United States: Pooled Employer Plans (“PEPs”): Putting a little PEP into a 401k retirement plan could help protect your portfolio companies
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Amid the ongoing spate of ERISA lawsuits against employers who sponsor retirement plans, pooled employer plans (“PEPs”) are emerging in the US retirement plan market as an alternative that may limit employer exposure to pension-related litigation. Since 2018, over 220 ERISA class action lawsuits related to pension plans have been filed, and the top 10 ERISA settlements for 2021 alone totaled $840 million. Because ERISA litigation is a serious and relevant issue, many plan sponsors, including private equity sponsors and their portfolio companies, would benefit from evaluating whether a PEP is a viable retirement solution for them.
Many of the salient attributes of PEPs appear to align with the priorities of our private equity clients’ portfolio companies in managing transactions and streamlining operations. PEPs are relatively new, but our Benefits Advisory Group has been closely monitoring the PEP market and can provide guidance and insight on which PEPs best fit the specific needs of your portfolio companies.
Overview of pooled employer plans
PEPs were introduced by the SECURE Act legislation and became effective on January 1st, 2021. At a high level, a PEP is a multi-employer defined contribution plan (ie, a 401(k) plan that allows independent employers to participate). A PEP is sponsored by a third party (rather than the employer) called a pooled tariff provider.
Under a PEP arrangement, a portfolio company would not sponsor its own plan — instead, it would be a “participating employer” outsourcing most of its ERISA fiduciary duties, as well as the burden of managing and administering the retirement plan, to the PEP. This is significant given that much of the current ERISA litigation is against employers subpoenaed for insufficient ERISA fiduciary oversight of their pension plans.
PEPs are now offered by many pension plan administrators, consulting firms, payroll providers and benefit administrators who have established PEPs and registered as pooled plan providers with the DOL.
Why Private Equity Firms / Portfolio Companies Should Consider PEPs
In addition to managing ERISA’s fiduciary legal risk, PEPs have the potential to offer employers and their plan participants the following advantages over traditional single-employer 401(k) plans:
- participant fees – Due to economies of scale, PEPs generally have lower recordkeeping and administration costs compared to smaller single-employer pension plans. Many of the ERISA class action lawsuits revolve around excessive subscription fees.
- Shift of fiduciary responsibilities from ERISA – PEPs allow employers to delegate the majority of their fiduciary responsibilities under ERISA (e.g. oversight of the investment options menu, administration of pension plans and investment management) to the PEP and its providers.
- Reduce management of plan management – The pool plan provider of the PEP takes over most of the day-to-day plan administration from the employer. The pooled plan provider is responsible for plan documentation, required regulatory filings, and ongoing compliance with the plan, reducing the amount of resources an employer must devote to benefit administration.
- reduce supplier relationships – Typically, for single-employer pension plans, a company must engage a clerk, custodian, investment adviser, trustee, auditor and possibly an actuary. These extra commitments can be costly — for example: an investment advisor can cost an employer or pension plan an additional $50,000 to $250,000 per year, depending on size. Under a PEP, all of these services are bundled with one provider, which offers economies of scale.
Private Equity Sponsors, Transactions and PEPs
Although the final decision to participate in a PEP must be evaluated and made by each individual portfolio company, PEPs can offer practical advantages to private equity sponsors in the context of transactions.
For private equity sponsors on the buy-side of a transaction, PEPs appear to have the following benefits:
- implementation time – In general, PEPs can be implemented more quickly than individual employer pension plans. Given the trend towards reduced sign-to-close times, PEPs serve as a viable option that can allow private equity sponsors to avoid unnecessary interim service contract fees while ensuring that a retirement plan can be established at the time of closing.
- carve outs – PEPs are becoming increasingly popular for carve outs.
- participant fees – Employees who are spun off from a larger employer are typically used to relatively low pension plan fees – a PEP is more likely to offer participation fees that are more comparable to those employers’ plans.
- Limited internal services/HR resources – In many cases, carve-outs acquire limited or no internal HR/Benefits resources during the transaction. This may affect the carveout’s ability to properly administer a traditional single employer plan and associated fiduciary obligations. With a PEP, however, outsourcing can delegate much of the administration of the pension plan to the PEP, significantly reducing administrative burden and costs and shifting much of the fiduciary responsibility (and risk) to the PEP.
- An alternative solution – Rather than inheriting/buying a pension plan that has outstanding compliance or litigation issues at inception, a PEP could be quickly implemented and serve as an alternative solution. As a result, the buyer is not forced to adopt a problematic seller’s plan just because of time constraints.
PEPs are designed to reduce enrollment costs, achieve higher levels of efficiencies, reduce plan administration overhead, and reduce the fiduciary liability of ERISA compared to individual employer pension plans. However, there are still certain risks and liabilities for employers participating in a PEP. Not all PEPs are structured equal and it is crucial to understand which risks and liabilities pass to the PEP and which remain with the portfolio company as a participating employer.
The decision to join a PEP requires a careful decision-making process, and a PEP’s fees and investments must continue to be monitored and compared on an ongoing basis. To this end, our Benefits Advisory Group has extensive knowledge of the PEP market and can provide unbiased advice on the various PEP offerings, how they compare to single person pension plans and which can be tailored to the needs of specific portfolio companies.
The content of this article is intended to provide a general guide to the topic. In relation to your specific circumstances, you should seek advice from a specialist.
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