A recent settlement entered into by the Delaware attorney general highlights an often-overlooked problem. The problem–deselected plan providers looking to pull assets out of employer-sponsored retirement plans on the way out the door.
The Delaware Settlement
The settlement involved Horace Mann, a recordkeeper and broker focused on offering plans to educators. In 2016, the State of Delaware transitioned its deferred compensation plans from multiple 403(b) service providers, including Horace Mann, to a sole provider, Voya Financial. Related to this transition, over 120 teachers with 403(b) accounts with Horace Mann opened IRAs in 2016 and 2017 with Horace Mann, through one of its registered representatives, Dieter Hofmann.
Upon review of the circumstances relating to the opening of these IRAs, the Delaware Investor Protection Unit concluded that this representative “engaged in dishonest and unethical practices” based on allegations that the representative “took unfair advantage of his customers with 403(b) accounts who were confused about the transition to Voya by providing them with inadequate or inaccurate information which was misleading”.
Horace Mann and the individual broker settled the Delaware claim by each paying a $250,000 fine and undertaking a variety of additional corrective actions.
On its face, you might say this is just an isolated incident based on the actions of one “rogue” employee. However, our experiences tell us that this case reflects a broader issue. Recordkeeper representatives will act in accordance to the compensation and incentive structures they are provided. Plan sponsors and fiduciaries should recognize these incentives can very well lead to participant solicitations at the termination of the recordkeeper relationship.
Should I Stay or Should I Go?
The pressure on plan provider fees is well documented. See our blog post on Actions and Reactions. And, we can expect that this pressure will continue–after all, fiduciary lawsuits and plan advisors regularly remind plan sponsors that the failure to obtain regular recordkeeper bids can be considered a failure of their fiduciary responsibility. See https://cammackretirement.com/knowledge-center/insights/fiduciary-breach-lawsuit-issues-explored-topic-5-no-regular-recordkeeper-rfp.
Moreover, when plans rebid recordkeepers, they may also require that the recordkeeper unbundle certain higher margin services (such as fixed income products or managed accounts) from the recordkeeping bid.
This activity, taken as a whole, can make retaining some clients far less lucrative.
The downward fee pressure in the employer market plays into another important market dynamic: plan providers (other than pure recordkeepers) have higher–much higher–margins for retail products than they do for institutional products. When you factor in the difference between retail vs institutional share classes, insurance products with complex features (and correspondingly complex fees) and the access to sell unrelated financial products, retail customers can be four or five times more profitable than participants in well managed employer-sponsored plans.
As a result, in some instances an incumbent plan provider can make more by losing a highly competitive bid for an employer-sponsored plan — and then actively “harvesting” accounts and assets from that plan. And the same logic applies to individual commission-based sales representatives.
This underlying dynamic–of seeking to win (profitability) while losing the employer-sponsored plan is exactly the dynamic that drives so many of the provider practices that require fiduciary scrutiny–practices that seek to leverage the institutional business (both assets and data) to sell retail products.
We are not privy to the financial analysis of Horace Mann’s bid or to the commission structure that motivated Mr. Hofmann–so we do not know the exact calculations that led Mr. Hofmann to open over 120 new accounts while on his way out the door. But we have seen this very analysis for other recordkeepers in other similar situations and have seen how the asymmetry between profitability in the retail and group market segments can lead providers to win while losing.
This market dynamic is important for all plan fiduciaries and should be factored into the vendor selection and contracting process. For example, consider:
- Does a vendor or candidate offer retail products that could “compete” with the employer-sponsored plan?
- How are the vendor’s “plan” representatives really compensated? In the bidding process vendors will use the “salary” label for all sorts of variable (commission-like) compensation.
- Does the plan fiduciary monitor nontaxable distributions to see whether a disproportionate share of these distributions go to the plan provider?
- Are there robust prohibitions against soliciting plan participants for non-plan products and against using plan data to market to plan participants?
This is one instance where plan fiduciaries do not simply want to “follow the money” if the money is being drained from the employer-sponsored plan. Rather, fiduciaries should focus on keeping the money.