Mitigating the billion-dollar litigation risk
It’s a billion-dollar risk, and it may soon be headed to your defined contribution plan. Let’s learn how getting your participants involved in a retirement plan’s regular performance review can mitigate your litigation risk.
My friends at CEM Benchmarking have published an excellent new whitepaper titled Prepare Today to Protect Your Defined Contribution Plan Tomorrow. In it, they outline key strategies to help defined contribution plan sponsors guard against fiduciary litigation.
Their study found that fiduciary liability insurance companies paid nearly a billion dollars in settlements in 2020, including $330 million spent in attorney fees.
I won’t be discussing all CEM’s findings and recommendations today. But I encourage you to download the free whitepaper from their website at www.CEMBenchmarking.com.
While a billion dollars in settlements is eye-popping, it also represents a fracture in participants’ relationship with their retirement plan. And that relationship is something you can measure and manage.
I’m not so naïve or idealistic as to believe each lawsuit filed represents purely altruistic motivations. But, I am a firm believer that transparency and listening to those you serve can build the awareness and relationships necessary to help avoid litigation.
In short, plan decision-making made on a solid foundation of participant input is the right thing to do, regardless of its ability to mitigate risk.
Now, before you tune out, I’m not suggesting you use surveying as some form of election in which participants directly select the investment options available in their plan menu. Rather, I’m suggesting it is an excellent way to listen to your participants.
One CEM recommendation is that you find a way to prove that you’ve aligned your investment line-up with participants’ needs and expectations.
This recommendation has two key words: participant needs and expectations.
Participant Needs
Plan sponsors often have excellent data at their fingertips to assess participant needs. With an understanding of participants’ age, income, deferment amounts, and total retirement savings, we can get some idea of what they need to secure a livable retirement.
I know a few plans that have used this data to complete excellent income replacement and retirement-readiness studies. If you have not done one for your plan, you should consider it.
Much of my research has involved participants in hybrid plans, with both defined benefit and defined contribution components.
Given the prospect of earning a good pension at their employers’ risk, these participants may – in theory – have the opportunity to take greater risk in their defined contribution investments. Depending on their pension formula and retirement goals, you could even call taking on more risk a definite need.
Based on that knowledge, a hybrid plan sponsor could conclude that their investment menus can – and perhaps should – incorporate more risk.
If we were strictly rational creatures, we could leave it there, with the math telling us our participants need to take on more investment risk to be ready for retirement.
Participant Expectations
And that gets us to the sticky issue that participant expectations may seem contrary to their needs. Expectations often are based on emotion. And those feelings may have their foundation in current life circumstances or past experiences, such as growing up in poverty.
Plan-specific participant expectations can be measured and understood through solid research. It can explain why your participants select a particular self-directed investment option, even if it appears not to be in their best interest.
To mitigate your legal risk, don’t skip this step. I enjoy presenting research at national conferences and have learned a great deal from others’ research at these gatherings. But you cannot assume studies done with other plans reflect the sentiments and expectations of your participants. National research can provide excellent benchmarks for your plan-specific research. But, it is risky to use it as a replacement for asking your participants what they expect.
Let me give you an example. A few years ago, I was involved in a discussion regarding why so many of a plan’s participants were invested entirely in a stable-value-fund-like investment option.
The answer began with an understanding that new participants had defaulted into that option for many years before target date funds became the default.
The reasonable assumption – based partly on national engagement research – was that these participants were entirely disengaged and unaware of where their money was invested. It seemed it could be in their best interest to re-enroll them into an appropriate target date fund.
Plan-specific participant research, however, revealed an unexpected risk. While it confirmed that many participants did not know how their funds were invested, it also revealed that half were fully aware. This aware group feared a loss of principle more than lost potential gains. They could be expected to oppose re-enrollment adamantly.
Understanding this did not change the plan’s investment line-up. But, it prompted a successful and award-winning education campaign to narrow the gap between participant expectations and their apparent needs.
And this is how participant research can help mitigate litigation risk. By understanding your unique participants, you can identify and address risks that are not apparent through analysis of the plan data alone.
Seeking this understanding allows you to prove that you’ve aligned your investment line-up with both participants’ needs and expectations.
