The defined-contribution world has never been more competitive. Retirement plan providers are fighting aggressively to keep existing clients, as pricing has come down dramatically, services have improved and, importantly, provider disclosures are significantly better.
The Securities and Exchange Commission is finally scrutinizing revenue-sharing agreements between mutual funds and retirement plan providers to gain a better understanding of the industry's "pay to play" shell game.
The SEC recently sent out detailed questionnaires to a number of the largest retirement plan providers asking about their revenue-sharing practices. At almost the same time, the Department of Labor has focused its attention on the fiduciary oversight of retirement plans.
Doing a thorough review and benchmarking of a plan's retirement plan provider has never been more prudent - or more rewarding. Historically, many providers sold "free" retirement plans to plan sponsors as mutual funds sent "soft dollars" to providers, making it difficult for plan sponsors to grasp total costs. In other words, participants were and still are bearing mutual fund expenses that are being rebated back to the provider without full disclosure to the plan or the participants.
The SEC is questioning providers as to whether the revenue sharing entitled some funds to better access to plans than others. In many cases, we believe that payment to providers is excessive and at the expense of participants in the form of higher mutual fund expenses. By renegotiating with the existing provider or by taking a plan out to bid, it is not unusual to save a plan and the participants tens of thousands - if not hundreds of thousands - of dollars each year. In reality, excess revenue sharing should come back to the plan to cover other plan expenses, such as legal, consulting and audit costs, or come back to the participants. With better markets and constant contributions into plans, the mostly asset-based rebates to providers have skyrocketed in many plans over the years.
More good news is that providers who previously only had proprietary products are opening their investment universes to virtually any fund that can provide daily pricing. This enables trustees and investment committee members to offer participants a sounder "best of breed" approach to the investment menu made available to plan participants. No longer do plan trustees need to be stuck with ill-performing products, whether proprietary or not, and trustees can simply unplug and replace when prudence calls for change.
Other services in the participant education arena are vastly improved as well. From tools and research to one-on-one participant advice, these educational services have become much more specialized and customized.
We believe that the best approach to analyze the current arrangement is for a plan sponsor to take a step back from their current situation and design the "perfect plan." Next, go to the existing provider and negotiate a more favorable arrangement, or take the plan to the marketplace and ask for the sponsor's perfect plan. In many cases, the plan sponsor and trustees may only be familiar with the current plan arrangement, and may need some education as to the possibilities and solutions that exist.
Consultants can be very helpful in assisting trustees and investment committees through this endeavor. Further, they can be very adept at benchmarking the current situation and in taking the plan out to bid through the request-for-proposal process. Consultants can have significant pricing power in the marketplace, and generally recognize that every vendor, good or bad, can put their product in an excellent light. A quality consultant's experience with a vast number of providers can keep a plan from jumping from the frying pan into the fire.
Choosing a consultant
* Make sure they are conflict-free! Fee-only consultants are a must. Using an insurance or securities broker that receives any compensation from a provider corrupts advice. If the provider has created room to pay a broker, then the consultant should carve it out for the benefit of the plan. Typically, if the "consultant" has a Series 6 or 7 license, they are selling products and are conflicted.
Sales stories are frequently told about "firewalls" keeping the businesses separate because of the conflict. However, experienced professionals are frequently shareholders or partners in the parent firm and receive bonuses, distributions and equity based on the success of the other businesses. That is a conflict! Further, some consulting firms that have these conflicts of interest have been asked recently to reduce expenses or even lay off employees to compensate for the misdeeds on the other side of the firewall (often involving the mutual fund scandals).
* Experience, experience, experience! The retirement vendor marketplace must be thoroughly understood, and the only way to grasp the idiosyncrasies of the market is to have a multitude of experiences with existing clients. Lack of expertise, time and history can lead to poor solutions and poor contracts with providers.
In addition, actual client experiences with providers will mean much more than a provider's professional proposal or presentation. At times, we've seen great proposals from these vendors that were in the process of being terminated by another client for poor performance. Furthermore, the consultant has clout in negotiations, as the provider often will be more flexible with a consultant with a book of clients than with any one particular client. We have paid for our consulting services many times over through favorable fee negotiations.
* Approach to investments. We believe many consulting firms are mistaken in their approach when analyzing proposed investments for plan sponsors. Typically, they ask the provider to recommend their best menu and then the consultant evaluates the quality of the proposed investment array.
The key to evaluating the investments for a prospective relationship is the size of the universe, the quality of the universe (many low-cost institutional products and share classes) and the true flexibility of the universe if a future fund change is warranted. Since the provider is conflicted with revenue sharing from the mutual fund, a conflict-free consultant will be the most objective. Investments cannot be evaluated in a vacuum and they will change over time.
* Investment expertise is critical. Anybody can crunch numbers; consultants and other advisors are too enamored with looking at historical data. Too little time is spent by investors and advisors on understanding "why" performance - good and bad - happened. A deep team of analysts is crucial. Ultimately, we believe that identifying quality products and managers comes only from experience and hard work. Data crunching gets you less than part way to truly understanding an investment.
This is an ideal time to re-evaluate your provider relationship to not only enhance a major benefit to participants, but to protect the plan sponsor and fiduciaries. A quality consultant can easily pay for their services and expertise through fee negotiation and can make a very complicated process much less taxing on the plan sponsor. The rewards can be astronomical - not only today, but for years to come.
Richard M. Todd, CIMC, is a consultant and principal of Innovest Portfolio Solutions in Greenwood Village, Colo. Reach him at (303) 694-1900 or richt
