Statement of James A. Klein, President, American Benefits Council
Testimony Before the Subcommittee on Oversight
of the House Committee on Ways and Means
Hearing on Employee and Employer Views on Retirement Security
March 5, 2002
Good morning, Chairman Houghton, Ranking Member Coyne and members of the Subcommittee, and thank you for the opportunity to appear this morning. I am James Klein, president of the American Benefits Council, which is a public policy organization representing principally Fortune 500 companies and other organizations that assist employers of all sizes in providing benefits to employees. Collectively, the Council’s members either sponsor directly or provide services to retirement, stock and health plans covering more than 100 million Americans.
Our Nation’s Retirement Savings and Employee Ownership System Is A Great Success
Let me begin, Mr. Chairman, by sharing the Council’s perspective on our nation’s 401(k) and employee ownership system. Today more than 42 million Americans participate in 401(k) plans and 14 million more participate in profit-sharing and employee stock ownership plans (ESOPs). These 56 million workers have accumulated more than $2.5 trillion in retirement savings and many have built a substantial ownership stake in their company. These successful employer-sponsored plans not only prepare workers for retirement and democratize corporate ownership, but also serve as an engine of economic growth by providing one of our nation’s most significant sources of investment capital. Congress has, over many decades, promoted these retirement savings and employee ownership plans through tax and other incentives,[1] with very positive results for tens of millions of American workers.
American Benefits Council member companies make frequent use of employer stock in both 401(k) and employee stock ownership plans (ESOPs). Many of our members provide their 401(k) match in the form of company stock[2] and those that do not typically make company stock available as one of the diverse menu of 401(k) investment options they provide to their employees.[3] A number also sponsor stand-alone ESOPs as a supplement to their 401(k) and other retirement programs.
While some of our members allow employer stock contributions made to a 401(k) plan or an ESOP to be diversified immediately, many others impose a holding period on how long employer contributions made in the form of company stock must remain in that stock.[4] These holding periods typically end when an employee reaches a certain age, such as 45 or 50, or when the employee departs the company.[5] Companies impose these holding periods because they want to create a long-term ownership stake on the part of employees. Needless to say, many employees have enjoyed tremendous investment returns as a result of this investment in company stock.[6] It is this positive investment performance of employer stock, together with employee preference for this investment option, that can result in a substantial percentage of a company’s 401(k) plan assets being invested in employer securities. The idea that this concentration in employer stock is due largely to employer contributions subject to holding periods is simply not accurate.[7]
Why do Council members make use of employer stock in their retirement plans? Because in many instances the employees of our member organizations, who want to share in the success of their companies, have asked their employers to do so. And Council members have responded favorably because they believe that providing employees with the opportunity to invest in the company creates a culture of ownership and accountability that promotes productivity and employment stability.[8] At the same time, however, Council member companies take the principle of diversification in retirement savings very seriously and make it a regular part of their communications to 401(k) participants.
Nearly all Council members also sponsor a defined benefit pension plan to help their employees build retirement security with a guaranteed, employer-funded benefit. Indeed, maintenance of a diversified defined benefit pension is typical of employers that provide a 401(k) match in company stock or that offer company stock as a 401(k) plan investment option.[9] Given this diversified and government-insured foundation, the retirement security of workers who have a 401(k) plan with a company stock feature should not be regarded as unduly at risk. The tens of millions of American workers who lack access to any retirement plan at all at their place of work are certainly at least, if not more, deserving of Congress’ attention and concern.
As Congress evaluates the appropriate retirement policy response to the Enron bankruptcy, we at the Council urge you to keep the employer-sponsored system’s success squarely in mind and hold true to the long and bipartisan congressional support for our nation’s voluntary retirement savings and employee ownership system.
The Appropriate Response: Information, Education and Professional Advice
Mr. Chairman, one cannot hear of the experiences of Enron employees and not be determined to take steps to prevent such a situation from occurring in the future. At the same time, one cannot examine the realities of the 401(k) system without concluding that overly aggressive legislative change could unintentionally harm the very people that Congress hopes to protect. Chairman Houghton, you and the members of this Subcommittee understand the delicate balance of regulation and incentives upon which the success of our voluntary, employer-sponsored pension system depends. We ask that you keep this delicate balance at the center of your deliberations as you lead this Committee’s response to the Enron bankruptcy.
In order to avoid unintended harm, the Council believes that retirement policy responses to Enron should focus on ensuring that 401(k) participants have the information, education and professional advice they need to wisely exercise their investment responsibility. To this end, we support the proposals contained in the Employee Retirement Savings Bill of Rights put forward by Representatives Rob Portman (R-OH) and Ben Cardin (D-MD) (H.R. 3669) and in the Pension Security Act put forward by Representatives John Boehner (R-OH) and Sam Johnson (R-TX), to provide employees with advance notice of transaction suspension periods as well as periodic notices that stress the importance of diversification. The Council likewise supports the provision of H.R. 3669 that will allow employees to save for the cost of retirement planning services on a pre-tax basis through payroll deduction at the workplace.
The Council further believes that enactment of Representative John Boehner’s Retirement Security Advice Act (H.R. 2269), which the House of Representatives approved last fall, should be a key component of the congressional response to Enron. This legislation will help many more 401(k) plan participants get the professional investment advice they desire by clarifying employer obligations and opening up the advice marketplace to a greater number of competitors. We are pleased that the Bush Administration has made the Retirement Security Advice Act a central part of its 401(k) reform package and that Representatives Boehner and Johnson have included this measure in their recent legislation (H.R. 3762).
While the Portman/Cardin and Boehner/Johnson bills reflect very careful thought and contain a number of reforms we support, we hope to work with the bill’s sponsors to address certain concerns. In particular, the Council looks forward to a continued dialogue on regulation of the holding periods sometimes imposed by employers on the sale of company stock they contribute to retirement plans. We are concerned that overly strict limits on these holding periods could risk reduced matching contributions in some circumstances since employers will no longer be able to guarantee that every worker has a long-term ownership stake. In particular, such changes may lead employers to divert resources from 401(k) programs into broad-based stock option programs, where the company can guarantee that employees will maintain an ownership interest. As a general matter, we believe that the earlier in a worker’s career that he or she is permitted to sell company shares and the greater the percentage of shares the employee may sell, the greater the risk that some employers will reduce their matching contributions. Consequently, we would urge you to continue to permit employers to require that some portion of employer contributions made in company stock remain in that stock.
We also have very significant concerns about the Bush Administration’s proposal for heightened fiduciary liability during transaction suspension periods. Specifically, that proposal would make plan fiduciaries responsible for the prudence of plan participants’ investments during suspension periods.[10] First of all, it is absolutely clear under current law that employers maintain their fiduciary duty to act prudently and solely in the interest of participants both when initiating transaction suspension periods and during such periods. No change in law is needed to achieve this result. The only protection granted to employers in this area under current law is that they are not responsible for the performance and prudence of employees’ investment choices when employees make these investment choices themselves. This protection has been absolutely critical to the growth of 401(k) and other defined contribution plans in recent decades.
By denying this protection during transaction suspension periods, the Administration’s proposal would result in a requirement that employers “second-guess” employees’ plan investment choices and would make employers liable for employees’ imprudent investments. It is not clear what an employer should do during a suspension period to satisfy this new obligation. Should it override the employees’ investment choices and move their account balances into different investments? Should it sell billions of dollars in company stock, driving the stock price lower and infuriating employees and other shareholders? The Council believes that there is simply no reasonable course for an employer to take in response to the new obligations this proposal would impose. If clarification of employers’ existing fiduciary duties during suspension periods is necessary, then the Department of Labor should issue additional guidance. But imposition of a vast new responsibility for the prudence and performance of employees’ investment selections will deter employers from initiating retirement plans and will drive existing plan sponsors from the system. We strongly urge you to reject the proposed legislative changes in this area.
Percentage Caps on Company Stock Would Harm Employees
The Council also strongly urges Congress to reject percentage caps on the amount of an employee’s 401(k) account that could be invested in company stock. These caps, which are included in a number of bills (H.R. 3463, H.R. 3640, H.R. 3677, S. 1838), would be unpopular with -- and contrary to the best interests of -- the many employees who benefit from having an ownership stake in their company. Indeed, recent research has shown that 401(k) investment returns for workers would be 4 to 8% lower were company stock removed from these plans.[11] Moreover, Congress simply cannot know how much investment in employer stock is appropriate for each 401(k) participant. This decision depends upon a myriad of personal variables -- a worker’s age and planned retirement date, traditional pension coverage or lack thereof, the existence of retirement savings from prior jobs or non-workplace savings, the pension situation of a spouse, etc. Given this reality, Congress should not substitute its judgment for that of the individual. Rather than limiting employee opportunity through the imposition of caps, we believe Congress should empower workers to wisely exercise their freedom of choice through provision of the new informational and educational tools discussed above.
Percentage caps would also prevent employers from continuing to provide 401(k) matching contributions in stock. Under a typical 401(k) matching formula, employers provide a 50% match on employee contributions up to a certain percentage of pay, often 6%. Thus, for every dollar of employee savings, the employer contributes 50 cents in stock. For the typical worker this would produce an account that is 33% invested in employer stock, which would automatically violate the 20% ceiling contained in the leading cap proposals. Unable to achieve their purpose of providing an ownership stake to employees via the stock match -- and given the greater expense of matching in cash -- many employers may respond to caps by reducing their matching contributions. The unfortunate result will be fewer employer match dollars contributed to employee accounts. This will weaken one of the most effective incentives for employee saving[12] and inadvertently harm the very people Congress wishes to protect.
Transaction Suspension Periods Are Normal and Necessary
Some of the retirement bills introduced in response to the Enron bankruptcy, such as those from Representatives George Miller (D-CA) (H.R. 3657) and Ken Bentsen (D-TX) (H.R. 3509), seek to cap the length of (or otherwise restrict) transaction suspension periods. These are periods during which employees are unable to make investment changes in their 401(k) accounts. Yet transaction suspension periods, which typically accompany a change in 401(k) record-keeper or the inclusion of an acquired firm’s employees in a company’s plan, are a normal and necessary part of 401(k) plan administration. In fact, the plan changes that require such suspensions are often undertaken to improve the services or investment options offered to employees. While we certainly understand the desire to minimize the length of these periods, a fixed time limit is simply not practical, nor is it in the best interests of the plan’s participants.
The length of the transaction suspension period is highly dependent on factors such as the quality of the participant data, the sophistication and compatibility of the computer systems and programs involved, the number of plan participants and the number of plan loans outstanding. Furthermore, individuals’ account information and investment selections must be correct when the transaction is complete, with neither employers nor employees tolerant of mistakes. I can assure you that employers seek to minimize the length of suspension periods, and such periods are declining due to competition among 401(k) providers. Yet employers and providers will not always be able to meet fixed time limits and attempting to do so will lead to mistakes. Simply stated, employers have no rational reason to extend transaction suspension periods any longer than the time needed to properly and accurately conclude the administrative matters prompting the need for the suspension. Sufficient advance notice of transaction suspension periods, as required under the Portman/Cardin and Boehner/Johnson bills, is a good idea and will ensure that 401(k) participants are well served. But arbitrary limits on how long such a suspension period may last is a classic example of a well-intentioned idea that will harm the very people it is designed to protect.
Radical Restructuring of the 401(k) System is the Wrong Response to Enron
Even beyond the issue of limits on transaction suspension periods, we are gravely concerned about the Miller legislation (H.R. 3657) because, unlike the Portman/Cardin bill (H.R. 3669), it does not advance targeted responses to the specific issues raised by Enron but rather seeks to make wide-ranging and fundamental changes to our nation’s defined contribution plan retirement system. The bill would radically change ERISA’s enforcement mechanism by creating vast new categories of defendants and damages applicable to ERISA claims (even those beyond the pension arena), fundamentally alter the retirement plan governance system by requiring joint trusteeship, and substantially reduce the vesting schedule for employer contributions.
Vast new remedies will increase litigation and costs, joint trusteeship will increase workplace conflict and hamper plan administration, and reduced vesting will lower employer contributions. Under such a regime, many employers will question whether it makes any sense to retain their voluntary retirement plan offerings, and businesses not yet in the system will be deterred from ever starting a plan. The unfortunate result will be fewer employees with retirement plan coverage.
Such steps are particularly unwarranted given that Congress, just last year, engaged in a thorough review of the 401(k) system before passing important 401(k) plan improvements included in the Economic Growth and Tax Relief Reconciliation Act of 2001. While the broad tax bill did not enjoy substantial bipartisan support, the Portman/Cardin 401(k) and pension reforms it contained enjoyed wide bipartisan co-sponsorship and passed the House of Representatives repeatedly with more than 400 votes. With this legislation, Congress wisely sought to build on the success of the 401(k) system and expand the number of employees with access to 401(k) plans. The important reforms enacted last year should be given time to work and Congress should not now head in a completely different direction based on the unfortunate developments at a single company.
Time for a Renewed Congressional Commitment to Defined Benefit Plans
In one potentially fortunate development, the losses suffered by Enron 401(k) participants have renewed interest in defined benefit pension plans. These types of plans, which are funded by the employer and insured by the federal government, make an effective complement to a 401(k) program. Yet the number of these plans continues to decline, from a high of 175,000 in 1983 to fewer than 50,000 today. This decline is partly attributable to over-regulation by Congress and its attendant costs and complexities. We believe Congress should now use the occasion of its Enron review to streamline the rules that apply to defined benefit pensions so that more companies can provide these employer-funded and insured benefits to their workers.
Representatives Portman, Johnson, Cardin and Pomeroy have led the way in addressing one of the most vexing problems faced today by defined benefit plan sponsors – the inflated liabilities, funding requirements and premium obligations that have resulted from the buyback and discontinuation of the 30-year Treasury bond. As you know, rates on 30-year bonds have fallen to historic lows as these bonds have become scarcer. Yet our pension laws require the 30-year rate to be used to calculate pension plan liabilities. The result has been to artificially inflate these liabilities by 15 to 25 percent, forcing many employers to make huge and unwarranted pension contributions in the midst of an economic downturn. Representatives Portman, Johnson, Cardin and Pomeroy were instrumental in including relief from these unwarranted obligations in the House-passed economic stimulus legislation (H.R. 3529) and we are pleased that they will be introducing bipartisan legislation this week to provide the necessary pension interest rate relief. With enactment of this urgently-needed measure, Congress can move quickly to shore up the defined benefit pension system, preventing additional employers from abandoning these guaranteed plans that effectively advance workers’ retirement security.
The decline in our nation’s defined benefit system also offers a sobering lesson about the dangers of overreacting to the Enron bankruptcy with over-regulation. The Council believes strongly that Congress must approach any new regulation of 401(k) plans with extreme caution so as not to produce the same disastrous decline in employer sponsorship of 401(k) plans that we have seen in the traditional pension arena.
Conclusion
In closing, Mr. Chairman, the Council urges a cautious and prudent retirement policy response to the Enron collapse so as not to undermine our successful retirement savings and employee ownership system. Information and advice -- rather than restricted choice, over-regulation and broad new liabilities -- are the strategies that will protect workers and retirees while fostering the continued growth of the private, employer-sponsored retirement system.
Thank you, Mr. Chairman, for the opportunity to appear today.
[1] The first stock bonus plans were granted tax-exempt status by Congress under the Revenue Act of 1921. See Robert W. Smiley, Jr. and Gregory K. Brown, “Employee Stock Ownership Plans (ESOPs),” Handbook of Employee Benefits, 5th ed., Jerry S. Rosenbloom, ed. (Homewood, Illinois: Dow Jones-Irwin, 2001).
[2] Researchers have estimated that less than 1% of 401(k) plans provide a match in company stock. Since plans that do so are typically sponsored by large employers, however, these plans cover 6% of the nation’s 401(k) plan participants. See Jack VanDerhei and Sarah Holden, “401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2000,” Employee Benefit Research Institute Issue Brief, November 2001.
[3] The typical Council member offers at least a dozen 401(k) plan investment choices to its employees. These generally include a range of diversified stock and bond mutual funds.
[4] A recent survey of employers with company stock in their 401(k) plans indicated that 56% require employees to hold the contributions made in stock for some period of time. See WorldatWork Survey on 401(k) Plans and Company Stock, January 2002, www.worldatwork.org.
[5] The same survey revealed that of those employers imposing holding periods, 51% did so until a particular age, 30% did so until the employee departs from the company and 19% did so until the employee reached a given length of service with the company. See WorldatWork Survey on 401(k) Plans and Company Stock, January 2002, www.worldatwork.org.
[6] Even during the recent years of depressed stock market returns, the share price of many companies that include stock within their retirement plans has risen substantially. From December 1998 through November 2001, the stock of Target rose 66.2%, the stock of Anheuser-Busch rose 41.3% and the stock of Home Depot rose 38.2%. Each of these companies includes substantial employer stock within its 401(k) plan. See IOMA’s DC Plan Investing, December 11, 2001.
[7] Indeed, even in the case of Enron, 89% of the Enron stock held in the 401(k) plan was not subject to the age 50 holding period imposed by the company but could be traded into other of the plan’s 20 investment options at any time. See Leigh Strope, “401(k) Plan Losing Steam in Congress,” Associated Press, February 27, 2002.
[8] A survey of the academic literature demonstrates that improvements in organizational commitment, productivity and employment stability are common among firms that provide for an employee ownership opportunity. See Douglas Kruse, Testimony Before the Employer-Employee Relations Subcommittee, House Education and the Workforce Committee, February 13, 2002.
[9] “About 75-75% of participants in plans that are heavily invested in employer stock are in companies that also maintain diversified pension plans, indicating that [defined contribution plans with investment in employer stock] tend to supplement rather than substitute for diversified plans.” Douglas Kruse, Testimony before the Employer-Employee Relations Subcommittee, House Education and the Workforce Committee, February 13, 2002.
[10] This would remove the protection granted under the law today by ERISA Section 404(c), under which a plan fiduciary is not responsible for the prudence of, and returns on, a participant’s plan investments if the participant controls his or her own investments.
[11] Under a recent simulation performed by Professor Jack VanDerhei of Temple University, the investment returns in 401(k) plans that included company stock were 4 to 7.8 percent higher than in plans without company stock. See Jack L. VanDerhei, Testimony before the Employer-Employee Relations Subcommittee, House Education and the Workforce Committee, February 13, 2002.
[12] See Jack VanderHei and Craig Copeland, “A Behavioral Model for Predicting Employee Contributions to 401(k) Plans,” North American Actuarial Journal (First Quarter, 2001).