CEBS GBA Exam 3 – Group Benefits
Certification Study & Prep
Explain the relationship between modern portfolio theory (MPT) and the
diversification requirement in ERISA (Mod 8.3) - -- answer --MPT constructs a
risk/reward frontier that assumes diversification always eliminates
nonsystematic risk. Since MPT is a bedrock tenet of ERISA, the diversification
requirement is very important. It reduces the risk of large losses ". . . by
diversifying the investments of the plan so as to minimize the risk of large losses,
unless under the circumstances it is clearly prudent not to do so."
Although an investment policy statement (IPS) is not expressly required under
ERISA, fiduciary best practices indicate that an IPS should be in place. List the
features or characteristics of a good IPS for innovative investments (Mod 8.3) - --
answer --(a) It should be more detailed than an IPS for standard investments, to
help assess the innovative investment and, most importantly, to help monitor the
innovative investment on an ongoing basis.
(b) It should be flexible enough that it can be implemented in a complex and
dynamic financial environment.
(c) It should not be so detailed as to require constant revisions and updates.
(d) It should be drafted in a way that does not increase the risk of failure by the
investment fiduciaries.
(e) It should be carefully drafted, typically by an attorney familiar with employee
benefit issues working in concert with the fiduciaries and their investment
consultants.
,(f) The investment criteria in the IPS should be written in the context of meeting
the needs of the participants.
In the Sulyma v. Intel case, the Intel plantiffs argued that the Intel ERISA
investments underperformed a passive index and therefore should be considered
imprudent. Does poor investment performance constitute imprudent investment
management under ERISA? Explain. (Mod 8.3) - -- answer --Prudent investing is
not judged on the investment results in hindsight, but rather by
the process employed to investigate and monitor the investment. So the mere
fact
that the Intel investments underperformed the passive index does not create an
imprudent process.
ERISA imposes an exacting standard of conduct for fiduciaries of employee
benefit plans. To what extent does ERISA set forth specific guidelines as to the
types of investment vehicles and other property that a plan can own or the types
of investment transactions in which a plan can engage? (Mod 8.4) - -- answer --
ERISA does not have any specific restrictions or guidelines on the types of
investments a plan can hold. It also does not have any guidelines or restrictions
on the types of investment transactions in which a plan can engage—other than
the fact that fiduciaries must confirm that making the investment (and engaging
in any other activities associated with the purchasing, holding and eventual
redemption or sale of the investment) will not constitute a "prohibited
transaction."
Many ERISA plans hire professional investment advisors to enable the plan
fiduciaries to obtain expert investment guidance. What are the three possible
tiers of investment assistance from which fiduciaries can choose? (Mod 8.4) - --
answer --(1) Provision of investment data—A plan's recordkeeper, consultant,
publication service or other vendor may simply collect and format data to render
,it accessible to the plan fiduciaries, without making investment recommendations
or otherwise injecting its viewpoint into the process.
(2) Investment advice, with final decision-making authority reserved to the plan's
named fiduciary—This arrangement, often called a 3(21) arrangement, involves
the rendering of investment advice for a fee or other compensation.
(3) Investment management—A so-called 3(38) arrangement involves a bank,
insurance company or registered investment advisor that has acknowledged
fiduciary status in writing and that has the authority to make investment
decisions without further involvement from the named fiduciary.
Does hiring an investment advisor or investment manager eliminate the
fiduciary's liability? Explain. (Mod 8.4) - -- answer --Hiring an investment advisor
or investment manager does not relieve the named fiduciary from understanding
the nature of the plan's investments and chosen investment strategies. It is in the
interest of fiduciaries to understand the investment professional's strategy and to
make sure they obtain enough information about investments to verify that the
chosen strategy remains appropriate and that the plan's
actual investments align with the strategy.
Mutual funds are often used as an investment vehicle in ERISA plans. Describe
these investment vehicles with regard to their (a) liquidity, (b) governmental
regulation and (c) appropriate disclosure documents (Mod 8.5) - -- answer --(a)
Mutual funds issue redeemable shares, meaning that investors wishing to leave
the mutual fund sell their shares back to the fund. Consequently the fiduciary can
generally expect the investment to be liquid in normal market circumstances.
(b) Mutual funds are not subject to direct regulation by ERISA, but they are
subject to
regulation under the Investment Company Act of 1940 and must meet regulatory
standards regarding liquidity of the portfolio, presence of independent directors
on the governing board, compliance oversight and other matters.
, (c) A mutual fund is required to provide appropriate disclosure documents,
meaning that the fiduciaries of a participant-directed plan do not need to design
customized fund descriptions for participants.
What are some basic considerations for an ERISA fiduciary in evaluating the
possibility of selecting mutual funds as a plan asset? (Mod 8.5) - -- answer --(a)
Fiduciaries should be sure to understand whether the fund uses an "active" or
"passive" strategy. Passive funds typically seek to match an index of securities,
while active funds attempt to outperform the market.
(b) In selecting a mutual fund, fiduciaries should consider the fund's performance,
expenses, alignment with the desired asset class parameters and other relevant
factors.
(c) Fiduciaries should make sure that they have selected the appropriate share
class. For example, plans making a large enough investment may qualify for more
favorably priced "institutional" class shares.
(d) Fiduciaries need to make sure all selected investment products are prudent
and
appropriate.
(e) Fiduciaries need to review expenses by reviewing more than just the expense
ratio. Redemption fees, minimum holdings and other terms must be considered.
(f) Fiduciaries need to understand the advantages and disadvantages of revenue
sharing. These arrangements involve a fee paid to the plan's recordkeeper directly
for certain fund-related services.
How do closed-end funds differ from open-end mutual funds? (Mod 8.5) - --
answer --Closed-end funds, in contrast to open-end mutual funds, generally do
not redeem their shares, although some do so at specified intervals. Instead,
investors sell shares on the market to other investors. This structure often makes
closed-end funds problematic for participant-directed plans. Some of these funds
tend to be actively managed and thus often are more expensive.
Certification Study & Prep
Explain the relationship between modern portfolio theory (MPT) and the
diversification requirement in ERISA (Mod 8.3) - -- answer --MPT constructs a
risk/reward frontier that assumes diversification always eliminates
nonsystematic risk. Since MPT is a bedrock tenet of ERISA, the diversification
requirement is very important. It reduces the risk of large losses ". . . by
diversifying the investments of the plan so as to minimize the risk of large losses,
unless under the circumstances it is clearly prudent not to do so."
Although an investment policy statement (IPS) is not expressly required under
ERISA, fiduciary best practices indicate that an IPS should be in place. List the
features or characteristics of a good IPS for innovative investments (Mod 8.3) - --
answer --(a) It should be more detailed than an IPS for standard investments, to
help assess the innovative investment and, most importantly, to help monitor the
innovative investment on an ongoing basis.
(b) It should be flexible enough that it can be implemented in a complex and
dynamic financial environment.
(c) It should not be so detailed as to require constant revisions and updates.
(d) It should be drafted in a way that does not increase the risk of failure by the
investment fiduciaries.
(e) It should be carefully drafted, typically by an attorney familiar with employee
benefit issues working in concert with the fiduciaries and their investment
consultants.
,(f) The investment criteria in the IPS should be written in the context of meeting
the needs of the participants.
In the Sulyma v. Intel case, the Intel plantiffs argued that the Intel ERISA
investments underperformed a passive index and therefore should be considered
imprudent. Does poor investment performance constitute imprudent investment
management under ERISA? Explain. (Mod 8.3) - -- answer --Prudent investing is
not judged on the investment results in hindsight, but rather by
the process employed to investigate and monitor the investment. So the mere
fact
that the Intel investments underperformed the passive index does not create an
imprudent process.
ERISA imposes an exacting standard of conduct for fiduciaries of employee
benefit plans. To what extent does ERISA set forth specific guidelines as to the
types of investment vehicles and other property that a plan can own or the types
of investment transactions in which a plan can engage? (Mod 8.4) - -- answer --
ERISA does not have any specific restrictions or guidelines on the types of
investments a plan can hold. It also does not have any guidelines or restrictions
on the types of investment transactions in which a plan can engage—other than
the fact that fiduciaries must confirm that making the investment (and engaging
in any other activities associated with the purchasing, holding and eventual
redemption or sale of the investment) will not constitute a "prohibited
transaction."
Many ERISA plans hire professional investment advisors to enable the plan
fiduciaries to obtain expert investment guidance. What are the three possible
tiers of investment assistance from which fiduciaries can choose? (Mod 8.4) - --
answer --(1) Provision of investment data—A plan's recordkeeper, consultant,
publication service or other vendor may simply collect and format data to render
,it accessible to the plan fiduciaries, without making investment recommendations
or otherwise injecting its viewpoint into the process.
(2) Investment advice, with final decision-making authority reserved to the plan's
named fiduciary—This arrangement, often called a 3(21) arrangement, involves
the rendering of investment advice for a fee or other compensation.
(3) Investment management—A so-called 3(38) arrangement involves a bank,
insurance company or registered investment advisor that has acknowledged
fiduciary status in writing and that has the authority to make investment
decisions without further involvement from the named fiduciary.
Does hiring an investment advisor or investment manager eliminate the
fiduciary's liability? Explain. (Mod 8.4) - -- answer --Hiring an investment advisor
or investment manager does not relieve the named fiduciary from understanding
the nature of the plan's investments and chosen investment strategies. It is in the
interest of fiduciaries to understand the investment professional's strategy and to
make sure they obtain enough information about investments to verify that the
chosen strategy remains appropriate and that the plan's
actual investments align with the strategy.
Mutual funds are often used as an investment vehicle in ERISA plans. Describe
these investment vehicles with regard to their (a) liquidity, (b) governmental
regulation and (c) appropriate disclosure documents (Mod 8.5) - -- answer --(a)
Mutual funds issue redeemable shares, meaning that investors wishing to leave
the mutual fund sell their shares back to the fund. Consequently the fiduciary can
generally expect the investment to be liquid in normal market circumstances.
(b) Mutual funds are not subject to direct regulation by ERISA, but they are
subject to
regulation under the Investment Company Act of 1940 and must meet regulatory
standards regarding liquidity of the portfolio, presence of independent directors
on the governing board, compliance oversight and other matters.
, (c) A mutual fund is required to provide appropriate disclosure documents,
meaning that the fiduciaries of a participant-directed plan do not need to design
customized fund descriptions for participants.
What are some basic considerations for an ERISA fiduciary in evaluating the
possibility of selecting mutual funds as a plan asset? (Mod 8.5) - -- answer --(a)
Fiduciaries should be sure to understand whether the fund uses an "active" or
"passive" strategy. Passive funds typically seek to match an index of securities,
while active funds attempt to outperform the market.
(b) In selecting a mutual fund, fiduciaries should consider the fund's performance,
expenses, alignment with the desired asset class parameters and other relevant
factors.
(c) Fiduciaries should make sure that they have selected the appropriate share
class. For example, plans making a large enough investment may qualify for more
favorably priced "institutional" class shares.
(d) Fiduciaries need to make sure all selected investment products are prudent
and
appropriate.
(e) Fiduciaries need to review expenses by reviewing more than just the expense
ratio. Redemption fees, minimum holdings and other terms must be considered.
(f) Fiduciaries need to understand the advantages and disadvantages of revenue
sharing. These arrangements involve a fee paid to the plan's recordkeeper directly
for certain fund-related services.
How do closed-end funds differ from open-end mutual funds? (Mod 8.5) - --
answer --Closed-end funds, in contrast to open-end mutual funds, generally do
not redeem their shares, although some do so at specified intervals. Instead,
investors sell shares on the market to other investors. This structure often makes
closed-end funds problematic for participant-directed plans. Some of these funds
tend to be actively managed and thus often are more expensive.
