Organizations that offer retirement plans such as 401(k) and 403(b) plans to their employees are being jolted to a harsh awakening.
Class action lawsuits and plan audits conducted by the U.S. government reveal that fees paid by many plans to their vendors are excessive. (Federal law makes plan sponsors not the vendors accountable.) According to the Department of Labor, the factors that cause excessive fees may be present in nearly every retirement plan.
Human resources leaders can feel challenged to know what makes a service provider’s fee “excessive.”
Five factors that lead to excessive fees
A good place to start for ensuring that your plan’s fees are reasonable is to know what could cause its fees to be deemed excessive. During our examinations of fees charged by service providers to ERISA qualified employee benefit plans, we have found five recurring factors. Each factor is listed below along with a suggestion on how to address it.
(1) The Vendors Over-Match the Buyers
The market for retirement plan services is lopsided in favor of vendors. That’s because vendors are specialists in the design of their products, services, and compensation arrangements, and are continually engaged in marketing to plan sponsors. Plan sponsors often lack this degree of specialization. Even very large, relatively sophisticated plan sponsors shop for services only periodically, generally once every three to five years. Smaller, less sophisticated plan sponsors engage with vendors in buy/sell discussions even less often. As a result, vendors are able to maintain an information advantage over their plan sponsor clients and to use that advantage to distort service offerings and pricing in their own favor. Before you negotiate be prepared! The Excellent Fiduciary training course is an effective inexpensive option.
(2) Asset-Based Pricing Structures are Loaded with Risk for Plan Sponsors
Compensation paid to retirement plan vendors that is based on an asset-based percentage is fueling the rise in lawsuits against companies. (That percentage is called the “multiplier.”) An asset-based vendor compensation arrangement can easily result in extra fees if the vendor does not deliver an increase in its services when the dollar value of its compensation rises. When comparing vendors’ fees, be sure you go beyond the multiplier in your evaluation to uncover what is a reasonable fee. The Vendor Value Index is an excellent tool for this purpose.
(3) Signed Contracts – Filed and Forgotten
Our firm’s examinations of the fiduciary files of a large number of ERISA plans has rarely found service agreements that show signs of modifications to their original pricing and servicing terms. Contracts that are not maintained to reflect changes in market conditions, a retirement plan’s servicing needs, and price movements among vendors fuel excessive fee cases. No less often than every three years, plan fiduciaries are well advised to conduct a review of the market for the plan’s required services. A time consuming Request for Proposal (“RFP”) project is not necessary to conduct such a review. In fact, RFPs are being replaced by periodic plan reviews where vendors’ fees and service quality are evaluated. This qualified plan review is unbiased and very effective at determining the reasonableness of service providers’ fees.
(4) Revenue Sharing and Multiple Hat Vendors
Vendors such as investment advisors, recordkeepers, third party administrators, and custodians have a history of receiving payments from the mutual fund companies in order to offset direct payments. This indirect payment practice is known as “revenue sharing.” A large number of vendors use it extensively. Federal law places on plan sponsors the burden of identifying unfair revenue sharing arrangements and correcting them. While a fee disclosure rule adopted in 2012 requires vendors to reveal the sources of all of their fees, the disclosures can be complex and difficult to evaluate. Making sense of revenue sharing and fee disclosures can be all the more difficult if more than one retirement plan service is obtained from the same vendor. The U.S. Supreme Court has warned executives about the increased diligence needed when they hire such “multiple hat” vendors. Use an unbiased expert to review your plan’s use of revenue sharing and get its opinion on whether your vendors’ compensation is reasonable. The money you invest in a review will pay huge dividends for you and your plan’s participants. Ask us if you are unsure of where to turn for help.
(5) Low Fees are Not Necessarily Reasonable Fees
Hiring the lowest cost vendors will not likely satisfy the fiduciary duty to pay only reasonable fees for retirement plan services. The test is as much about the quality of services received as it is about the actual fees. The rule under which fiduciaries operate is not clear on how to answer the reasonable fee question. It can be a confusing issue to resolve but it is important that every ERISA plan manager knows the answer. You can know where you stand with a Roland|Criss ERISA fee assessment.
