Why defined-contribution plan innovation is so slow

At a recent defined-contribution industry conference, the topic presented by one of the panels, which included an executive from a company that sponsors a large retirement plan, was “radical innovation.” Before the discussion could begin, the plan sponsor warned that anyone coming to his organization suggesting “radical innovation” would be shut down before they could even present their idea.

That, in a nutshell, explains why innovation is so slow for 401(k) and 403(b) plans. Major change comes with significant risk in the view of most senior managers while providing minimal benefit — not a recipe for success.

DC plan sponsors have a “herd” mentality and try to stay as close to the middle as possible. Leaders and laggards get picked off by predators like plaintiff’s attorneys and regulators. There are other barriers to change, including opinionated and vocal plan participants, as well as the lack of time and training among DC plan administrators at small and midsize companies.

And though a few specialized plan advisers might be courageous and confident enough to challenge DC clients and prospects to make bold moves, they represent just a tiny percentage of advisers who manage or get paid on a DC plan. The other advisers — even if they’re aware of “radical innovation” or, to put it more mildly, “future best practices” — are more likely than not to validate the herd mentality.

Let’s look at two potential future best practices, one that is experiencing great resistance and another that could be widely adopted, to understand the psyche of DC plan sponsors.

Using managed accounts as a retirement plan’s default investment option is starting to make more sense for DC plans as costs continue to decline and technology makes access to participant data easier than ever. The results are potentially much better than target-date-fund investments, which rely on a single data point, retirement age.

Yet adoption is slow because increased fees are likely to cause concern among plan sponsors. There are also still questions about benchmarking results, a fiduciary concern.

On the other hand, open multiple employer plans (open MEPs) or so-called pooled employer plans (PEPs) are seeing widespread approval from lawmakers, plan sponsors, advisers, broker-dealers, record keepers and money managers. PEPs, if done right, provide lower costs, simplicity, better service and less fiduciary liability. Though still waiting for lawmakers to address some legal issues, which could really accelerate the growth of open MEPs, some groups are already moving ahead with little resistance.

So while I am becoming a big proponent of managed accounts as DC plan default options and feel very optimistic that the concept will continue to grow in popularity, I am convinced that open MEPs will dramatically change the small and midsize DC plan market much more quickly — the risks are low and the benefits are relatively high.

Compare that with the idea of managed accounts as a default investment option, which could benefit participants but potentially expose employers to more risk. Ironically, open MEPs may eventually speed up the adoption of managed accounts — they may be incorporated into the MEPs and reach several employers at once, rather than having to be adopted by each individual plan sponsor.

The best approach for plan advisers who want to introduce change — through auto features (automatic enrollment and escalation, for example), health savings accounts, managed accounts, financial wellness and open MEPs — is to highlight the overwhelming benefits while trying to minimize the risk, work and costs.

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Fred Barstein is the founder and CEO of The Retirement Advisor University and The Plan Sponsor University. He is also a contributing editor for InvestmentNews‘ Retirement Plan Adviser newsletter.