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Pension Reform Warrants Funds' Interest: Beyond Business Opportunities, More Regulation Ahead


PHOENIX - The nation's retirement system is in desperate need of an overhaul, and the mutual fund industry is likely to play a vital role in that renovation.

That was the message that Ann L. Combs, assistant secretary of the Employee Benefits Security Office, brought from the White House to the Investment Company Institute's 2006 Mutual Funds and Investment Management Conference, held here recently.

In her address to the conference's 1,600 attendees, Combs outlined elements of President Bush's massive pension reform initiative, how the migration from defined benefit plans to defined contribution plans might impact mutual funds, and how, as enforcer of ERISA guidelines, her office regulates one of the fund industry's key customers, retirement plan sponsors.

For example, Combs explained, in the wake of the collapse of Enron's retirement plan, where thousands of employees lost millions of dollars vested solely in company stock, the Bush administration proposed legislation that would allow corporate plan participants to diversify out of company stock after three years into mutual funds. That proposal didn't survive, but has resurfaced as a key element of the pension reform bill currently under consideration in Congress.

The administration is also bullish on greater access to investment advice for participants in employer-sponsored defined contribution plans, another element of pension reform legislation, and is a key supporter of the Securities and Exchange Commission's initiative toward "plain-English" disclosure documents for retirement plans.

And, finally, Combs indicated that the administration is focused on solving a dilemma confronting the single employer defined benefit system, where many old-line corporations are either finding it impossible to meet their contribution obligations, or have gone through Chapter 11 and had those obligations shed to the Pension Benefit Guarantee Corp., the Federal insurer for defined benefit plans that's currently shouldered with a $23 billion deficit. Those two forces have combined to severely diminish benefits and left many people with a short investment horizon to make up what they've lost.

While it might be cold comfort to those folks, the pension reform bill includes language that would strengthen existing pension funding rules, improve disclosure that employers must make regarding contributions to plans, as well as keep them from making additional contribution promises during collective bargaining sessions until shortfalls are accounted for and fulfilled.

"We feel passionately about fixing this system. It is clearly broken," said Combs, whose agency oversees approximately 700,000 pension plans with nearly $7 trillion in assets and another six million health and welfare benefit plans.

Although weaker than the President intended, versions of the pension reform bill have passed both Houses and are being debated by lawmakers with an eye on an April 15 resolution deadline, which, not coincidentally, is also the quarterly deadline for corporations to fulfill their pension obligations.

"It is the natural forcing event that you often need in Washington to get people to make tough decisions," Combs remarked. "But the President will not sign a bill that is weaker than current law."

But while the pension reform debate is undoubtedly of great significance to the nation's future both socially and economically, particularly in light of the strains that 79 million Baby Boomers are expected to place on the Social Security system, the relevancy of defined benefit plans would seem outside of the universe of mutual funds.

Think again, Combs said.

"Defined benefit plan reform may not seem to be in your bailiwick, but it's important for you to understand how your customers are trying to manage the retirement benefits they offer their employees," she said. "They're going through a lot of changes."

For starters, more and more big corporations, like IBM most recently, are migrating away from costly defined benefit plans to more inexpensive defined contribution plans. A new study shows that 37% of the nation's chief executives are planning such a switch (see related story, page 6). But as companies lean more heavily on 401(k)s and the like, they're also increasing contributions to upwards of 6% of an employee's annual salary, deliberating whether to add an automatic enrollment feature and increasing the matching amount they submit.

"They are trying to do things that will likely lead to more assets in the 401(k) environment, which are typically invested in mutual funds," Combs said, noting that more than half of the 54 million households invested in mutual funds do so through employee retirement plans.

Combs warned, however, that signs of growing pains between the two camps are beginning to emerge. Plan sponsors, for instance, are becoming increasingly sensitive to mutual fund fees.

"Plan sponsors are thinking, Why am I paying retail?' and they're pushing back," said Combs, who expects that retirement plan sponsors will soon have the clout to negotiate fees.