The Issue

Asset allocation models (AAMs) take many different forms. Some AAMs are considered designated investment alternatives (DIAs) of the plan while others function as a service that enables participants to allocate among the plan’s DIAs. In either case, the responsible plan fiduciary (i.e., the plan sponsor or plan committee) has a fiduciary duty to prudently select and monitor the AAM and therefore, needs to understand how the AAM functions.

The Solution

This article discusses how RIAs can assist plan sponsor clients in carrying out this fiduciary duty by developing selection and monitoring criteria for AAMs in the investment policy statement (IPS).

Analysis

Under ERISA, the plan sponsor must engage in a prudent process in the selection and monitoring of plan investment options. If an AAM is a DIA, then this same prudent process applies to the selection and monitoring of the AAM. This means that the plan sponsor needs to evaluate the AAM’s asset classes (e.g., stocks, bonds, cash), the underlying investments held by the AAM and the principal strategies and risks of those investments. Also, the plan sponsor needs to understand the fees and expenses of the AAM, including the expense ratios of the individual component funds. RIAs can assist the plan sponsor in performing this evaluation by developing criteria and guidelines that take into account these factors. These guidelines should be reflected in an IPS to support the plan sponsor’s prudent process. Although there is no specific requirement in ERISA that a plan have an IPS, it is a best practice to have one -- as long as it is followed.

AAMs that are DIAs are subject to detailed participant disclosures about expense ratios, performance history, portfolio turnover rates and more. In our experience, most RIAs do not object to presenting this detailed investment information, but many recordkeepers do not have the systems in place to capture and report it. For this reason, many RIAs are structuring AAMs in a way that is intended to avoid DIA status.

DOL guidance indicates that, to avoid DIA status, an AAM must be clearly presented to participants as an investment service that helps participants allocate their accounts among the plan’s DIAs. Also, it must have the following characteristics:

  • It cannot use investments that are not in the Plan’s line-up of DIAs;
  • It cannot be unitized – meaning that it does not have its own trading value and operate like an investment

The DOL guidance further indicates that to avoid DIA status, the plan must provide participants with an explanation of how the AAM functions and how differs from the plan’s DIAs. The plan sponsor has a fiduciary responsibility to prudently select an AAM service that is appropriate for plan participants. Also, the plan sponsor must understand how the AAM service will be presented to participants - i.e. through a website, on an election form, etc. - and the characteristics that impact the way the AAM service will function so that it can be adequately described to participants consistent with the DOL guidance. For instance, many AAMs have a re-balancing feature that restores the participant’s account to its original allocation. Also, if one or more of the underlying DIAs are replaced, this could impact the status of the AAM. These features must be described to participants, so that the participants can determine whether to use the asset allocation service.

RIAs can assist plan sponsors in carrying out these fiduciary responsibilities by developing guidelines that can be reflected in the IPS to support a prudent process in selecting the AAM service. These guidelines should also include an evaluation of factors that impact the functioning of the AAM service (e.g., rebalancing, DIA replacement) and the fees charged in providing the service to participants. Also, the IPS description of the AAM service should be consistent with the description provided to participants.

In conclusion, RIAs can add real value by developing IPS guidelines that plan sponsors can follow in selecting and monitoring AAMs to support the plan sponsor’s prudent process.