For DC Plans, Operational Failures Can Pose a Significant Risk

Risk is inherent in any 401(k), 403(b), 457 or other defined contribution (DC) plan. Some of these risks – such as investment, credit and longevity risks – are shared by both the plan sponsor and the participants. With proper due diligence in selecting investment options and communicating participants’ responsibilities, plan sponsors can often avoid the most damaging consequences when negative events occur related to these risks.

One category of risk – operational risk – is the sole responsibility of the plan sponsor. When operational failures occur, plan sponsors often face severe damage to their reputations – and this potentially can lead to financial losses, litigation and even threatened tax status.

Types of Operational Risks

Operational risk can stem from:

  • External events that begin outside of the plan sponsor’s immediate control (e.g., in a recordkeeper’s system),
  • Internal errors made by administrative staff, the plan sponsor’s decision makers or even administrative software, or
  • Malicious or criminal activity either by staff or those unrelated to the plan.

These events can be grouped as relating to:

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Compliance

 

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Transaction Processing

 

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Participant Financial Reporting

 

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Vendor Service

 

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Data Security

 

Benefits of Managing Operational Risk

While many DC plan sponsors delegate parts of their operational risk management to service providers, clear oversight is still needed. Effectively managing operational risk can lead to improved service quality, reduced costs, improved participant decision making and strengthened compliance. A first step is adopting a framework that includes:

  • Governance structure
  • Audits and risk assessments
  • Management of cybersecurity and data risks
  • Peer reviews and benchmarking
  • Comprehensive investment policy
  • Key performance and risk measures

Learn more about recognizing and managing operational risk in Sibson’s publications:

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