The New York City Comptroller has proposed a program (the “New York City Nest Egg”) that would default every New York City worker into either a tax-qualified retirement plan or an IRA. NYC’s proposal is part of a broader, Blue State movement to require employers that don’t already have retirement programs to provide them to their employees.
In what follows, I begin with some background on this movement generally – where it came from and where it’s going. I then discuss some features of the NYC proposal that are both interesting and distinctive – a “curated marketplace,” a city-sponsored qualified retirement plan for private sector employers, and mandating investment exclusively in passively-managed funds.
The state retirement savings program project
A number of states have adopted or are considering legislation requiring employers (other than those that currently offer a retirement plan) to default all employees into a payroll deduction IRA, typically at a 3% contribution rate. These programs are generally described as “Auto IRAs.” California, Illinois and Oregon are close to implementing Auto-IRA programs, and Connecticut and Maryland just passed legislation beginning the implementation process.
The Auto-IRA idea reflects a view with which nearly everyone – the industry, policymakers and participant advocates – agrees: that the best way to get American workers to save is to “nudge” them – in effect, default them into saving.
Retirement savings and nudge
If ObamaCare represents a kind of “hard paternalism” under which individuals are (more or less) forced to buy health insurance, Auto-IRAs are what Richard Thaler (of Big Short fame) and Cass Sunstein (formerly Obama’s Regulatory Czar) have called “soft paternalism.” Individuals are defaulted into saving – but if they really don’t want to, they can get out of it. Given humans’ natural propensity to under-save, most – left and right – agree that soft paternalism is a pretty good solution here.
The problem is, to implement this sort of program using, e.g., a 401(k) plan requires a pretty significant overhead. The administrative and fiduciary burden of maintaining a 401(k) plan – complicated nondiscrimination testing, a blizzard of forms and the very real risk of lawsuits – has discouraged many small employers from establishing them. And if there’s no employer plan, then there’s no employer “nudge.”
This problem is exacerbated by the fact that – most agree – given current conditions (most significantly, mid-single-digit investment returns), it’s critical to get individuals to start saving early. And a large number of first jobs are at smaller employers.
State efforts follow on failure at the federal level
The current effort to require small employers to offer payroll deduction retirement savings is anchored in the very blue states – California and Illinois have been leaders. This state-based effort is best understood as a second-best choice, after passage of federal Auto-IRA legislation was foreclosed by Republican Congressional opposition.
Most of these state proposals simply mandate that employers who do not already maintain a plan establish an Auto-IRA. They differ (from each other) on the extent to which they exempt very small employers. Illinois exempts employers with fewer than 25 employees, while Connecticut, for instance, would only exempt employers with fewer than 5 employees.
A couple of states – Washington and New Jersey – have taken a different approach, establishing a “marketplace” designed to (as the New Jersey legislation puts it) “remove the barriers to entry into the retirement market for small businesses by educating small employers on plan availability and promoting, without mandating participation, qualified, low cost, low burden retirement savings vehicles.”
State “multiple employer plans”
A number of federal law questions have been raised with respect to these state efforts – both Auto-IRAs and marketplaces. I’m not going to detail these here, other than to note that (1) they exist and (2) the Obama Administration has made every effort to make them go away.
In that regard, in guidance intended to provide a “path forward” for these state efforts, the Department of Labor suggested that a state may want to sponsor its own 401(k) plan and make it available to private sector employers looking for a cheap, “turnkey” retirement plan solution. Many believe that this sort of plan – if it were sponsored by, say, a bank, mutual fund or insurance company – would relieve employers of most of the administrative and fiduciary burdens that are preventing them from adopting plans.
DOL, however, does not allow private sector businesses to offer these sorts of plans – called “Open MEPs.” Instead, private sector businesses can only offer “Closed MEPs” – plans for a limited group of employers where the sponsor has some sort of “genuine economic or representational [interest] unrelated to the provision of benefits.” For example: a state bar association could (and some do) offer a multiple employer plan for law firms.
But DOL did (in that guidance I just noted) say that states (and cities) could provide these sorts of “open” plans. Because states have “a unique representational interest in the health and welfare of its citizens.” That’s an interesting notion that I want to come back to below.
This sounds like an incredibly nerdy issue. But in real life, many view Open MEPs as the solution to the high cost of retirement savings. How they are developed and regulated may determine whether – in a low-return environment – an employer-based retirement saving system remains viable.
The NYC Nest Egg
Now let’s turn to this proposal by the NYC Comptroller. To be clear, at this point, the NYC Nest Egg is just a proposal. To become law, it will have to be approved by the NYC City Council, the Mayor and (conceivably) the state. In addition, some aspects of the proposal may require “approval” (or some sort of relief) from DOL and the Department of the Treasury.
The NYC Nest Egg is an “all of the above” program. Drawing on the work of a group of NYC officials and academics, it includes all three of the approaches to state-plans-for-private-employers that we just discussed: an Auto-IRA; a “curated” 401(k) marketplace; and an Empire City NYC 401(k) MEP.
While the NYC proposal is unusual in a number of respects, I want to focus on three: First, it articulates that concept of a “curated marketplace” – an idea I find thought-provoking and a little odd. Second, it’s the first proposal involving a state- (or in this case, city-) sponsored MEP: in effect, NYC is proposing to go into the retirement plan administration business. Third, it aggressively attacks a retirement savings issue that many view as of paramount importance – high active investment management fees – by mandating that all plans/IRAs in the program invest exclusively in passively-managed funds.
In what follows, I’ll discuss and then assess each of these features.
What is a “curated marketplace?”
This is such an interesting linguistic construction. How do you “curate” a market? According to the proposal, the program’s Board will select providers that “meet minimum criteria, including low ‘all-in’ fees for administration and investments” and that can “handle investments and/or recordkeeping in a transparent, objective manner based on the best combination of price and quality.” The proposal envisions that there will be “perhaps four to eight” of these marketplace participants, a number which NYC believes will “ensure robust competition without the risk of overwhelming and discouraging busy employers from selecting a 401(k) plan.”
And to safeguard this process, the Board would “provide ongoing oversight of the Marketplace, although it could elect to operate or contract out some or all functions.”
As noted above, as part of the proposal, NYC would set up its own retirement plan – the Empire City NYC 401(k) MEP – and offer it to any NYC employer that wants to adopt it. Thus, NYC would be going to go into the retirement plan administration business. Ask anybody who is in that business (or who used to be in it): it’s very hard to profitably administer 401(k) plans for a living. It’s pretty much a zero-error product with ultra-thin margins. And that’s if you’ve invested hundreds of millions in software and expertise.
Obviously, NYC is anticipating outsourcing a lot of the administration here. But that just begs a host of questions. Who is going to actually run this plan? Who will want to? How will he/she/it be chosen? And how compensated? Is it conceivable that the answers to those questions may have … a political dimension? And, if you’re going to outsource this MEP, why not just let these private retirement plan operators come into New York and offer these sorts of open plans directly? (More on that last issue below.)
Passively managed funds
As noted, generally (and with the exception of accounts worth $15,000 or less), all investment – in the curated marketplace, the NYC MEP and the auto-IRA – would be limited to passive investment funds.
The passive vs. active investment argument continues to rage. But in the retirement savings policy world participant advocates (more or less identified with the left) have showed a distinct bias in favor of passive investment – because of the (presumed) low fees.
As Warren Buffett famously said in his 2013 Shareholder Newsletter: “My advice to the trustee [of my estate] could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund.” Frankly, in most cases, I would probably agree with him.
The curated marketplace as a brand
These three proposals – the curated marketplace, the NYC MEP and the passive-only mandate – reflect a fundamental distrust of the results the retirement savings market has thus far produced. And, frankly, you can see where that distrust comes from.
There is a lot of literature showing that, particularly, small employers and participants don’t make especially good – outcome maximizing – investment choices. And with future returns likely to be in the single digits (and perhaps the low- to mid-single digits), paying 100 basis points for an actively managed fund (that in many cases underperforms the index) looks like a bad idea.
If this were just a branding exercise – in effect, simply identifying plans and funds that meet NYC’s best practices criteria – I would give it a high chance of success. Viewed that way, it is more or less equivalent to that quote from Warrant Buffett – if someone asks you how to invest their retirement savings, simply tell them to go buy an index fund. If someone asks you what sort of retirement plan to adopt for their small business, just tell them to pick one from the NYC marketplace.
The NYC MEP as your local food coop
Like the ObamaCare health insurance coops (and, before them, the HillaryCare purchasing “alliances”), like the electrical coop movement of the 1930s and your local food coop – the NYC MEP seems to spring from the notion that – given scale and government funding – a handful of bureaucrats, well-intentioned “advocates” and academic experts can provide a better and fairer product than is provided by ordinary (and vulgar) businesswomen. In this case: deliver a cheap and effective employer-based retirement savings plan to New York City employers.
These “coop” projects, it seems to me, always shipwreck on the same sort of brute facts: Getting things done in the real world is much more complicated and difficult than it appears to (generally naive) disinterested and well-intentioned observers. These things always look easier from the outside. Go read Friedrich Hayek.
Making this work will require keeping daily, error-free records on the savings of employees scattered among (conceivably) hundreds of thousands of small employers. Finding the most efficient investment vehicle in our incredibly dynamic capital markets requires much more than invoking the (admittedly powerful, but also pretty much universally understood) theoretical insight that large cap index funds (net of fees) generally out-perform actively managed large-cap funds.
As such – as, in effect, a complicated exercise in virtue signaling and magical thinking – the NYC MEP will “do no harm” – other than waste some taxpayers’ money and perhaps make a few providers rich. But it also (in my humble opinion) will do no particular good and will in the medium-run prove itself to be unsustainable. Just like the ObamaCare coops.
Politicians are not necessarily more virtuous than businessmen
None of this is, in fact, the fault of the city officials and academics who crafted the Nest Egg proposal. As the proposal itself notes:
Current federal policy does not provide a level playing field between private sector multiple employer 401(k) plans and the Empire City 401(k) MEP. Understandably, some financial service providers, employers, and other observers believe that private entities should be able to organize a MEP plan without a “common bond” requirement and without government involvement.
The Obama Administration has endorsed allowing private sector Open MEPs, and there is a bipartisan Open MEP proposal in Congress. But I want to point out a different strain in the Administration’s (and some on the left’s) thinking here. Let’s look at (more fully) what DOL said about the virtuousness of these state and city-sponsored MEPs:
In the Department’s view, a state has a unique representational interest in the health and welfare of its citizens that connects it to the in-state employers that choose to participate in the state MEP and their employees, such that the state should be considered to act indirectly in the interest of the participating employers. Having this unique nexus distinguishes the state MEP from other business enterprises that underwrite benefits or provide administrative services to several unrelated employers.
To paraphrase: governments = good; businesses = bad.
This sort of thinking – which, again, is reflected in such projects as the ObamaCare coops and the famous health insurance “public option” – is hopelessly out of date. The Royal Swedish Academy of Sciences has awarded several Nobel Prizes (most importantly, probably, for the work of James M. Buchanan on public choice) for research showing that “governments” – like, e.g., the City of New York – are in fact just made up of people – just like you and me and the people who run businesses. And those government people are just as susceptible as business people to “bad” influences (aka economic incentives) and, indeed, to corruption.
You would think the experience of Jefferson County Alabama – the bankruptcy of which was featured in the development of Dodd-Frank – would have made it clear to all that government officials are not necessarily the sorts of individuals you would want managing other people’s money. And, please, everybody: of course there are many virtuous state and city officials. But there are also – notwithstanding what they say in the movies – many virtuous business people.
Finding the most efficient investment is way easier said than done
It appears that NYC’s panel of experts believes that the “high cost of investment” problem can be solved by simply invoking a passive-only strategy. Let’s just list (some of) the problems with that idea:
An all-passive strategy sounds great when you’re talking about US large-cap, but: What about mid- and small-cap? Is a bond index (which NYC seems to anticipate) or short term Treasuries (as Mr. Buffett recommends) really the right choice? What about real estate and alternatives?
Conventional wisdom is that in a bull market stock indexes outperform actively managed funds. What happens if we get another once-in-a-century “correction?”
As the Wall Street Journal reported just last week, there are some serious people who believe (pace Mr. Buffett) that market cap-weighted index funds are not the best way to exploit the “market perfection” of the US large cap market. And they have the data to prove it.
Right now there are several lawsuits against major universities (which is uh … where academics come from and have the greatest influence) challenging the use of, among other things, over-priced index funds. Professor Alicia Munnell of Boston College – one of the members of NYC’s panel of experts – has reported that her college had (until 2013) an S&P 500 Index fund with an expense ratio of 43 basis points.
There are also lawsuits against private employer-plan sponsors whose plans offer, e.g., an S&P 500 Index fund with an expense ratio of 4 basis points, because (so the plaintiffs claim) the plan fiduciaries could have gotten the same (or a similar) fund for 2 basis points.
What will NYC do about economically targeted investments (ETIs, AKA “social investments”)? There will certainly be pressure to include them in this program. Indeed, they are a feature of the NYC public funds and an investment option in the NYC defined contribution plan (the “Socially Responsible Fund”). Someone will have to explain to me how you can do socially responsible investing without (somewhere in the chain) employing some sort of active management principle. And if it providing an actively managed ETI fund doesn’t violate NYC Nest Egg principles, then why exactly would, say, an actively managed mid-cap fund or an actively managed investment quality bond fund violate them?
Finally, will the NYC Board be suable – in, e.g., an ERISA-based prudence lawsuit? Or will the Board have sovereign immunity protection? Will someone want to serve on the Board if they are suable? Go ask a private employer plan fiduciary – these lawsuits are a huge concern and … kind of a turn-off.
Bottom line – here’s how I score the NYC program:
Curated marketplace – A- it’s useful as a brand, competing with other brands (like Vanguard, Fidelity and T. Rowe Price).
NYC MEP – C- not, in my opinion, a good idea for a city to go into the retirement plan management business. And if they’re going to outsource the whole thing – which is likely to be a process fraught with politics – why not just let private Open MEP sponsors go into New York and compete directly for employers’ business? As noted, that private financial services institutions cannot offer Open MEPs is not really NYC’s fault – the fault lies with DOL, who (despite the evidence) seems to think that a city can do a better job running a retirement plan than can someone actually in that business.
Passive only investment – C+ let’s see how this works. I am sympathetic – we have to find some way of reducing the cost of retirement saving – but I think in the end this approach will create more problems than it solves.
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Notwithstanding the above-vented doubts, I consider the NYC Nest Egg to be an interesting and thought provoking contribution to the debate over how we get American workers covered by workplace retirement plans. And I’ll be interested to see how it turns out.