Changing the Menu
Transparency regulations and lawsuits are leading many defined-contribution plan sponsors to not only cut costs, but alter their plans' investment offerings. However, experts recommend they tread carefully.
By Andrew R. McIlvaine
A combination of the 2012 fee-disclosure rules from the Department of Labor and lawsuits filed by defined-contribution-plan participants is leading a growing number of organizations to benchmark the costs of their defined-contribution plans and sharply scrutinize the investment options within those plans. The goal is to not only comply with the rules and stay out of hot water, say experts, but to also give employees a better shot at having enough saved for retirement.
"Even a 1 percent difference in expenses can make a huge difference as to when a plan participant can afford to retire," says Robyn Credico, a senior retirement consultant at Towers Watson in Washington.
A recent Aon Hewitt survey of more than 400 DC plan sponsors, representing more than 10 million employees in plans totaling $500 billion in assets, reveals more than three-quarters of respondents said they've made efforts to reduce fund or plan expenses over the past two years, compared to just over half who said as much in a similar study conducted in 2007.
Sixty-two percent of respondents said they planned to reduce fees by switching share classes to lower-cost alternatives. Fees are a top criterion for organizations that are selecting fund options, according to the survey, with historical investment performance and fund investment process rounding out the top three.
More than 90 percent of the respondents offer at least one non-mutual-fund option in their plans, such as collective trusts and separate accounts, up from 59 percent in the 2007 survey. Forty-four percent of respondents used investment vehicles such as these as their primary fund option in 2013, up from only 19 percent in 2007. Larger plans -- those with more than $1 billion in assets -- were more likely than smaller plans -- with less than $1 billion in assets -- to have more than half their investment options in non-mutual funds (61 percent to 21 percent), according to the survey.
The Aon Hewitt survey respondents are hardly alone. According to the 2013 Retirement Planscape report by Cambridge, Mass.-based Cogent Research, 51 percent of plan sponsors say they intend to modify their investment line-ups this coming year, compared to 44 percent that anticipated taking such action one year ago.
Credico says many of Towers Watson's retirement clients are also taking a close look at their DC plans' recordkeeping and investment-management fees. She cites the DOL's 2012 fee-transparency regulations and recent lawsuits, including those filed by plaintiffs' attorney Jerome Schlichter against plan sponsors and their record keepers alleging excessive fees were charged to plan participants, as the biggest factors.
"Within the last three years, we've conducted at least 250 benchmarking studies for our clients so they can feel comfortable with the fees they're paying," she says. "The fees don't necessarily have to be the cheapest, but they should be reasonable with respect to what other plans of similar size are paying. And, if they're choosing to utilize record keepers and funds that are more expensive, then they need to be prepared to justify that to the plan participants."
Clients do tend to make changes to their plans after the studies are conducted, says Credico. Typically, investment line-ups are the first things to be changed, as those tend to be the easiest changes to make, she says.
"It might be an opportunity to get a lower share class, or you may keep the same fund but with different expense ratios," says Credico. "Larger plans are looking into institutional funds or managed accounts, because there's an opportunity there to get a better return with lower expenses."
As for fee reductions, many clients are renegotiating their fees so that they're no longer contingent on the size of the plan's assets, she says. "The work associated with managing record keeping only goes up or down based on the number of participants, not the size of the assets, so plan sponsors may question why fees are based on asset size," says Credico.
As a result, many of those clients are charging plan participants a per-participant fee so that they no longer pay more if their account gets bigger, she says. Even these relatively small changes can make a big difference over time in terms of retirement preparedness, she adds.
"Even small changes in 401(k) fees can have a significant effect on employees' nest eggs over time," says Rob Austin, Aon Hewitt's director of retirement research. Decreasing fees from 1 percent to 0.75 percent per year has the same effect on a typical plan participant's account as contributing an additional 0.5 percent of pay, he says.
Kendall Storch, a principal and retirement consultant at Boston-based Longfellow Advisors, says that he, too, sees clients taking a more aggressive approach by regularly benchmarking the record-keeping and management fees they're paying against those paid by similar-sized plans and renegotiating those fees if they appear unjustifiable.
"You can't really go wrong by going low," he says. "The more you can drive down costs -- that can't hurt you."
Some companies are changing the service agreements they have with their plan administrators so that fees better reflect the services provided, says Storch. "Instead of just paying a percentage of the assets for administering the plan, these sponsors will convert to flat-dollar amounts or per-participant costs, or a la carte pricing," he says. "When plan administrators are paid based on the percentage of the assets, a big concern is that their fees go up because the stock market's doing well, not because they're doing more work."
However, record-keeping fees represent only a small portion of plan expenses, says Storch, which is why clients are also taking a hard look at the investment options offered to participants to determine how to cut investment-management fees without affecting financial returns.
"A lot of ways in which we see sponsors approaching this is by looking at the share class and asking 'Is there a less-expensive version of the fund we can use that won't upset the economics of the plan?'" he says.
Other companies -- particularly those with plan assets in excess of $1 billion -- are turning to alternatives to mutual funds, such as collective trusts and managed accounts, says Credico.
Such alternatives give the sponsors of large plans the ability to negotiate lower fees than those typically charged by retail mutual funds in return for similar -- or in some cases, better -- returns, says Austin.
However, collective trusts and separate accounts aren't for everyone, says Storch.
"These vehicles can be a double-edged sword: You'll reduce your fees, but you'll give up a lot in terms of investor transparency," he says.
Independent sources of information on collective trusts, for example, are usually harder to come by than for mutual funds, which must provide detailed prospectuses and are typically rated by sources such as Morningstar, says Storch. Instead, plan participants may have to be content with the information provided them by the record keeper -- and for many employees, this simply won't do, he says.
"The average person out there is not going to be familiar with collective trusts because they're just not that common," says Storch. "It can create suspicion -- if you have an employee population of highly educated, highly skilled people, collective trusts aren't going to fly, because they tend to want a lot of data and there's not a lot of data on investment vehicles like these."