Wrestling For The 401(k) Purse
It's the battle royal of retirement. Last August, Congress passed the Pension Protection Act, which encourages companies to sign up employees for 401(k) plans automatically. Since then, mutual fund firms and insurers have been clashing over which investments should get the Labor Dept.'s stamp of approval.
A lot's at stake. Roughly a third of eligible employees don't participate in their 401(k) or other defined-contribution plans. The new rules, designed to combat that inertia, could bring investment managers an extra $90 billion in retirement assets—and the annual fees generated by that business.
At issue in the regulation are the default investment options. Washington will decide what those products can be. And because many employees, whether they sign up for the plan or their employer does it for them, stick with the default options, the biggest windfall is likely to go to the firms managing those investments. "This is an industry food fight, with the mutual funds saying 'I want it all' and insurance companies saying 'I want in,'" says former Federal Reserve economist Alicia H. Munnell, who runs the Center for Retirement Research at Boston College.
For now, mutual fund companies have the edge. In its original proposal, the Labor Dept. O.K.'d just three categories: balanced funds, target-date funds, and investment pools, all of which typically own a mix of stocks and bonds. Such portfolios are the bread and butter of Fidelity Investments, T. Rowe Price (TROW ), and other mutual fund shops, which manage 25% of the nation's $16.4 trillion in retirement assets.
Meanwhile, the early version of the regulation snubbed stable-value funds, insurance vehicles filled with high-quality bonds and other interest-bearing securities. It was a blow to insurers. Until now, stable-value funds, which guarantee principal and interest, have been the go-to choice for companies with automatic enrollment plans. The funds accounted for $413 billion in retirement savings last year—money that may shift to the mutual fund industry if stable-value funds don't make the final list or default options in existing plans don't get grandfathered in. "Previously, there was no reason for the plan sponsor to take any risk, even if it was better for the investor," says Peng Chen, president of Chicago research firm Ibbotson Associates.
But the Labor Dept., which has been developing the final rules, thought investors needed a little extra juice in their retirement portfolios. "It is unlikely that the returns of [stable-value] funds will be sufficient to generate adequate retirement savings for most participants or beneficiaries," the Labor Dept. wrote in its initial proposal, asserting that stable-value funds were little better than holding cash. It's a sentiment echoed by many academics: "The insurance industry is talking about a total riskless investment," says Peter Wallison of the American Enterprise Institute, a think tank. "But it can actually be harmful to investors over time."
That's why rulemakers initially opted for default options with a healthy dose of equities. According to fund tracker Morningstar, balanced funds, which invest in stocks and bonds, have returned as much as 9.7% a year since 2004, depending on the mix. So-called target-date funds, which usually give investors exposure to domestic and international equities as well as bonds, base the allocation on the investor's retirement age. The most aggressive, which typically has an 85% stake in stocks, gained 12.4% a year over the past three years. "Labor got it right the first time," says Paul Schott Stevens, president of Investment Company Institute, the mutual fund industry trade group. "Young workers shouldn't be encouraged to stick their money in a mattress."
Still, proponents say stable-value funds make sense for conservative investors. The funds have gained 5.5% a year since 1997, with little volatility according to research firm Hueler Cos. "They may not be right for all employees, but they should have the choice," says Stable Value Investment Assn. President Gina Mitchell.
The fight has intensified since Labor sent its revised rules to the Office of Management & Budget for approval on July 11. It's unclear whether the latest draft has changed much from the first. But in a last-ditch effort, lobbyists and top executives from MetLife, (MET ) John Hancock, and the American Council of Life Insurers pleaded with OMB to scrap the new rules altogether, arguing that the economic analysis used in developing them was flawed.
Most sources close to the action figure the insurance industry won't triumph in the end. But given the financial markets' recent swings, its voice may yet be heard.
By Dawn Kopecki