Academic journal article Journal of Risk and Insurance

Fiduciary Decision Making and the Nature of Private Pension Fund Investment Behavior

Academic journal article Journal of Risk and Insurance

Fiduciary Decision Making and the Nature of Private Pension Fund Investment Behavior

Article excerpt

Fiduciary Decision Making and the Nature of Private Pension Fund Investment Behavior

ABSTRACT

The Employee Retirement Income Security Act of 1974 (ERISA) was enacted in

order to protect and enhance the welfare of employees and others covered by private

pension plans. In order to achieve this objective, ERISA required pension plans to vest

the accrued benefits of employees with significant periods of service, meet minimum

standards of funding, guarantee the adequacy of the plan's assets against the risk of

premature plan termination, and change the legal status of plan administrators from

that of nonfiduciary agents of the sponsoring firm to that of fiduciaries whose primary

responsibility is to plan beneficiaries. This study considers the extent to which changing

the legal status of plan administrators may have had incidental, and perhaps

unintended, side effects. Empirical evidence suggests that, since the enactment of

ERISA, private pension fund portfolios have underperformed portfolios held by

comparable investment funds not subject to ERISA. This study analyzes the extent to

which this change in legal status, which holds administrators to a higher standard of

conduct and subjects them to increased liability exposure, may have contributed to this

underperformance phenomenon.

Introduction

This study analyzes the implications of the change in the legal status of private pension fund administrators from that of nonfiduciary to fiduciary economic agents that resulted from the enactment of ERISA. The analysis focuses on the manner in which differences in the legal/institutional environments within which fiduciaries and nonfiduciaries must operate lead to differences in their incentives, and in turn, their behavioral tendencies. As a result, to the extent that ERISA altered the status of private pension fund administrators from that of nonfiduciary agents of the sponsoring firm to that of fiduciary agents whose primary responsibility is to plan beneficiaries, differences in pre- and post-ERISA private pension fund investment behavior may be attributable, in part at least, to this change.

Several previous studies that have empirically studied the relationship between the enactment of ERISA and the change in the nature of private pension fund investment behavior have reported finding a statistically significant effect. For example Cummins and Westerfield [4] found that post-ERISA private pension fund investment portfolios contain a greater percentage of lower risk, lower rate of return securities than did pre-ERISA securities. More recently, Berkowitz and Logue [2] evaluated the investment performance of corporate pension plans in an attempt to determine, inter alia, if ERISA has had a significant impact on plan performance. The data revealed that private pension

plans have consistently underperformed endowment plans (not governed by ERISA) during the sample period (1968-1983); however, when the time series is divided into pre- and post-ERISA periods, a significant increase in the relative magnitude of the differential is discernible.(1)

Given the similarity of investment objectives of private pension plans and endowments, how might this marked discrepancy in relative performance be explained? One possible explanation is that the change in the legal status of private pension plan administrators, brought about by ERISA, may have exacerbated the discrepancy by altering the incentive structures under which they operate. In enacting ERISA, Congress attempted to protect interstate commerce and the interests of private pension plan participants and their beneficiaries by, inter alia, establishing standards of conduct, responsibility, and obligations for fiduciaries of employee benefit plans and by providing for appropriate remedies, sanctions, and ready access to the federal courts [ERISA Section 2]. …

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