401(K) Plans: Improvements Can Be Made to Better Protect Participants in Managed Accounts
Released: 2014-07-29T00:00:00

Letter

Background

Managed Accounts in Other Workplace Defined Contribution Plans and Individual Retirement Accounts (IRAs) As managed accounts have gained popularity in 401(k) plans, there are indications that they may also be gaining popularity in government and non-profit workplace retirement savings plans, commonly referred to as 457 or 403(b) plans. Many of the providers we spoke to that offer managed accounts to 401(k) plans also offer services to other plans like these. In addition, some providers are starting to offer managed accounts in IRAs, and in particular rollover IRAs—when participants separate from their employer they may decide to roll their funds into an IRA. One of these providers noted that it is easier to engage participants who use managed accounts through products such as IRAs, and there is more flexibility with investment options, even though the provider’s marketing costs may be higher.

Under Title I of the Employee Retirement Income Security Act of 1974 (ERISA), as amended, employers are permitted to sponsor defined contribution plans in which an employee’s retirement savings are based on contributions and the performance of the investments in individual accounts. Typically, 401(k) plans—the predominant type of defined contribution plan in the United States—allow employees who participate in the plan to specify the size of their contributions and direct their assets to one or more investments among the options offered within the plan. Investment options generally include mutual funds, stable value funds, company stock, and money market funds. To help participants make optimal investment choices, an increasing number of plans are offering professionally managed allocations—including managed accounts—in their 401(k) plan lineups.

Managed accounts are investment services under which providers make investment decisions for specific participants to allocate their retirement savings among a mix of assets they have determined to be appropriate for the participant based on their personal information. As shown in figure 1, managed accounts were first offered to 401(k) plans around 1990, but most providers did not start offering them until after 2000.

Managed accounts differ from other professionally managed allocations, such as target date funds and balanced funds, in several key ways. Target date funds (also known as life cycle funds) are products that determine an asset allocation that would be appropriate for a participant of a certain age or retirement date and adjust that allocation so it becomes more conservative as the fund approaches its intended target date. Target date funds do not place participants into an asset allocation; instead, participants generally self-select into a target date fund they feel is appropriate for them based on the fund’s predetermined glide path that governs asset allocation. Balanced funds are products that generally invest in a fixed mix of assets (e.g., 60 percent equity and 40 percent fixed income assets). While target date funds manage the fund to reach a target date, managed accounts may consider other, more personalized factors such as a participant’s stated risk tolerance, even though they are not required to do so. As shown in figure 2, managed accounts may offer higher levels of personalization than other types of professionally managed allocations.

Managed accounts are generally considered to be an investment service—not one of the plan’s investment options—while target date funds are considered to be investment options. In the latter, participants can invest all or a portion of their 401(k) plan contributions in a target date fund, but generally cannot directly invest in a managed account. Instead, the role of the participant is to enroll in the managed account service, or be defaulted into it, generally relinquishing their ability to make investment decisions unless they disenroll from, or opt out of, the managed account. As shown in figure 3, managed account providers decide how to invest contributions, generally among the investment options available in a 401(k) plan, and then manage these investments over time to help participants reach their retirement savings goals. By comparison, participants not enrolled in a managed account have to make their own decisions about how to invest their 401(k) plan contributions.

DOL Oversight

DOL’s Employee Benefits Security Administration (EBSA) is the primary agency through which Title I of ERISA is enforced to protect private pension plan participants and beneficiaries from the misuse or theft of their pension assets. To carry out its responsibilities, EBSA issues regulations and guidance; investigates plan sponsors, fiduciaries, and service providers; seeks appropriate remedies to correct violations of the law; and pursues litigation when it deems necessary. As part of its mission, DOL is also responsible for assisting and educating plan sponsors to help ensure the retirement security of workers and their families.

Managed Accounts as Qualified Default Investment Alternatives and Opt-in Services

In 2007, DOL designated certain managed accounts as one type of investment that may be eligible as a qualified default investment alternative (QDIA) into which 401(k) plan fiduciaries may default participants who do not provide investment directions with respect to their plan contributions. DOL designated three categories of investments that may be eligible as QDIAs if all requirements of the QDIA regulation have been satisfied—these categories generally include: (1) an investment product or model portfolio that is designed to become more conservative as the participant’s age increases (e.g., a target date or lifecycle fund); (2) an investment product or model portfolio that is designed with a mix of equity and fixed income exposures appropriate for the participants of the plan as a whole (e.g., a balanced fund); and (3) an investment management service that uses investment alternatives available in the plan and is designed to become more conservative as the participant’s age increases (e.g., a managed account). DOL regulations indicate that plan fiduciaries who comply with the QDIA regulation will not be liable for any loss to participants that occurs as a result of the investment of their assets in a QDIA, including investments made through managed account arrangements that satisfy the conditions of the QDIA regulation. However, plan fiduciaries remain responsible for the prudent selection and monitoring of any QDIA offered by the plan. To obtain relief, plan fiduciaries must provide participants with advance notice of the circumstances under which plan contributions or other assets will be invested on their behalf in a QDIA; a description of the QDIA’s investment objectives, risk and return characteristics, and fees and expenses; and the right of participants to opt out of the QDIA, among other things. A 2012 survey of defined contribution plan sponsors by PLANSPONSOR indicated that managed accounts were used as a QDIA less than 5 percent of the time.

Managed accounts are also offered as opt-in services by over 30 percent of defined contribution plan sponsors. Managed accounts can be offered as both QDIA and opt-in services, allowing the plan sponsor to choose which services to offer their participants. Plan fiduciaries who offer managed account services only to participants who affirmatively elect to use the service (i.e., on an opt-in basis), rather than by default, are not required to comply with the QDIA regulation, although such fiduciaries still are subject to the general fiduciary obligations under ERISA with respect to the selection and monitoring of a managed account service for their plan.

Disclosure Regulations

Plan sponsors, including those who offer managed account services in their 401(k) plans, are required to issue a variety of informational disclosures and notices to plan participants and beneficiaries at enrollment, on a quarterly and annual basis, and when certain triggering events occur. These disclosures—often referred to as participant-level disclosures—when made in accordance with regulatory requirements, help ensure that plan participants have access to the information they need to make informed decisions about their retirement investments. In addition, when a plan sponsor chooses to default participants into managed accounts as a QDIA, the sponsor must inform participants of this decision annually through a number of specific disclosures, based on the plan’s design. The QDIA disclosures, when made in accordance with regulatory requirements, provide relief from certain fiduciary responsibilities for sponsors of 401(k) plans.

Service providers that provide managed account services to a plan may be required to provide certain disclosures about the compensation they will receive to plan sponsors offering a managed account service under different DOL disclosure requirements. These disclosures—often referred to as service provider disclosures—are intended to provide information sufficient for sponsors to make informed decisions when selecting and monitoring service providers for their plans. DOL’s final rule on these disclosures requires service providers to furnish sponsors with information to help them assess the reasonableness of total compensation paid to providers, to identify potential conflicts of interest, and to satisfy other reporting and disclosure requirements under Title I of ERISA, including the regulation governing sponsor’s disclosure to participants.

Roles and Fiduciary Obligations Under ERISA

Managed account provider roles may differ from those of other plan service providers. As shown in figure 4, when a plan sponsor decides to offer participants a managed account service, other entities may contribute to its implementation and operation.

Some record keepers and intermediary service providers refer to themselves as “managed account providers” because they make this service available to participants, but they do not ultimately decide how to invest participant contributions. Similarly, even though target date fund managers or collective investment trust managers may select an overall asset allocation strategy and investments to fit that strategy for the funds they offer to 401(k) plan participants, these managers also do not ultimately decide how to invest participant accounts.

Plan sponsors are typically the named fiduciaries of the plan. Managed account providers and record keepers may also be fiduciaries, depending on their roles and the services they provide. Fiduciaries are required to carry out their responsibilities prudently and solely in the interest of the plan’s participants and beneficiaries. Plan service providers that have investment discretion or provide investment advice about how to invest participant accounts generally may be “3(38) Investment Manager” fiduciaries or “3(21) Investment Adviser” fiduciaries. A 3(38) Investment Manager fiduciary can only be a bank, an insurance company, or a Registered Investment Adviser (RIA). Under ERISA, 3(38) Investment Manager fiduciaries have the power to manage, acquire, or dispose of plan assets, and they acknowledge, in writing, that they are a fiduciary with respect to the plan. In contrast, a 3(21) Investment Adviser fiduciary usually does not have authority to manage, acquire, or dispose of plan assets, but is still a fiduciary because its investment recommendations may exercise some level of influence and control over the investments made by the plan. When managed account services are offered as QDIAs, the managed account provider is generally required to be a 3(38) Investment Manager fiduciary. There is no similar explicit requirement for managed account providers whose services are offered within a plan on an opt-in basis.

Providers Structure Managed Accounts Differently, which Can Harm Participants

Managed Account Providers Vary Their Services

Managed account providers vary how they provide services, even though they generally offer the same basic service—initial and ongoing investment management of a 401(k) plan participant’s account based on generally accepted industry methods. The eight providers in our case studies use different investment options, employ varying strategies to develop and adjust asset allocations for participants, incorporate varying types and amounts of participant information, and rebalance participant accounts at different intervals. As a result, participants with similar characteristics in different plans may have differing experiences.

Investment Options

To develop participant asset allocations, most of the eight providers in our case studies use the investment options chosen by the plan sponsor. By contrast, other providers require plan sponsors that want to offer their managed account to accept a preselected list of investment options from which the provider will determine participant asset allocations, including exchange traded funds or asset classes not typically found in 401(k) plan lineups, such as commodities. Because they are atypical investment options, participants who do not sign up for managed accounts may not be able to access them. Compared to typical 401(k) plan investment options, these atypical investment options may provide broader exposure to certain markets and opportunities to diversify participant retirement assets.

Asset Allocation Strategies

The eight managed account providers in our case studies generally reported making asset allocation decisions based on modern portfolio theory, which sets a goal of taking enough risk so that participants’ 401(k) account balances may earn large enough returns over time to meet their retirement savings goals, but not so much that their balances could earn lower or even negative returns. Managed account providers generally help participants by constructing portfolios that attempt to provide maximum expected returns with a given level of risk, but their strategies can range from formal to informal. The formal way of determining this type of portfolio is called “mean-variance optimization” (MVO), under which providers plot risk and return characteristics of all combinations of investment options in the plan and choose the portfolio that maximizes expected return for a given level of risk. There are a number of specific techniques that managed account providers can apply to improve the quality and sophistication of asset allocations, including Monte Carlo simulation. However, some providers incorporated less formal ways of achieving a diversified portfolio, such as active management and experience-based methods. The eight providers in our case studies use varying strategies and participant goals to develop and adjust asset allocations for participants, as shown in table 1. As a result, participants with similar characteristics may end up with different asset allocations.

Providers’ use of different asset allocation strategies leads to variation in the asset allocations participants actually experience. As shown in figure 5, four of the eight providers in our case studies vary in their recommendations of specific investment options for a 30-year old participant.

The type and amount of information providers use can also affect the way participant account balances are allocated. For example, two of the eight providers in our case studies only offer a customized service—allocating a participant’s account based solely on age or other factors that can be easily obtained from the plan’s record keeper, such as gender, income, current account balance, and current savings rate. The other six providers also offer a personalized service that takes into account additional personal information to inform asset allocations, such as risk tolerance or spousal assets. Providers that offer a personalized service reported that personalization could lead to better asset allocation for participants, but they also reported that generally fewer than one-third, and sometimes fewer than 15 percent, of participants furnish this personalized information. As a result, some industry representatives felt that participants may not be getting the full value of the service for which they are paying. For example, participants who are defaulted into managed accounts that offer a highly personalized service run the risk of paying for services they are not using if they are disengaged from their retirement investments. As shown in table 2, we found that among five of the seven providers that furnished asset allocations for our hypothetical scenarios, there was little relationship between the level of personalization and the fee they charged to participants for the managed account service.

Some managed account providers’ services may become more beneficial as participants age or as their situations become more complex because personalization seeks to create a tailored asset allocation for each participant. Such an individualized approach could even mean that older participants who are close to retirement and very young participants just starting their careers could be placed in equally risky allocations based on their personalized circumstances. However, industry representatives told us that participants who never supply additional, personalized information to managed account providers may be allocated similarly over time to those participants in target date funds.

Rebalancing Approaches and Time Frames

Providers differ in their approaches and time frames for rebalancing participant managed accounts—adjusting participant accounts to reflect any changes to their asset allocation strategies based on changing market conditions and participant information. Seven of the eight providers in our case studies use a “glide path” approach to systematically reduce participant risk over time but one does not set predetermined glide paths for participants. Similarly, two of the eight providers in our case studies rebalance participant accounts annually, while the other providers generally review and rebalance participant accounts at least quarterly. Despite these differences in approaches and timeframes, our analysis of provider hypothetical asset allocations indicated that providers generally allocated less to equity assets and more to fixed income or cash-like assets for the older hypothetical participants than for the younger hypothetical participant.

Providers Vary Their Fiduciary Roles and Some May Offer Less Liability Protection for Sponsors

Some managed account providers in our case studies offer their services under “direct” arrangements in which the plan sponsor directly contracts with a provider to offer these services, as shown in figure 6. According to the providers we spoke with, managed account providers in this type of arrangement are generally fiduciaries, but record keepers may not be fiduciaries with respect to the managed account service, as their role consists primarily of providing information to the managed account provider and implementing asset allocation changes to participant accounts.

By contrast, some managed account providers use “subadvised” arrangements to offer their services. According to the providers we spoke to, in these arrangements, the plan sponsor does not directly contract with the managed account provider, and the plan’s record keeper, or an affiliate, may take on some fiduciary responsibility with respect to the managed account, as shown in figure 7. The record keeper may fulfill some of the responsibilities the managed account provider would have in a direct arrangement. These responsibilities may include providing periodic rebalancing based on the provider’s strategy, marketing managed account services, or offering other ongoing support for participants.

All of the eight managed account providers in our case studies told us that they take on some level of fiduciary responsibility—regardless of whether their services are offered as QDIAs or on an opt-in basis—so they each offer some protections to sponsors and participants in managed accounts. Seven of the providers in our case studies told us that they willingly accept 3(38) Investment Manager fiduciary status for discretionary management over participant accounts, but one of the eight providers in our case studies noted that it never accepts 3(38) Investment Manager fiduciary status because it only has discretion over participants’ accounts once a year. This provider told us that it is only a 3(21) Investment Adviser fiduciary even though its managed account service is similar to that of the other providers in our case studies. Under ERISA, 3(21) Investment Adviser fiduciaries usually do not have authority over plan assets, but they may influence the operation of the plan by providing advice to sponsors and participants for a fee. As such, they are generally liable for the consequences when their advice is imprudent or disloyal. In contrast, a 3(38) Investment Manager fiduciary has authority to manage plan assets at their discretion and with prudent judgment, and is also liable for the consequences of imprudent or disloyal decisions. Because 3(38) Investment Manager fiduciaries have explicit discretionary authority and must have the qualifications of a bank, insurance company, or RIA, sponsors who use 3(38) Investment Manager fiduciaries may receive a broader level of liability protection from those providers as opposed to providers who offer managed account services as 3(21) Investment Adviser fiduciaries. In addition, when a 3(38) Investment Manager fiduciary is used, participants may have a broader level of assurance that they are receiving services from a qualified manager in light of the requirements related to qualifications of such fiduciaries.

As noted previously, when managed account services are offered as QDIAs, DOL requires the managed account provider to generally be a 3(38) Investment Manager fiduciary, but DOL has no similar explicit requirement for managed account providers whose services are offered on an opt-in basis. Absent explicit requirements or additional guidance from DOL, some managed account providers may choose to structure the services they provide to limit their fiduciary liability, which could ultimately provide less liability protection for sponsors for the consequences of provider investment management choices. Given the current lack of direction or guidance about appropriate fiduciary roles for providers that offer managed accounts on an opt-in basis, sponsors may not be aware of this potential concern. Industry representatives we spoke with expressed concern about managed account providers who do not accept full responsibility with respect to managed account services by acknowledging their role as a 3(38) Investment Manager fiduciary. Other representatives also noted that it was important for sponsors to understand providers’ fiduciary responsibilities given the important differences between 3(21) Investment Adviser and 3(38) Investment Manager fiduciaries with respect to the nature of liability protection they may provide for sponsors and the services they may provide for both sponsors and participants.

Some Providers Offer Additional Services That Could Lead to Conflicts of Interest, which DOL Has Not Addressed

Managed account providers may offer potentially valuable additional services to participants in or near retirement regarding how to spend down their accumulated retirement savings, but these services could lead to potential conflicts of interest. Most of the providers in our case studies allow participants to continue receiving account management services when they retire as long as they leave all or a portion of their retirement savings in the 401(k) plan. Some of those providers also provide potentially useful additional services to participants in or near retirement and do not typically charge additional fees for doing so. These services may include helping participants review the tax consequences of withdrawals from their 401(k) account and advising them about when and how to claim Social Security retirement benefits. However, these providers may have a financial disincentive to recommend an out-of-plan option, such as an annuity or rollover to other plans or IRAs, because it is advantageous for them to have participants’ continued enrollment in their managed account service offered through a 401(k) plan.

Providers have developed ways to mitigate some of this potential conflict of interest by, for example, offering advice on alternate sources of income in retirement such as TIPS. Regardless, representatives from a participant advocacy group noted that managed account providers should have little involvement in a participant’s decision about whether to stay in the managed account. As part of its responsibilities to protect plan participants under ERISA, DOL has not specifically addressed whether conflicts of interest may exist with respect to managed accounts offering additional services to participants in or near retirement. As a result, participants can be easily persuaded to stay in the managed account given the additional services offered to them by managed account providers. Additionally, the ease that these services offer could discourage managed account participants from fully considering other options, which can ultimately put them at risk of making suboptimal spend-down decisions.

Managed Accounts Offer Advantages for Some Participants, But Fees and Lack of Standardized Reporting Requirements from DOL Can Offset These Advantages

Various Industry Representatives Report that Managed Accounts Can Provide a Number of Advantages for Participants

Increase Diversification

Some managed account providers and plan sponsors have said that increased diversification of retirement portfolios is the main advantage of the managed account service for 401(k) plan participants. Increased diversification for participants enrolled in a managed account can result in better risk management and increased retirement income compared to those who self-direct their 401(k) investments. For example, one provider’s study of managed account performance found that the portfolios of all managed account participants were believed to have been appropriately allocated, but that 43 percent of those who self-directed their 401(k) investments had equity allocations that were believed to be inappropriate for their age, and nearly half of these participants’ portfolios were improperly diversified. The advantages of a diversified portfolio include reducing a participant’s risk of loss, reducing volatility within the participant’s account, and generating long-term positive retirement outcomes.

Another reported advantage of managed accounts is that they help to moderate volatility in 401(k) account performance, compared to accounts of those who self-direct their 401(k) investments. For example, in two recent reports on managed account performance, one record keeper concluded that the expanded use of professionally managed allocations, including managed accounts, is contributing to a reduction in extreme risk and return outcomes for participants, and is also gradually mitigating concerns about the quality of portfolio decision-making within defined contribution plans. Managed account providers in our eight case studies also claim that the increased personalization and more frequent rebalancing of managed accounts create an appropriately diversified portfolio that better meets a participant’s retirement goals than target date funds or balanced funds. According to these providers, periodic rebalancing combats participant inertia, one of the main problems with a self-directed 401(k) account, and the failure to update investment strategies when financial circumstances change over time.

Encourage Larger Contributions

Several managed account providers told us that another advantage of managed accounts is the tendency for participants to save more for retirement compared to those who are not enrolled in the service. For example, in a study of managed accounts, a provider reported that participants in plans for which this provider offers the service contributed $2,070 more on average in 2012 than participants who self-directed investments in their 401(k) accounts (1.9 percent of salary more in contributions on average than participants who self-direct 401(k) investments). This provider noted that managed account participants are better at taking advantage of their plan’s matching contribution than participants who self-direct their 401(k) investments. For example, they found that 69 percent of managed account participants contributed at least to the level of the maximum employer matching contribution, while only 62 percent of participants who self-directed investments contributed to this level. This provider said that communication with managed account participants can lead to increased savings rates when they are encouraged to increase savings rates by at least 2 percentage points and to save at least to the point where they receive the full employer match, if such a match exists. Another service provider told us that it offers an online calculator that managed account participants can use to understand their retirement readiness. The provider also said that participants who use the calculator can see how increased savings can lead to improved retirement outcomes and will often increase their savings rate into their managed account.

Improve Access to Retirement Planning Information

Retirement readiness statements received by participants who are enrolled in a managed account are another reported advantage of the service. Participants generally receive retirement readiness statements that can help them assess whether they are on track to reach their retirement goals, and the statements generally contain information about their retirement investments, savings rate, asset allocations, and projected retirement income. These statements help participants understand the likelihood of reaching their retirement goals given their current investment strategy and whether they should consider increasing their savings rates or changing risk tolerances for their investments. In some cases, these statements may provide participants with their first look in one document at the overall progress they are making toward their retirement goals. As shown in table 3, our review of three providers’ statements shows that they use different metrics on participant readiness statements to evaluate participants’ retirement prospects. For example, each statement provided participants with information on their retirement goals and risk tolerance, and a projection of their future retirement income to demonstrate the value of the service.

Similar advantages, however, can be achieved through other retirement investment vehicles outside of a managed account and without paying the additional managed account fee. For example, in one recent study, a record keeper that offers managed accounts through its platform showed that there are other ways to diversify using professionally managed allocations, such as target date funds, which can be less costly. Although managed account providers may encourage participants to save more and review their progress towards achieving a secure retirement, participants still have to pay attention to these features of the managed account for it to provide value. Even if 401(k) plan participants are not in managed accounts, we found that in some instances they can still receive advice and education from a provider in the form of retirement readiness statements.

Fees for Managed Accounts Can Be a Disadvantage for Participants

The additional fee a participant generally pays for a managed account was the primary disadvantage mentioned by many industry representatives, plan sponsors, and participant advocates. Because of these additional fees, 401(k) plan participants who do not receive higher investment returns from the managed account services risk losing money over time. Some managed account providers and record keepers have reported that managed account participants earn higher returns than participants who self-direct their 401(k) plan investments, which may help participants offset the additional fee charged. For example, one provider told us that participants enrolled in managed accounts saw about 1.82 percentage points better performance per year, net of fees, compared to participants without managed accounts. Given these higher returns, this provider projects that a 25-year-old enrolled in its managed account could potentially see up to 35 percent more income at retirement than a participant not enrolled in the service, according to this provider’s calculations. Another provider reported that the portfolios of participants who were defaulted into managed accounts were projected to receive returns of nearly 1 percentage point more annually, net of fees, after the provider made allocation changes to the participants’ portfolios.

However, the higher rates of return projected by managed account providers may not always be achievable. For instance, we found limited data from one record keeper that published returns for managed account participants that were generally less than or equal to the returns of other professionally managed allocations (a single target date fund or balanced fund) as shown in figure 8.

We used these and other returns data published by this record keeper to illustrate the potential effect over 20 years of different rates of return on participant account balances. On the lower end, this record keeper reported that, over a recent 5-year period, 25 percent of its participants earned annualized returns of -0.1 percent or less, not even making up the cost of the additional fee for the service. On the higher end, the record keeper reported that, over a slightly different 5-year period, 25 percent of its participants earned annualized returns of 2.4 percent or higher for the service. These actual returns illustrate the substantial degree to which returns can vary. If such a 2.5 percentage point difference (between these higher and lower reported managed account rates of return of 2.4 percent and -0.1 percent, respectively) were to persist over 20 years, a participant earning the higher managed account rate of return could have nearly 26 percent more in their ending account balance at the end of 20 years than a participant earning the lower rate of return in their managed account. As shown in Figure 9, using these actual rates of return experienced by participants in managed accounts, such a variation in rates of return can substantially affect participant account balances over 20 years.

Further, this record keeper’s published data on managed account rates of return were net of fees—rates of return would be higher if participants did not pay the additional fee for the service. For example, using this record keeper’s average fee rate in our analysis, we estimate that a hypothetical managed account participant who earned a higher rate of return of 2.4 percent will pay $8,400 more in additional fees over 20 years than a participant who self-directs investments in their 401(k) account and does not pay the additional fee. To illustrate the potential effect that fees could have on a hypothetical participant’s account balance over 20 years, we used a higher fee of 1 percent reported to us by one provider to estimate that a participant would pay $14,000 in additional fees compared to a participant who self-directs investments in their 401(k) account over the same period. However, based on the reported performance data we found, there is no guarantee that participants will earn a higher rate of return with a managed account compared to the returns for other professionally managed allocations or self-directed 401(k) accounts. The limited performance data we reviewed show that in most cases, managed accounts underperformed these other professionally managed allocations and self-directed 401(k) accounts over a 5-year period. However, managed account participants with lower rates of return still pay substantial additional fees for the service. To further illustrate the effect of fees on account balances, a hypothetical participant who earns a lower managed account rate of return of -0.1 percent would pay $6,900 in additional fees using this record keeper’s average fee over 20 years compared to a participant who self-directed investments in their 401(k) account, and the additional fees would increase to $11,500 at the 1 percent fee level using the lower rate of return.

The additional managed account fees, which are charged to participants over and above investment management and administrative fees, can vary substantially, and as a result, some participants pay no fees, others pay a flat fee each year, and still others pay a comparatively large percentage of their account balance for generally similar services from managed account providers. In our case studies, we reviewed the additional fees charged to participants for the service. One managed account provider charges a flat rate and fees for the other seven providers ranged from 0.08 to 1 percent of the participant’s account balance annually, or $8 to $100 on every $10,000 in a participant’s account. Therefore, participants with similar balances but different providers can pay different fees. As shown in table 4, participants with an account balance of $10,000 whose provider charges the highest fee may pay 12.5 times as much as participants whose provider charges the lowest fee ($100 and $8, respectively). However, participants with an account balance of $500,000 may pay up to 250 times as much as other participants but one is subject to a provider who charges the highest fees while the other is at the lowest fee provider ($5,000 and $20, respectively).

Participants with large account balances whose managed account provider caps fees at a certain level benefit more than similar participants whose fees are not capped. Of the providers we reviewed who charge variable fees, one provider caps the fee at a certain amount per year. For example, this provider charges 0.25 percent or $25 for every $10,000 in a participant’s account, with a maximum of $250 per year, so participants who use this provider only pay fees on the first $100,000 in their accounts. As a result, the difference in fees paid by participants using this provider, or providers who charge flat rates, widens as participant account balances increase.

Plan characteristics can affect fees participants pay to managed account providers. For example, at one managed account provider included in our review, a participant in a small plan may pay more for a managed account than a similar participant in a large plan. Similarly, a participant in a plan with high enrollment or that uses managed accounts as the default may pay less for a managed account than a participant with the same balance in a plan with low enrollment or that offers managed accounts as an opt-in service. We also found through our case studies that fees can vary based on factors beyond the plan’s characteristics, such as the types of providers involved in offering the managed account, the size of participant account balances, and the amount of revenue sharing received by the managed account provider. Fees calculated through revenue sharing can vary in accordance with the investment options the plan sponsor chooses to include in the plan and the amount of revenue the provider actually receives from these options. In these cases, initial fee estimates for the managed account may differ from actual fees they pay. In addition, some plan sponsors also pay fees to offer managed account services, but since these fees may be paid out of plan assets, participants in these plans may pay more than participants in plans that do not pay fees.

As shown above, paying higher additional fees to a provider for a managed account service offers no guarantee of higher rates of return compared to other providers or compared to the reported rates of return earned by participants who invest in other professionally managed allocations or who self-direct investments in their 401(k) accounts. Because the additional fee is charged to participants on a recurring basis, such as every quarter or year, the costs incurred over time by participants who use managed accounts can accumulate. We used fee data reported by managed account providers to illustrate the effect that different fees could have on a participant’s managed account balance over time. As shown in figure 10, a hypothetical participant in our illustration who is charged an additional annual fee of 1 percent of their account balance for their managed account may pay nearly $13,000 more over 20 years than they would have paid in any other investment without the managed account fee. This compares to about $1,100 in additional fees paid over 20 years by a participant who is charged an annual fee of 0.08 percent for a managed account, the lowest variable non-capped fee we found.

Lack of a Requirement for Performance and Benchmarking Information Inhibits Participant Evaluation of Managed Accounts

The limited availability of returns-based performance data and lack of standard metrics can also offset the reported advantages of managed accounts. In its final rule on participant-level disclosures, DOL requires that sponsors disclose performance data to help participants make informed decisions about the management of their individual accounts and the investment of their retirement savings, and that sponsors provide appropriate benchmarks to help participants assess the various investment options available under their plan. By requiring sponsors to provide participants with performance data and benchmarking information for 401(k) investments, DOL intends to reduce the time required for participants to collect and organize fee and performance information and increase participants’ efficiency in choosing investment options that will provide the highest value.

Since the applicability date of the participant-level disclosure regulation, for most plans in 2012, DOL has required plan sponsors to provide participants who invest in a “designated investment alternative” in their 401(k) account with an annual disclosure describing the fees, expenses, and performance of each of the investment funds available to them in the plan. DOL defines a designated investment alternative as “any investment alternative designated by the plan into which participants and beneficiaries may direct the investment of assets held in, or contributed to, their individual accounts.” For designated investment alternatives, plan sponsors are required to disclose to participants specific information identifying the funds available to them in the plan, results-based performance information over varying time periods, and performance benchmarks in a way that invites comparison with established benchmarks and market indexes, as shown in table 5.

Despite DOL’s requirements for designated investment alternatives, with respect to managed accounts offered either as an opt-in or default service, plan sponsors are generally only required to disclose to 401(k) participants the identity of the managed account provider or investment manager and any fees and expenses associated with its management. Neither plan sponsors nor managed account providers are required to isolate within the participant-level disclosure investment-related information on the individual funds that comprise the participant’s managed account or present aggregate performance of the account for a given period. DOL generally does not consider most managed accounts to be “designated investment alternatives.” Instead, according to DOL, managed account providers are generally considered to be “designated investment managers” as they provide a service to participants rather than an investment option, such as a mutual fund. As a result, the investment–related information required in DOL’s participant-level disclosure regulation does not apply to investment services, such as many managed accounts.

Because DOL does not require plan sponsors to provide participants information on the performance of their managed accounts or to compare performance against a set of standard benchmarks, it is potentially difficult for participants to evaluate whether the additional fees for managed accounts are worth paying, considering the effect of fees on returns and retirement account balances. As a result, participants may be unable to effectively assess the overall value of the service and to compare performance against a set of standard benchmarks. Not all of the retirement readiness statements we reviewed included returns-based performance data or information on the amount of additional fees the participant had paid for the service. Some managed account providers did include projections of a participant’s future retirement income on these statements. Even though the projections may be based on sound methodologies, if standard returns-based performance data are absent from these statements, participants will have to rely primarily on these projections to gauge the overall value of the service. Without performance and benchmarking information presented in a format designed to help participants compare and evaluate their managed account, participants cannot make informed decisions about the managed account service.

Likewise, with respect to QDIAs, DOL only requires plan sponsors to disclose to participants a description of each investment’s objectives, risk and return characteristics (if applicable), fees and expenses paid to providers, and the right of the participant to elect not to have such contributions made on their behalf, among other things. In 2010, DOL proposed amendments to its QDIA disclosure requirements that would, with respect to target date funds or similar investments, require sponsors to provide participants historical returns-based performance data (e.g., 1-, 5-, and 10-year returns). According to DOL officials, the proposed QDIA rule change may apply to managed accounts offered as a QDIA to participants. However, the proposed requirements as written may be difficult for plan sponsors to implement because they are not tailored specifically for managed accounts. One participant advocacy group noted that, without similar information, participants may not be able to effectively assess managed account performance over time and compare that performance to other professionally managed investment options available under the plan or across different managed account providers.

As mentioned above, DOL affirms in the participant-level disclosure regulation that performance data are required to help participants in 401(k) plans to make informed decisions about managing investments in their retirement accounts, and that appropriate benchmarks are helpful tools participants can use to assess the various investment options available under their plan. The benefits outlined in the participant-level disclosure regulation would also apply to the proposed changes to the QDIA regulation. Specifically, DOL expects that the enhanced disclosures required by the proposed regulation would benefit participants by providing them with critical information they need to evaluate the quality of investments offered as QDIAs, leading to improved investment results and retirement planning decisions by participants. DOL believes that the disclosures under the proposed regulation, combined with performance reporting requirement in the participant-level disclosure regulation, would allow participants to determine whether efficiencies gained through these investments are worth the price differential participants generally would pay for such funds. However, absent DOL requirements that plan sponsors use standard metrics to report on the performance of managed accounts for participants who are defaulted into the service as a QDIA, it would be potentially difficult for these participants to evaluate the effect that additional fees could have on the performance of their managed accounts, including how the additional fees could affect returns and retirement account balances, possibly eroding the value of the service over time for those participants.

Improved performance reporting could help participants understand the risks associated with the additional fees and possible effects on their retirement account balances if the managed accounts underperform, which is critical information that participants could use to take action to mitigate those risks. Discussions with managed account providers suggest that returns-based performance reports and custom benchmarking can be provided to managed account participants. For example, as shown in figure 11, one managed account provider we spoke to already furnishes participants access to online reports that include returns-based performance data and custom benchmarks, which can allow them to compare performance for a given period with an established equity index and bond index. Some providers told us that it would be difficult to provide participants in managed accounts with performance information and benchmarks because their retirement portfolios contain highly personalized asset allocations. While it may be more challenging for providers to furnish performance information on personalized managed accounts compared to model portfolios, we identified one participant statement that included performance information from a provider who personalizes asset allocations for their participants’ retirement portfolios.

The provider told us that the blended custom benchmark described in figure 11 allows participants to more accurately evaluate and compare the aggregate performance of the different individual funds held in their managed account because the benchmark is linked to the participant’s risk tolerance. The online report also describes any positive or negative excess returns for the portfolio relative to the return of the custom benchmark, net of fees. The provider said that the excess return statistic is representative of the value that the provider or portfolio manager has added or subtracted from the participant’s portfolio return for a given period. Another managed account provider furnishes retirement readiness statements that include returns-based information for each of the funds in participants’ accounts. However, the statement did not include standard or custom benchmarks that would allow participants to compare the performance of their managed account with other market indexes.

Absent Guidance, Sponsors Face Challenges in Selecting and Overseeing Managed Account Providers

DOL Has Not Addressed Sponsor Access to Managed Account Provider Options

Some sponsors report that their choice of a managed account provider may be limited to those options—sometimes only one—offered by the plan’s record keeper. Although DOL’s general guidance on fiduciary responsibilities encourages sponsors to consider several potential providers before hiring one, six of the 10 sponsors we interviewed said that they selected a managed account provider offered by their record keeper without considering other options and two other sponsors said that their record keeper’s capabilities partially restricted their choice of a provider. Some record keepers voluntarily offered sponsors more managed account provider options when sponsors asked for them. In the absence of DOL requiring sponsors to request multiple provider options, sponsors said they were reluctant to pursue options not offered by their record keeper for a variety of reasons. These reasons included: (1) concern that their record keeper’s systems might be unable to support additional options; (2) familiarity with the current provider offered by their record keeper; and (3) belief that there was no need to consider other options—one sponsor said that its record keeper has consistently provided excellent service and support for a reasonable fee and, as a result, the sponsor felt comfortable accepting the record keeper’s recommendation of the provider offered on its recordkeeping system.

Without the ability to choose among multiple providers, sponsors have limited choices, which can result in selecting a provider who charges participants higher additional fees than other providers who use comparable strategies to manage participant investments, which are ultimately deducted from participant account balances. In addition, limited choices can result in sponsors selecting a provider whose strategy does not align with their preferred approach for investing participant contributions. For example, a sponsor who endorses a conservative investment philosophy for their plan could select a provider who uses a more aggressive method for managing participant investments.

Several managed account providers and record keepers said that a limited number of providers are offered because, among other things, it is costly to integrate 401(k) recordkeeping systems with managed account provider systems. In addition, record keepers may offer a limited number of providers to avoid losing revenue and because they evaluate a provider before deciding to offer its managed account service. Such steps include reviewing the provider’s investment strategy and assessing how the provider interacts with participants. One managed account provider estimated that sponsors might have to spend $400,000 and wait more than a year before offering the provider’s managed account to plan participants if it is not already available on their record keeper’s system. Additionally, record keepers may lose target date fund revenue or forgo higher revenue opportunities by offering certain managed account providers and may believe that offering multiple options is unnecessary once they have identified a provider that is effective.

Although sponsors may have access to a limited number of managed account providers on their record keepers’ systems, some providers have developed approaches that make it easier for record keepers to offer more than one managed account option to sponsors. For instance, one provider we interviewed, which acts as an intermediary and fiduciary, contracts with several other providers and makes all of these providers available to its record keepers, thus allowing the record keepers’ sponsors to choose among several managed account providers without incurring additional costs to integrate the record keeper with any of the providers. Another managed account provider has developed a process to transfer information to record keepers that does not require integration with the recordkeeping system, thus making it less difficult for any record keeper to work with them.

Sponsors Lack Sufficient Guidance from DOL to Inform Their Selection and Oversight of Managed Account Providers

Available evidence we reviewed suggests that sponsors lack sufficient guidance on how to select and oversee managed account providers. Several of the sponsors we interviewed said that they were unaware of any set list of standards for overseeing managed accounts, so they do not follow any standards, and even managed account providers felt that sponsors have insufficient knowledge and information to effectively select a provider. Because sponsors may not have sufficient knowledge and information, record keepers could play a larger role in the selection process. In addition, providers indicated that it is difficult for sponsors to compare providers and attributed this difficulty to the absence of any widely accepted benchmarks or other comparison tools for sponsors. Some industry representatives indicated that additional guidance could help sponsors better select and oversee managed account providers and highlighted specific areas in which guidance would be beneficial, such as: determining whether a managed account fee is reasonable; understanding managed accounts and how they function; and clarifying factors sponsors should consider when selecting a managed account provider.

Although DOL is responsible for assisting and educating sponsors by providing them with guidance, it has not issued guidance specific to managed accounts, as it has done for target date funds, even though it has issued general guidance on fiduciary responsibilities, including regulations under ERISA 404(a) and 404(c), which explicitly state DOL’s long-standing position that nothing in either regulation serves to relieve a fiduciary from its duty to prudently select and monitor any service provider to the plan. DOL guidance on target date funds outlines the factors sponsors should consider when selecting and monitoring target date funds, such as performance and fees, among other things. The absence of similar guidance specific to managed accounts has led to inconsistency in sponsors’ procedures for selecting and overseeing providers and may inhibit their ability to select a provider who offers an effective service for a reasonable fee. Specifically, without assistance regarding what they should focus on, sponsors may not be considering factors that DOL considers relevant for making fiduciary decisions, such as performance information. For example, sponsors considered a range of factors when selecting a managed account provider, including record keeper views on the quality of the provider, the provider’s willingness to serve as a fiduciary, and the managed account provider’s investment strategy. In addition, as shown in table 6, while nearly all of the sponsors said that they considered fees when selecting a managed account provider, only 1 of the 10 sponsors we interviewed said that they considered performance information when selecting a managed account provider. In addition, only half of the sponsors we interviewed reported that they take steps to formally benchmark fees by, for example, comparing their participants’ fees to the amount of fees that participants in similarly-sized organizations pay.

The extent to which sponsors oversee managed account providers also varies. Nearly all of the 10 sponsors we interviewed said that they review reports from their managed account provider or record keeper as part of their oversight process, and the managed account providers we interviewed highlighted the role that these reports play in the oversight process. Several of these providers noted that the reports they provide help sponsors fulfill their fiduciary responsibility for oversight. Most sponsors said that they also take other steps to oversee managed account providers, such as regularly meeting with them. However, only one sponsor said that, as part of its oversight activities, it independently evaluates benchmarks, such as stock market performance indexes. In addition, even though participants generally pay an additional fee for managed account services, not all of the sponsors we interviewed said that they monitor fees.

Inconsistent Performance Information Allowed by DOL Hinders Sponsor Evaluation of Managed Accounts

Some industry representatives indicated that consistent performance information could help sponsors more effectively compare prospective managed account providers and ultimately improve selection and oversight. Similar to the challenges participants face in evaluating managed accounts because of a lack of performance information, industry representatives said that sponsors need information as well, including: useful, comparative performance information and a standard set of metrics to select suitable providers; access to standard performance benchmarks to monitor them; and access to comparable managed account performance information to evaluate performance.

Some providers highlighted challenges with providing performance information on managed accounts and, as a result, furnish sponsors with other types of information to demonstrate their value to participants. For example, providers may not furnish returns-based performance information to demonstrate how their offerings have affected participants because the personalized nature of managed accounts makes it difficult to measure performance. In lieu of providing returns-based performance information, providers furnish sponsors with changes in portfolio risk levels and diversification, changes in participant savings rates, and retirement readiness. One managed account provider said that it does not believe there is a way to measure the performance of managed accounts, noting that it develops 20 to 50 investment portfolios for any given plan based on the investment options available in the plan.

Nonetheless, a few providers voluntarily furnish sponsors with returns- based performance information. One provider that used broad-based market indexes and customized benchmarks noted that it would be difficult for a sponsor to select a managed account provider without being able to judge how the provider has performed in the past. In addition, this provider, unlike some other providers, noted that the personalized nature of some managed accounts does not preclude managed account providers from being able to generate returns-based performance information. For example, even though plans may differ, providers can collect information from record keepers for each of the plans that offer managed accounts and create aggregate returns data, which could then be disclosed to sponsors along with an explanation of how the data were generated. As shown in figure 12, the report that this provider distributes to sponsors contains an array of performance information for participant portfolios, including rates of return earned by the portfolios for multiple time periods and benchmarks. In addition, the report provides a description of the benchmarks—broad-based market indexes as well as customized benchmarks.

DOL regulations require that service providers furnish sponsors with performance and benchmarking information for the investment options available in the plan. DOL maintains that sponsors need this information in order to make better decisions when selecting and monitoring providers for their plans. However, DOL regulations generally do not require managed account providers to furnish sponsors with performance and benchmarking information for managed accounts because, as previously noted, managed accounts are not considered to be designated investment alternatives. Without this information, sponsors cannot effectively compare different providers when making a selection or adequately determine whether their managed account offerings are having a positive effect on participant retirement savings, as they can currently determine with the designated investment alternatives available in the plan.

Conclusions

Managed accounts can be useful services and may offer some advantages for 401(k) participants. They build diversified portfolios for participants, help them make investment decisions, select appropriate asset allocations, and estimate the amount they need to contribute to achieve a secure retirement. Given these potential advantages, it is no surprise that the number of managed account providers has grown and that plan sponsors, seeking to provide the best options for plan participants, have increasingly offered managed accounts. The extent to which managed accounts benefit participants may depend on the participant’s level of engagement and ability to increase their savings. Despite the potential advantages, better protections are needed to ensure that participants realize their retirement goals. These protections are especially important as additional fees for this service can slow or erode participants’ accumulated retirement savings over time.

Helping plan sponsors understand and make appropriate decisions about managed accounts can better ensure that participants are able to reap the full advantages of managed accounts. Since plan sponsors select a managed account provider, participants who use these services are subject to that managed account provider’s structure and strategies for allocating participant assets, which can potentially affect participants’ ability to save for retirement, especially if they pay high fees. Some participants cannot be assured that they are receiving impartial managed account services or are able to rely on accountable investment professionals taking on appropriate fiduciary responsibilities. Clarifying fiduciary roles for providers who offer managed accounts to participants on an opt-in basis or for providers who offer additional services to participants in or near retirement could help ensure that sponsors have a clear understanding of provider responsibilities so they can offer the best services to their participants.

DOL can also help sponsors gain clarity and confidence in selecting and monitoring managed account providers. This is particularly salient since managed accounts can be complicated service arrangements and there are considerable structural differences among the managed account options offered by providers. By requiring sponsors to request multiple provider options from their record keeper, DOL can help ensure that sponsors thoroughly evaluate managed account providers before they are offered to participants. In addition, providing sponsors with guidance that clarifies standards and suggests actions for prudently selecting and overseeing managed account providers, such as documenting their processes and understanding the strategies used in the managed account, positions sponsors to better navigate their fiduciary responsibilities. Additional guidance also positions sponsors to consider additional factors when choosing to default participants into managed accounts. Supplementing this guidance by requiring providers to furnish consistent performance information to sponsors so that they can more effectively compare providers can assist sponsors in their efforts to provide a beneficial service that could help preserve and potentially enhance participants’ retirement security.

Finally, DOL can also help participants evaluate whether their managed account service is beneficial. Without standardized performance and benchmarking information, participants may not be able to effectively assess the performance of their managed account and determine whether the additional fee for the service is worth paying. For participants who opt into managed accounts, this information could help them more effectively assess the performance of their managed account and compare that performance to other professionally managed alternatives that may be less expensive, such as target date funds. Alternatively, for participants who are defaulted into managed accounts, this information could be valuable when they start to pay more attention to their retirement savings.

Recommendations for Executive Action

To better protect plan sponsors and participants who use managed account services, we recommend that the Secretary of Labor direct the Assistant Secretary for the Employee Benefits Security Administration (EBSA) to: a) Review provider practices related to additional managed account services offered to participants in or near retirement, with the aim of determining whether conflicts of interest exist and, if it determines it is necessary, taking the appropriate action to remedy the issue. b) Consider the fiduciary status of managed account providers when they offer services on an opt-in basis and, if necessary, make regulatory changes or provide guidance to address any issues.

To help sponsors who offer managed account services or who are considering doing so better protect their 401(k) plan participants, we recommend that the Secretary of Labor direct the Assistant Secretary for EBSA to: c) Provide guidance to plan sponsors for selecting and overseeing managed account providers that addresses: (1) the importance of considering multiple providers when choosing a managed account provider, (2) factors to consider when offering managed accounts as a QDIA or on an opt-in basis, and (3) approaches for evaluating the services of managed account providers. d) Require plan sponsors to request from record keepers more than one managed account provider option, and notify the Department of Labor if record keepers fail to do so.

To help sponsors and participants more effectively assess the performance of managed accounts, we recommend that the Secretary of Labor direct the Assistant Secretary for EBSA to: e) Amend participant disclosure regulations to require that sponsors furnish standardized performance and benchmarking information to participants. To accomplish this, EBSA could promulgate regulations that would require sponsors who offer managed account services to provide their participants with standardized performance and benchmarking information on managed accounts. For example, sponsors could periodically furnish each managed account participant with the aggregate performance of participants’ managed account portfolios and returns for broad- based securities market indexes and applicable customized benchmarks, based on those benchmarks provided for the plan’s designated investment alternatives. f) Amend service provider disclosure regulations to require that providers furnish standardized performance and benchmarking information to sponsors. To accomplish this, EBSA could promulgate regulations that would require service providers to disclose to sponsors standardized performance and benchmarking information on managed accounts. For example, providers could, prior to selection and periodically thereafter, as applicable, furnish sponsors with aggregated returns for generalized conservative, moderate, and aggressive portfolios, actual managed account portfolio returns for each of the sponsor’s participants, and returns for broad-based securities market indexes and applicable customized benchmarks, based on those benchmarks provided for the plan’s designated investment alternatives.

Agency Comments and Our Evaluation

We provided a draft of this report to the Department of Labor, the Department of the Treasury, the Securities and Exchange Commission, and the Consumer Financial Protection Bureau for review and comment. The Department of the Treasury and the Consumer Financial Protection Bureau did not have any comments. DOL and SEC provided technical comments, which we have incorporated where appropriate. DOL also provided written comments, which are reproduced in appendix IV. As stated in its letter, DOL agreed with our recommendations and will consider each of them as it moves forward with a number of projects.

In response to our recommendation that DOL review provider practices related to additional managed account services offered to participants in or near retirement to determine whether conflicts of interest exist, DOL agreed to include these practices in its current review of investment advice conflicts of interest, noting that such conflicts continue to be a concern. Regarding our second recommendation, to consider the fiduciary status of managed account providers when they offer services on an opt-in basis, DOL agreed to review existing guidance and consider whether additional guidance is needed in light of the various business models we described. By considering managed account service provider practices and fiduciary roles in its current efforts and taking any necessary action to address potential issues, we believe DOL will help ensure that sponsors and participants receive unconflicted managed account services from qualified managers.

DOL also agreed to consider our other recommendations in connection with its current regulatory project on standards for brokerage windows in participant-directed individual account plans. We believe that this project may be a good starting point for requesting additional information and considering adjustments to those managed account services participants obtain from advisers through brokerage windows. As we noted in our report, we did not include these types of managed accounts in our review because the plan sponsor is not usually involved in the selection and monitoring of these advisers. Since participants can obtain managed account services without using a brokerage window, we encourage DOL to also consider our third and fourth recommendations outside of the context of brokerage windows. Providing guidance to sponsors for selecting and overseeing managed account providers, as suggested by our third recommendation, may help sponsors understand their fiduciary responsibilities with respect to managed accounts. Similarly, requiring plan sponsors to ask for more than one choice of managed account provider, as suggested by our fourth recommendation, could encourage record keepers to offer additional choices. By taking the steps outlined in these recommendations, DOL can help ensure that participants are being offered effective managed account services for reasonable fees.

With respect to our recommendation requiring plan sponsors to ask for more than one choice of managed account provider, DOL noted that it needs to review the extent of its legal authority to effectively require plans to have more than one managed account service provider. We continue to believe that the action we suggest in our recommendation—that DOL simply require plan sponsors to ask for more than one choice of a provider, which is slightly different than how DOL has characterized it— may be an effective method of broadening plan sponsors’ choices of managed account providers. However, we agree that DOL should examine the scope of its existing authority in considering how it might implement this recommendation.

Finally, DOL agreed to consider our recommendations on the disclosure of performance and benchmarking information on managed accounts to participants and sponsors in connection with its open proposed rulemaking project involving the qualified default investment alternative and participant-level disclosure regulations. We believe that DOL’s consideration of these recommendations in connection with this rulemaking project will be helpful for participants and sponsors, and encourage DOL to include managed accounts in this rulemaking. Although managed accounts are different than target date funds in multiple ways, as presented in our report, we believe that managed account providers can and should provide some level of performance and benchmarking information to sponsors—and sponsors to participants—to describe how managed accounts perform over time and the risks associated with the service. In addition, to the extent that managed accounts offered on an opt-in basis are not covered by DOL’s project, we encourage DOL to consider adopting similar changes to the participant- level disclosures for those managed accounts that are not governed by QDIA regulations.

As arranged with your office, unless you publicly announce its contents earlier, we plan no further distribution of this report until 30 days from the date of this letter. At that time, we will send copies of this report to appropriate congressional committees, the Secretary of Labor, the Secretary of the Treasury, the Chair of the Securities and Exchange Commission, the Director of the Consumer Financial Protection Bureau, and other interested parties. In addition, the report will be available at no charge on GAO’s website at www.gao.gov. If you or your staff members have any questions about this report, please contact me at (202) 512- 7215 or jeszeckc@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made key contributions to this report are listed in appendix V.

Appendix I: Objectives, Scope, and Methodology

Our objectives for this study were to determine (1) how service providers structure managed accounts, (2) the advantages and disadvantages of managed accounts for 401(k) participants, and (3) the challenges, if any, that plan sponsors face in selecting and overseeing managed account providers.

To answer our research objectives we undertook several different approaches. We reviewed relevant research and federal laws, regulations, and guidance on managed accounts in 401(k) plans. We reviewed available documentation on the structure of managed accounts in 401(k) plans and the role of service providers, including Securities and Exchange Commission (SEC) filings of the Form ADV by 30 record keepers, managed account providers, and other related service providers. We interviewed industry representatives and service providers involved with managed accounts—including record keepers, academics, industry research firms, and participant advocacy groups—and government officials from the Department of Labor’s Employee Benefits Security Administration (EBSA), SEC, the Department of the Treasury, and the Consumer Financial Protection Bureau.

Case Studies of Managed Account Providers

To examine key issues related to how managed accounts in 401(k) plans are structured, we conducted in-depth case studies of eight selected managed account providers. Since we were unable to identify a comprehensive list of managed account providers that provide services to 401(k) plans, to select providers for case studies we first developed a list of 14 managed account providers based on discussions with two industry research firms and our own analysis of information from record keeper websites and other publicly available documentation. To assess the reliability of these data, we interviewed the two industry research firms and compared their information with the results of our analysis for corroboration and reasonableness. We determined that the data we used were sufficiently reliable for selecting managed account providers for case studies. From the list of 14 providers, we selected 10 providers based on their size, location, and legal and fee structures, from which we used eight as the basis for our case studies. According to our estimates, the eight managed account providers we included in the case studies represented over 95 percent of the managed account industry in defined contribution plans, as measured by assets under management in 2013.

In conducting case studies of managed account providers, we interviewed representatives of the managed account provider and chose five providers for site visits based on their locations and size. We also reviewed publicly available documentation describing the nature of the managed account and sample reports furnished by providers, confirmed the type of information these providers consider when managing a participant’s account, and analyzed fee data furnished by managed account providers. To assess the reliability of the fee data furnished by managed account providers, we corroborated and assessed the completeness of reported fee data based on information in provider SEC filings and any other relevant documentary evidence, when possible. We determined that the data were sufficiently reliable for depicting the range and types of fees charged to sponsors and participants by providers. In addition, to further understand the different strategies and structures of managed accounts, we developed and submitted five hypothetical participant scenarios in one hypothetical plan to the eight service providers and asked them to provide example asset allocations, and advice if practical, for those participants. Seven of the eight managed account providers completed and returned asset allocations to us. See appendix II for additional detail on the development of hypothetical scenarios and results from this work.

Illustrations of Fee and Return Data Over Time

To illustrate potential performance outcomes for participants in managed accounts, we used available data on actual managed account rates of return and fees to show how managed accounts could affect 401(k) account balances over 20 years. We developed two scenarios, isolating the effects of variability in the following factors: 1. Managed account rates of return – We used annual average managed account rates of return ranging from -0.1 percent to 2.4 percent, based on published performance data. We compared the change in account balances for those managed account rates of return with the change in account balances for a 1.4 percent rate of return experienced by participants who directed their own 401(k) investments. 2. Managed account fees – We used different fee levels obtained from published reports and provider interviews ranging from a low additional annual fee of 0.08 percent to a 1 percent annual fee. We compared fee totals and ending account balances for varying fee levels with those of participants who did not pay the additional fee because they directed their own 401(k) investments.

For each scenario, we held all other factors constant by assuming that the participant’s starting account balance was $17,000 and starting salary was $40,000, the salary increased at a rate of 1.75 percent per year, and the participant saved 9.7 percent of their salary each year. To the extent possible, we developed scenarios using information provided to us during interviews with industry representatives or found in published reports on managed accounts or on other economic factors. To assess the reliability of these data, we considered the reliability and familiarity of the source of the data or information and, when necessary, interviewed representatives of those sources about their methods, internal controls, and results. Based on these interviews and our review of published data, we determined that the data we used were sufficiently reliable for use in these illustrations.

Because this work presents simplified illustrations of potential effects on participants over time, we used nominal dollar amounts over 20 years and did not take into account inflation or changes in interest rates. Similarly, to minimize effects of percentage growth/loss sequencing on account balances, we applied the same rates of return to each of the 20 years for each scenario. The rates of returns we used in both scenarios already incorporated different asset allocations for participants with a managed account or a self-directed 401(k) account. This work does not attempt to specify or adjust these specific asset allocations.

Semi-Structured Interviews with Plan Sponsors

To identify the advantages and disadvantages of managed accounts for 401(k) plan participants and any challenges sponsors face in selecting and overseeing managed account providers, we conducted semi- structured interviews with 12 plan sponsors. Our process for interviewing plan sponsors involved multiple steps, as outlined below.

Sponsor Selection

Since a comprehensive list of sponsors that managed accounts did not exist at the time of our review, to select sponsors for semi-structured interviews, we conducted a non-generalizable survey facilitated by PLANSPONSOR, a member organization. The survey included questions about sponsors’ 401(k) plans, such as the amount of assets included in the 401(k) plan and the number of participants in the plan, and the reasons why sponsors decided to offer, or not offer, managed accounts to 401(k) plan participants. To minimize errors arising from differences in how survey questions might be interpreted and to reduce variability in responses that should be qualitatively the same, we conducted pretests with industry representatives. Based on feedback from these pretests, we revised the survey in order to improve question clarity. PLANSPONSOR included a link to our survey in an e-mail that was sent to approximately 60,000 of its subscribers. In addition, PLANSPONSOR promoted the survey eight times over 4 weeks between June 3 and June 28, 2013. A record keeper and one industry association also agreed to forward a link to our survey to their clients and members, respectively.

Fifty-seven sponsors completed our survey, and 25 of them provided contact information, indicating they were willing to speak with us. Forty- eight sponsors indicated that they offer managed accounts to their 401(k) plan participants, and 20 of these sponsors provided us with their contact information. Nine sponsors indicated that they do not offer managed accounts to their 401(k) plan participants, and five of these sponsors provided us with their contact information.

We reviewed the survey responses of those sponsors willing to speak with us and selected sponsors to interview based on the following characteristics:

Plan size (assets in the plan, number of participants)

Managed account provider

Enrollment method (Qualified Default Investment Alternative, or QDIA, vs. opt-in)

Length of time sponsors have been offering managed accounts To obtain a variety of perspectives, we selected at least two sponsors with any given characteristic to the extent possible. For instance, we selected several (1) sponsors of varying sizes in terms of the amount of assets included in their 401(k) plans and the number of plan participants; (2) sponsors that use different managed account providers; and (3) sponsors that have been offering managed accounts for more than 5 years. Also, we selected one sponsor that offered managed accounts as a default option. In total, we selected 10 sponsors that offer managed accounts and 2 sponsors that do not offer managed accounts, as shown in table 7.

We developed semi-structured interview questions to capture information on how sponsors learn about and select managed accounts, how they oversee managed accounts, and the advantages and disadvantages of managed accounts for participants. We developed separate questions for sponsors offering managed accounts and those not offering managed accounts. We shared the interview questions with three sponsors before we began conducting the semi-structured interviews to ensure that the questions were appropriate and understandable. We made no substantive changes to the questions based on this effort. We interviewed 10 sponsors that offer managed accounts and 2 sponsors that do not offer managed accounts. As part of our interview process, we also requested and reviewed relevant documentation from plan sponsors such as quarterly managed account reports from managed account providers or record keepers.

Participant Survey

As part of our approach for determining the advantages and disadvantages of managed accounts for 401(k) plan participants, we developed a non-generalizable online survey to directly obtain participant perspectives on managed accounts, such as the advantages and disadvantages of managed accounts for 401(k) plan participants and participants’ level of satisfaction with their managed account offering. However, we did not receive any completed responses to our survey. The survey was conducted on a rolling basis from August 1, 2013 to February 25, 2014—a link to the survey was distributed at various points in time.

We conducted this performance audit from October 2012 through June 2014 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives.

Appendix II: Methodology and Additional Results from Hypothetical Scenarios

Participant and Plan Scenarios

To understand the different strategies and structures of managed accounts, we developed and submitted five hypothetical participant scenarios in one hypothetical plan to the eight managed account providers chosen for our case studies. Table 8 shows basic information provided for the hypothetical participant scenarios 1, 2, and 3.

Table 9 shows the additional personalized information provided to managed account providers for hypothetical participant scenarios 1 and 3.

Table 10 shows some of the hypothetical plan level information we compiled for scenario development.

In addition, to generate hypothetical plan information, we selected 14 hypothetical plan investment options from various asset classes, as shown in table 11. We selected these mutual funds to represent a range of asset classes and based on available information from April 2013 about whether these funds could be found in 401(k) plans.

We developed the hypothetical scenarios based on data and information from industry representatives—including research firms, other industry groups, and providers—and a calculator and statistics provided by a number of government agencies. To assess the reliability of these data, we considered the reliability and familiarity of the source of the data or information and, when necessary, interviewed representatives of those sources about their methods, internal controls, and results. We determined that the data we used were sufficiently reliable for developing hypothetical participant- and plan-level scenarios.

Provider Responses

We asked all eight managed account providers chosen for our case studies to provide example asset allocations and advice, if practical, for all five hypothetical participant scenarios. Seven of the eight managed account providers completed and returned asset allocations to us for the hypothetical scenarios. Five of the seven providers who sent allocations furnished two allocations for each scenario, but each gave different reasons for doing so. One of the providers furnished two allocations for each scenario because they actively manage participant allocations given changes in market conditions and their allocations could generally range within the two extremes. Another provider furnished two allocations for each scenario assuming different initial holdings because, for that provider’s strategy, a person’s initial holdings of plan investment options influence the provider’s recommended allocations, even though both of these allocations have the same overall risk and return characteristics. In some of the figures presenting results of this work, we have included one or both of these two providers’ second allocations. For the other three providers we have chosen to only include one of their asset allocations in the figures presenting the results of this work because they did not pertain to managed account service by itself or they did not include the full services offered by the managed account. We did, however, incorporate the more general understanding we gained from these alternate asset allocations in our report findings.

In addition, a number of providers’ systems required that they make certain assumptions about participants outside of the hypothetical scenario information we provided. In these cases, the assumptions they made did differ, sometimes substantially, and this may have affected their asset allocation results. For example, to generate a participant’s goal, providers used varying assumptions of a participant’s annual salary growth—from 1.5 to 3.5 percent. We did not attempt to categorize or eliminate any inconsistencies in provider strategies, but instead report their results to show the variation that a participant may experience.

Additional Results

As shown in figure 13, the median values of all providers’ allocations show a downward trend in asset allocations to equity assets and an upward trend in asset allocations to fixed income and or cash-like assets as participants age.

For each hypothetical participant, we found that providers varied widely in their recommendations of specific investment options, but participants could be similarly allocated to asset classes, such as cash and cash equivalents, equity, and fixed income. For the hypothetical 30-year-old participant, select asset allocations were presented in the report at figure 5, and all allocations to specific investment options are shown in figure 14.

The results were similar for the 45 and 57-year-old hypothetical participants. Starting from an initial asset allocation of 55 percent equity and 45 percent fixed income, providers reported varying asset allocations to investment options for the 45-year-old hypothetical participant, as shown in figure 16, and allocations at the asset class level shown in figure 17.

Starting from initial asset allocation of 43 percent equity and 57 percent fixed income, figure 18 shows variation in allocations to investment options for the 57-year-old hypothetical participant and figure 19 shows variation in allocations at the asset class level.

Appendix III: Additional Performance Information from One Record Keeper’s Report

Appendix IV: Comments from the Department of Labor

Appendix V: GAO Contact and Staff Acknowledgments

Contact

Charles A. Jeszeck, Director, (202) 512-7215 or jeszeckc@gao.gov.

Staff Acknowledgments

In addition to the individual above, Tamara Cross (Assistant Director), Jessica Gray (Analyst-in-Charge), Ted Burik, Sherwin Chapman, and Laura Hoffrey made significant contributions to this report. In addition, Cody Goebel, Sharon Hermes, Stuart Kaufman, Kathy Leslie, Thomas McCool, Sheila McCoy, Mimi Nguyen, Roger Thomas, Frank Todisco, Walter Vance, and Kathleen Van Gelder also contributed to this report.