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Fee Equity: Has Your Board/Committee Considered It?Written by Julie Klassen, ChFC, REBC, Regional Director, Market Development and Kent Morris, CFP, Vice President, Great-West Retirement Services In these challenging economic times, many plan sponsors have revisited their analyses of plan costs relative to third party administrators or record keepers, consultants, legal counsel and investment providers. Plan sponsors seek to manage internal costs associated with plan administration, and if any excess plan revenues exist, use the excess to defray plan costs. Fee transparency is also currently under scrutiny in various forms in Congress as it relates to mutual fund shareholder service fees. Target date funds and stable value fund fees are areas of additional focus. But has your Board or Committee considered fee equity as it relates to how vendor payments are collected across all plan assets and used to cover plan costs?
Consider the following:
What is fee equity and how can the equitable assessment of fees be determined?
Fee equity is a fairly complex topic, yet it has received relatively little attention. One view is that participants are given equal access to plan services, e.g., web site, voice response unit and customer service representatives, and as such, participants should share plan costs equally. Other fees, such as those for loan maintenance or for a self-directed brokerage account option, are charged only to participants who utilize these options.
Specifically, fee equity may be defined as an assessment of how plan revenue is generated by individual participant accounts and their associated investment options compared to plan costs. Typically, there is a correlation between the revenue generated by a fund and the expense of a fund.
The equitable assessment of fees is not easy to determine and is best illustrated by reviewing a few examples:
Example Number 1 – All plan expenses paid from revenue sharing generated from plan investment options.
Compare two participants with unique asset allocations with the only difference being the revenue generated by the investment options. There is potential for fund selection bias when the need for plan revenue is considered along with an analytical analysis of fund expense and performance. Unless all vendor fees are explicit, fund revenue is expected to provide for the record keeping and communication services for the plan. If non revenue producing funds are chosen by one participant, and another participant chooses funds that are revenue producing, then fee equity is not realized. See an example below:
Example Number 2 – A requirement of a proprietary fixed or variable fund product. The current trend in fixed options is the establishment of a separate account or pooled stable value fund. Such funds offer the greatest fee and revenue transparency. Many plans retain general account fixed product options. General account options generally do not offer fee transparency. The margin or difference between what a portfolio earns and the rate credited to participants is generally not disclosed, similar to deposit accounts. Plan sponsors are usually unable to determine what the general account margins are, and in fact, margins may be “pinched” or reduced depending on the current interest rate environment as well as by the revenue needs of the offering company. As such, plan participants pay an unknown fee with these types of products.
On the variable fund side, there is fee transparency with the investment management expense and with the applicable revenue sharing. What is not readily transparent is what portion of the investment expense covers actual costs and what is profit.
Example Number 3 – Explicit fee choices passed through to the participant.
Plan record keeping or administrative fees may be collected in basically three ways:
1. Per participant dollar fee;
2. Percentage of assets based fee on all plan assets;
3. Combination of the two.
Though per participant or “per head” fees are frequently considered, often an asset base fee is implemented. Per head fees may appear to be cost prohibitive to new participants where the fee assessed would seem disproportionate to a new participant’s beginning account balance. Conversely, a participant with a relatively large balance would pay substantially more where both participants have access to similar services.
Both asset based fees and per participant charges may be partially or completely offset by the fund revenue paid by the underlying funds and consideration should be given to whether there is a total fee offset. With an asset based fee, a record keeper would typically contract for the revenue produced by the underlying plan assets; the assumption being that plan assets will grow over time. The risk with a per head fee is that a plan could be in a deficit position, if fund revenue does not completely offset the per head charge (assuming there is no direct or explicit charge to participants).
Example Number 4 – Attempt at fee equity arrangements.
Some record keepers offer various fee collection arrangements in response to plan sponsor interest in fee equity. For example, a combination of fixed and asset based fees is feasible. Additionally, asset based fees may be “capped” at an agreed upon asset level.
Increasingly, plan sponsors are also interested in crediting excess revenue, i.e., the difference between plan costs and revenue produced from a plan’s fund line-up, back to participant accounts. How these credit backs are allocated should also be reviewed. Should the credit back be allocated by fund, or should excess revenue be “weighted” to each participant, regardless of individual participant fund selection? Alternatively, should credits be structured in such a way as to attract new participants?
In Summary
A plan sponsor has discretion over its plan and plan assets. A plan sponsor’s fiduciary responsibility is to select investment options for the exclusive benefit of its plan participants and beneficiaries. Perhaps fee equity needs further study in consideration of these obligations.
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