Governmental employee retirement savings do not have the same protections as employees in the private sector.
Over 20 million Americans are employed by state and local governments. United States Department of Labor, Bureau of Labor Statistics. These numbers include teachers, police officers, and social workers; in effect, they are public servants. This blog will focus on some unique risks facing the retirement assets of these public servants.
There is increasing evidence that service providers use access to retirement plan participants as a source of revenue and an opportunity to sell a range of retail financial products and services (such as annuities and managed accounts). See Fiduciary Lawsuits: A New Chapter Opening? To date, much of the focus on these practices has been on ERISA-plans; however, plans covering governmental employees represent a special risk that is often overlooked.
ERISA sets the “gold standard” for retirement plan fiduciaries. ERISA contains a detailed listing of fiduciary obligations. These obligations — coupled with numerous fiduciary lawsuits based on ERISA’s requirements — have spurred plan sponsors and outside fiduciaries into taking ERISA’s requirements seriously. Additionally, the expertise needed to comply with ERISA has given rise to an industry of independent plan fiduciaries available to provide outside expertise to ERISA plan sponsors.
But, ERISA does not apply to governmental plans. Whether for political or constitutional reasons, Congress has excluded governmental plans from all aspects of ERISA, including the fiduciary provisions. This has both direct and indirect consequences:
• Governmental plan sponsors and administrators are simply not under the same legal obligation to monitor plan recordkeepers and other plan providers. Although states may have their own fiduciary standards (and, indeed, some states seek to apply ERISA standards to state plans), state-based fiduciary requirements simply lack the “heft” of ERISA’s obligations.
• The threat of fiduciary litigation is missing in the governmental plan space. The plaintiffs’ attorneys who bring these cases rely on the well-established body of law under ERISA as a part of their calculus in determining whether to bring a (contingency-fee based) lawsuit. It is a “safer” bet for these attorneys to focus their cases on ERISA plans. Accordingly, please note that there are no state universities included in any of the fiduciary lawsuits brought in recent years against numerous colleges and universities.
And so, the fundamental fact is that participants in governmental plans do not receive the same fiduciary protections as employees in corporate or private, non-profit plans.
Whose Money is it Anyway?
Governmental plans are subject to other factors that exacerbate the gap left in ERISA:
• Historically, governmental DC plans were voluntary, supplemental plans. This means there were no employer contributions and the only contributions were employee, unmatched deferrals. This reinforced the narrative that plan sponsors’ responsibility to oversee these plans is somehow reduced–after all, there, is no employer funding at stake.
• Plan providers (such as recordkeepers) provide valuable administrative services for plan sponsors, such as employee education and enrollment support. And these plan sponsors, with limited administrative resources, are glad to get the help. As a result, plan administrators may not be eager to investigate practices that generate revenue for the provider for fear of disrupting providers’ services to the plan participants.
• Governmental employers must also deal with budgetary and procurement limitations. Retaining outside experts to monitor plan providers – particularly in a voluntary, supplemental plan- may simply not be a budgetary priority for these plan sponsors.
A Shifting Status Quo
Defined benefit plans for state employees have been a hot-button issue for years. Critics of these plans claim they are too expensive and traditional design features (such as annual cost of living increases and early retirement subsidies) do not represent a good use of public resources. Defenders of these plans note that pensions are an appropriate component of the total compensation package for public servants with dangerous work (police and firefighters) or who accept lower pay to engage in noble professions (teachers and social workers). Also, as noted by the Brookings Institution approximately 25% of state and local government employees (including 40% of public school teachers) are not covered by Social Security.
However, both critics and supporters of governmental pension plans have been focused on the financing of these plans. According to the Pew Charitable Trusts, state pension funds cumulatively reported a $1.4 trillion deficit—representing disclosed assets of $2.6 trillion to cover total pension liabilities of $4 trillion. And although there are differing perspectives on the source of this deficit (intentional state underfunding vs unaffordable programs), it is reasonable to assert that defined contribution plans for governmental employees are going to play an increasingly important role in the future.
At this point it is not clear what role DC plans will play for state and local government employees. In recent years, state and local governments have taken a variety of approaches: some states (Michigan and Alaska) have replaced their DB plans with DC plans for new hires, while others (such as Georgia and Virginia) have added matched savings plans to accompany revised DB plans.
Fish in a Barrel?
For the historical reasons discussed above, outside commissioned salespeople (including broker/dealers and insurance agents) play an outsized role in counseling state and local government employees. These salespeople have significant economic incentives to promote retail, commissioned products and little obligation to advance participants’ best interests. https://blog.retireaware.com/2018/05/31/dancing-on-the-head-of-a-pin/ And, this lack of oversight is costly; these fees and commissions can cost governmental employees tens of thousands of dollars over the course of their careers. https://www.sec.gov/investor/alerts/ib_fees_expenses.pdf Moreover, these salespeople utilize their access to governmental employees (through the DC plan) to encourage lump sum payments (where available) and rollovers from defined benefit plans.
These comments are not meant to unfairly lump together all providers and financial advisors who support governmental plans; there are some fiduciaries (and non-commissioned investment advisors) serving this market who understand the risks posed to governmental employees and offer services (and fees) that better protect the interests of these public servants. The governmental plan market needs more advisors and planners who are not financially incented to sell investment and insurance products.
Regardless of your position on about what to do about governmental pension plans, it is vitally important that state and local governments should take more steps to protect the integrity of employees’ retirement savings. These are funds generated by taxpayer dollars and employee contributions; they should be used for public servants’ retirement and not “leaked” out of the system in the form of fees and commissions.