When plans compete for it, can employees win?

by Larry Heller

When it comes to tax-deferrable income, employees can win if their employer helps them understand the true value of each type of savings or coverage offered to them, depending on their financial situation and where they are in their career.

Distinguishing Factors

The chart below compares seven common plans. That comparison, plus company matching, use it or lose it provisions, investment performance, flexibility of distribution options, and differences in tax law can make one type of salary deferral more appealing than another. However, it is not only possible but also appropriate that the appeal of one plan over others will evolve over time for any given employee.

Choosing a Pre-tax Savings Hierarchy

At most ages and circumstances, paying for medical expenses generally comes first. These can be direct payments premiums for medical coverageor indirecta flexible spending account (FSA) or health savings account (HSA). Next will usually be some form of savings, often in a plan offering a company matchlong-term for retirement or nearer-term for education or home purchases. The challenge for many companies is communicating the right information to help their employees choose how deeply to invest in the plan(s) that make sense for them at the time. Ideally, employers should present this information in a way that facilitates easy and regular re-evaluation by employees of their contribution and premium options.

The Life-cycle View

Employees savings goals change as lives and careers progress. For instance, employees unburdened by homeownership, childcare, or high medical costs might be inclined to save the maximum matchable percentage of their pay in their companys plan. Employees accompanied by children and a mortgage or other debt often find saving for education, home purchase, retirement, and family medical coverage or elder care to be higher priorities. Of course, as employees reach their 50s and 60s, their own age-related increases in medical costs further affect their spending behavior.

Can More Options Affect Nondiscrimination Testing?

The concern about the magnitude of lower-paid employees 401(k) contributions (relative to those of highly paid) remains relevant. Is the plan already suffering from poor nondiscrimination testing results? Or is current publicity about HSAs steering lower-paid employees away from 401(k) contributions and creating new nondiscrimination tension? Conversely, if the lowest-paid employees are living paycheck to paycheck, are they justified in paying pre-tax premiums for current medical coverage but for little else?

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The changing scope of defined benefit outsourcing.

by Curtis S. Morgan

Once upon a time, the defined benefit (DB) pension plan system in the United States included a large number of plans fully cared for within the insurance marketplace. Insurance companies managed the investment of assets, provided draft or model plans, annuitized benefits upon retirement, and even took on mortality and investment risks post-retirement. Reporting and filing requirements, required communications to employees and retirees, and actuarial valuations were all included in the scope of the services.

However, several factors drove significant portions of the market away from these fully bundled approaches:

ERISA and subsequent regulations made design and operation of the plans more complicated and firmly ensconced the pension consultant as a plan sponsors trusted advisor.

The impact of asset growth and trust investment performance on plan and corporate bottom lines led many sponsors to pull away from insurance companies conservative investments, general funds, and investment and mortality charges. Companies also came to expect their own trusts to perform better than insurance company investment pools.

Declining purchase of defined contribution (DC) plans, growing scale of DB plans, and proliferation of lump-sum options in these plans eliminated the perceived need for insurance companies to assume the mortality risk (and to provide annuity products for DC plans).

The number of plans in the small and mid-sized market decreased dramatically, eliminating much of the insurance industrys market.

In the 15 to 20 years after the introduction of ERISA, most DB plan sponsors built their own infrastructures to support their growing plans. Internal staff typically used rudimentary programs to perform pension calculations for employees leaving or considering retirement. External actuaries provided plan design, compliance guidance, funding results, and certified annual government filings. Separate trustees and investment managers supported the growing trusts and ongoing benefits disbursements. This period was, perhaps, the high point of non-integrated administrative servicing. However, the DB plan was about to begin a migration back out of the halls of the plan sponsor and into integrated outsourced solutions.

Participant service technologycall centers, voice response, Web applications, and robust calculation engines and databaseschanged the pension system from one used to support former employees to an integral element in recruiting, retention, and retirement planning. Plan participants growing expectations of instant access to information, online transactions, and better support led to outsourcing.

Next came the financial reporting nightmares. In the late 1980s, DB plan sponsors became subject to separate financial accounting requirements. During the 1990s, plan assets generally performed well and plan sponsors enjoyed latitude with respect to financial assumptions. This allowed many plans to produce pension income for their sponsors and to continue to improve their funding levels. As long as these trends continued and participant service improved, the benefits department was often the hero. However, the heros welcome came to a dramatic end when the bad investment markets of 2001 to 2002 combined with low interest rates to produce higher reported liabilities on DB plan sponsors books.

Moving into 2005, we see a reversal of the disintermediation trend in the DB marketplace. Plan sponsors at all market levels are looking for providers to assume much of the plans management and devise strategies to minimize associated risks. But there are key differences between now and the days when insurance companies provided fully bundled services. For instance:

The number and type of providers have grown beyond the insurance companies. Other large financial players can offer the investment options and low investment costs that large employers may want along with continual monitoring of the investment mix versus investment policy.

Actuarial services, financial reporting support, audit support, government filings, and other plan management services are being reintegrated as added regulation and focus on financial reporting decreases plan sponsors discretion regarding assumptions and funding levels.

Outsourced administration has removed the plan sponsor from most interactions with plan participants. Communication requirements are integrated into the providers overall administrative solutions. Fully automated electronic solutions continue to replace costly paper and labor-intensive processes.

For many of the remaining (and declining number of) DB plan sponsors, outsourcing many of these interactions to as few providers as necessary is increasingly compelling. In the future, more plan sponsors will retain only the true basicsplan design decisions, plan funding responsibility, and vendor management.

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Case Study: Pharmacy benefit management can be the perfect prescription for improved benefits services.

by Jake Murdock

Like many health plans, Deseret Mutual has been facing increasing challenges presented by dramatic rises in the use and cost of specialty drugs. Several years ago, we realized the need for an improved system of managing specialty pharmacy benefits to better control costs and provide a higher level of clinical care support for members who use specialty medications. In choosing a pharmacy benefit manager (PBM) as our specialty drug provider, we found a partner whose experience and capabilities are helping us achieve that goal.

When we began developing our specialty pharmacy strategy, Medco Health Solutions offered consultative support that helped us understand the current state of Deseret Mutuals specialty pharmacy spending and utilization among our plan members. Historically, Medco managed all of Deseret Mutuals pharmacy benefits. When we asked them to look into specialty pharmacy benefits, they were able to provide an analysis of specialty pharmacy spending across our pharmacy and medical plans to give us an increased understanding of the specialty pharmacy challenge. We created a comprehensive plan to align coverage of specialty medications across Deseret Mutuals medical and pharmacy benefits and to provide new services through Medcos Special Care Pharmacy program.

The extraordinary expense of specialty drugs makes proper management essential to ensure that patients who need these treatments receive them, while having systems in place to prevent potential underuse, overuse, and waste of these medications. By selecting a PBM with vast experience in utilization management, Deseret Mutual was able to ensure that the same tools used to control utilization of traditional pharmaceutical products would also apply to managing specialty drugs. This includes prior authorization, step therapy, and product selection strategies. By working withour PBM, Deseret Mutual is better able to identify those members that will truly benefit from specialty therapies and those that may benefit from a more cost-effective therapy.

Deseret Mutual realized significant savings by requiring that select specialty drugs be dispensed through the PBMs specialty pharmacy. By doing so, we have been able to bring consistency to the pricing and utilization management of specialty drugs under the pharmacy benefit without compromising the services and quality of care available to members.

Controlling costs is a major concern, but equally important to Deseret Mutual is a specialty pharmacy that can provide the most comprehensive clinical care for our members. Medco offers the advantage of being able to look across a patients entire prescription drug profile and find out if traditional or specialty drugs are being used. This is particularly important for specialty patients, who are often also prescribed traditional medications for conditions associated with a disease that requires specialty treatment.

There are additional advantages to having all our pharmacy services provided under one roof. Through Medco, we are able to offer a coordinated approach to managing all of a members pharmacy needs. Having a single point of contact makes the system much more streamlined and less complicated for both physicians and patients. Physicians can order both specialty and traditional medications from the same source, and, at the same time, obtain comprehensive patient prescription information while qualifying the member for coverage under prior authorization. This coordinated system also improves patient careour PBMs specialty pharmacists and nurses work closely with Deseret Mutuals case managers to coordinate patient support services.

Administration for all out pharmacy benefits is also simplified by working with a single point of contact. When using stand-alone specialty pharmacies, plans must often manage multiple specialty pharmacies in order to provide members access to the wide array of specialty products in the market today. Many of these niche specialty pharmacies focus only on a limited number of conditions or products. However, our PBM gives us access to the services and drugs needed to provide our members with a comprehensive specialty drug benefit plancreating a much more efficient system that has helped us reduce administrative time and costs associated with specialty benefits.

Deseret Mutuals experience shows that by working with a PBM that offers specialty benefit management services, we can provide members using specialty medications with high-quality care in a cost effective manner.

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Passive enrollment may be automatic in many ways, but it still requires action.

by Maria J. Petrino, Larry Heller

The concept of passive enrollment appeals to many 401(k) plan sponsors. Surveys show an increasing number of sponsors adopting this approach also referred to as automatic or negative enrollment. Passive enrollment is essentially the opposite of conventional enrollment, where employees do not make any contributions to their company’s 401(k) plan until they submit specific instructions. Passive enrollment allows the employer to automatically enroll employees into its 401(k) at specified contribution and investment percentages immediately upon hire or upon meeting eligibility requirements. These specified (default) percentages remain in effect until the employee instructs otherwise. Passive enrollment has the potential to benefit both the employer and the employee. But there are communications requirements and pitfalls worth avoiding that plan sponsors should note before implementing.

With all employees contributing (at least upon their initial eligibility), the plan will likely produce more favorable nondiscrimination test results. Meanwhile, employees may come to appreciate that salary deferrals are an easy way to save for retirement, without having a significant effect on take-home pay.

However, there are potential downsides. Its automatic nature may confuse some employees as to their options for changing the default contribution and investment percentages. Others will question whether the plans default investment options take the proper amount of investment risk (perhaps too little for younger employees or too much for older ones). Furthermore, IRS Revenue Ruling 2000-8 requires that, upon hire, the plan administrator must advise all employees affected by passive enrollment of the following:

• the default salary deferral percentage automatically applicable to their pay (typically 3% or 4%);
• their ability to change the initial default contribution, and specifically how and when to do so; and
• their right and the timeframe to opt out of making contributions altogether (meaning a change to 0%).

The plan administrator must provide similar notifications annually to all employees who remain in a passive enrollment status i.e., those who never revised the defaults initially applied to their contributions.

The Revenue Ruling sets these requirements only for the contribution percentage aspect of these automatic contributions, not for their investment. But these notification requirements present an excellent opportunity for the plan sponsor to highlight the plans investment options. This is especially true since plans with a passive enrollment provision must provide at least one default investment fund usually either fixed income or low-risk equities until the employee specifies otherwise.

When exercising passive enrollment, the employer loses some of ERISA Section 404(c)s protection against participants legal action, because the Department of Labor views default investment elections as the employee not having exercised control over their account. Therefore, while reinforcing the long-term benefit of plan participation, salary deferrals, and (where applicable) the company match, the plan sponsor may want to include additional advice to employees about their passive enrollment process, such as:

• the default investment fund(s) that will apply to their contributions;
• the funds available in the plan and how to transfer from the default investment fund;
• procedures and timeframes for changing investments;
• the value of assessing their personal financial situation and risk tolerance, and how to do so; and
• how and where to obtain more information on the plans investment options.

In short, initial and ongoing employee communications about passive enrollment is far from a passive exercise for the plan sponsor and the plan administrator. However, passive enrollment can consistently yield higher participation levels if plan sponsors think carefully and innovatively about how to weave it into the plans overall design and administration.

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An occasional review of its moving parts is usually a good idea.

by Larry Heller

Recent scandals — ranging from questionable timing of stock trades to questionable communications to employees about the stability of their 401(k) plan investments — have brought to light a truism that benefits consultants have been gently sharing with plan sponsors for a very long time. Once in a while, just like you and your car, even the most uncontroversial of DC plans needs a check-up.

In technical terms, this check-up would ask, “Are you adhering to your fiduciary responsibilities to plan participants?” In plain English, it asks “Have you or anyone else looked lately to see how your plan’s administrators — i.e., your payroll system, recordkeeper, trustee, and anyone else with their hands on your plan’s data and/or its assets — are doing their jobs?”

Although plan sponsors typically think first of reviewing investment products, the operational review these questions suggest, sometimes called an “audit” (though not at all an accounting function), warrants attention and explanation. Such a review is often inspired by one of three general circumstances:

1. preparation for an impending merger or acquisition, where the acquiring or controlling entity wants to confirm the operational stability of what it’s taking on;
2. response to one or more major, visible breakdowns in, for example, recordkeeping accuracy, communications, payment timing, etc.; or
3. responsibility of management (recognized, documented, and legally required) to monitor the benefits and related services provided to employees, even if nothing in particular has apparently gone wrong.

In other words: this exercise can be defensive, reactive or proactive, any of which is better than it being nonexistent.

There are many behind-the-scenes administrative aspects to DC plans. Some are very technical and some, rather mundane. The failure of any one of them can escalate into costly customer service problems, potentially with legal implications. The fundamental objectives of any operational review are almost always to confirm that:

• the day-to-day operation of the plan is in keeping with its rules (i.e., what is written in the plan document, any formal administrative documentation, SPDs, and any other formal employee communications); and
• no aspect of the plan’s operation is out of compliance with federal law (e.g., IRS contribution and pay limits, permissible hardship withdrawal circumstances, etc.).

While collecting and assessing an adequate variety of tell-tale participant test cases and plan-wide data and documentation to meet those two primary objectives, you might also want to confirm, for example, that:

• participants’ accounts are accurately updated with appropriate investment results;
• deposits into plan assets are correctly timed in relation to corresponding payroll deductions or participants’ instructions;
• the timing and amount of payments to plan participants properly relate to their submitted requests;
• generic and personalized communications regarding any particular transaction — whether on paper, a Web site, or an automated telephone voice response system — are accessible (and helpful) to current and former employees and beneficiaries as soon as they are first eligible to make the transaction or state an interest in doing so; and
• statistical reports provided to benefits management on plan utilization and customer service activity are accurate and informative.

Even if you didn’t have contracts or service level agreements with your administrative service providers, wouldn’t you want an objective appraisal of at least how these aspects of your plan’s operations are working, if not a more in-depth review of data management and customer service? It’s true that technological advancements and growing industry-wide expertise have rightfully led the DC plan administrative function to be taken for granted by many (think “commodity”). However, imperfections in any of the functions listed above can and still do spawn from payroll data problems, complex plan design, and customer service overload.

If identified, these imperfections would not necessarily lead to plan qualification or compliance issues (although they could). But any of them could be signs of potential or actual administrative breakdown and, possibly, someone’s failure to meet their fiduciary obligations to plan participants. If that is happening, or if significant required documentation (or charters or policy statements) turns out not to exist, wouldn’t you prefer to know that sooner rather than later?

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