Guest Article

Fiduciary Case Study: Measuring the Impact and Effect of Fiduciary Decisions

By Matthew D. Hutcheson, MS, CPC, AIFA®, MPF™, an independent fiduciary and a nationally recognized authority on qualified plans and fiduciary responsibility. He may be contacted at matt@erisa-fiduciary.com.

Facts and background:

In early 2004, I was commissioned by an employer with approximately 2,600 employees to investigate the nature of fees and operational processes with their plan. The objective was to resolve lingering questions the committee had about how their service providers were paid. Concerns arose when questions were answered nebulously. The plan at the time had just over one hundred million dollars in assets.

The investigation was performed, and we discovered approximately three hundred eighty thousand dollars of annual fees that the named fiduciaries and the committee were unaware of. We also discovered the four equity funds were basically identical, and the fund where most of the participants had invested their assets also had the highest 12(b)-1 and other revenue sharing characteristics of all the funds.

Oddly, it was discovered that as the portfolios of each participant became more conservative, the higher the long-term rate of return. In other words, contrary to expectation, the rate of return for a more aggressive portfolio was lower in the long term than that of the conservative portfolio. The procedural (fiduciary process) flaws causing this result were also discovered.

A decision was made to make changes. Before changes were made, the plan sponsor agreed to engage in a sound fiduciary process, one that strictly adhered to both proprietary processes I have developed over many years and the processes set forth by the Foundation for Fiduciary Studies. (see www.fi360.com) The committee also extensively utilized the Fiduciary Toolkit developed by Rick Meigs, editor of www.401khelpcenter.com.

Approximately 18 months following the fiduciary decisions to reconstruct the operational and investment platform of their plan, the CFO and Director of Benefits contacted me once again to perform a follow-up investigation and audit, as a matter of prudence and diligence.

The follow-up investigation was broken down into two phases or steps. The first was to verify that the fiduciaries had indeed followed a prudent process leading up to their ultimate decisions. The second step or phase was to measure the actual impact or result of their fiduciary decisions.

Within the framework of fiduciary governance, there may be nothing more important than prudence. Prudence is a noun, therefore exists, or it does not. Courts have said that prudence, or "fiduciary duty" is the highest duty known to the law. Prudence is demonstrated through processes that focus on protecting or enhancing retirement income.

With anything that requires forethought, anticipation, expectation, forecasting, and so forth, the unknowns require exercising professional judgment in our measurements. In step two I measured the effect of fiduciary decisions upon a select group of participants, omitting those with fewer than five years of service. I built into my assumptions that those who remain after five years will most likely remain longer still. The average years of service of the sample group was 10.02 years. Obviously all of these participants will not remain permanently employed until they retire. Also, it is highly unlikely that all of these participants had selected optimal portfolios before or after the transition. Therefore, in order to measure effect, we viewed all participants as though (a) they will work until a standardized age, in this case I have used age 65, and (b) they have selected optimal portfolios with modeled risk and returns, and (c) the economic conditions that now exist, and which the portfolios' structure are based, remain unchanged. You will immediately note that it is highly unlikely that a, b, and c. will exist simultaneously over a consistent period of time. Notwithstanding, it is reasonable to compare apples to apples, meaning pre conditions to post conditions, all other things being equal. This is where the result and effect of your prudent process will be revealed.

Critical questions:

Q: If Fiduciary Prudence is about protecting participant and beneficiary benefits, did our fiduciary decisions yield favorable results in that regard?

A: Attorney, Fred Reish recently published an article which contained these comments:

"ERISA" requires that fiduciaries act for the exclusive purpose of providing retirement benefits. A reasonable interpretation of the language would mean that fiduciaries must focus on the actual benefits being produced by [retirement] plans, as opposed to the current culture of looking at a plan's features and services. Also, the prudent man rule requires that fiduciaries act as a knowledgeable investor (or "prudent expert") would in accomplishing the "aims" of the plan. If the aim of a [retirement] plan is to provide adequate retirement income, the prudent fiduciaries should focus first and foremost on whether or not the plan actually is accomplishing that goal. If it is not, then the prudent man rule would require that fiduciaries determine why the plan is not working and take prudent steps to improve its performance."

This is exactly what I was commissioned to evaluate and measure, especially in light of the decisions made in the past few years.

Using general retirement plan math and specific assumptions, I constructed optimal portfolios yielding modeled returns using the old funds, and the new funds. Using these modeled returns, given various time horizons and risk profiles, I computed income replacement rates, and compared each rate to the other within the same portfolio objective. For example, the 60/40 portfolio using the old funds was compared to the 60/40 portfolio using the new funds.

Results:

1. A prudent process was followed and verified
2. The prudent process yielded favorable results, saving $380,000 in hidden fees annually
3. The prudent process enabled the committee to select funds that when carefully combined into portfolios, could be expected, over the long-term, to yield particular results.
4. A snap shot was taken of the estimated projected increase in monthly benefits 15 years from now. In the most conservative portfolio, future benefits were estimated to have increased (subject to change due to regular economic conditions, demographics, etc.) by $95,000 (per month) and $1.9 million (per month) in the longer-term portfolio.

Conclusion:

• A measurable increase in Retirement income is the result of a prudent process
• Avoiding assurances without third party investigation made a measurable difference
• Having an conflict-of-interest-free independent fiduciary involved made a measurable difference
• Utilizing fiduciary intelligence™ tools made a measurable difference, in this case, the Fiduciary Toolkit
• Understanding and managing all fees made a measurable difference
• Ensuring correct portfolio structure made a measurable difference
• Being proactive made a measurable difference to the participants and their beneficiaries

If you are interested in exploring these matters within your plan, please feel free to contact independent fiduciary, Matthew D. Hutcheson, by email at matt@erisa-fiduciary.com.

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