Fees Loom Large, but Misunderstandings Linger

October 12, 2004 (PLANSPONSOR.com) - Participants in even the smallest retirement programs today have access to an amazing level of one-on-one financial counsel in their workplace, and many at no explicit cost to them.

Much of this is funded, in one form or other, by the current fee structures of the underlying investments.   However, soft investment markets, events such as the mutual fund trading scandal, and heightened media scrutiny have combined to bring those traditional structures into question.   A recent Wall Street Journal article, ” As Returns Sag, Employers Turn Up Heat on 401(k) Fees” ), quoted one consultant as saying, “If you haven’t squeezed your retirement plan provider on fees, chances are they probably are making a little more juice than they need to.”  

In a recent PLANSPONSOR “PLUGGED IN” webtable, Brent Glading, whose comments were broadly interspersed in that same Wall Street Journal article, noted that the paper “did take some of our comments out of context.”   In fact, Glading, managing director, The Glading Group LLC, was quoted in the article as saying that providers were raking in profit margins “as high as 80%.”

“The Wall Street Journal gave plan sponsors a sense that they could just pick up the phone, call their vendor, and say ‘give me some money,’ Glading told the PLANSPONSOR audience.   However, he noted that not every vendor is deriving excess fees, he said.   Peter Demmer, CEO, Sterling Resources, Inc. ,said there was a “big misunderstanding” about what are fees and what are costs.   In terms of general industry profitability, Demmer noted that his firm had analyzed data from roughly 60% of the providers, and that in 2002 – admittedly a rough year because of the investment markets – half of them were “underwater,” and the average profitability was about half of 1%, even when everything – including investment management fees – was bundled together.   “On average, these are very thin margins,” Demmer noted.

As a result, there has “certainly been a lot of consolidation” in the space Demmer concedes (see Ducks in a Row at ).   “There have been 30 transactions in the last three years, people who literally went out of business, either sold or abandoned” their practice, Demmer noted.

Margin “Call”

Those margin considerations notwithstanding, Glading cautioned, “there is no one-size-fits-all” model for a determination as to how much a plan sponsor should be paying for the services they receive.   “A plan sponsor has to look at the unique features of their plan,” including the level of assets and number of participants, and then “analyze and determine if the fees are reasonable,” Glading said.   He went on to note that the Wall Street Journal article may have stirred the pot up, but plan sponsors recognize they have a duty to monitor those fees.

Indeed, plan sponsors need look no further than the Department of Labor’s  web site to be reminded “Among other duties, fiduciaries have a responsibility to ensure that the services provided to their plan are necessary and that the cost of those services is reasonable.” 

Fred Reish, managing director and partner of the Los Angeles-based law firm of Reish Luftman Reicher & Cohen, cited a “range of reasonableness,” noting that average cost information and industry cost data is valuable in establishing that range.   “The law will look for deviations from that,” he said.   “We may say every plan is different, but I don’t think the law will look at it that way.   There has to be a starting point,” he concluded.  

For most plan sponsors, the panelists agreed, the starting point was the costs of the plan, most particularly when plan assets are involved.   "If plan assets aren't used, the plan can pay as much or as little as it wants.   The fiduciary responsibility and prohibited transaction rule only applies to plan assets," Reish continued.   Ironically for most providers, 80% of the costs are associated with administration/recordkeeping, while 80% of the revenues come from investment management-related services, according to Demmer.

The issues, of course, aren't just how much, but how much for what services.   Reish noted that a lot of plan sponsors make the mistake of monitoring "within the sandbox," but don't compare what they are paying to what they might be paying.   "So much attention has been focused on a prudent selection process, and nowhere near enough on the duty to monitor" the existing selections, Reish noted, going on to say he sees a trend emerging on the latter.   Turning again to the Department of Labor's own website, plan sponsors can find that "After careful evaluation during the initial selection, you will want to monitor plan fees and expenses to determine whether they continue to be reasonable in light of the services provided."

Shop Talk

As for how often to "shop around," Glading cited a "three-year rule of thumb" for external comparisons, but cautioned that there was a cost of conversion that was generally included in pricing.   Mark Davis, president of Mark A. Davis Consulting, noted that he generally recommends that plan sponsors make some form of external evaluation every two or three years (see Shop Around).   Reish said that to monitor fees you "have to go out at least periodically because you have to benchmark what you are doing."   He suggested a review at least every three years, even if you rely on the services of an expert/consultant because "things change so quickly."   A full-blown request for proposal (RFP) might then make sense every 5-6 years, he said.

The panel also discussed the responsibility of plan sponsors to seek help from professionals in reviewing fee arrangements if they feel they lack the requisite expertise.   As for evaluating those consultants, Reish counseled that plan sponsors should, in the hiring process, ask consultants how they should be reviewed.   "Tell me about what kind of information you will give us to evaluate you, what benchmarks we should use, how you will report that performance," he said.

While the panel was unable to cite any ERISA cases in a participant-directed plan over fees (except for some related to surrender-related charges), Reish noted that the Department of Labor was "more focused on fees than investment performance," and cautioned plan sponsors to make sure their plan fees were "at least mainstream, particularly investment fees."

"Unfortunately, with the market declining, regulators are focusing on the wrong thing at the wrong time," Demmer noted with a wry reference to the recent Presidential debate.   With asset-based fees comprising 80% of provider fees, and the market down about 3% year-to-date, this is "not good for our profitability model."