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Solutions for DC Plan Sponsors

From the Sep 2019 Thought Leadership BlackRock Retirement Report

In December 2017, Fiduciary News polled retirement plan service providers to see what they felt were the top challenges defined contribution (DC) plan sponsors might not realize are, in fact, challenges. The top answer was “understanding the extent of legal liability.” It’s not that plan sponsors don’t know there is legal risk in running a plan – but the pace of change and minutiae of the regulatory landscape can be dizzying. That’s why the lead focus of what follows zeroes in on a lingering legal and fiduciary concern for sponsors – company stock.

1 5 Myths About Company Stock

Two decades ago, 19% of defined contribution assets were invested in company stock, effectively “doubling down” on the financial risk participants already had in their firm’s financial future. While company stock is not as common as it once was on DC menus, it still has a major presence: According to the Employee Benefit Research Institute (EBRI), 49% of plans with more than 5,000 participants offer company stock, with average participation allocation ranging between 10–20%. In other words, company stock in DC plans is not not an issue.

The appeal of company stock in DC plans to relevant companies and plan sponsors is understandable – employees might feel more engaged and committed to the business knowing they have extra skin in the game. But it’s also a risky pursuit, especially when you know this: According to EBRI, 5% of DC participants in plans with company stock have virtually all their savings invested in this option. That is an eye-opening statistic for two reasons: concentrating investment risk in any single stock runs contrary to accepted wisdom on diversification; and, employees who rely on company stock for retirement savings are essentially doubling down on their dependence upon their employer’s financial health. 

There are many misconceptions around employees holding stock in their DC plans. Here are five common myths about company stock that DC plan sponsors should know about. The next chapter of this report will offer some suggestions on how plan sponsors can manage their company stock risk. 

Myth #1: It’s mostly executives and higher income participants who hold company stock in DC plans.

The assumption that company stock is concentrated among executives and other higher salary employees makes sense. Very often they are required to hold it, and as more sophisticated investors, they can be trusted to diversify outside their workplace plan. The data tells a different story. When BlackRock conducts plan design analysis using participant level data, it has consistently found that it’s the lower income participants with the largest concentrations in company stock. Why? Inexperienced investors may choose the company they believe they know, a fallacy known as familiarity bias (a close relative of home country bias). Whatever the reason, it appears that the more financially vulnerable participants are exposed to excessive undiversified risk. Clearly, this could be a fiduciary concern. 

Myth #2: The company benefits from increased engagement and productivity. 

One of the justifications for including company stock on the investment menu is the belief that it will help align employer and employee interest, creating greater employee engagement and productivity. Academic studies of both the monetary and non-monetary benefits have found mixed evidence at best. For instance: 59% of surveyed participants stated that owning company stock did not make them feel better or worse about their company, and 32% stated company ownership did make them feel better.1  Interestingly, in the same study, researchers found that these employees were predominately working for companies whose stock had performed very well, suggesting that picking a winner was the prime driver of goodwill. 

Evidence on whether employee stock ownership positively affects company performance by encouraging increased productivity is also inconclusive.2  Keep in mind that company stock is typically offered by large plans with many employees, so a rank-and-file employee effort is likely to have an extremely small impact on overall firm performance, giving him or her little incentive to work harder. Given the research, the benefit to the company is either non-existent or negligible. It’s hard to make a case that it’s enough to justify the risk. 

Myth #3: It’s paternalistic to assume participants don’t understand the risk.

While most participants are not sophisticated investors and may lack basic investment terminology, many have absorbed enough to have a sense of risk. For example, surveys find that participants correctly rate a single stock investment as riskier than an equity fund. So far, so good. 

Unfortunately, surveys also find that participants rank their employer stock as less risky than a diversified equity fund. Because they feel they know their firm and its products and services, they may feel they have some level of control over its stock performance. On the other hand, they may never have heard of many of the companies that make up the diversified portfolio and associate the unknown with risk. Even sophisticated investors suffer from discomfort about unknown or less familiar options, allowing it to affect their decisions. 

When it comes to potentially less sophisticated investors, such as participants whose investment experience may be limited to their workplace plan, extra caution in describing the risks of holding company stock may be justified. 

Myth #4: If the risk were significant, ERISA would prohibit it. 

ERISA (Employee Retirement Income Security Act) requires fiduciaries to act with prudence and diversify the plan’s investments to minimize the risk of large losses. Yet ERISA explicitly exempts company stock from the diversification requirement, which paves the way for unsophisticated DC participants to invest their retirement savings in a single stock that is correlated with their labor income. Despite the exemption, plan sponsors have found themselves involved in costly litigation over company stock. 

There are many complex and, occasionally, competing reasons why ERISA provisions take the shape they do. But if you look to ERISA for insight regarding the risk of company stock, consider this: the law imposes a 10% limit on employer securities in defined benefit (DB) plans. Therefore, while the most sophisticated investment managers in retirement have guardrails in place, participants selecting their own investments do not. 

Myth #5: Everyone learned from past mistakes such as Enron. 

Plan sponsor attitudes have shifted regarding company stock. For example, it was once common practice to match participant contributions with company stock, but it would be less common to see the practice today. Nonetheless, the problem persists in many large plans because of participant inertia and the hesitation of plan sponsors to reenroll participants. That leaves it to individual participants to make the choice. Have they learned from the past? There is considerable evidence that the answer is no.

Enron’s collapse in 2001 is likely the most well-known dark chapter in the history of company stock. Over 60% of participants’ DC assets were invested in Enron stock, so when the firm filed for bankruptcy, many lost their retirement savings along with their jobs. In the aftermath, Boston Research Group3  conducted a study in the Houston area (Enron’s headquarters), where it was assumed survey respondents were likely to have first- or second-hand experience of the dangers of investing significant amounts of retirement savings in employer stock. Did it change their appetite for company stock? Despite the well-publicized local retirement catastrophe, the study found that participants were unfazed: they continued to invest in their company stock. 

There are few “free lunches” in life, but modern portfolio theory suggests that diversification may be one. It holds that investing in a portfolio of stocks allows us to earn the weighted return of the individual stocks, but with typically less risk than the weighted risk of the individual stocks. If that’s the case, then it isn’t only the outliers like Enron that cause concern. Any single stock portfolio poses diversifiable risk.

There are more misconceptions about company stock that plan sponsors should understand. Learn more about them.  


1 Benartzi, S., Thaler, R. H., Utkus, S. P., & Sustein, C. R. The Law and Economics of Company Stock in 401(k) Plans. The Journal of Law and Economics 50, No. 1 (February 2007), pp. 45-79.

 2 Mitchell, O. S., & Utkus, S. P. The Role of Company Stock in Defined Contribution Plans. National Bureau of Economic Research, Working Paper No. 9250, October 2002.

 3 Boston Research Group. Enron Has Little Effect on 401(k) Participants’ View of Company Stock. April 25, 2002. 

2 Taking Stock: Potential Solutions

According to the 2019 BlackRock DC Pulse Survey, 87% of plan sponsors agree that it’s important to monitor or limit participant investment in company stock. There are a number of steps a plan sponsor can take to achieve that goal, ranging from mapping company stock allocations into a QDIA (qualified default investment alternative) to closing company stock to new participants in order to “age out” the exposure. In this section, we’ll take a look at some of the issues and potential actions that may emerge when managing company stock within DC plans. 

Issue: Governance and monitoring company stock 

The committee overseeing the DC plan is tasked with managing the plan in the best interest of participants and beneficiaries by providing prudent investment options. Prior to 2014, plan fiduciaries could rely on the “Moench Presumption,” which held that offering company stock was in itself prudent. However, after the U.S. Supreme Court’s 2014 ruling in Fifth Third Bancorp v. Dudenhoeffer, plan sponsors must monitor company stock for prudence like any other investment option on the plan menu. 

Potential action

  1. Hardwire company stock into the plan documents investment policy statement. Some plan sponsors have included language in the plan documents that explicitly states that company stock is offered. In light of the Dudenhoeffer ruling, a plan sponsor may consider stipulating how company stock will be reviewed for prudence on a regular basis. 
  2. Remove insiders from the committee. Removing company insiders from investment committees helps to manage potential conflicts of interest and mitigate the use of material non-public information. Justices in the Dudenhoeffer case stated that absent any special circumstances, the market price of a stock is a prudent indicator of the firm’s value and that insider information should not be used to determine if company stock should be offered or not. 
  3. Hire an independent fiduciary to oversee the company stock fund. An increasingly common practice to manage company stock is for plan sponsors to hire an independent fiduciary. One of the advantages of outsourcing decisions about company stock is that an independent fiduciary will not have access to material non-public information, thereby eliminating potential conflicts of interest. 

Issue: Using plan design to reduce company stock exposure 

Plan design can be an effective tool to manage company stock exposure and there are multiple variations of how holding limits or caps can be used and implemented. Consistency and clear objectives are critical for success. 

Potential action

  1. Introduce caps on company stock allocations. The most frequently used cap today limits company stock allocations to 20% of a participant’s balance. Most plans grandfather higher allocations in while others require higher balances to be liquidated and reinvested. The sponsor needs to determine how to treat company stock exposures that exceed the cap due to performance. One option is to let those holdings ride while another option is to force participants to sell to remain within the cap. In all cases, company stock remains open on the menu and participants can continue to increase their company stock holdings up to the cap. 
  2. Freeze the company stock option. Doing so allows participants to sell company stock but no longer purchase it—effectively capping their allocation at its current level. This step does not address excessively high allocations of current participants, but it eliminates such a problem for newly hired participants. Over time, company stock allocations will fade from the plan as participants retire and draw down their balances or change jobs and roll over assets to a new employer.
  3. Sunset company stock. If the fiduciary determines that company stock no longer fits into the plan design, a thoughtful liquidation strategy, with ample participant notification and communication, is critical. 

Learn more about what to expect when sunsetting a company stock fund. 

3 Nailing Re-Enrollment

Limiting new defaults and plan design innovations to new hires creates two separate and unequal participant populations: those who benefit from your best ideas, and those left behind. As a result, you’re best thinking might not be reaching everyone in the plan even though you provide a thoughtfully designed defined contribution plan, with a carefully selected default option designed to encourage savings, create diversification and help build retirement security. 

Reenrollment can get your participant population aligned with your current best practices. Here are a few common scenarios that have spurred plans to consider reenrollment:

  • A new target date fund is the default option for new hires only, raising fiduciary concerns that legacy populations may not be in age-appropriate investments or sufficiently diversified.
  • Despite offering a diversified menu, participant data analytics reveal concentrations of inappropriate risk, insufficient savings rates or potentially inadequate retirement outcomes.
  • Following a merger or acquisition, executive leadership wants to combine all employees into a single plan or create a common experience across the workforce.
  • Participant communications about the new qualified default investment alternative (QDIA) have not driven legacy populations to switch to the new default.

It’s more common than you think

Most plan sponsors are aware of the benefits of reenrollment. In fact, BlackRock’s 2019 DC Pulse Survey found that 86% of employers believe that automatically reallocating their participants’ assets to more appropriate age-based investments would help improve retirement planning. Almost 1 in 5 plan sponsors have conducted a QDIA reenrollment, according to the Defined Contribution Institutional Investment Association biennial plan sponsor survey in 2017. 

Help participants help themselves

Very few participants have the expertise, time and specialized insight needed to manage their own asset allocation. Even those who feel confident enough to make their own investment decisions are unlikely to review or adjust their investments over time, as shown by the more than 40% of participants surveyed who said they have never changed their investments. That means even participants who “got it right” when they first selected their investments may no longer have an age-appropriate risk exposure.

Reenrollment can help address these issues, and, may even take advantage of participant inertia by automating the investment management they may need to reach their retirement goals. By reenrolling employees who aren’t currently invested in the QDIA, you can provide the same target date fund benefits to all your participants, no matter when they joined the plan – ensuring that everyone may benefit from your current best thinking.

Wish you had a guide to re-enrollment? Good news. There’s one right here.

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