Delay in Effective Date for Regulations Under Section 403(b)

From the IRS:

WASHINGTON —The Internal Revenue Service announced today that the general effective date for the regulations regarding section 403(b) arrangements that were proposed in 2004 (including the related controlled group regulations under section 414(c)) will be extended.

In order to provide employers, employees, insurance carriers, and mutual funds involved in section 403(b) arrangements a reasonable advance period before the regulations go into effect, the final regulations generally will not be effective earlier than January 1, 2008.

Effects of Expense Subsidies

Jeb Graham CEBS, CIMA® of CapTrust Financial Advisors has written an excellent article at 401khelpcenter.com on plan fees. The article can be read at:

http://www.401khelpcenter.com/401k/graham_stable_value.html

Preliminarily, he focuses on stable value fund economics. Stable value fund is such a loose term that different stable value funds may be invested in different asset types and may have different expense structures. Expenses may not even be fixed in amount or by a formula.

The more essential point made by Mr. Graham is that fees that are not disclosed, but are instead applied to reduce the expenses of plan administration through, e.g., sub-TA fees, are inevitably allocated unfairly.

For example, suppose two employees invest the same amounts in different funds, and one has an expense total of $100 while the other has an expense total of $200. Because the extra expense of $100 reduces the second participant's income, the plan and that participant are bearing that cost, which may or may not be reasonable. If the extra $100 is, instead, paid to the plan’s TPA, then (a) the extra is clearly not needed by the investment provider to operate the investment, (b) the use of the extra money to reduce plan administration is needed to restore fairness to the plan, and (c) the second participant, by selecting the more expensive investment, is subsidizing the operations of the plan.

If the plan’s sponsor would otherwise pay the extra $100, because the sponsor pays the plan administration fees, then there is an indirect benefit to the sponsor of $100. This may constitute a prohibited transaction under §4975 of ERISA §406, although since the effect is to pay for plan administration, and plans are allowed to defray administration expenses, it should not be a prohibited transaction, or at least not a violation of the exclusive benefit rule.

If the plan receives a subsidy from the investment provider and uses it to reduce total plan administration expenses paid by the plan, then the plan as a whole is treated fairly but there is, in effect, a subsidy of the first participant who invested in the lower-expense investment by the second participant who bore higher expenses that now reduce everyone else’s costs.

To eliminate the subsidy from one set of participants to another, the plan would have to apply the subsidy it receives to reduce the expenses only of those participants who invested in the higher-expense investment.

But look at the result of doing so. If the participant bears the higher expense through reduced investment yield, then gets it back through an expense reduction, the whole exercise is pointless. That is, the investment provide‚’s setting up of the arrangement only makes sense if it is not returned to the participant who bears the expense.

The only reason to jump through the hoops needed to create the arrangement is to use the money to influence the behavior of the plan or its advisers in the fund selection process. (To encourage use of the investment by participants, the best approach would be to eliminate the extra fee and have a higher product yield.) If the subsidy is created to encourage sales outside of employee benefit plans, and a full rebate is made, the arrangement may be defensible, although the plan needs to know about the subsidy to decide if it should be specially allocated. Otherwise, defending such an arrangement cannot be much fun.

What's Not a Top-Hat Plan

A thank you to PlanSponsor for finding Guiragoss v. Khoury, E.D. Va., No. 1:06vy187, 8/10/06, a case determining that a plan was not a top-hat plan exempt from ERISA. Unfortunately, the case is not all that useful, as is true of most cases on top-hat plan status. At least it makes clear one way to screw up top-hat status.

The plaintiff and sole participant was a clerk for the employer jewelry store, so the result is hardly surprising. Some of the language is troubling, saying "Guiragoss had no influence on the terms of the agreement and never consulted with an attorney prior to signing the agreement." Both of these statements are true of most top-hat plan participants, which is why the language is troubling. With any luck, and because this is a District Court decision, future courts will ignore that language and focus instead on the participants'' bargaining power, or lack thereof, rather than whether there was any actual bargaining.

A Reminder About Moral Hazard

There is an interesting post at http://www.bostonerisalaw.com/, the blog of Steven D. Rosenberg of the McCormack Firm in Boston relevant to reviews of claims decisions by benefit plan administrators. Those of us who do not subscribe should thank Mr. Rosenberg.

The post refers to a New York Times article that says, essentially, that some people who receive disability benefits don't go back to work when they could. No professional who has worked with plans that offer disability benefits, including LTD, STD, subsididized disability benefits under defined benefit plans or vesting up defined contribution account balances on disability, is surprised by this statement. Nor is any worker's compensation lawyer on either side. All one really has to do is notice (1) that the word "lie" exists and is frequently used, and (2) the statement that "Money is the root of all evil."

A disproportionate number of cases on reveiw standards under ERISA relate to subjective, non-verifiable symptoms, and particularly reported pain. Insurance companies are used to people who lie, but many of the cases appear to we cynics to, in essence, find some reason to reduce the deference given to the plan administrator, ignore the possibility that the, e.g., reviewing physician simply thought the claimant was lying, and take the claimant's word.

The response to this is (1) to be explicit when credibility affects a decision, and (2) to use experts and/or research to remind the court that the concept of moral hazard has always been a core component of insurance economics, not a novel way of arguing for deference to plan administrators under ERISA.