Fee Compression: Fiduciaries Take Note

Fee Compression Fiduciaries Take Note

Retirement plan recordkeepers are seeing ongoing pressure on fees. Their approach to developing alternative revenue sources could have implications for plan fiduciaries.

Several recent items in InvestmentNews describe market trends that should be noted — and followed by — plan fiduciaries. These items (Unintended fiduciary consequences of 401(k) fee compression and 401(k) record keepers seek new revenue streams to ‘save themselves’) address different aspects of the same issue: a number of long-term market trends are creating significant pressure on bundled recordkeepers’ revenues. And — here is the headline for fiduciaries — these recordkeepers are responding to these revenue pressures through a variety of ways that impose additional costs on plans and participants.

Why the Pressure?

There are many reasons that bundled recordkeepers may be feeling revenue pressure. Some of the more commonly cited sources are well-known to industry insiders — but worth noting:

• U.S. Department of Labor regulations mandating enhanced fee disclosure, from plan providers to fiduciaries and from fiduciaries to plan participants

• Excessive fee class action lawsuits brought against plan fiduciaries. Some of these suits — against household names, such as Boeing, Nationwide, Cigna and International Paper — have settled for tens of millions of dollars. These lawsuits have forced plan fiduciaries (and participants) to put plan fees under the microscope.

• Market trends, particularly since the financial crisis of 2008, have rewarded passive asset management over active managers. In this environment, a focus on investment cost becomes even more important.

As a result of market pressure, fees paid by retirement plans have dropped dramatically. Over the past decade recordkeeping fees have dropped 50 percent. Investment fees paid by 401(k) plans have dropped by 38 percent over a similar period.

In light of these market pressures, bundled recordkeepers are developing a variety of new ways to increase revenue and are looking to a variety of sources — including fund managers, retirement plans and plan participants — to generate this revenue.

The remainder of this blog will describe how bundled recordkeepers are seeking to generate this revenue.

Revenue from Fund Managers
One way to recoup losses to lower cost investment funds is to … charge more in fees to those low-cost funds. Specifically, recordkeepers are charging certain funds more to retain those funds on the recordkeepers’ “shelves.”

For example, as noted in InvestmentNews:

“Empower Retirement, which administers more than $570 billion in retirement assets, has a new product for small and midsize retirement plans that requires mutual-fund providers to pay for fund distribution, according to advisers familiar with the platform, called Empower Select.

Fund firms pay Empower in a tiered model based at least partly on how many funds they’d like to distribute, ranging from a few thousand dollars a year up to $1 million, advisers said.”

401(k) record keepers seek new revenue streams to ‘save themselves’

Similarly, Fidelity investments has begun to impose a fee, starting at 5 bps (0.05%) on 401(k) assets held in Vanguard Group investment funds. The fee applies to new plans with less than $20 million in assets. According to Fidelity executives, this new fee was imposed to preserve fairness since, as noted in the InvestmentNews article, “Vanguard is the only fund firm that doesn’t pay Fidelity for shareholder and administrative services”. On the other hand, this fee may also serve to make Fidelity funds more attractive than those of Vanguard. And, although the fee is billed to the plan sponsor, the real “target” of the fee is Vanguard.

Revenue from Plans
Bundled recordkeepers are also developing new fees to charge directly against plans, including the following fees identified in the InvestmentNews article:
      o Additional fees and/or higher recordkeeping fees if nonproprietary funds offered;
      o Increased use of proprietary funds inside plans’ target date funds, managed accounts or stable value funds;
      o Additional fees for activities such as fund changes and plan mergers; and
      o Integrating proprietary or white-labeled managed accounts and bundled collective investment trusts to generate additional revenue.

Revenue from Participants
And, last but not least, bundled recordkeepers are looking to increase revenue directly from participants. Approaches to increasing this revenue stream include:
      o Increased use of proprietary funds through target date funds, managed accounts, or stable value funds;
      o Sale of non-retirement investment- generating services, such as HSAs, financial wellness, and student loan accounts;
      o Capturing IRA rollovers by reducing investment expenses;
      o Capturing more nonretirement assets through lower cost proprietary funds/CITs or higher fee nonproprietary options;
      o Developing more “sticky” relationships with participant assets by offering additional (fee-generating) services, such as investment advice and financial planning.

So What?

Recordkeepers should be paid fairly for the services they provide. However, the use of these indirect revenue sources poses special concerns for retirement plan sponsors and fiduciaries:
• Bundled recordkeepers have been “endorsed” by the plan sponsor: after all, the sponsor has selected the recordkeeper to administer the retirement plan. It is not uncommon for employees to conflate this explicit endorsement with an implicit endorsement of the recordkeeper’s nonplan products. The more non-plan products and services promoted by the recordkeeper, the greater risk that one of these offers will create an HR backlash for the plan sponsor.

• Bundled recordkeepers freely share participant information (provided by the plan sponsor or participants directly) with affiliates. The increased use of non-plan products as a revenue source increases the risk of unwanted solicitations by the recordkeeper’s affiliates and, more importantly, increases the risk that participant confidential data can be compromised when a recordkeeper employee terminates and takes his or her “book of business (i.e., participant) data to a new employer.

• Plan fiduciaries must receive information about any “indirect compensation … that the covered service provider, an affiliate, or a subcontractor reasonably expects to receive in connection with the services” provided to the plan (https://www.law.cornell.edu/cfr/text/29/2550.408b-2)
Understanding this indirect compensation is a key element of a fiduciary’s ability to assess the reasonableness of that service providers fees. The use of these alternative revenue sources makes it increasingly difficult for fiduciaries to obtain and assess meaningful information on this indirect compensation.

• Due to consolidation among recordkeepers (see InvestmentNews, September 1, 2018, Consolidation of record keepers for 401(k) plans ‘worrisome’), bundled recordkeepers may be in a better position to make these extra fees and revenue sources “stick” and leave plan fiduciaries with fewer alternatives.

Plan service providers — such as bundled recordkeepers — are, understandably, engaged in an ongoing quest to enhance revenue and profitability. Plan fiduciaries, in turn, must ensure that recordkeepers’ revenue needs do not undermine the progress made in recent years to improve retirement outcomes by reducing plan costs.