March 7, 2019
William Ryan and Aaron Chastain are members of Aon’s North America Qualified Default Investment Alternative (QDIA) Manager Research team. Bridget Steinhart and Rhonda Jinks are members of Aon’s DC Plan Consulting team. Elizabeth Groenewegen is a member of Aon’s Legal Consulting & Compliance team.
“It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.” – Warren Buffett
We are approaching 20 years from the U.S. Department of Labor's issuance of the “SunAmerica” opinion that paved the way for DC plans to offer managed accounts to participants. However, while the technology has advanced, the industry’s thinking has not similarly advanced around the fees being charged and the relationships among Plans, recordkeepers, and managed accounts providers.
Based on our understanding of the managed accounts service models as well as ERISA requirements, we believe that managed accounts providers need to be more proactive in disclosing direct or indirect compensation received from DC plan assets as well as shared revenue between managed accounts providers and recordkeepers. We are still on a journey to achieve consistent fee sharing disclosure industry-wide. Plan sponsors should help drive this change as part of their fiduciary duty to evaluate the reasonableness of fees and identify potential conflicts of interest. The improvements that we have observed have been driven by plan sponsors competitively rebidding their managed accounts services, when possible, and asking for more detailed disclosures.
In 2018, the 401(k) plan turned 40 years old. What have we observed in that time?
In particular, we have witnessed a continuous expansion of defined contribution (DC) plan service offerings, which requires plan fiduciaries to remain up-to-date on their oversight responsibilities under the Employee Retirement Income Security Act of 1974, as amended (ERISA). The fees charged to participant accounts in 401(k) plans have received increased attention in recent years. In 2012, a set of regulations became effective which requires that plan fiduciaries receive specific fee and expense disclosures from certain plan service providers. The goal was to assist the responsible plan fiduciary in determining whether the fees paid from the plan were reasonable in light of the value of the services received by the plan.
Aon has advocated for more effective plan expense management and transparency for defined contribution plans for many years. The service provider fee disclosure regulations were an important step toward ensuring that plan sponsors (and their responsible plan fiduciary decision-makers) have sufficient information to make informed decisions when assessing plan service provider fee structures and potential conflicts of interest.
For this discussion, we will focus on the managed accounts offering in the context of applying the ERISA 408(b)(2)1 regulation. In general, this regulation requires a covered service provider (CSP)2 to provide qualified retirement plan fiduciaries with a description of the services that it provides, the direct and indirect compensation it expects to receive in connection with those services, and identification of any services provided as a fiduciary.
Managed Accounts Providers and Recordkeepers are CSPs by Definition
Within the context of CSPs, let’s begin to peel back the layers of the managed accounts provider and recordkeeper service models. We have identified two distinct managed accounts models for this discussion:
- Direct relationship
- Indirect relationship
A direct relationship model is one in which an ERISA 3(16) plan administrator (ordinarily, the plan sponsor or its retirement plan committee) contracts directly with a managed accounts provider to have its managed accounts product be used for its DC plan on the recordkeeper’s platform. To illustrate, Financial Engines is a managed accounts provider on the recordkeeping platform of recordkeepers such as Fidelity and T. Rowe Price. A plan administrator with a plan that is recordkept by Fidelity or T. Rowe Price could contract directly with Financial Engines to have the Financial Engines managed accounts product be offered to its plan.
An indirect relationship model is one in which the recordkeeper has already established a partnership with one or more managed accounts providers, and the plan administrator contracts with the recordkeeper to offer the service. Common examples of this type of relationship would be Morningstar “powering” the managed accounts services provided by recordkeepers such as Empower, Schwab, and Voya as well as Financial Engines driving the managed accounts services offered by Vanguard, Alight Solutions, Empower, and Voya. In these examples, note that some recordkeepers provide the plan administrator a choice in managed accounts providers.
In either relationship, a participant typically pays investment management fees related to using the managed accounts option, which are based on a plan-level contracted fee schedule. The total fee in the aforementioned fee schedule includes services provided by the managed accounts provider and the recordkeeper (note that these fees are in addition to any underlying fund expense ratios). We break these services down into two categories:
1. Investment management and advice services – from the managed accounts provider to design and possibly execute the participant’s asset allocation and investment selection, as well as provide suggestions for the deferral savings rate that could be optimal, and
2. Administrative services - from the recordkeeper to make the managed accounts services available to participants and process the related transactions.
In addition, the managed accounts provider may “share” some of its fees with the plan recordkeeper. This relationship is very much like the DC revenue model that has been falling out of favor with many market participants in recent years. In the DC revenue model, a plan offers a designated investment alternative which provides “revenue sharing” included in that fund’s expense ratio to the plan’s recordkeeper, ostensibly to offset certain communications and fund information expenses incurred by the recordkeeper. The potential existence of this type of fee sharing arrangement becomes more apparent when recordkeepers discount the explicit plan recordkeeping/administration fee if managed accounts are offered. Our interest as a consulting firm is to ensure that all revenue shared with the recordkeeper is disclosed to plan fiduciaries so that they are fully aware of the total revenue that the recordkeeper is receiving. In any event, we believe that plan fiduciaries need to ask plan recordkeepers to address any otherwise undisclosed amount of revenue the recordkeeper receives from the managed accounts provider.
Call to Action
It is a prohibited transaction under ERISA and the U.S. Internal Revenue Code for plan fiduciaries to continue to do business with a CSP if that CSP is delinquent in providing the required disclosure or provides incomplete information. Penalties for both parties can include a 15% excise tax on the amount involved (typically, the annual fees under the contract). We believe that managed accounts providers are CSPs under ERISA. As such, these CSPs need to be more proactive in disclosing direct or indirect compensation received from DC plan assets as well as shared revenue between managed accounts providers and recordkeepers.
We are still on a path for achieving consistent fee sharing disclosure industry-wide. The improvements that we have seen have been driven by working with our clients to competitively rebid their managed accounts services, when possible, and by asking for more detailed CSP disclosures. Over the past year, we have observed a decrease in fees for managed accounts service offerings, and we believe this trend will continue. Meanwhile, plan fiduciaries have the right under the ERISA 408(b)(2) regulation to receive clear documentation addressing any split in direct and/or indirect compensation each CSP receives when a plan offers managed accounts to participants. The call to action centers on the fiduciary duty to evaluate the reasonableness of fees and identify potential conflicts of interest.
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