Pension Trends   Volume VIII, No. 1, February 2007    

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The Year 2007 in Review
          

The Year 2007 in Review

Cathy MacLeod, one of our actuaries at Independent Actuaries, Inc. (IAI), has a cousin who writes a column for a Midwest newspaper. In a recent column he penned a tongue-in-cheek "look back" at 2007. He said anyone can do a retrospective of 2006. It takes a special talent to look back at the year to come.

Challenged, but undaunted, here is our “look back” at qualified plans in 2007.

401(k) Plans

Life cycle funds gained in popularity at the expense of participant a la carte selection. The investment performance results for 2007 did not vary from documented results in prior years - 401(k) plan participants who leave the management of their funds to professional money managers outperformed those who pick their own funds. The important corollary to that statement is that those 401(k) plan participants who rely on professional money managers will retire with bigger nest eggs.

Life cycle funds and life style funds are two means of offering participants a professionally managed retirement portfolio geared, at least in general terms, to the investment temperament and retirement timing of the individual employee. Each has its advantages but life cycle funds continued to grow at a faster pace than any other form of 401(k) plan investment in 2007.

401(k) litigation was also a growth industry in 2007. No surprise here. Warnings about litigation over 401(k) fees, and failure of plan fiduciaries to act prudently to protect the interests of plan participants have been increasing for the past few years. Class action lawsuits that began in 2006 continued at an accelerating pace in 2007. The lawsuits dealt principally with unreasonable and undisclosed fees, conflicts of interest among plan service providers and vendors, and failure on the part of fiduciaries to exercise adequate care to protect the interests of the plan participants.

While most costs of doing business increased in 2007, fees paid by 401(k) plans and plan sponsors actually decreased. The decrease in fees was attributable to two factors. First, the law of supply (in this case the limited supply of 401(k) plans) and demand started to grab hold. With fewer new 401(k) plans being set up, plan vendors set out in search of new dollars from existing plans. In order to attract a 401(k) plan away from a competitor, especially in an era of increased scrutiny of 401(k) plan fees, vendors showed a willingness to accept lower margins.

Second, vendors realized that even with lower margins, the built-in growth of assets in a typical 401(k) plan would result in higher absolute profits, if not now, then in the very near future. Consider a plan with $20 million in assets in 2005 that grew in value to $32 million by 2007. A 65 basis point fee in 2007 will still produce significantly higher income for the vendor who was able to charge an 80 basis point fee in 2005.

Defined Benefit Plans

2007 was another banner year for small defined benefit plans. IAI added over 70 new defined benefit plan clients in 2007, about 15% more than in 2006. The driving force remained the baby boom business owner who after years of denial or neglect, decided he or she needed to accumulate a significant retirement nest egg in a short period of time. In most instances, it was the business owner’s advisor – financial planner, CPA, or attorney – who advised the client to talk with IAI about a defined benefit plan, a good indication that more professionals are beginning to understand the flexibility and opportunities available with a defined benefit plan.

Another trend that began in late 2006 continued throughout 2007: defined benefit plan sponsors adopting a 401(k) plan in addition to the defined benefit plan. The Pension Protection Act of 2006 significantly expanded the amount of contribution to a 401(k) plan that can be made in addition to the contribution to the defined benefit plan. This option proved especially attractive to the business owner with no employees looking to add another $30,000 or so. (See our November 2006 Pension Trends for more details.)

For larger defined benefit plans, 2007 once again saw a shrinking marketplace. The combination of the funding reform provisions of the Pension Protection Act and new financial accounting requirements introduced a level of volatility that many large plan sponsors shied away from. In the second half of 2007 there was another wave of plan terminations and freezing of benefit accruals.

Hybrid defined benefit plans (e.g., primarily cash balance plans) continued to grow in popularity. Among larger employers (at least those who weren’t terminating or freezing their plans), conversion from a traditional defined benefit plan to a hybrid plan has become almost commonplace. Smaller employers have also started to show some interest in hybrid plans now that most legal challenges have been set aside.

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This newsletter has been published in order to share general information with our professional contacts. The information presented in this newsletter should not be acted upon without first seeking the advice of a CPA, attorney or other benefit professional. 

Pension Trends, Volume VIII, No. 1, February 2007
Copyright © 2007 Independent Actuaries, Inc.