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December 2015

Spotlight
Research

Grading the Pension Protection Act, Ten Years Later

Success Stories and Near Misses

The end of the year is always a time for nostalgia. Do you remember the Pension Protection Act (PPA)?
More than 900 pages of legislation touching seemingly every part of the retirement system. It presented
challenges for defined benefits plans. Defined contribution (DC) plans instead saw beneficial provisions,
including the permanance of certain provisions of the 2001 Economic Growth Tax Relief Reconciliation Act
(EGTRRA) and the creation of safe harbors for using target date funds as defaults and for implementing
automatic enrollment. The PPA heralded a new era for DC plans with the potential to greatly increase workers access to retirement income security.
But looking at the PPAs report card, we do not see straight As over the last decade.
Many of the provisions took years to enact, and plan sponsors still seem to struggle with them. As the PPA
celebrates 10 years, we ask: Was it successful? Did it transform DC plans in the way the industry had
hoped? How can we do better?
In this DC Spotlight, Callan gives a grade to the performance of nine key PPA provisions over the past
decade. We start with the least effective.
9. The PPAs Fund-Mapping Safe Harbor is arguably its least impactful DC provision, despite
appearing promising back in 2006. It afforded much-sought-after ERISA Section 404(c) protection
for assets being mapped from one fund to another within the plan, potentially expediting a desirable
streamlining of fund lineups. To qualify, the PPA stipulated that balances be reallocated among one
or more remaining or new investment options the stated characteristics of [which]arereasonably
similar to those of the existing investment options...1

This fund mapping safe harbor was important because plan sponsors tended to allow legacy funds
which either no longer fit the plan or were weak performersto remain in the lineup out of concern for
the fiduciary consequences of removing them and having to map participant assets. This led to fund
proliferation and confusion when participants needed to select funds.

Knowledge. Experience. Integrity.

Unfortunately, this proliferation continues. Although 15% of plan sponsors said they seek to decrease
the number of funds in their plan,2 the opposite is occuring. Excluding target date funds, the average number of funds rose from 11.4 in 2006 to 14.5 in 2015.3 Sponsors are often confused over how
to interpret mapping requirements, and are concerned that participants will loudly object if certain
beloved funds disappear from the planeven if those funds are redundant or poor performers.

Study Tip: Plan sponsors and consultants should revisit this provisions potential. In reality, very few
participants object when plan funds changemost dont even notice. For the few that do, offering a
self-directed brokerage account is one possible alternative.

Grade: C
8. Quarterly Benefits Statements are another low-impact PPA provision. Prior to the PPA, 81% of DC
plans already provided them.4 There is little evidence to suggest that such statements positively affect
behavior. Recently, the Department of Labor (DOL) has been seeking to require lifetime income projections on benefits statements to encourage higher savings levels, but research shows only a small
percentage of people respond to these types of projections.5

Study Tip: Researchers continue to explore ways to motivate saving. The most promising appears
to be personalized, just-in-time communication. For example, Shlomo Benartzi of UCLA recommends
texting or emailing workers a little financial advice every time they are in danger of making a poor
financial decision, such as taking a loan or a withdrawal from the DC plan.6 The ERISA Advisory
Council has developed this type of communication to prevent workers from cashing out their retirement plans upon termination. Plan sponsors should continue to seek participant communications that
go beyond quarterly benefits statements.

Grade: B7. Vesting comes in seventh. In an attempt to reduce vesting schedules, the PPA required that employer
contributions be vested 100% after three years or 20% per year starting with year two.

Shorter vesting periods is a laudable goal: the more quickly DC participants are vested in a plan, the
less likely they will experience leakage as they navigate the retirement system. This is particularly an
issue for workers ages 25 to 34, over a quarter of which, the Bureau of Labor Statistics notes, have
been with the current employer for 12 months or less.7

The PPAs vesting requirements can be labeled a modest success. Plans with immediate vesting
increased from 34% in 20058 to 45% in 2014.9 Yet plan leakage remains an issue as workers persist
in cashing out small balances.11

Study Tip: Plan sponsors should not forget about leakage when considering ways to improve their DC
plans. Offering fewer loans, implementing loan origination fees (which may impede loan taking), allowing repayment of loans upon termination, and educating workers on the long-term impact of cashing
out their plan can all help to reduce plan leakage.

Grade: B

6. Investment Advice, courtesy of a prohibited-transaction exemption (PTE), comes in sixth on our list.
The PTE was intended to expand the availability of online investment advice while preventing conflicts
of interest by advice providers. Indeed, advice has become more prevalent. In 2005, 15% of plan
sponsors provided participants with online investment advisory services;11 in 2014, this jumped up to
47%.12 However, usage remains low; the Plan Sponsor Council of America reports that in plans with
5,000 or more participants, average advice utilization by participants is 13%.13

Study Tip: Increasingly, plan sponsors are reexamining advice and guidance solutions beyond retirement savings, such as financial wellness options intended to support workers overall financial situation. Given the DOLs upcoming regulation on the definition of a fiduciarywhich could impact a wide
range of participant interactionsit may be time for plan sponsors to reevaluate the role and scope of
advisory solutions.

Grade: B
5. Automatic Contribution Escalations impact has truly been a mixed bag. The PPA gave it credibility
when it made it part of a new non-discrimination-testing safe harbor. Prior to the PPA, just 9% of plans
offered automatic contribution escalation14today that figure has more than quadrupled to 42%.15

At the same time, the PPA safe harbor hobbled automatic contribution escalation by requiring escalated savings to be capped. Many plan sponsorsmost of whom have no interest in this non-discrimination testing safe harborhave been loath to allow contributions to escalate to robust levels. This
is too bad, as many financial planners suggest saving between 10% and 15% of pay to amass a sufficient nest egg. Another reason it does not rank higher on our list: about half of the time it is an opt-in
solution,16 which tends to result in low utilization; conversely, utilization tends to be very high when
employees must opt out.

Study Tip: Given DC participants persistently low savings ratesespecially under auto enrollment
plan sponsors should consider opt-out automatic contribution escalation. Further, they should consider caps as high as 15% of pay; research shows that when participants choose their own caps, they
commonly pick 15% or higher.

Grade: B
4. Company Stock Diversification takes the fourth spot. This provision compelled plan sponsors to
allow immediate diversification of employee contributions invested in employer stock in DC plans,
with the ability to diversify out of employer contributions in employer stock after three years. It also
required employers to provide participants with a notice describing their diversification rights and the
importance of diversifying investment of retirement account assets.

The decline in company stock prevalence and utilization since 2006 has been striking: then, 34% of
plans offered company stock with an average allocation of 22%; now, 26% of plans offer company
stock with an average allocation of 12%.17

Study Tip: Plan sponsors should continue to evaluate the role of company stock in the DC plan. In
light of the Supreme Courts 2014 judgment that offering company stock in a DC plan is a fiduciary
function, sponsors should consider adopting a process for regularly reviewing company stock, including incorporating company stock evaluation language into the plans investment policy statement.

Grade: B
3. Automatic Enrollment significantly benefited from PPA safe harbors, including fiduciary relief from
state wage laws, which made implementation a much easier decision for plan sponsors. The data
bears this out. Prior to the PPA, 19% of plans had auto-enrollment;18 62% of plans do today.19

Auto-enrollment can powerfully increase plan participation20 but it still isnt the top PPA success story
because it is not often robustly implemented. Default contribution rates of 34% remain the norm, and
research shows participants are slow to move from such low savings levels. Saving at nominal levels
is a sure way to fall short when it comes to retirement income adequacy.

Study Tip: Plan sponsors should consider higher default contribution rates under auto-enrollment,
as well as tying auto-enrollment with opt-out automatic contribution escalation. Research shows that
participant opt-outs are no higher when the default contribution rate is 6% of pay than when it is 3%.
To address cost, plan sponsors may need to rethink the company match, e.g., incorporate a stretch
match requiring participants to save at higher levels in order to receive the full company contribution.

Grade: B+
2. Target Date Funds take second place. The PPA created qualified default investment alternatives
(QDIAs) including balanced funds, managed accounts, and target date fundsthe latter is the clear
favorite. Today, 75% of plans offer target date funds21 as the default investment alternative for non-participant directed monies. Not only has prevalence soared, but so has utilization: as a common default
under auto-enrollment, the money directed into them has stuck. The average allocation to target date
funds has grown from 4.1% in 200622 to more than 25% (and growing) today.23

Study Tip: Target date funds have been a big success in terms of prevalence and utilization, but
have not always delivered on performance. During 20082009, target date fund losses created headlines and concerns that participants did not understand their risks. Managers have made concerted
efforts to improve diversification and management of their glide paths, but nonetheless, considerable
diligence is required of plan sponsors when it comes to evaluating and monitoring target date funds.
Risk-adjusted performance ranges widely by manager, and the typical target date fund has failed to
outperform the Callan DC Index since 2006.

Grade: A-

1. EGTRRA Permanence, in our view, is the PPAs biggest success. In 2001, EGTRRA made a number
of DC-beneficial changes to Federal tax laws, including a variety of provisions that increased DC savings opportunitiessuch as making catch-up contributions available, increasing DC savings limits,
and creating Roth contributions. However, EGTRRA had a sunset date, which meant its provisions
were set to expire in 2011. As a result of EGTRRA permanence, today catch-up contributions are permitted in more than 97% of large plans,24 while 62% of plans offer Roth contributions.25

Unfortunately, few participants test the contribution limits: the average savings rate for lower-paid
participants is 5.3%, the average for all eligible participants is 6.7%, and only one-fourth of eligible
participants have made a catch-up contribution.26

Study Tip: Over time, implementing automatic contribution escalation is bound to help workers reach
higher savings levels. Plan sponsors might also consider encouraging catch-up contributions by providing a matching employer contribution (45.7% do),27 or even automatically enrolling workers into
catch-up contributions when they turn 50.

Grade: A-

Conclusion
Authored by Lori Lucas, CFA,

Has the PPA changed DC plans for the better? In many ways, the evidence shows it hasbut it also

Callans Defined Contribution

reveals that there is room for improvement. Enthusiasm around auto features is evident, but savings lev-

Practice Leader.

els are not nearly high enough. Opportunities to augment investment outcomes abound for those taking
advantage of QDIAs, online advice, and company stock diversification, but the path remains bumpy. While

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the PPA doesnt receive an A+ when it comes to DC plans, that is not necessarily because of its provisions.

with questions.

Rather, it is because of the way those provisions have been implemented by plans sponsors and used by
plan participants. A fresh look at the advantages of the PPA provisions should be on the New Years resolution list for plan sponsors and participants.

Notes:

1 United States. Government Printing Office. (2006). Pension Protection Act of 2006 (Public Law 109-280, Section 621.C).
Washington, DC.
2 Callan Associates Inc. (2015). DC Trends Survey. [Survey]. Pg 28.
3 Callan Associates Inc. The Callan DC IndexTM. As of September 30, 2015. Available at https://www.callan.com/tools/dcindex/.
4 Hewitt Associates, LLC. (2005). Survey Findings: Trends and Experiences in 401(k) Plans. [Survey]. Pg 79.
5 Goda, Gopi Shah, Manchester, Colleen Flaherty, Sojourner, Aaron. Do Income Projections Affect Retirement Saving? Center for
Retirement Research at Boston College. 2013. No. 13-4.
6 Benartzi, Shlomo, Lehrer, Johan. The Smarter Screener: Surprising Ways to Influence and Improve Online Behaviors. (Portfolio
Publishing Ltd, 2015).
7 United States. Department of Labor. Bureau of Labor Statistics. (2014). Employee Tenure in 2014 (USDL-14-1714). [News Release].
8 Hewitt. Pg 34.
9 The Vanguard Group, Inc. (2015). How America Saves. [Report]. Available at https://institutional.vanguard.com/iam/pdf/HAS15.pdf.
10 A 2014 AonHewitt study found that 43% of participants who terminated employment took a cash distribution.
11 Hewitt. Pg 48-49. Four out of ten sponsors offered outside investment advisory services, and 40% of those offered the service
online.
12 Callan. DC Trends Survey. Pg 33. Nearly 80% of sponsors offered outside investment guidance, and 59.8% of those offered the
service online.
13 Plan Sponsor Council of America. (2014). 57th Annual Survey of Profit Sharing and 401(k) Plans. [Survey].
14 Hewitt. Pg 1.
15 Callan. DC Trends Survey. Pg 15.
16 Ibid.
17 Callan. The Callan DC Index.
18 Hewitt. Pg 13.
19 Callan. DC Trends Survey. Pg 3.
20 According to DCIIAs 2014 Plan Sponsor Survey (available at www.dciia.org), the portion of plans with over 90% participation more
than doubled, from 18% prior to the implementation of automatic enrollment to 45% afterwards.
21 Callan. DC Trends Survey. Pg 20.
22 Plan Sponsor Council of America. (2007). 50th Annual Survey of Profit Sharing and 401(k) Plans. [Survey].
23 Callan. The Callan DC Index.
24 Plan Sponsor Council of America. (2014).
25 Callan. DC Trends Survey. Pg 16.
26 Plan Sponsor Council of America. (2014).
27 Ibid.

About Callan Associates

Callan was founded as an employee-owned investment consulting firm in 1973. Ever since, we have
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2015 Callan Associates Inc.

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