W. Allen Reed, president and CEO of General Motors Asset Management.

When the high tech and telecom bubbles popped, workers went from overwhelmed to paralyzed, Reed notes, feeling even less confident about their ability to interpret market forces and invest for themselves, "Now," contends Wray, "the attitude is, 'Help.'"

Companies were hesitant at first. Traditionally, concerns about fiduciary liability risk have been the biggest factor keeping companies from offering advice.

But following scandals in which plan participants lost everything in 401(k)s that were sometimes almost 100% invested in company stock, companies are changing their thinking: The worry no longer is what might happen if they provide advice; it is what might happen if they don't.

Advice as Risk Mitigation

Insurers, from a liability perspective, seem to agree. For instance, Ann Longmore, fiduciary liability practice leader at insurance broker Willis Group Holdings, says that carriers are more willing to provide fiduciary liability coverage if advice is provided. "The fact that advice is being offered at this point is being seen as a strong mitigating factor against problems" arriving down the road, she says. Companies that are currently being sued in relation to company stock holdings in 401(k) plans would be in a better position had they provided advice, Longmore says, because the employees that are suing would be "far less sympathetic if they were told by a professional that it's not in the best interest of their portfolio to have such a concentration."

Rhonda Prussack, vice president and product manager for fiduciary liability at National Union Fire Insurance Co., a subsidiary of American International Group and one of the biggest providers of fiduciary liability coverage, says that supplying investment advice "removes one argument that [participants] can make in a suit, especially arising out of self-directed 401(k) plans, that is, 'I am not a sophisticated investor and I didn't have enough information." However, Prussack calls the risks of offering advice "almost a wash" compared with the risks of not providing it. The reason: A company that provides advice runs the risk that the advice is low quality or that the plan sponsor isn't properly monitoring the third-party provider, she says.

The three biggest independent providers of advice are Financial Engines, Chicago-based Morningstar Inc., and mPower.com Inc., which is headquartered in San Francisco. All three offer Internet platforms that take data about the employee, much of it supplied by the plan's record keeper in order to make the process as painless as possible for the employee, and generate advice on how much to save and how to allocate those savings among the funds available in the company's 401(k) plan.

All three companies say that employees who go online and use their services tend to increase their savings rate. Morningstar sees 10% to 15% usage in the first year that participants have access to its platform and says that on average those who use it boost their savings rate to 7% from 5%. Financial Engines says that at companies with more than 1,000 employees, 25% of the employees with Internet access use their service within the first year and close to 40% within the first two years. Eighty percent of those who use the platform get recommendations to save more, the company says, and about 20% follow the advice, increasing their contributions on average by 40%.

Unfortunately, not all participants use the platforms. Lori Lucas, a defined contribution consultant at Hewitt Associates, predicts that the next step will be the "pushing out" of advice to plan participants. In fact, Financial Engines, mPower and Morningstar all now offer to provide statements to all plan participants, based on the record keeper's information. The statements not only show the participant's balance; they often comment on the participant's asset allocation choices or savings rate, for example noting if he or she isn't fully utilizing the company match. Providing statements without any input from the participant involves some assumptions, so "the choices wouldn't be as good as with one-on-one [advice], but it would still be better than nothing given the poor asset allocation on many people's parts," says Lucas.

Maggioncalda points out that such statements are also attractive to employers because they provide a record of the plan sponsor warning employees about the risks involved in investing. "Sponsors love this," he says, adding that the statements are "making sure that no employee can say, 'I didn't know the risks I was taking.'"

Even advice isn't enough for some employees, who would prefer that someone else take over the whole chore for them. The PSCA's Wray says professional management will evolve as a 401(k) plan option for those employees and points to ProManage Inc. of Chicago, a company currently providing professional management as an option for 401(k) plans. Michael Falk, ProManage's chief investment officer, says that in plans where ProManage is an option, 80% of participants elect to have ProManage do the work for them. "If you take away the difficulty and confusion about the investment decision, people will participate more," he says. And after all, that's the point.

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