The investment or risk management business is completely different from DC plan recordkeeping and other administrative services. It is likely that very few investment companies got into these roles by design. As a strategy to drive assets into their proprietary investments, firms developed plan administration and recordkeeping operations to offer the full range of services necessary to attract new plan assets. Since investment related margins were wider, revenue sharing was born as a form of internal transfer pricing whereby the investment side of the house subsidized the service and operations side.
In the early days of the participant-directed DC plan marketplace, very little attention was paid to the investments offered. If the delivery of recordkeeping and administrative services was solid, the investments could be mediocre. Assets flowed in to providers that offered the most advanced service platforms. As technology improved, however, much of the recordkeeping and administration service delivery became a commodity and more focus was placed on investment oversight.
The consolidation in the recordkeeping and administration business over the past ten years has been mostly a function of investment related firms (banks, broker dealers, mutual fund and insurance companies) deciding to focus on their core business of investments, risk management, securities custody/ trading operations, or trust services. As the DC plan market matured, many of these firms discovered that the long range assumptions used in pricing models were inaccurate, and came to the realization that margins on the operations side were too thin to continue in that space when it was not a core business, and they lacked scale to generate operational efficiency.
In of itself, pricing complexity is a result of bundled service providers transferring the cost of recordkeeping and administrative services to the investment side. Revenue sharing is a by-product of this process, simply a cost transfer methodology.
To make comparison shopping easy for committees, total plan costs are often distilled down to a single expense number, commonly referred to as “all-in” pricing. All plan costs are shown as an asset-based fee as a percentage of total plan assets. This allows committees can more easily compare prices from provider to provider, but the services are not necessarily comparable.
In this all-in pricing format, costs are not itemized for specific services, nor are the services always clearly spelled out, thus it can be difficult to match up specific services to specific costs. This is the situation many committees find themselves in, where they really do not know if fees are reasonable for the services being provided.
Providers are grudgingly accepting the need to separate investment and non-investment costs, returning to the early days of DC plans when services and related costs were clearly spelled out. This makes the process of evaluating provider service platforms more challenging and time consuming, but clearly allows the plan fiduciaries to make more prudent decisions.
As someone with considerable experience in this industry, I still believe bundled service platforms offer defined contribution plan sponsors and participants the best overall value proposition in the mid-sized and large plan market space. It seems to be very clear, however, that pricing formats need to adapt to the demands on plan fiduciaries to more prudently monitor services and related fees.
Changes to the Form 5500 starting in 2009 will require itemized disclosure of service fees being paid from plan assets. Interestingly enough, the bundled service providers are seeking an exemption from the new disclosure requirements, taking the position that they cannot separate costs and services at a plan level. This would seem to significantly water down the impact of required disclosure, given that most mid-sized and large plans use some type of bundled service arrangement and, therefore, most participants are serviced under such platforms.
My experience working for a large company leads me to believe that service providers have very specific internal transfer pricing formats that allocate costs and revenues attributed to both the investment side of the business and the administration/recordkeeping side. These firms may have combined two businesses into one, but they know how much each side costs, and how much revenue is generated. Law or no law, 403(b) plan sponsors should be demanding that services and fees be itemized. This is the only way a plan committee can carry out its obligation to participants for fiduciary oversight.
- James E. "Jeb" Graham, CEBS, CIMA, AIF, Retirement Plan Consultant, CapTrust Advisors, LLC
This material is distributed solely for information purposes and is not a solicitation of an offer to buy any security or instrument or to participate in any trading strategy. It is not intended as legal or tax advice.
CapTrust Advisors, LLC is a Registered Investment Advisor with the SEC. CapTrust is not a legal or tax advisor.
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