A small but growing band of employers is fueling a rebellion against long-opaque cost structures in the 401(k) plan market. Working with pension consultants to ferret out esoteric expenses, these plan sponsors are dissecting fee arrangements. Where the assets at stake are big enough to provide negotiating leverage, the sponsors are squeezing vendors for more-attractive deals.
The benefits can be enormous. A worker who socks away $10,000 a year for 30 years and nets 8 percent annually could retire with an additional $109,000 if her plan found a way to pay 50 basis points less in operating expenses. Those types of savings are within reach of plans that are saddled with high-cost investment options.
Employers have always had a fiduciary duty to make sure their retirement-savings plans are paying reasonable fees, but that responsibility has often been difficult to fulfill. Vendors generally don’t reveal the true cost of their products when pitching them. Sometimes sponsors don’t understand the cost structure behind vendor pricing and so remain blind to opportunities to trim fat. While many plan providers now disclose costs more clearly than they did a few years ago, the pricing waters are still murky throughout much of the industry.
In the past, such obscurity might have helped to head off potential complaints about fiduciary liability, but pressure is building on companies to focus on this issue. After investigating compensation practices in the defined-contribution-plan marketplace, the Securities and Exchange Commission recently warned sponsors about conflicts of interest within the system. Meanwhile, the Department of Labor, which oversees the Employee Retirement Income Security Act (ERISA), is encouraging sponsors to do more to rein in fees.
Also, an increasing number of smaller retirement-plan providers operate on a so-called open-architecture framework, which gives plans access to funds from multiple investment managers and clearly lays out the costs for each one. If these providers can sweep aside the cost curtain, sponsors reason, then the big banks, brokers, insurers, and mutual fund companies that dominate the 401(k) plan business should be able to as well. Much more money is at stake, as the value of assets in 401(k)s and other defined-contribution plans has mushroomed, from $1.4 trillion in 1994 to $3.2 trillion 10 years later.
Shirking fiduciary responsibility in this arena is especially risky for any executives who serve on companies’ retirement-plan committees. With more workers relying on defined-contribution plans for retirement, failure to ensure that plans operate as efficiently as possible is increasingly likely to spawn lawsuits. The penalties for fiduciaries could be high, as their personal liability equals the value of the assets in their plans. “It’s going to be the next big wave of litigation,” suggests Washington, D.C.-based ERISA attorney Sherwin Kaplan, counsel to the law firm of Thelen Reid & Priest LLP. Kaplan says a fiduciary should be aware of all sources of payments made to a service provider in connection with the plan (see “Under Fire” at the end of this article).
Quantifying the Savings
Among those companies whose awareness has been raised is Atlanta-based Internet Security Systems Inc. About two years ago, the company asked its financial adviser, White Horse Advisors LLC of Atlanta, to evaluate what ISS was paying vendors to run its $27 million 401(k) plan. Although ISS found its costs to be in line with market rates, Daniel Eidson, the company’s director of treasury, says the exercise triggered a fresh assessment of pricing policy by its plan provider, which promptly lowered the plan’s asset-based fees by a couple of basis points. ISS also discovered that it was paying administrative fees on a number of dormant accounts that it was able to eliminate by cashing out some of those account owners and convincing others to roll their assets into another retirement account somewhere else.