The attitudes of ERISA plan sponsors toward the incorporation of ESG factors into their plans have followed stages that have reflected the PRI’s approach to the US market. Each stage has required distinct approaches, arguments and strategies. 

The first stage involved clarifying to all stakeholders in the ERISA eco-system that the incorporation of ESG and economically targeted investments (ETI) was not prohibited by US policy makers. This included broad education and articulation of the basic tenets of ESG incorporation.

The frame then shifted to demonstrating the clear economic benefits of ESG incorporation to plan participants and beneficiaries, and to argue for plan sponsors and other stakeholders to act. Building on quantitative data and research into the benefits of ESG incorporation in risk management, the focus was on connecting ESG incorporation to investment performance. Finally, through the recent report, Fiduciary Duty in the 21st Century, the focus has broadened to make the point that fiduciaries now have an obligation to integrate ESG factors if they are to fulfill their fiduciary duties. ESG incorporation is now viewed as an essential tool to identify and address investment risks and opportunities, such as climate change mitigation and adaptation.

Evolution of the case for ESG incorporation into the investment process

Evolution of the case for ESG incorporation into the investment process

Stakeholders will drive ESG incorporation more than policy

Given that any clear policy directives supporting ESG incorporation remain highly unlikely in the US, the growth of ESG incorporation in the ERISA market will be driven less by policy and more by companies seeing ESG incorporation as a business imperative and source of competitive advantage as they seek to build corporate cultures and CSR initiatives that attract and retain the best talent. Members of the general public, and specifically beneficiaries, are expected to increasingly engage with plan sponsors on the environmental and societal impact of retirement assets. Given this increased awareness of ESG among stakeholders, a long-term increase in ESG incorporation in the US remains likely.

ERISA retirement plans in the US

In the United States, private sector retirement plans are subject to the provisions of ERISA. The act sets standards for fiduciaries of defined benefit and defined contribution plans based on the principle of a prudent person standard. Under ERISA, plan sponsors and other fiduciaries generally must:

(1) Act solely in the interest of the plan participants and beneficiaries;

(2) Invest with the care, skill, and diligence of a prudent person with knowledge of such matters; and

(3) Diversify plan investments to minimize the risk of large losses. Plan sponsors that breach any of these fiduciary duties can be held personally liable.

The Employee Benefits Security Administration (EBSA), part of the US Department of Labor (DOL), is responsible for enforcing the fiduciary responsibility provisions of ERISA and issuing related regulations and guidance. Although public sector and religious plans are exempt from the provisions of ERISA and the jurisdiction of the DOL, these plans often look to ERISA principles as a benchmark for best practice in meeting common law fiduciary standards in their governance.

Public sector plans are subject to federal and state laws other than ERISA, and their investment management is typically overseen by a board of trustees; however, their governance is also similar to the ERISA prudent person standard.

Defined benefit and contribution plans and qualified default investment alternatives

Private sector retirement plans in the US are typically either defined contribution (DC) or defined benefit (DB). Within a DB plan, the beneficiary is provided a monthly retirement benefit commencing at retirement based on factors such as years of service and salary, with the company obliged to provide the specified benefit. For decades, US companies have sought to reduce their corporate pension liabilities by closing DB plans and offering DC plans in their place.

In a DC plan, the employee has the option to participate and make tax-favored contributions during the period of employment. The company’s direct costs are typically confined to plan administration. However, most firms now provide a modest contribution match of 1-3% of the employee’s income as an incentive for employee participation. The employee chooses from a menu of investable options, making all investment decisions and assuming all investment performance risk. However, the menu of investable options is determined by the company. When employees change jobs, they maintain ownership of the funds accrued and are eligible to transfer their funds to another retirement plan.

In order to increase employee participation, plan sponsors may choose to automatically enroll eligible workers in a DC plan. When the employee does not select an investment option, the plan beneficiary may provide a default investment option. The DOL has specified criteria for these qualified default investment alternatives (QDIAs) that offer plan sponsors a “safe haven” from liability when they are included.

 

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    Untangling stakeholders for broader impact: ERISA plans and ESG incorporation

    September 2018

 

Untangling stakeholders for broader impact: ERISA plans and ESG incorporation