Recordkeepers can engage in practices to mask the total revenue they obtain from plan participants. Plan sponsors need to be smarter and more aggressive in eliminating these practices.
Recordkeeping services have pretty much become a commodity for retirement plan fiduciaries; virtually every major recordkeeper (and most minor ones) provide the same core services. And, as with any commodity, there is increased focus on price. In the case of recordkeeping fees, the focus on price is made more intense by the fiduciary responsibilities imposed by ERISA (or state law in the case on non-ERISA plans), the Department of Labor’s fee disclosure rules, and the threat of participant litigation for “excessive” fees.
So, woe be the recordkeeper whose “sticker price” for recordkeeping services is too high – or whose price actually reflects the recordkeeper’s full cost of doing business (plus, of course, an “appropriate” profit margin). Some recordkeepers have responded to these pressures in ways that are not exactly “transparent” and perhaps it is time to shed some light on these practices.
Recordkeepers set their own assumptions on fees to be generated by a plan. The assumptions are based on a wide range of factors that include, but are not limited to:
• contribution rates,
• average account balance,
• length of the contract,
• use of proprietary funds including stable value funds or fixed interest accounts, and
• service and administrative requirements.
These are fair factors to consider. But what happens when a recordkeeper’s costs to administer a plan is in excess of the “number” the recordkeeper understands to be a competitive bid?
Levers get pulled.
Concessions are made, resources get pooled, service compensation gets cut, assumptions are internally renegotiated and at times, profitability requirements get reduced. Indeed, sometimes profitability requirements get reduced to virtually zero. Reconcile this with the cold hard fact that nothing is free in the retirement plan Industry. And there is nothing wrong with recordkeepers making a reasonable profit margin on their business.
Here’s the catch: recordkeepers that bring their fees in line with competitive pressures may do so by dramatically reducing the direct compensation paid to the recordkeeper’s employees who provide advice to plan participants. These recordkeeper employees may be given a variety of titles, including “plan representatives” and “financial advisors” – for purposes of this blog, we’ll call them “reps.” Recordkeepers that trim the sticker price for recordkeeping services by reducing the direct compensation of reps servicing a plan may have a service construct and compensation policy that rewards these reps in other ways. Specifically, the recordkeepers may reward these reps for sales of certain higher-margin products and the reps’ compensation can include payments for the transfer of plan assets to non-plan related products. Managed accounts, life insurance, mutual funds, retail variable and fixed (and index) annuities are all products that may be sold to plan participants.
These practices are especially common among recordkeepers for 403(b) plans and for employers that use an insurance company as their 401(k) recordkeeper. But, these are practices that, at some level, should be addressed by all plan sponsors.
The use of sales-based reward structures raises a number of significant issues for plan sponsors.
• It can be very difficult for a plan sponsor to find out if these practices are occurring. After all, fee disclosure under DOL guidance is only required with respect to “services to be provided to the covered plan.” DOL regulation section 29 CFR 2550.408b-2. So, if a recordkeeper’s reps sell unrelated products to plan participants, the revenue from those products is not even on the DOL’s radar.
• Plan reps covered by these compensation structures are, in effect, trapped. Some recordkeepers may pay reps as little as several thousand dollars a year to service a plan. In the absence of a living wage, reps are under tremendous pressure to sell higher cost, undisclosed products to plan participants. We have a term for that: ACTingTM (Agent Commission Trapping). ACTing is the practice of introducing service reps to a plan, paying them nominal compensation from plan revenue (calling this nominal compensation ”salary” for the purpose of communicating to the plan sponsor and employees), and effectively forcing reps to sell these products in order to generate commissions and make a living income.
Make no mistake, the reps’ income potential is very high – and can easily exceed $100,000 per year –and so the incentive to sell is remarkable.
This practice is especially pernicious because a rep who fails to meet sales objectives can be terminated by the recordkeeper and (if the rep is a registered advisor) the termination will be on the rep’s permanent record with FINRA. Specifically, if an advisor is terminated, the recordkeeper submits a form U-5 with regulators describing the cause of the termination. So, an advisor who doesn’t play the game can lose a job – and have trouble finding a new one.
• In the eyes of plan participants these reps have the “endorsement” of the plan sponsor and the sponsor has approved the sales of these products. Plan sponsors should consider the power of this implicit endorsement – after all, reps capitalize on this imprimatur in gaining the confidence of participants. It is not in the interest of plan sponsors or participants for participants to come to work in an environment where they are solicited by sales agents to purchase complex, commission and/or fee based financial products.
With increasing (downward) pressure on recordkeeping fees plan sponsors (and their consultants) need to “up their game” in reviewing recordkeeper fees and compensation structures. Plan sponsors should be in a position to learn the true cost of recordkeeping services and these alternative revenue sources for recordkeepers must be exposed to the light of day. Too much is at stake – both for plan sponsors and participants – for current practices to continue.