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A Crystal Ball and a Compass

It’s that time of year again, when we look into the crystal ball for what lies ahead in the new year for retirement plans. In this article, CAPTRUST practice leaders cover four main themes—like the directions on the face of a compass: DOL’s Conflict of Interest Rule, the rise of litigation, the economic environment, and future policy direction.

While no one knows for sure what the future holds, we dust off our crystal ball each year to document our predictions for the new year—and their likely impact on our clients. This year, when we challenged our colleagues to come up with their predictions for 2017, we ended up with a list so long we could not cover it at any level of detail. So to avoid getting lost in the fog, we limited ourselves to four main themes—the number of directions on the face of a compass. That seems like an apt metaphor since 2017 seems fraught with more uncertainties than usual, leaving plan sponsors in need of navigational assistance.

History will likely show that the events of 2016 were an impetus for significant change in the landscape of America’s retirement system. How exactly events will play out is difficult to predict at this point, but we believe the following issues will be the main drivers of change.

North: The DOL’s Fiduciary Rule

We have not yet begun to feel the true impact of the Department of Labor’s Conflict of Interest Rule—otherwise known as the fiduciary rule—which was finalized in early April of this year, as its first noticeable effects will be felt in April 2017. Interestingly, the direct effect on plan sponsors will be less dramatic than the impact on retirement-industry service providers, and the complexity created by this regulation will take years to sort through.

Perhaps the best way to illustrate the business complexity introduced by this sweeping body of rules, which defines all financial professionals who provide advice to retirement plan sponsors or participants as fiduciaries, is through its size. When Congress enacted the Employment Retirement Security Act in 1974, the entire law was about 200 pages in length. By contrast, the final version of the fiduciary rule came in at well over 1,000 pages—five times longer!

We have written extensively, and hosted two webinars, on the fiduciary rule over the past several months. Please visit those resources on the web if you would like to learn more.

The Trump administration may make modifications to the rule, but most providers have already put the wheels in motion to ensure their businesses are compliant. Because the new standards will affect many of the service providers they employ, plan sponsors of all types and sizes will find this new rule will change the ways in which they are used to fulfilling their duties as plan fiduciaries. Additionally, if the rule stands, we believe it will lead to more participants staying in defined contribution plans after separating from their employers, which—particularly as it relates to retirees—may change the way plan sponsors wish to structure their plan offerings, designs, and features.

South: Litigation on the Rise

A record number of lawsuits targeted retirement plan sponsors, committees, and investment and service providers in 2016. These suits covered an expansive list of allegations, including conflicts of interest, fee reasonableness, distribution of plan costs, fiduciary processes, investment results, and much more. In a new twist, several higher education institutions found themselves targets of suits similar to those brought against corporate plan sponsors in recent years.

Unfortunately, we expect the trend toward ERISA-plan-related lawsuits to continue—and perhaps increase in frequency in 2017. This means that more plan sponsor committees will be forced to navigate these waters. Rather than exclusively focusing on their chief goal of creating successful retirement outcomes for plan participants, they will expend some of their already limited time and resources attempting to protect themselves from litigation.

We are likely to see a few trickle-down effects of plan litigation, such as a continued uptick in use of passive investment options and institutionally priced vehicles such as collective investment trusts (CITs). Request-for-proposal activity may also rise as plan sponsors seek to validate the reasonableness of their plan fees relative to the services provided.

East: An Improving Economic Environment

Where we are in the economic and market cycles—and where we go next—will certainly influence retirement plans, plan sponsors, and participants.

Monetary policy has dominated the post-financial-crisis economic landscape. The result has been low interest rates, low inflation, and strong stock and bond returns. Today, the U.S. economy is showing signs of emerging inflation, driven by rising oil and gas prices and falling unemployment. With a boost from more government spending and tax cuts, the flicker of inflation could become a full-on flame.

This new environment will present challenges for investors, as they grapple with a new market dynamic, and for plan sponsors, as they cope with a tightening labor market and rising wages. When that happens, what’s old will become new again as employers shift the focus of retirement benefits back to recruitment and employee retention. We may see them adding nonqualified plans, cash balance and hybrid defined benefit solutions, or other valuable benefits as a way to attract, retain, and reward their best workers.

Meanwhile, 2016 has set up a perfect storm for pension risk transfer. The combination of strong equity market returns, rising interest rates, and Pension Benefit Guaranty Corporation (PBGC) premium increases, sets the stage for more partial or full pension terminations.

West: Future Policy Direction

2016 was arguably one of the most polarizing election years in recent history, and it will take some time to sort out the implications of future policy on retirement plans. However, the incoming administration’s messaging has focused on reduction of government regulation and tax reform, both of which could have a substantial impact on retirement plans.

Although it is tough to predict exactly how future policy direction may influence retirement plans, the most likely outcome will be some form of limitation or alteration of the tax treatment of qualified retirement plan contributions. Several proposals have been floating around Washington for the past several years but each failed to get traction. That may change in 2017 as lawmakers look to offset revenues lost via tax reform.

On a side note, driven by a rising market and a desire to improve retirement plan coverage, open multiple-employer plans (MEPs) and automatic individual retirement account (IRA) plans for small employers could pick up steam in 2017. This is a continuation of a trend initiated under the Obama administration.

Keep Calm and Carry On

While the waters of 2017 may look more uncertain than usual, the situation does not warrant panic and should not cause plan sponsors to delay plans for the new year. A thoughtful and well-documented fiduciary process that ensures you are acting in your plan participants’ best interests should be your north star.

Remember, you choose the course you chart; it is not dictated by the world in which you operate. Therefore, you should control what you can, and not let yourself be distracted by what you cannot.

What does that mean in practical terms? Here are a few thoughts for plan committees operating in this environment:

  • Define (or redefine) your goals and objectives for your plan.
  • Make sure you are able to articulate what you are doing and why you are doing it at all times.
  • Keep a journal to document your processes and decisions—but not every little detail.
  • Make the easy decisions first; then you will see a path forward for the more difficult decisions.
  • Plan sponsor decisions are evaluated in the context of the world and time in which they were made, so don’t be afraid to correct your course as events unfold.
  • If an answer is not immediately clear, deliberate and wait for more clarity on the path forward, but remember that no decision is, in fact, a decision.

As we embark upon the new year, keep your eye on the horizon, rather than on your next obstacle. With all of this uncertainty, it is easy to shift the focus of one’s decisions to risk management. But don’t allow fear of risk or uncertainty to control your actions. We encourage the committees we work with to point the needles of their compasses toward participants first, be proactive in decision-making, and adjust courses as needed. And, as always, if you don’t have the expertise you need to navigate the storm in house, find trusted partners who do.