Insurer sued for offering nothing but in-house funds

The lawsuit brought by New York Life Insurance Co. employees over how the company manages its pension plans hasn’t been settled, but already the litigation might be causing some industry experts to recommend changes in how plan investment options are chosen.

The class action contends that the insurer created a conflict of interest by using its own mutual funds as the only investments in its defined-benefit and defined-contribution plans. But that’s not the sole concern.

Consultants and lawyers are warning plan sponsors that they run the risk of participant lawsuits when they decline to drop high-cost, low-performing funds or decide to add funds requested by participants without conducting a full search.

In the New York Life case, the employees who brought the suit argued that the company “broke faith” with its employees and agents by investing its $4 billion in defined-benefit and $2.8 billion in defined-contribution assets only in the company’s own line of mutual funds, the Eclipse Funds.

The employees contend that New York Life used the assets to prop up the Eclipse Funds – a new line of mutual funds and that the company charged its plans retail fees, which were too high for plans of their size.

On April 1, New York Life transferred the defined-benefit-plan money out of Eclipse funds and into separate accounts managed by the same money managers who run the Eclipse Funds, says George Trapp, an executive vice president who heads the board of trustees for the pension plans.

Company executives intend to keep the defined-contribution assets invested in Eclipse Funds.

“Most plan participants like mutual funds and want daily valuation,” Mr. Trapp says. “That type of investment structure fits very much on the defined-contribution side.”

Currently, the two 401(k) plans offer a guaranteed-investment-contract portfolio managed by New York Life Investment Management and seven Eclipse funds, he says.

Meanwhile, plaintiffs in the case are asking the court to add anti-racketeering charges to their complaint.

They argue that moving the defined benefit into separate accounts is an “admission by conduct,” explains Eli Gottesdiener, the Washington lawyer who filed the suit.

Executives administering New York Life’s plans did not investigate outside investments for their plans, Mr. Trapp says.

“We did not feel the need to do that,” he says. “We felt the investment options were available within New York Life. There is a specific [regulatory] exemption for financial services companies that recognizes that it would be foolhardy [for financial service companies] to be forced to go outside to invest their own money.”

New York Life moved the defined-benefit assets out of mutual funds as a result of an asset allocation study begun in 1999 by outside consultant DeMarche Associates Inc. in Overland Park, Kan., explains Mr. Trapp.

As a result of the DeMarche study, New York Life executives moved the overall asset allocation of the defined-benefit plans to 60% equities and 40% fixed income, from 50-50.

“We wanted to [make changes] in a rational way over a period of time,” Mr. Trapp says. “There is some savings on some of the fees, but that was not the primary issue or the only issue. Performance was the important factor.”

Mr. Gottesdiener, however, contends that New York Life shouldn’t have used mutual funds, even institutional ones, for its large defined-contribution plans, because the costs are too high.

It is not common for defined-benefit plans the size of New York Life’s plans to use mutual funds, which include charges for services defined-benefit plans do not need, explains Michael Weddell, a lawyer and consultant for Watson Wyatt Worldwide in Bethesda, Md.

widespread

Nevertheless, the practice of using proprietary investment options in a financial service company’s own defined-contribution plan is fairly widespread, he says.

The New York Life case raises questions about how all plan sponsors – not just those in financial services – should select and monitor their investment options.

Sometimes the problem is not that an investment costs 0.2 or 0.3 percentage points more, but that the menu is not adequately diversified, is redundant, has inconsistent education materials and lacks an oversight mechanism, says Ron Eisen, president of Investment Management Consultants Inc. in Portland, Ore.

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