United States: Revisiting Pooled Employer Plans ("PEPs"): A Cost-Effective, Low-Risk Solution For Providing Retirement Plan Coverage (Part I) (Podcast)

In part one of this two-part podcast series, David Kirchner and Elliot Saavedra of the Ropes & Gray benefits consulting group, revisit one of the biggest advances in retirement plan design in recent memory: pooled employer plans ("PEPs"). Based on their findings from a survey they conducted of several of the leading providers in this space and their experiences with this new, innovative approach to employer-sponsored retirement plans, they take a fresh look at PEPs and how the market has evolved over the last three years.

Stay tuned for part two, where they will dive deeper into the responsibilities that employers should be mindful of when considering, evaluating and monitoring PEPs, as well as recent regulatory changes impacting PEPs.

To accompany this podcast, please review our two-page overview to help determine if a PEP might be the right fit.

Transcript:

David Kirchner: Hello and thank you for joining us today. I'm David Kirchner, a principal in the benefits consulting group in both Boston and San Francisco, and I am here with my colleague, Elliot Saavedra, a benefits consultant who is based in Boston. It's a new year, and we thought it would be a good time to revisit one of the biggest advances in retirement plan design in recent memory—pooled employer plans (or "PEPs"). As listeners of our podcast series on emerging issues for retirement plan fiduciaries risk management strategies may recall, we have periodically focused on this new retirement plan option that was created by the SECURE Act (for example, see our June 2021 podcast as well as our April 2022 article). PEPs have now been around and operating for a few years. From our vantage point, these plans appear to be turning out to be a viable alternative to the single- and multiple-employer retirement plans. In this two-part series, we're going to take a fresh look at PEPs in terms of how the market has evolved over the last three years based on our findings from a survey we conducted of several of the leading providers in this space and our experiences with this new, innovative approach to employer-sponsored retirement plans.

Since their initial rollout in early 2021, PEP 401(k)s have become increasingly prevalent among small employers—those with fewer than 100 employees—as well as for small to mid-sized employers with up to 500 employees. This isn't to say PEPs aren't well suited for larger employers as some PEPs have participating employers with more than 1,000 eligible employees and it's really dependent on the internal benefits structure employers have in place and how they want to manage risk associated with their 401(k)s. PEPs have proven to be a good option for our private equity sponsors in the transactional space. Particularly in the case of a smaller carve-out or spin-off where the private equity sponsor who is seeking to set up a new 401(k) plan quickly and also reduce the administrative expense and fiduciary risk associated with sponsoring a stand-alone single-employer plan. For private equity sponsors who are already familiar with PEPs in general, later in the podcast we take a deep dive into the benefits of PEPs for private equity portfolio companies.

Separately, as a result of the SECURE 2.0 legislation that passed in December 2022, PEPs for 403(b) plans are now permitted, which means a great, new option for our not-for-profit clients.

All of this is to say that the future of PEPs seems bright, which is why more plan sponsors may want to consider them as a viable option—not just in the transaction context, but for plan sponsors who are having issues in negotiating reasonable participant fees and/or finding the plan administration a burden to their company.

But before we go any further, Elliot, can you provide listeners a quick refresher on what a PEP is and describe the structure and roles of the various third parties who provide services and make up the components of the PEP's structure?

Elliot Saavedra: Absolutely. So, for those who might not be familiar with it, a PEP 401(k) offers employers an alternative to sponsoring a traditional single-employer defined contribution retirement plan like a 401(k) or 403(b) plan by outsourcing most of the fiduciary responsibilities that come with sponsoring a stand-alone retirement plan to third-party professionals. This can be seen as quite a competitive advantage. PEPs were created by the SECURE Act at the end of 2019 and were first rolled out starting on January 1, 2021—so, they are still quite new, which means there are still some bumps in the road. By pooling the participants and assets of multiple employers under one plan, a PEP provides economies of scale that may result in lower fees and reduced administrative burden for the organization.

A PEP can be a great alternative to a single-employer 401(k) or 403(b) plan for a handful of reasons:

• First, its structure allows employers to outsource certain plan-related administrative tasks to third parties beyond the typical services vendors provide to single-employer plans. By participating in a PEP, the employer delegates and outsources most plan administrative tasks and fiduciary responsibilities to various third-party professional service organizations—most importantly of which is the pooled plan provider (or "PPP").
• The pooled plan provider is the named fiduciary and plan sponsor of the PEP—replacing the employer in this fiduciary role. As the sponsor, the pooled plan provider is responsible for managing plan documents and summary plan descriptions, drafting and distributing required notices to participants like annual reports and fund disclosures, filing 5500s and engaging plan auditors, approving withdrawals and loans, and approving plan compliance testing—all of these requirements have historically been the responsibility of the company.
• In addition to handling these administrative tasks, the pooled plan provider takes on the fiduciary responsibilities of selecting and monitoring all of the other third parties involved in the operation of the PEP, including:
  • the ERISA Section 3(38) investment manager,
  • the plan recordkeeper, and
  • the plan trustee.

David Kirchner: So, Elliot, if I've got this correct, everything that you've just described has historically been both the administrative and fiduciary responsibility of the sponsoring company—including things like keeping documents up to date, distributing notices, hiring auditors and filing 5500s, hiring investment advisors, and negotiating and monitoring recordkeeping fees.

Elliot Saavedra: You've got that right, David. In the PEP 401(k) model, many of the administrative and fiduciary responsibilities that would ordinarily be those of the sponsoring employer, can be delegated to the pooled plan provider instead.

The pooled plan provider selects the investment manager, who in turn monitors and manages the investment lineup offered under the PEP—acting as the ERISA Section 3(38) fiduciary for the PEP.

The recordkeeper and trustee play the same role in a PEP as they do for a standard single-employer plan—the recordkeeper administers the plan and provides the technology platform, while the trustee holds the plan assets. And more importantly, from a participant's perspective, they really don't perceive any real difference from a more traditional single-employer plan structure.

The employer is still tasked with going through a prudent process to select a PEP just like any other service provider for a retirement plan, but once selected and implemented, the PEP should result in significantly reduced administrative burden for the employer.

David Kirchner: Thanks, Elliot. So, if an employer goes through an RFP process and ultimately selects a PEP 401(k) for its employees, its ongoing fiduciary responsibilities after that point are really just periodically monitoring and benchmarking the PEP—almost sounds too good to be true!

So, the clear benefit of moving to a PEP is the outsourcing of administrative tasks to the PEP and leaving the management and evaluation of these professional third-party providers to the pooled plan provider, as opposed to the employer. Looking back on when the SECURE Act legislation was being considered in 2019, what do you think Congress was trying to accomplish in creating the PEP structure?

Elliot Saavedra: It's pretty clear that Congress's main objective in creating PEPs was to offer a reasonably priced, low maintenance retirement plan option primarily for smaller employers that don't have the human resources and benefits bandwidth internally to do it on their own. As you know, maintaining a stand-alone retirement plan can be cost-prohibitive and resource-heavy, and for small employers, these factors often act to deter them from offering a retirement plan benefit. According to the Federal Reserve, nearly 50% of families in the U.S. have no retirement savings. Considering this fact, Congress saw PEPs as a way to significantly expand employee access to tax-favored retirement savings programs. The PEP model has created a way to leverage the economies of scale afforded to larger employers while alleviating the administrative burden for smaller employers.

But what actually seems to be happening since PEPs first started coming onto the market has been more complex. Among the many PEPs we've worked with, there are definitely some that seem to cater to smaller employers that arguably would otherwise not be able to offer a retirement plan to their employees. But we have also found that some of the larger PEPs seem to be attracting what we would consider to be more mid-sized employers, some of which have more than 1,000 eligible employees. And some of these PEPs are now averaging over 100 employees per participating employer. Among these employers, many already had established and maintained single-employer 401(k) plans, and they were looking to off-load administrative and fiduciary responsibilities, meaning fiduciary liability, to the PEP.

David Kirchner: So, not only have we begun to see smaller employers benefit from PEPs, it seems like some mid-sized employers may want to consider and evaluate the option when reviewing their current retirement plan offerings. Are there other benefits of PEPs for mid-sized employers besides what you've discussed already?

Elliot Saavedra: There certainly are. In addition to providing access to competitive participant and employer fees and outsourced administration, employers and PEP 401(k) participants can take advantage of the following:

• First, by pooling your employees' retirement assets with the assets of other employers, PEPs are able to offer institutional share class investments, which have some of the lowest and most competitive fees available. Giving PEP participants access to these low-cost investments enables them to more likely achieve their retirement savings goals by reducing the investment management fees paid from their accounts.
• Another benefit is that PEPs can significantly ease retirement plan administration for employers. As previously mentioned, benefit compliance and administration can be burdensome for small- and mid-sized companies that have lean or no HR departments. PEPs reduce this burden by having the pooled plan provider take on nearly all of the administrative tasks that are usually performed by a company's finance, HR and benefits team, including the important fiduciary responsibility of educating participants on features or investments in the PEP 401(k). This is particularly advantageous to a start-up or spin-out company where virtually no internal resources exist. These small companies need to compete with larger employers and offer a comparable retirement benefit in order to attract and retain employees. Retirement benefits are a basic and important element of total compensation.
• Lastly, and perhaps the most important: from a risk management perspective, PEPs help limit an employer's ERISA fiduciary responsibility and potential liability. Litigation of 401(k) and 403(b) plans has continued unabated, and in some cases, employers have been held responsible for substantial payouts or settlements as a result of these class action lawsuits. As plaintiffs' lawyers troll for disenchanted participants, the size of the targeted plans has continued to get smaller and smaller. While some employers may think they're actually a small fish in a big sea of larger employer-sponsored retirement plans, there have been cases where even small- or mid-sized plans were subject to lawsuits regarding plan administration and excessive fees. By participating in a PEP, employers can limit this risk due to their pooled plan provider acting as the plan sponsor, named fiduciary, and ERISA Section 3(16) administrative fiduciary, and the investment manager acting as the ERISA Section 3(38) fiduciary with respect to the composition and selection of the investment lineup.

David Kirchner: Got it. But just to be clear, choosing to participate in a PEP 401(k) doesn't completely absolve an employer of its fiduciary duties under ERISA, right?

Elliot Saavedra: That's right. A PEP can help an employer offload many of its fiduciary obligations that come with offering a retirement plan—however, the employer will still need to adhere to the duties of prudence and loyalty when it comes to (i) selecting a PEP that best fits the needs of the employees and (ii) monitoring the PEP on an ongoing basis. In our next episode, we dive a bit deeper into the responsibilities that employers should be mindful of when considering, evaluating and monitoring PEPs on an ongoing basis.

David Kirchner: Thanks, Elliot—sounds like something to look forward to. So, let's shift focus to something we touched on a bit earlier. Can you talk more about how PEPs can help private equity sponsors, particularly with their small- to mid-sized portfolio companies and spin-out transactions?

Elliot Saavedra: Sure, David. A PEP can be a good option for a private equity portfolio company for a number of reasons.

Out of the box, PEPs can add value to the bottom line of portfolio companies by accessing competitive fee structures through economies of scale afforded by the PEP's large volume structure. As most of our listeners know, the more assets and participants a single-employer retirement plan has, the lower that plan's third-party service provider fees will be. By pooling assets and participants of multiple employers into one plan, a PEP can use these economies of scale to leverage lower participant and employer fees, which are then passed through to the PEP's participating employers and employees. As PEPs continue to grow in assets and participants, the overall fees at the PEP level should also continue to decrease, and these lower fees should again pass through to the PEP's participating employers and employees. By accessing these lower fees, every dollar saved goes to the bottom line of the portfolio company or to the participant. Even more, it reduces a portfolio company's finance and HR duties and responsibilities by significantly reducing the workload that comes with sponsoring a single-employer retirement plan—reducing the administrative overhead costs for the company.

In addition, by participating in a PEP, a portfolio company would not be required to sponsor its own retirement plan. This will make the retirement plan offering more easily transferable to a buyer in a transaction. Remember, when an employer chooses to use a PEP as its retirement vehicle, it becomes a "participating employer" under a PEP that is sponsored by a separate entity: the pooled plan provider. While diligence would still be performed on a retirement plan offering through the PEP, the pooled plan provider and not the participating employer is ultimately responsible for overall administration and compliance, including the maintenance of plan documents, compliance, Form 5500 filing, and audits reducing or virtually eliminating both fiduciary and poor-plan administrative risks associated with single-employer plans.

David Kirchner: So, in other words, Elliot, participating in a PEP 401(k) would lower the chances of uncovering potential retirement plan-related issues during a diligence review of the company when it comes time to sell it. I know in a few more recent transactions we've worked on, we've actually seen multi-million dollar escrows to address benefit plan operational issues that historically occurred and were discovered during the diligence process. Seems like the PEP structure places these administrative and fiduciary responsibilities squarely on the PEP and its providers rather than the employer or seller, in the context of a transaction.

Elliot Saavedra: Indeed, it does, David. All of these benefits together help to mitigate or even eliminate the retirement plan as a potential issue during a sale process, including in cases where a 401(k) plan is transferring to a new employer or terminating altogether.

Finally, we see PEPs as a good alternative to new start-up plans resulting from a transaction, particularly for spin-out transactions where new benefits must be put in place quickly. While there may be a transition agreement negotiated with the seller, in most cases, the seller will want to exclude 401(k) plan participation in order to avoid creating an incidental multiple-employer plan, which would require the seller to amend their retirement plan before closing. In situations like this, the new spun-out company will generally be required to provide a 401(k) plan offering to its employees in very short order from closing. Given the time pressure, a PEP can offer a company in this situation a quick solution to implement a retirement plan. Actual implementation times vary depending on certain factors like the complexity of the plan or PEP being set up or the time of year, but we are aware of some PEPs that have been able to commit to implementation timelines as quickly as 60 days, and we have actually been involved in situations like this where plans were implemented in less than 60 days. This is far quicker than the standard 90-120-day timelines associated with establishing a new single-employer 401(k) plan.

David Kirchner: So, all in all, it sounds like the benefits of PEPs for private equity sponsors may vary depending on the type of transaction but are clear on their face that they can help create value and ease the process for sponsors and portfolio companies. Is it safe to say that these benefits can exist for all employers looking at new 401(k) options for their employees?

Elliot Saavedra: I would agree with that. There has been considerable growth in the PEP market since 2021, which means competition between the PEPs themselves. According to a recent article in Bloomberg Law, the number of PEPs newly registered with the DOL grew by 76% between 2021 and 2022. The level of interest in these plans bodes well for employers because it gives them a larger pool of options and potentially better negotiating power compared to simply checking the single-employer recordkeeper market occasionally for fee and service benchmarking purposes. While PEPs are still relatively new and working out the kinks, we would certainly recommend employers consider throwing a few PEP options into the mix during their next fee benchmarking process or if they are performing a full RFP for a new 401(k) service provider.

David Kirchner: I can certainly see how having more options can result in a better bidding process for a new service provider. Thanks so much, Elliot. If our listeners want to learn more about how to search for and evaluate PEP 401(k) alternatives as a retirement plan offering, do we offer any resources to assist them?

Elliot Saavedra: We do. In fact, our listeners can head right now to ropesgray.com to download a two-page overview that can help them understand whether a PEP might be the right fit and how our team here at the Ropes & Gray benefits consulting group can assist in making that determination. We have been in regular contact with many pooled plan providers and have had experience with the bidding and implementation process for several of them. If you are looking for a new 401(k) plan option or simply want to streamline your retirement plan administration, you can again head to ropesgray.com to download our overview to learn more. David and I are always available as a resource, as well, so please feel free to reach out to either of us if you have any questions related to PEPs. And don't forget, this is the first episode in our two-part PEP series, so be on the lookout for another podcast in the near future.

David Kirchner: That's right. In the next episode, we will dive into some of the regulatory changes surrounding PEPs as a result of the passage of SECURE 2.0 in late 2022, including the expansion of PEPs to 403(b) plans. We'll also discuss ways for employers that already are participating in PEPs to ensure they have an appropriate internal governance set up to prudently evaluate and monitor PEPs on an ongoing basis. In addition, we will address some of the "growing pains" we are seeing as the industry expands and adapts to the evolving complexities of this new market

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