Don’t lose sight of the forest for the fees: Benchmarking your defined contribution plan

benchmarking-your-defined-contribution-plan

ERISA section 404(a)(1)(a) REQUIRES that a fiduciary make sure the fees for a retirement plan be “reasonable.” Recent litigation has emphasized the importance of this fiduciary requirement with emphasis being added by the $16.5 million dollar settlement in the Caterpillar case from November 2009.

In addition, it is simply a good business practice to benchmark your defined contribution plan.  Such a benchmarking exercise can also provide answers to the following useful questions:

1.     Are my participants saving more and investing better?

2.     Is my plan design more or less complex?

3.     Am I receiving the right amount of fiduciary support from my current service providers?

4.     Does my plan require more or less work from my recordkeeper/TPA?

Thus, any benchmarking exercise should not solely concentrate on fees.  It should also examine the value being received for those fees.  Related to this thought, note that the Department of Labor does not require plans to have the "lowest" fees.  Instead, it requires that all fees be REASONABLE.  In fact, the DOL clearly states:

"...fees aren't everything. In effect, it can be reasonable to pay higher fees if a plan is receiving more or higher quality services or is attaining higher participant 'success measures' than similar plans."

In summary, the job of the fiduciary is to "weigh" the fees they are paying for the value they are receiving in terms of services, support and success measures.

Benchmarking a retirement plan, however, is not a simple exercise.  There are a plethora of fee and service value propositions that exist in the marketplace.  In addition, any logical benchmarking exercise should make sure that you do not compare apples to oranges.  Having studied this topic in depth for the past three years, Fiduciary Benchmarks believes any benchmarking exercise should have three important components:

1.     Make sure your benchmark groups are "apples to apples."

2.     Make sure you examine your fees "in detail."

3.     Thoroughly examine value to ensure you "don't lose sight of the forest for the fees."

1 - Building an Apples-to-Apples Benchmark Group

Four factors should be considered when building a proper benchmark group:

1.     Plan Size and Number of Participants.  Plans included in a benchmark group should be of similar size and participant count to ensure matching economic profiles.  In addition, if there is sufficient data, industry comparisons are also useful since workforce and benefit structures can vary by industry.

2.     Date of Fees and Services Review. By considering only those plans that have bid or reviewed fees and services within the last three years, the plan benchmarking process will reflect a current, but smoothed assessment of the marketplace.

3.     Allocation to Passive Index Funds. It would not be appropriate to compare a plan with 100% passive investments to one with 100% active investments.  The passive plan will definitely have lower costs due to the fiduciary's belief in indexing.  But, those passive costs may be high when compared to other passively managed plans.  Therefore, it is important to compare plans with similar active/passive investment ratios.

4.     Use of a Managed Account Program. Plans offering a managed account program should be compared with other plans offering managed accounts that have similar utilization. Managed Accounts provide participants with an important additional service albeit at higher structural costs.  Thus, plans with similar exposure to Managed Accounts should be compared to each other.

In summary, the most important thing to remember about building a proper benchmark group is to make sure you have "apples-to-apples" comparisons.

2 - Examining Your Fees "In Detail"

While most people focus on fees at the plan level, the fact of the matter is the current statute and the pending regulations are targeting fees by service provider.  Thus, fees at the plan level should represent an accurate rollup of the fees for your recordkeeper, advisors/consultant, investment managers and any other plan service providers.  In addition, those fees should be converted to a percentage of assets to ensure comparisons are mathematically normalized.

Keep in mind, however, that fees at the plan level and fees by service provider still do not provide the "Actionable Intelligence" the fiduciary needs with respect to fee adjustments.  Since 90% of all fees in the industry are driven by investments, one must look at each investment option and examine two important issues:

1.     The Total Expense Ratio for each investment option.

2.     How that Total Expense Ratio is divided among various service providers.

Lastly, it is important to consider fees at the participant level for participant-elected services like loans, distributions, managed account advice and self-directed brokerage transactions. And of course, all of these fees should be compared within their "apples-to-apples" benchmark group.

3 - Making Sure You Don't Lose Sight of the Forest for the Fees

The last important step in any benchmarking exercise is to examine those services, support and success measures that constitute value for a defined contribution plan.  First, let's examine five different services and support measures and why they are important to plan fiduciaries and fee comparisons.

• Plan Complexity - The two dozen plan design provisions that comprise Plan Complexity indicate how your plan design compares to the plan designs of other plans in the benchmark group.  Plan Complexity is neither good nor bad since every plan is designed to suit each employer's individual situation.  What is important to know, however, is that a plan that is more complex costs more to administer.
• Fiduciary Services - Every plan has a named fiduciary whose job it is to make sure the plan stays in compliance and is run properly. A perfect example is the development and monitoring of an investment policy statement.  A proper benchmarking tool should give credit for these types of services since they can help minimize fiduciary liability as well as improve the performance of the plan.
• Plan-Driven Services - Some plans require more payroll processing or more compliance testing or more employer contribution calculations.  Some plans even have more merger and acquisition events.  These services have a SUBSTANTIAL impact on the resources of your service providers and therefore should be considered in any benchmarking exercise.
• Participant-Driven Services - Similarly, not all participant populations are equal.  Some participants turn over at a more rapid pace, some take more loans and some call the 800 number more often.  These services also impact the cost of your service providers and should be considered in any benchmarking exercise.
• Service Standards - Up until this year, the #1 reason recordkeepers and TPAs were fired was poor service.  Therefore, any benchmarking exercise should evaluate the accuracy and timeliness standards of your recordkeeper/TPA.  It would be even better if the recordkeeper/TPA could prove their service standards on an ongoing basis.

While services and support measures are important, probably the most important metrics are those related to helping participants retire.  The ultimate "What is Winning" statistic for our industry can simply be expressed as follows: How many participants can retire well?  Thus, any proper benchmarking exercise should examine 10 leading indicators that predict how well participants will retire. To prove the importance of these participant success measures, we calculated how much a typical employee would have for retirement using nine important assumptions:

Using this data, the employee would have a life annuity at age 67 of approximately $39,160 which is equal to 41% of his final salary.  Combining this amount with a Social Security benefit of approximately 54% of final salary would give the participant a benefit that is 95% of his final salary.

We then conducted "sensitivity analysis" on each of these nine assumptions to determine which items have the biggest impact on retirement outcomes.  Specifically, the table below shows the impact on wage replacement of making each assumption BETTER by 20%:

All calculations can be observed at www.fiduciarybenchmarks.com/rri.  Surprisingly, the bottom line is that fees have the smallest impact on retirement outcomes by far.  Therefore, if you really are interested in helping participants retire, you should be asking your service providers to prove their expertise in helping employees to change their behavior as follows:

• Picking the right retirement age
• Starting their retirement savings programs earlier
• Making sure they rollover or preserve their pre-retirement balances
• Contributing more
• Earning a higher rate of return

A service provider that can PROVE their expertise in these areas is certainly worth a few pennies or even a few dollars more each day.  And by prove, I mean the ability to measure, monitor and improve these statistics for their clients.

In summary, one of the most famous sayings in the history of American business is: "First things first."  The author of course is Stephen Covey.  So, while there is no doubt that we must make sure that fees are reasonable under ERISA, let's not forget the fact that the largest impact on retirement outcomes will NOT be generated by squeezing every fee dollar possible from service providers.

Or put another way, the great Peter Drucker once said: "What gets measured gets managed."  Without meaningful value measurements the industry will continue to focus on the one thing that is relatively easy to measure: fees.  And by doing so, we run the risk of underestimating the importance of value components like participant success measures that really drive "What is Winning" for our industry - helping participants retire well.  So, let's make sure fees are reasonable, but let's not lose sight of the forest (i.e., value) for those fees.