Qualified Default Investment Rules
May Spark Legal Action

CHICAGO, Oct. 3 /PRNewswire/ -- U.S. workers will have legal recourse against Plan Sponsors when, at retirement, they are left with insufficient balances in their 401(k)s because their Plans were defaulted into Formulaic Asset Allocation (FAA) funds, (Lifecycle, Target Date, Managed Accounts), according to the Chicago-based research organization, Compass Institute, LLC.

Under the Pension Protection Act of 2006, employers can default employees into qualified funds based on the fiduciary's recommendation for a prudent investment choice. Currently approved Qualified Default Investment Alternative (QDIA) funds include Lifecycle, Target Date and Managed Accounts. It is expected that investments in these traditional FAA funds will balloon as a result of this rule. But in a recently issued report by Compass, empirical research irrefutably proved that the FAA investment strategy must fail, leaving retirees impoverished.

"Our empirical research -- covering years of data -- shows that FAA investing leaves retirees with long-term average annual returns (AAR) of 6.4% over market cycles," Compass Institute senior vice president Elliot Fineman said. "That is nowhere near the long term 12% AAR over market cycles that retirees need to earn on their 401(k)s in order to have sufficient funds at retirement."

As a result of the rule change last year, Plan Sponsors are now at risk for litigation if retirees ask why their 401(k) funds were defaulted, guided or had advice made available that was doomed to fail them based on publicly available research. Participants will also want to know why Plan Sponsors did not guide them to successful alternatives that were known to be available. In the past, these kinds of disagreements would not have been played out in a court of law.

"Good fiduciary practice requires that plan fiduciaries assess all emerging issues that may impact their plans and participants; the recent 401(k) fee litigation is a very high-profile example," said Sally Doubet King, partner in the Chicago office of McGuireWoods LLP where she specializes in compensation and employee benefit issues.

Because the Compass Institute research has shown definitively that FAA investing is a failed approach that does not prudently serve the individual's best interest, fiduciaries will no longer be able to claim that they 'did not know,' nor that they were not aware of non-FAA investment options.

"In our view, this reality when combined with the provisions of the Pension Protection Act of 2006 -- which provide that a 'complaining participant' can challenge in a court of law the quality of advice the Plan Sponsor made available to the Plan -- has created a ticking fiduciary liability time bomb," Fineman said.

Compass Institute's research shows that only investments being guided by an unrestricted (no asset class rules) objective (no attempt at predicting the future) asset allocation approach that adapts to known market and economic conditions, not those that are forecasted or probable can provide retirees with optimal long-term annual average returns over market cycles. A 10-year review of this approach called UO-AAA (Unrestricted Objective -Adaptive Asset Allocation) showed long-term AAR of 14.1% over market cycles.

"The information presented in this study regarding problems with the formulaic asset allocation approach and the benefits offered through the Adaptive Asset Allocation approach define a new set of issues that plan fiduciaries must address," King said.

"With the publication of this information, plan fiduciaries must take a new look at how they advise, default or make advice available to their constituents," Fineman added.

Copies of the Compass research are available upon request by sending an email to reports@compass-institute.com.