Is fee compression absolute? Is it always better for 401(k) plan sponsors and participants, or do diminishing returns mean less is no longer more? Article Presented By: Securian Financial
Fee compression is frequently billed as a consumer good—less for 401(k) providers is more for 401(k) participants.
It’s also causing an expansion in the breadth and depth of services that 401(k) advisors now provide, as a quest for value has resulted in new and creative business models.
But is it absolute? Are lower fees always better for plan sponsors and engaged employees, or do diminishing returns mean that at some point less is no longer more?
Ted Schmelzle, Senior Director of Plan Sponsor Services with Securian Financial, has answers.
The company has taken a somewhat contrarian view on fee compression for some time. While celebrating the obvious benefits lower fees provide, they come with a price (pun intended) in various forms.
Schmelzle sat with 401(k) Specialist for a candid discussion of what’s sacrificed for cost savings, and the regulatory and legal dangers that result.
Download Securian Financial’s white paper “Fee compression isn’t free”
Q: Fee compression is causing advisors and recordkeepers to expand their services in order to provide new revenue streams, and it’s portrayed as generally good for participants and their retirement outcomes. But Securian cautions it’s not always the case. Why not?
A: In many instances, I disagree with the term “fee compression.” There are times when it’s accurate, but too often the more appropriate term is “subsidization.” The compression that is ordinarily referred to in the industry can be thought of like a balloon—it’s really a matter of pushing on one side and watching the other side expand.
Over the last 10 to 12 years, either through regulatory action or more successfully through fee and expense litigation, what’s come to life is that money is simply being taken from one pocket (or being illustrated as a compression on one side of the fence) when, in reality, these are just reaped on the other.
That’s an important thing to level-set on. You then need to question how that is better for the participant or, more importantly, the plan sponsor who has the fiduciary duty to understand all of this, whether or not they actually do.
Q: What other fee compression misconceptions are there that cause frustration because they are (or could be) relatively simply addressed?
A: From a recordkeeper’s standpoint, I think that most of this has been addressed and in general is disclosed, but that arguably creates a shift in who’s responsible for these arrangements. Either through regulatory disclosures they’re required to make to plan sponsors and/or participants or voluntary ones, they technically disclose the additional revenue streams, whether it’s from proprietary investment options, revenue sharing arrangements or the like.
But I think that burden has now shifted to plan sponsors to understand those often-complex arrangements and to come to a conclusion under 408(b)(2) that what they’re paying is reasonable relative to the services provided. And therein lies the problem; you asked about would be revenue-sharing arrangements, and proprietary investment options that can be incented or required on some platforms.
In my view, the one most difficult to pin down is IRA rollover or capture programs from a recordkeeper. Specifically, business strategies built around taking in assets knowing that a portion of it is going to roll over to a proprietary IRA, and then using the recordkeeping as a loss leader simply to gather those assets.
Q: Rollovers were once billed as a “tsunami” fueled by demographic changes, but uncertainty driven by regulation and specifically fiduciary issues clouded the outlook. How does fee compression fit in with rollovers going forward?
A: It’s definitely part of the equation today. I think that the demise of the Department of Labor’s fiduciary rule shouldn’t give anybody any real comfort. Clearly, the regulatory authorities know that this is a problem. They know about it both on the SEC side and on the DOL side, so I expect there’ll be further regulation, specifically around IRA decisions. Obviously, we’ve already seen that with the SEC. I think we’re likely to see it with the Department of Labor. If I’m a plan sponsor, one thing I would want to know as a threshold matter, is whether or not the recordkeeping fee is independent of, and not subsidized by, IRA rollover captures. I think that would be a very good starting point to have a conversation with a recordkeeper. If I’m a fiduciary as a plan sponsor, it’s something that I would want to know right out of the chute.
Q: Where does this all end up? Is it a race to the bottom with lower fees at this point?
A: There has been a lot of efficiency that has been reaped in the industry and plan sponsors and participants are better for it.
Recordkeepers, as they add to scale, are able to spread those costs out over additional participants and plan sponsors, thereby lowering fees legitimately. That’s a good thing. Some of it is illusory because of the industry problems we discussed, but it’s very difficult to say what percentage.
Couple that with the notion that you really can’t divorce this fee subsidization or fee compression (if you want to call it that) from service, because we’re seeing a deterioration in service offerings in the industry, and value is something to which plan sponsors need to pay attention.
It’s not just about the lowest fee, it’s about the value I’m getting for that fee.
Q: So, 401(k) advisors should be confident in their fees as long as they demonstrate value?
A: They absolutely go hand-in-hand. There are many audiences that are looking for a rock-bottom price, and they really don’t care about the value provided. That will certainly always have a place in the market. If you are a plan sponsor that is not of that ilk, and you believe there is value in a service offering that takes administrative burdens off your plate or assists you in meeting your fiduciary responsibilities, then there is justification driven by that differentiation.
At the end of the day, you get what you pay for; there’s no free lunch. Here’s what’s provided and the value proposition. The plan sponsor then simply has to make the determination of whether or not it’s worth it.
Q: Will we hit critical mass at some point, where there’s demand for higher quality services from the marketplace, rather than 401(k) advisors having to explain it? Will plan sponsors realize the need for value and come looking for it, regardless of the higher price?
A: I humbly think we’re there. That is a shift that we certainly have noticed. We still have to be competitive in the marketplace relative to what we charge for our services, but we have seen over the last two to three years a very big focus on value. That’s not just from the plan sponsor community, it’s also from the advisory community. Advisors are getting more and more fed up with the service they’re getting from a recordkeeping chassis that only treats recordkeeping as an accumulation of assets.
Our industry is far too complex and has too many intricacies, too many opportunities for error and too much at stake to settle for that type of service.
Advisors are leading this charge. We’re an advisory-assisted sales model. I don’t ever see that changing. And so not only do we have to demonstrate our value relative to plan sponsors, we have to do that relative to the advisors with whom we’re privileged to work. To the extent we can show our value proposition, we’re going to win that fight.
Download Securian Financial’s white paper “Fee compression isn’t free”