Regulators and the Law of Unintended Consequence

“When we try to pick out anything by itself, we find it hitched to everything else in the universe.”

— John Muir

The adoption of well-intentioned investor protection legislation can come with unintended (and sometimes harmful) consequences. For example, when British rule-makers wanted to put a cap on interest rates in the 17th Century to protect the man in the street against unscrupulous lenders, the economist John Locke wisely pointed out that the measure would have the unintended consequence of actually hurting borrowers by making credit less available.

A more recent example of a similar paradoxical result is the recent effort to provide investors with better information on future investment returns and costs of investing within retirement accounts and investment funds. At first blush, the idea seems non-controversial because giving retail investors more transparency about their retirement portfolios is almost always considered a good thing. But with financial regulation the devil, as they say, is always in the details.

A Comprehensive Revision of Rules

On April 2, the powerful US House Ways and Means Committee passed the Setting Every Community Up for Retirement Enhancement Act of 2019, otherwise known as the SECURE Act, the most comprehensive revision of rules applying to US private retirement accounts in more than a decade. This well-intended policy shift is aimed at increasing retirement savings across the working population to address the ever-increasing retirement savings gap. 

Think about the scope here: ICI estimates that 401(k) plans held $5.2 trillion in assets as of December 2018. That represents 19% of all US retirement assets.

The 140-page SECURE Act tweaks many of the existing rules surrounding 401(k) accounts, but one particular provision, known as the Lifetime Income Disclosure Act (LIDA), requires plan sponsors to release future performance projections – or “the amount of monthly payments the participant or beneficiary would receive if the total accrued benefits were used to provide lifetime income streams based on certain assumptions, including that the participant or beneficiary has a spouse of equal age and a single life annuity.”


Insurance companies, which offer annuities to pension plans, were understandably thrilled at this language. Not surprisingly, the asset management industry had a different take, saying in a letter to legislators that it was concerned that the government is “inadvertently providing its imprimatur to one specific product—annuities—over other investment products.” The asset management industry believes that the currently-proposed LIDA formulation fits more favorably with insurance products than it does with investment vehicles and products. Asset managers contend that a diversified portfolio that includes a mix of asset classes including equities have the potential to outperform fixed income investments, such as annuities, over the long term without undue risk being added to savers. But the problem is that equity returns are more volatile by their nature and not guaranteed and, therefore given the nature of equity investments, they cannot be neatly reduced to one, three, and five-year forward-looking predictions. Managers argue that actual past performance is a far better metric to inform investors.

This fight has already played out in Europe, where investment products known by the unwieldly name packaged retail and insurance-based investment products (PRIIPs), have been the subject of a similar debate. PRIIP rules adopted in March 2017 required that the documentation spell out four types of future returns: “a stress scenario, an unfavorable scenario, a moderate scenario, and a favorable scenario.” This was a sea change from the method of presenting past performance with the caveat that “past performance is not an indicator of future results” or similar.

As with 401(k) plans in the US, PRIIPs in Europe has come under scrutiny from asset managers who suggest the formulae for assessing the risks, costs, and projection of future performance are flawed and do not adequately provide investors with a view of their participation in a fund, since they do not operate in a similar fashion to annuities. This is why there is a concerted push to change the rules before PRIIPs methodology becomes applicable to UCITS funds across the EU. Significant efforts have been made to retain past performance data in PRIIPs Key Investor Documents (KIDs), which would correct the perceived imbalance between annuities and investment funds, but the Joint Committee of European Supervisory Authorities decided in February 2019 not to include this information “at this time.”

The SECURE Act must now be considered by the full House of Representatives, as well as companion legislation in the US Senate, where the bill is known as the Retirement Enhancement Savings Act. The Senate adopted so-called Safe Harbor provisions to protect plan sponsors in case future projections proved to be inaccurate, a major concern, but the Senate bill also based LIDA projections on future returns in the last two iterations.

The SECURE Act legislation pending in both the House and Senate is a laudable bipartisan attempt to address the current gap in US retirement and pension funding, a problem which has now become a global crisis, but in its details, it should work across the full range of investment products available in the retirement savings marketplace or else it runs the risk of inadvertently favoring one product over another.