Small firms’ pension pitfalls
Bill Korth thought he was getting a bargain when he hired an insurance company to run the retirement plan for workers at Vernon’s Maas-Hansen Steel Corp.
The family-owned steel supplier was paying a bank $30,000 a year to manage the plan, which now has 95 participants and $14 million in assets. When Principal Financial Group offered to do the work for no charge, Korth eagerly accepted.
Three years later, he wishes he’d left well enough alone. The company has found itself stuck with the bulk of its retirement assets in a poorly performing fund and handcuffed by restrictions that made transfers impractical, he says.
“There have been too many roadblocks that they didn’t disclose to us,” said Korth, Maas-Hansen’s vice president of finance. “We have a reputation of taking care of our customers through thick and thin, and we expect the same treatment.”
Independent retirement experts say the company’s experience illustrates the challenges that small businesses face in running retirement plans. These plans often are complex, and unlike larger companies, small employers typically lack the time and expertise to understand their intricacies.
“It’s a lot tougher for small employers because they don’t have the resources,” said Rick Blain, a 401(k) consultant in Orange County’s Trabuco Canyon. “They don’t know who to trust or who to go to. Their focus is on running their business.”
Their size works against them in other ways. Vanguard Group, which made its reputation on low-priced mutual funds, generally won’t manage corporate retirement plans with less than $10 million in assets, said Gerry Mullane, head of 401(k) sales at Vanguard.
Employees at small companies may consider themselves lucky just to have a retirement plan. Of the 66 million people who work for companies with fewer than 100 workers, only 32% have employer-provided retirement plans, according to the Employee Benefit Research Institute in Washington.
At the smallest companies -- those with nine or fewer workers -- only 15% have retirement plans. That contrasts with 70% of employees at companies with 1,000 or more workers.
Like larger employers, small companies typically farm out management of their retirement plans to mutual fund companies, employee benefit firms or insurance companies.
Retirement experts say there are advantages and disadvantages to each of those three options. Plans run by insurance companies, however, often are burdened by two features that critics say saddle workers with extra costs.
First, insurer-run plans are often structured as group annuities, which are insurance-based investment contracts. Insurers say group annuities benefit participants because they can easily be transferred to individual annuities upon retirement. But critics say group annuities are expensive and difficult to understand.
For example, the total fees that workers pay sometimes aren’t listed in one place in the annuity contracts, said Parker Payson, executive vice president of Employee Fiduciary Corp., a 401(k) administration firm in Mobile, Ala.
Second, insurance plans are known in the industry for the lucrative commissions they provide to brokers, industry experts say. Mutual funds may also be sold by brokers, but insurers often pay full commissions upfront on multiyear 401(k) contracts -- a big enticement that mutual funds generally don’t offer, said David Wade, president of 401(k) Direct Inc., a record-keeping and consulting firm based in Agoura Hills.
The promise of rich commissions can lead brokers to recommend plans that may not be the best for employees and time-strapped small-business owners, who usually are too busy to scrutinize the details, said W. Waldan Lloyd, an employee benefits lawyer in Salt Lake City.
“The insurance company holds all the cards,” Lloyd said. “They are the financial sophisticate and know what they’re doing. The small employer is just busy making widgets. He’s relying on the person across the table who’s selling him the contract.”
The insurance industry rejects such characterizations, saying its broker-driven model provides top-notch service at fair prices.
“There are plenty of insurers getting 401(k) business in a competitive market going head-to-head with mutual funds, and I don’t believe they’d be getting that business if they weren’t providing good value for the prices they charge,” said David Wentworth, vice president of research at the American Council of Life Insurers.
Korth has a different point of view.
Maas-Hansen, which sells steel to home appliance makers and furniture manufacturers, managed its retirement plan in-house until 2000, when Korth said concerns over stock market volatility and fiduciary responsibility prompted executives to seek professional help.
Maas-Hansen has a profit-sharing retirement plan in which the firm makes an annual contribution equal to 15% of employee salaries. Profit-sharing plans are similar to 401(k) plans, but in profit-sharing plans employers make all contributions on behalf of workers. In 401(k) plans, employees set aside a portion of their own earnings, often with a match from their employer.
The company hired Union Bank of California in 2000 to run the plan, and Korth said he was satisfied until the broker who handled Maas-Hansen’s workers’ compensation insurance policy suggested that the company could save money by hiring Principal Financial Group to handle its retirement plan.
By focusing on small and mid-size employers, Principal has become one of the nation’s largest providers of employee-funded retirement plans. Although Principal was founded as a life insurer in 1879 and still runs a large insurance operation, the retirement business generates the bulk of its profit, according to regulatory filings.
Korth hired Principal in 2003 after being enticed by its promise not to charge Maas-Hansen the $30,000 a year that the steel supplier was paying Union Bank.
“That’s too much to ignore,” Korth said.
Just as important, however, was Principal’s agreement to include a type of stable value fund as an investment option.
Money in this fund is invested in interest-paying government and corporate bonds, and the insurance company provides a guaranteed rate of return -- important features at a company where the average worker age was approaching 50, Korth said.
Nearly 80% of the participants’ assets were invested in the stable value fund. But problems arose when Principal lowered the guaranteed rate on its fixed-income fund to 3.4% for the first six months of 2006, down from 3.5%. Each rate guarantee lasted for six months.
That seemed odd to Korth given that market rates were rising, and he was shocked when Principal later cut the rate for the second half of the year to 3.3%.
Korth compared that with rates paid by bank certificates of deposit, some of which currently top 5%.
“They’re out and out ripping us off for the next six months,” Korth said.
Principal refused to explain its rationale for lowering Maas-Hansen’s rate, he said.
The worst part, Korth said, came when he asked Principal to replace the stable value fund with a money market fund. Such funds were then yielding more because interest rates had risen.
Principal initially said Maas-Hansen couldn’t switch funds for 12 months, Korth said. After he objected, Principal agreed to add the money market fund to the plan. But it barred employees from transferring money directly between the two funds. They first would have to move the money for at least 90 days into a fund invested in stocks -- a riskier investment than bonds, because stocks are subject to steep market downturns.
“It’s totally ridiculous,” Korth said.
Principal declined to discuss the Maas-Hansen account but referred to a survey by Boston Research Group, in which Principal ranked third in customer satisfaction among 22 retirement plan providers.
Employers “who want our level of quality, service and long-time commitment to the marketplace recognize the value they get for the dollar spent,” the company said in a statement.
Industry supporters say insurers have to impose such delays to protect themselves against losses. When interest rates rise, as they have generally done in the last year, the value of the underlying bonds falls. So insurers want to wait until the bonds mature, rather than risk a loss by selling them immediately.
“This is not a case where the plan provider is trying to take advantage of the plan participants,” Wentworth said. “This is just dealing with the economic reality of how the bond market works.”
In trying to figure out what went wrong, Korth found a Principal document disclosing that dropping the stable value fund required either a 12-month advance notice or the payment of a 5% surrender charge. Nevertheless, Korth feels duped.
The Principal representative, whom he declined to name, never mentioned the pitfalls and left the impression that the company would work to correct any problems or misunderstandings that arose, Korth said.
“They presented it to us as everything is going to be good,” Korth said, “and we find out two or three years later that the product is not what we thought.”
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Tips for employers
Experts say small-business owners should take the following precautions when hiring companies to run their retirement plans:
* Review offers from several plan providers. The broker who sets up a company’s health insurance plan may not be the best person to advise it on a retirement plan.
* Require each firm to provide
a detailed accounting of how
much employees will pay in administrative fees, mutual fund expenses and any other costs. Plans are never truly provided free; overhead costs often are taken out of employee accounts.
* Hire an attorney specializing in retirement plans to review contracts and agreements.
* Ask brokers how much they are being paid and whether they get additional compensation by recommending certain providers, funds or investments.
* Consider hiring fee-based consultants, who do not receive commissions. Initial costs may be higher, but plan participants might save money in the long run.
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Source: Times research
