Workers steered to high-risk investing

Federal rule imposed just before market crash

By Michael Kranish
Globe Staff / April 5, 2009
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WASHINGTON - Shortly before the first signs of the stock market collapse, the Bush administration made a crucial decision that has propelled an estimated one to two million workers into stock-heavy retirement funds.

Many of the funds in which workers were automatically enrolled dropped more than 25 percent last year, while a more conservative investment strategy rejected by the Bush administration would have resulted in a gain of 4.7 percent.

The administration's decisions came in response to a congressional mandate to encourage more workers to participate in company-sponsored retirement savings plans. The Bush administration came up with a rule that enabled businesses to automatically enroll their workers in tax-free 401(k) retirement plans.

If the workers failed to specify how they wanted their money invested, the company would be required by law to place their retirement money in investment funds that, for the most part, relied heavily on stocks. The administration specifically rejected calls for a more conservative investment option.

"Everybody was going to win, everybody was going to Disney World, everyone would ride the equity wave" and make profits, said Gina Mitchell, president of the Stable Value Investment Association, which represents some of the companies whose conservative strategy was rejected. "They really underestimated the volatility of the market."

But federal officials who wrote the regulation said it reflects their belief that stock investments would pay off over the course of many years and cannot be evaluated on the basis of a year in which the stock market has collapsed.

"I firmly believe that the regulation is a very good one and will serve people very well," said Bradford Campbell, the former assistant secretary of labor for employee benefits, who oversaw the writing of the rule. "I believe what we put in was appropriate strategy for long-term retirement savings."

While there is no official tally of how many people have been subject to the regulation, an analysis by the private Employee Benefits Research Institute, based on overall enrollment in retirement plans, estimated that up to two million workers have already been enrolled into the accounts since the regulation was adopted in 2007.

The intent behind the regulation was to get more people to contribute to retirement savings accounts. Such savings are considered a pressing need at a time when the number of company-run pension plans is shrinking and many baby boomers are on the verge of retirement. About two-thirds of workers opted into such plans before 2006, and participation was expected to rise to more than 90 percent with an auto-enrollment provision.

There was bipartisan support in Congress for finding a way to increase worker participation. But many companies told Congress that they were reluctant to automatically enroll workers for fear that they would be sued if the funds performed poorly. Congress responded by passing legislation that provided protections against lawsuits if the companies put employees into certain categories of default funds and provided a match for part of an employee's contribution.

The impact was immediate: The percentage of companies offering automatic enrollment jumped from 24 percent to 36 percent after the measure was passed, according to industry studies.

But Congress left it up to the Bush administration to determine what categories of funds should be allowed. That set off a lobbying frenzy between companies that sold stock-heavy funds and those that offered nonstock "stable value" funds.

Stable value funds are composed of fixed-income investments and are coupled with insurance contracts that are designed to offset fluctuations in interest rates. They are not guaranteed, and a small number have lost value. But the mostly stable returns - an average return of 4.7 percent last year - have made them increasingly popular.

Backers of such funds said they were particularly well suited for people who did not opt in or out of their retirement plans because such individuals might be unfamiliar with the risks associated with stock funds.

The Bush administration, however, rejected the pleas of stable value fund managers to have their product be available as a stand-alone option for automatically enrolled workers, reasoning that the funds would be vastly outperformed by stock-heavy investments over the long term. The administration asserted that the stable value funds would not provide "meaningful retirement savings over the long term."

The Bush administration instead required that automatically enrolled workers be placed in other types of funds, with the most popular category being "target date" funds that have a mix of stocks, bonds and other products and are designed to become more conservative as a person nears retirement.

But the funds have not always worked as advertised, with even some of the funds designed for people near retirement being far more heavily invested in stocks than the government had expected. In one case, a fund with a 2010 retirement target had 64 percent of its portfolio in stocks and has lost 40 percent of its value in the last year.

Morningstar, a market analysis company, surveyed all the major 2010 funds and found that their one-year return, as of March 31, ranged from a loss of a little more than 6 percent to a loss of nearly 41 percent.

The Senate Special Committee on Aging says that target date funds are expected to make up 20 percent of savings in 401(k) and related retirement plans by 2010 - up from just 3 percent in 2006.

"I am very concerned that so many Americans are being moved into a financial product devoid of any regulation," the committee's chairman, Herbert Kohl, Democrat of Wisconsin, wrote recently to the Obama administration, requesting a review of the way workers are being put into target date funds under the Bush-era regulation.

Kohl wrote that large losses "simply should not occur in a financial product that was designed and is specifically advertised to limit risk and volatility as one nears retirement."

Campbell said it is "flatly wrong" to call the funds unregulated. But he said some of the funds for those nearing retirement may have been too heavily into stocks. If the funds were not managed according to "prudent" standards, he said, workers who were put into the funds may have legal recourse against those who ran them.

Brian Reid, the chief economist of the Investment Company Institute, whose members offer the target date funds, said the plans are here to stay because they help people balance their plans for their retirement. Asked if some of the plans were too aggressively into stocks, he said, "This is the first generation of understanding of how these work in the markets."

Given the impact of the stock market decline on the funds, he predicted that "we will be observing more firms offering target date funds that have much more conservative glide paths."

Workers who are automatically enrolled in such funds usually are given the option of later choosing from a broader array of funds offered by their employer.

Michael Kranish can be reached at