Trending Toward Fee Equalization

    Amy Barber, JD
    Director of Technical Services

     

    Introduction

    As our 2014 Fee Benchmarking Study Results white paper indicates, there has been increasing interest among retirement plan sponsor fiduciaries to try to equalize the costs of revenue sharing among their participants. This is due to the transparency from the fee disclosure rules that took effect in 2012, and the resulting knowledge by plan sponsors in realizing that plan fees are often being allocated to participants unfairly.

    Current Structure of Paying Recordkeeping Fees

    Plan recordkeeping and administrative fees are often offset (either in whole or in part) by “revenue sharing” payments from the investment products available within the investment menu of a plan. Revenue sharing is paid by the investment product manager to the recordkeeper out of the investment product’s expense ratio in return for providing services to the plan.   

    Revenue sharing can vary widely among the investment products within the investment menu based on a variety of factors, such as the share class of the funds. As a result, some participants will pay more, and some will pay less than other participants within the plan as measured as a percentage of total assets. However all participants, regardless of the funds they invest in, receive the same services and resources from the recordkeeper, so some participants end up subsidizing others, creating an issue of fairness for the plan.

    Options (and Challenges) for Revenue Sharing

    To combat the inequity of the existing fee structure, plan sponsors are considering a few different options to more fairly allocate fees among participants. The two primary options are to institute a zero revenue sharing investment menu or equalize the fund level revenue generated by the plan.

    Unfortunately, the first option is limiting as not all investment managers have developed zero revenue sharing investment products, thereby limiting the universe of investment choices available to the plan fiduciaries.

    The second option is potentially easier to implement because it adapts to the existing fund menu. With this option, the sponsor and recordkeeper agree on a fixed revenue target for the plan, typically expressed as a percentage of plan assets, and apply this fee equally to all plan participants. The recordkeeper then evaluates the revenue sharing of each individual fund and calculates an additional asset based fee or credit to apply to that fund in order to equal the plan target.

    For example, if the recordkeeping requirement was 30 basis points (0.30%), the sponsor might build a platform out of mutual funds whose expense ratios ranged from 0 to 50 basis points. Then, in order for all participants to pay roughly the same fee, the recordkeeper would calculate a credit for those participants utilizing funds that pay revenue sharing over 30 basis points, and assess a fee to participants utilizing funds that paid revenue sharing below 30 basis points. The fee credits and charges could be accrued on a daily basis and credited and/or assessed on a monthly or quarterly basis.   

    Unfortunately, not many recordkeepers currently have the systems to equalize revenue sharing; they are unable to calculate who paid how much revenue sharing, in order to rebate back fees to those who paid too much and charge accounts of those who did not pay enough. However, this technology argument (and mainly the time investment and cost to upgrade the technology) may quickly be losing steam, as plan sponsor fiduciaries are often pushing this desire to the forefront of conversations when conducting a recordkeeping vendor search or review.  As plan sponsors become more vocal on this issue, recordkeeping vendors are likely going to need to get on board to develop the technology, as those who choose to ignore the call may begin to be left out of a search process.

    Participant Concerns

    Until recently, revenue sharing derived from the funds’ expense ratios was not explicitly required to be stated. Plan sponsors have expressed concerns that fee equalization would require an explicit line item on participant account statements, calling attention to the fact that participants do, in fact, subsidize the costs to administer the plan. However, in light of recent regulations which required plan sponsor to provide participants with fee disclosure notices over the past few years, participants should already have a basic understanding of the fact that their plan is not free. Plan sponsors can help participants understand fee equalization by explaining that paying for the plan is not new - it was simply structured differently before and that this new structure is designed to make the fees more equitable.  Eventually, participants will appreciate having fees be clearer and easier to understand - especially if they also understand the full range of services and resources that are provided by their vendor.

    How to Begin the Process of Equalization

    Plan sponsors should start by reviewing and benchmarking their fees annually.  Make sure the fees being paid are reasonable in light of the services being provided by the vendor to the plan. As a part of this process, consider how the recordkeeping fees are currently being paid.  If fees are being paid by revenue sharing, discuss with your consultant whether your recordkeeper has the capabilities to support fee equalization, or their potential timeframe for being able to support fee equalization.

    Conclusion

    Multnomah Group believes fee equalization is an attractive solution for plan sponsors looking at a more equitable distribution of plan fees. Given the fact that revenue sharing will continue to exist within investment products for the foreseeable future, implementing this practice will become a priority for plan sponsors. Participants also will understand how fee equalization promotes fairness. Speak with your Multnomah Group Consultant to learn more about best practices for fee equalization.


    Multnomah Group, Inc.
    Phone: (888) 559-0159
    Fax: (800) 997-3010
    www.multnomahgroup.com