There are several fundamental principles and concepts that governmental plan sponsors and fiduciaries need to bear in mind as they select and monitor their plan providers and the fees that these providers charge.
Practically all governmental plan providers use assets under management, or AUM, to measure success. This is what makes larger, more mature, plans attractive to recordkeepers and investment advisors. Based on decades of practice, most plan providers, such as recordkeepers and investment advisors, structure their fee arrangements so that they are paid a percentage of the AUM. The percentage is described in terms of “basis points,” with a basis point being equal to 1/100 of 1 percent. For example, a 25 basis point fee on an AUM of $1 million would be $2,500. Correspondingly, the same fee on a plan with $100 million in assets would be $250,000. The question is whether the plan provider is doing any more work (or providing greater services) in the case of the larger plan than the smaller plan? What if both plans have the same number of participant accounts? Does it cost a recordkeeper or advisor substantially more (i.e., 50 times) to keep track of a $50,000 account versus a $1,000 account? Does your bank charge you more simply because your account has grown?
As previously described in earlier blogs posts, the fiduciaries of governmental retirement plans are responsible for ensuring that the fees charged to the plan are reasonable and appropriate. The difficulty with monitoring and evaluating the reasonableness of plan fees is the considerable number of ways in which a provider can structure its compensation. A good basic resource to help you understand the variety of fees and expenses is the booklet, “Understanding Retirement Fees and Expenses,” published by the U.S. Department of Labor.
While each plan is different from the next, here are a few things to focus on when it comes to plan fees and expenses:
- Each provider requires a certain level of fees/revenues to make their engagement worthwhile. If it seems that a particular provider is giving your plan a deal that is “too good to be true,” take note — they probably are not. For example, it is fairly easy for an insurance company provider to explicitly lower your recordkeeping fees (i.e., reduce the basis point charge) while at the same time reducing the crediting rate or guarantee on the stable value option that many participants utilize. For example, a five basis point reduction in recordkeeping fees for a $100 million plan would save $50,000. But, this savings would be offset or erased if the vendor lowered the guaranteed crediting rate on participants’ stable value fund investments of let’s say $30 million by 17 basis points (0.17 percent). Because stable value funds are not regulated like mutual funds, it is often quite hard to see how much it “costs” the insurer to provide this option.
- Most administrative service agreements explicitly state that the recordkeeper will get paid certain fees, but they do not always require the recordkeeper to state or disclose that such fees are the “only” fees it is receiving from all sources in connection with the plan. When reviewing or negotiating such fees, make sure that you are “seeing” everything, not just the tip of the iceberg.
- Like the salespeople at the regional auto mall, the representatives of your plan providers generally are extremely experienced and savvy. You are well advised to obtain the assistance of an independent financial advisor to help you uncover and evaluate the entire fee/expense situation.
- Unless you understand the exact basis upon which your plan providers are being paid, you cannot evaluate whether the current arrangement is “fair” to your plan participants. For example, a fee arrangement predicated on a “high-profit” stable value fund and very low-cost mutual funds may discriminate against your participants with less investment experience.
Because it is difficult to understand all of the fees and expenses charged to your plan, and to understand how they affect various participants, you may want to obtain assistance with these tasks so that you can better fulfill your fiduciary obligations.
Jeff Chang is a partner at Best Best & Krieger LLP. He has four decades of experience skillfully evaluating benefit and retirement plan compliance to achieve maximum outcomes for public agency clients throughout California. He can be reached at firstname.lastname@example.org or (916) 329-3685.