The Buying Power Challenge Facing ERISA 403(b) Plans
One of the foundational tenants of fiduciary responsibility is the prudent selection and oversight of plan service providers and investments. Since the 408(b)(2) regulations became effective, we have been living in a new age of accountability for determining, evaluating, documenting and capitalizing on the “reasonableness” of fees for a company or non-profit institution ERISA retirement plan. In the final 408(b)(2) regulations alone, the Department of Labor (DOL) used the word "reasonable" forty-one times specifically referring to fees, compensation, contracts and arrangements.
A new wave of lawsuits against notable higher education institutions has put the pursuit and realization of plan improvement back on the front page. It is the expectation from these suits that organizations must document they carried out a prudent process of evaluation in the areas of provider service and investment selection and fees charged for these investments and services. These institutions also must regularly evaluate these fees and services in the future. This fee and service reasonableness evaluation is more than simply an observation. According to each of the recent higher education lawsuits, the plaintiffs assert that the institutions have a responsibility to use their “size and bargaining power to demand low cost investments” and to create “economies of scale” in the services being provided1. So how exactly does an institution do this? What if there are multiple historical record keepers and a large portion of the assets might remain in “individual contracts” under participant authority? Although “reasonableness” and “bargaining (buying) power” can be difficult targets to shoot for, we will attempt to identify these terms and see what positively impacts fee reduction and what may not.
Since the DOL did not provide a definition of “reasonable” we created a working definition for the term as it applies to fiduciary decisions under 408(b)(2) as part of a free, downloadable white paper from Flautt Hare Davis, Let's Be Reasonable: 408(b)(2) Fee and Service Evaluations.
Reasonable: Prudent arrangement or contract for investments or services with moderate and fair (inexpensive) cost or compensation. Inexpensive is noted in parentheses as it is the implied default criteria without justified increased value from services.
While many investment providers have standardized their share classes based on the extent of expected revenue sharing, not all plans have the same ability to contract the very lowest cost services nor the very lowest cost investments. Establishing “bargaining power” or creating “economies of scale” is both difficult and essential.
Buying power is the ability to reduce fees for investments or services based on the assets or head count of a plan. For plan services, such as record keeping or employee education, this is due to the relationship of the assets in the plan or the number of participants compared to the revenue required by the service providers to provide the services. Whether the fee calculation for services is made based on percent of assets or on a per head basis, larger plans generally have the ability to spread the service fees over a larger base2. For investments, the larger amount of potential assets a plan can offer an investment often dictates the share class cost or investment type in which the plan participants may invest. While the majority of investments historically offered in higher education included embedded revenue to pay for services (revenue sharing), newer investments with limited or no revenue sharing allow a clearer view of the prudence of each service and the quality of the investment itself.
Recent Changes in Higher Education Buying Power
Higher education retirement providers have become very competitive for all size organizations, not just the “jumbo” plans which were the focus of the recent spate of litigation. The openness of the investment architecture and reduction of required revenue for record keeping and participant services create the environment for platform improvement and fee reduction. However, simply going to your current provider and asking for a new record keeping platform and investment structure will not yield benefit from buying power. These service providers are not fiduciaries and are not entitled to provide their best pricing simply because you asked for it. Older “Legacy” contracts often contain limited proprietary investments which dictate the available fees and revenue sharing allocated to services based on asset size. In other words, the provider is dictating what they feel are prudent costs for investments, record keeping, and other services. The plan sponsor and the participant have no say in the amount or allocation of these costs. More troubling is that investments in these legacy contracts are often the largest in the entire plan. So you need to create enhanced buying power through leverage. In next week's post, we will discuss how to create buying power and how to overcome challenges from legacy contract restrictions.
2 The number of participants in itself is not a valuable commodity for record keepers as more accounts will need to be serviced. The ideal buying power position for most record keeper required revenue models is the combination of high assets and low head count. This results in a high average account value.
Up next: Buying Power for Higher Education Institutions Part 2: Creating Buying Power in ERISA 403(b) Plans.
John Hare, AIF®, CPFA, is Managing Director, Central and Southeast for Fiduciary Plan Governance. He is based in Nashville, TN.