Determining the reasonableness of plan fees in relation to services and value received.
As fiduciaries, plan sponsors are required to act prudently and solely in the interest of the plan’s participants and beneficiaries when selecting and monitoring service providers and plan investments.1 To that end, plan sponsors should engage in a careful, documented process to consider the quality, cost and results of the plan’s service providers.
Under the Employee Retirement Income Security Act of 1974 (ERISA), plan sponsors are required to establish fiduciary processes designed to ensure, among other things, that plan fees are “reasonable.” Looking at fees alone does not provide an accurate waypoint for the value of the services offered; in many cases, higher fees can be justified based on the scope of the service, the value to the participants and the plan’s success metrics in place. Determining what is “reasonable” is where benchmarking can help.
ACCORDING TO A DELOITTE 2015 ANNUAL DEFINED CONTRIBUTION BENCHMARKING SURVEY, Just 31% of plan sponsors strongly agree that they have performed a detailed fee analysis and have a thorough understanding of all plan expenses (see below).
As evolving technology, increased competition and new features have impacted the DC market, reviewing fees and services on a regular basis can help ensure a plan is in sync with the times. By proactively benchmarking existing plan fees and services against plans of similar size and industry — and properly documenting the process and subsequent decisions –– plan sponsors can potentially:
- Determine value for services and support provided
- Ensure plan fees are “reasonable” or take action to reduce them
- Gauge the plan’s efficiency and improve plan design as needed
- Shield themselves and the company from fiduciary liability and legal action
Retirement plan advisors and consultants, acting in an objective third-party capacity, can help with the benchmarking process — including obtaining plan data, reviewing plan fees against similar plans, recommending changes (if any) and providing proper documentation — to keep the plan in line with ERISA guidelines.
Obtaining and understanding plan fees2
A Spotlight on Plan Fees
While monitoring DC plan fees has always been critical, the advent of 408(b)(2) and 404(a) mandatory disclosure regulation from the Department of Labor (DOL) in 2012 increased the spotlight dramatically, resulting in increased transparency of plan fees to both plan sponsors and participants.
A rise in litigation has also increased plan fee scrutiny. Class action lawsuits brought against some of the nation’s largest employers allege that the targeted employers, as sponsors of 401(k) plans, authorized the payment of excessive fees for the administrative and investment services provided to the plans, which is considered a breach of their duty under ERISA.4
As an example, a provisional settlement was reached in August 2015 in the Spano v. Boeing Company case, a class action suit filed on behalf of 190,000 Boeing retirement plan participants. One of the original and longest-running examples of 401(k) excessive fee litigation, plaintiffs alleged that Boeing violated ERISA by permitting a variety of excessive fees to be charged to 401(k) plan participants. They also claimed that Boeing engaged in self-serving conflicts of interest and permitted imprudent funds to be included in the company retirement planN.5
To help participants save more for retirement through appropriate versus excessive fees and potentially avoid fiduciary liability and litigation, plan sponsors should:
- Review plan fees at least every three years, if not annually
- Document the benchmarking process, data and the decisions made regarding the “reasonableness” of plan fees or any conflicts of interest
What is Reasonable?
A plan sponsor’s fiduciary responsibility is to confirm they have the right value for the price derived from proper due diligence and documentation, not to make sure they have the least-expensive option. There are significant differences in the level of support, service and success achieved among providers, as well as in the benefits they ultimately deliver to participants. Plan complexity can add to the required time and effort of service providers.
For example, advisors who receive positive reviews on criteria — such as performing investment reviews, understanding the client company’s changing needs, offering strategies to improve the plan’s performance, sharing strategies to improve the participation rate, deferral rates and investment allocations, proactively checking in with the sponsor, updating the sponsor on new industry and legislative developments, helping the sponsor understand its fiduciary and administrative responsibilities, serving in a 3(21) or 3(38) fiduciary capacity, offering day-to-day support to the sponsor, working on employee education, and assisting employees with retirement planning — may have higher fees that are justified for the high value provided.
Recordkeepers with above-average participant communications, plan sponsor website, and participant and administrative support, resulting in increased retirement readiness for participants, may be considered a value despite a higher cost, while Investment Manager fees may reflect consistent performance or other factors.
In some cases, above-average fees that result in above-average plan success — such as a higher percentage of participants that used automatically diversified options, the number maximizing the company match, the contribution rate by the non-highly compensated and the overall participation rates — can be assessed accordingly. Benchmarking can help plan sponsors understand the value they are receiving based on services rendered.
According to the DOL’s final 408(b)(2) regulation: 6
- Responsible plan fiduciaries must ensure that arrangements with their service providers are “reasonable” and that only “reasonable” compensation is paid for services.
- Fundamental to the ability of fiduciaries to discharge these obligations is obtaining information sufficient to enable them to make informed decisions about an employee benefit plan’s services, the costs of such services and the service providers.
Benchmarking Best Practices
Working with a retirement plan advisor or consultant, plan sponsors should:
Step 1: Determine Scope of the Benchmarking Effort
Depending on the size and complexity of the plan, decide which type of benchmarking analysis fits the plan’s bandwidth, budget and timing.
- Fees for Service of Service Providers: Reviewing fees at the plan level is helpful, but reviewing fees at the service provider level (recordkeeper, advisor/consultants, investment managers and any other service provider) is critical to be in line with legal requirements to assess “reasonable” fees for specific service(s).
- Comprehensive Plan Review: Beyond plan fees, consider measuring the effectiveness of the plan based on how well the plan is helping participants meet their saving and retirement income goals, in addition to participation and deferral rates. Determine if there are opportunities where the various plan design, investment lineup and communication efforts can be more effective to meet the objectives for the plan.
Step 2: Gather Information from Comparable Plans, of the Same Size, in Similar Industries
For an accurate review, it’s important to obtain “apples to apples” data regarding total plan assets, number of participants, year the plan was bid or last reviewed, company industry, plan type, use of auto-features (auto-enroll, auto-increase), match offering and more.
There is a wide range of benchmarking services that cover various levels of plan data, services, participant metrics and fees. Retirement plan advisors and consultants can help plan sponsors select the benchmarking service that fits the plan’s needs, and ensure the correct data are recorded and analyzed. When determining which benchmarking service to use, consider the following:
- How many plans are in their sample?
- How many years of data do they have?
- What types of data are available?
- How narrowly can peer groups be constructed by size, industry group and other factors?
Step 3: Ensure Plan Fees Are Reasonable, or Take Action
When evaluating plan expenses, plan sponsors need to understand all direct and indirect compensation that is being paid to service providers, including recordkeeping fees, revenue sharing payments, investment consulting fees, etc. Then, they need to engage in a reasonable evaluation of fees in light of the services provided, compared with similarly situated plans, to help them make an informed decision on how their plan stacks up. From there, if the plan compares favorably in key participant success metrics, plan sponsors can determine, and document, that above-average fees may be justified in terms of the better retirement outcomes their participants are likely to achieve. The risk is not that a plan sponsor will, after a thoughtful analysis, make a bad decision. The fiduciary risk is for a plan committee that does not perform the analysis.
Given the increased spotlight on fee disclosures, plan sponsors are now more than ever increasingly sensitive to costs, which can lead to better value for all services provided. Depending upon the plan’s complexity and benchmarking analysis, consider a Request for Information (RFI) or a more comprehensive Request for Proposal (RFP) if specific provider fees need to be or adjusted or re-negotiated for the services offered, and/or if the plan prefers a formal review across multiple providers.
Revenue Sharing Considerations
Plan committees must decide whether to select mutual funds or other investments that pay revenue sharing. Typically, investments that pay revenue sharing are more expensive than those that don’t. However, it is legally permissible to select investments that pay revenue sharing and use the revenue sharing to pay for plan expenses. However, those decisions cannot be made without the committee examining specific information, such as:
- Which investments pay revenue sharing? How much?
- How does that affect participants?
- What is the total dollar amount of revenue sharing paid to the recordkeeper and is that reasonable?
Step 4: Evaluate the Information and Document Decisions
Having a relatively recent benchmarking report in the plan files is a great way of demonstrating effective due diligence if questioned (via an audit or lawsuit) regarding the plan’s due diligence in monitoring fees. Proper documentation of information reviewed and decisions made is critical in the event a decision is ever challenged.7
Consider adopting fee and expense policy statements to help address the revenue sharing issues for the plans, in addition to documenting the process and decisions made regarding revenue sharing.
Tussey v. ABB Inc. (ABB) Case Example8
The ABB case is an example of 408(b)(2) disclosure requirements for service providers, and the fiduciary duty to prudently evaluate the compensation of service providers, both initially and on an ongoing basis.
According to the opinions, the ABB investment committee failed to calculate the amount of the money that the recordkeeper was receiving (mostly or entirely through indirect payments, such as revenue sharing). Unfortunately for the committee, it had a report from its consultant about the reasonable compensation that a recordkeeper should receive in comparable circumstances, and it was millions of dollars less than the compensation that their recordkeeper actually received. In short, there were two problems:
- The committee did not calculate the dollar amount that the recordkeeper was receiving.
- The committee did not compare that amount to market data (which it had in its consultant’s report).
Benchmarking is an important, yet potentially complex, component of any plan. At BNY Mellon, we encourage plan sponsors to work with their retirement plan advisor or consultant — and, as needed, an ERISA attorney — to:
- Determine an appropriate course of action for benchmarking the plan
- Assess “reasonable” levels of fee for service
- Properly document the process and decisions made
- Implement best practices across the plan