Administration December 27, 2018

Progressive Sponsors Will Push Custom Designs, Fee Transparency in 2019

Year-end conversations with recordkeepers suggest plan sponsors are highly focused on improving fee transparency, exploring custom default solutions and strengthening fiduciary processes.
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Art by Luyi Wang

As managing director for institutional financial services at TIAA, Mark Foley frequently speaks with plan sponsor clients about their evolving goals and expectations in offering defined contribution (DC) retirement benefits to employees.

Like other executives working at both established and up-and-coming recordkeepers, Foley told PLANSPONSOR 2018 has been a big year for both his firm and its clients—and for the broader retirement services industry.

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“Especially from my perspective being in charge of default solutions, it’s been a very busy year in terms of working with plan sponsors on improving their plans and creating innovative solutions to long-standing challenges,” Foley said. “We have been doing a lot of work to continue to enhance and broaden the use of custom approaches to default offerings, and we’re pleased with the steps that our clients are taking to address participant outcomes.”

According to Foley, clients are increasingly asking for helping in addressing lifetime income within the DC plan context.

“This is another very positive development we saw in 2018,” Foley said. “When we can get lifetime income solutions linked up with the default options in a plan, we know this can be a powerful combination for improving participant outcomes and confidence about retirement.”

Foley said the lifetime income conversation among DC plan sponsors “is really ramping up,” but one of the persistent challenges is being able to actually operationalize this type of a solution.

“I joined TIAA from Prudential, and when I was there I was directly involved in their plan-linked lifetime income products,” Foley noted. “So, I can say I’ve been in the trenches on this issue for some time. My assessment is that the industry is only now getting to the point where we can offer this type of solution in a pretty straightforward way. We can make it relatively simple for the participants and the sponsors, and so we’re seeing increased demand as a part of that.”

Whether talking about clients using customized solutions or those going with pre-packaged default products, Foley said conversations about fee transparency remain front and center as 2019 approaches.

“Talking about fees and transparency remains a key part of client conversations; it is inherent to the discussions we have about the new custom solutions we are trying to deliver,” Foley said. “With our custom model service, for example, it is a key selling point that the client gets transparency all the way through. It’s one of the things that makes this kind of approach appealing to a wide variety of sponsors.”

Foley was candid that plan fiduciaries have to pay “a little more attention to performance and costs” when they run a custom default investment, because they maintain additional responsibility for controlling and overseeing the different pieces of the custom model. Providers and advisers can ease this oversight burden significantly, but plan sponsors cannot wholly offload their fiduciary duties.

“But in turn, you have really good visibility into exactly what is going on with the fees, returns, etc.,” Foley explained. “We find that clients who go with custom default investments tend to put a high value on having this visibility into fees, underlying holdings and performance.”

Clients Focused on Fees and Fiduciary Oversight

Another plan service provider executive who candidly discussed year-end trends with PLANSPONSOR was Mark Klein, CEO of PCS.

“If we think back to where we were at the start of 2018, it’s been a dramatic 12 months for DC retirement plans,” Klein said. “At the start of the year the new Department of Labor fiduciary rule was still in effect, for example.”

According to Klein, a lot of industry stakeholders have overlooked what it means that the system has returned to the older set of fiduciary advice regulations and prohibited transactions rules.

“If you remember, the updated fiduciary rule that was vacated this year would have made a lot more advisers into fiduciaries, but it also included a new set of prohibited transaction exemptions that would have eased the compliance burden of being a fiduciary adviser,” Klein said. “Those exemptions required certain disclosures, yes, but they otherwise freed fiduciary advisers to make recommendations that would result in a higher fee being paid to them or to a partner—i.e., prohibited transactions under the old system.”

As 2019 draws nigh and the DOL fiduciary rule overhaul languishes, Klein said, the retirement industry is “left in kind of a limbo situation.” The crux of the issue is that some fiduciary advisers and service providers (and by extension, their plan sponsor clients) decided to rely on the new fiduciary rule to make or permit certain recommendations that they might not feel as comfortable with today, Klein said.

“This will remain a sensitive and pressing topic in 2018, both for advisers and their plan sponsor clients,” he warned. “I still pause now and again and think about what an incredible regulatory struggle we’ve seen advisers and providers go through in the last two years. Together with the influence of accelerating litigation, this has been a very influential time period for our industry and our clients.”

On Klein’s assessment, even though the retirement plan industry has evolved in a lot of important ways, the manner in which providers present fees and articulate value to plan sponsors and to individual participants and beneficiaries has not really evolved. He is firmly in the camp advocating for more transparency.

“At PCS, we strive to explain the benefit of per-capita pricing for recordkeeping versus asset-based pricing—we’re always trying to coach advisers and sponsors about this,” Klein said. “One challenge we have is educating advisers and sponsors about looking at the overall fees.”

According to Klein, even when the structure will result in a better deal overall, there is often a reluctance among plan sponsors to accept a new, stated per-capita fee up front, rather than to just continue to pay what appears to be a small asset-based fee.

“We are working hard to educate advisers and sponsors about not only the benefit of being up-front and more transparent about our fee, but also about how this approach is likely to be less expensive over time,” Klein said. “We are working to find ways to better express this and prepare our advisers to talk about the long-range impact of different pricing structures.”

Revenue Sharing Debate Will Continue

According to Jason Brafman, director at John Hancock Investments, DC retirement plan sponsors continue to pare back their investment menus in the interest of making it easier for participants to build rational allocations.

Brafman spoke recently on a panel with Vincent Smith, partner and senior consultant at Fiduciary Investment Advisors, during the Best of PSNC 2018 event in Boston.

While it may seem almost patronizing from the perspective of those working in daily on retirement plans, Smith and Brafman said, it is important to be frank with participants and make sure they don’t think their funds or account administration is free. In fact this remains a pervasive incorrect belief among plan participants, they warned.

“It is the responsibility of providers and sponsors to be transparent about how fees are being assessed, why they are being assessed this way, and what the exact terms of that structure are,” Smith said.

Both panelists agreed there is still a debate going on about the use of revenue sharing—a debate that is unlike to be resolved even by the end of 2019. In particular, plan sponsors are debating whether simply declaring no revenue sharing is better in the name of simplicity and transparency, or whether it is still worthwhile to collaborate with a recordkeeper to create pricing efficiencies through proprietary investment revenue sharing on a net cost basis.

“Often you can get a cheaper all-in cost by using revenue sharing, but the other side of the coin is that this can be very confusing for participants, and for that reason alone it may be better to go with zero revenue sharing, unless you can really educate the plan population and get everyone to realize what is really going on,” Brafman said. “That’s where the trend away from revenue sharing is coming from.”

According to the pair, most plan sponsors placing new recordkeeping business today are favoring paying up front a flat dollar fee for recordkeeping. However, Brafman and Smith agreed this is also not always the best way to pay, especially for smaller plans.

“Plan sponsors want to know how they should address the ‘fee-leveling’ conversation with participants,” Smith said. “This will remain an important conversation to have with advisers and providers.”

Administration December 24, 2018

Cash Balance Plans Need Different Administration Systems Than Traditional DB Plans

The characteristics of cash balance plans that are similar to defined contribution plans create a need for different technology than traditional defined benefit plans.
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Art by Jackie Ferrentino

Cash balance plans are defined benefit (DB) plans, but are different than traditional DB plans in that they have characteristics of defined contribution (DC) plans.

For this reason, using traditional DB plan administration systems for cash balance plans can be complex and costly.

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Kravitz President Dan Kravitz, based in Los Angeles, says since 1984 when Bank of America implemented its cash balance plan, DB administration providers would take some programming from DC plans and overlay that with the DB plan system. Some plan sponsors developed their own systems. In addition, actuaries would do manual work in an Excel spreadsheet and input that into traditional DB plan systems.

“DB plan administration providers would do workarounds—we did for years—but that is not efficient,” Kravitz says.

Monica Gallagher, partner at October Three, who leads its defined benefit administration services practice and is based in Jacksonville, Florida, explains, “Pension administration systems built to handle traditional pension plans naturally focused on complex calculations. These pension benefit calculations generally involved looking back at years of data (e.g., 5 to 10 years of pay, complete service history from date of hire including any breaks in service etc.). Some complex formulas also involved items such as Social Security benefit offsets or coordination with Social Security Covered Compensation. As a result, many existing pension administration tools were built using robust mainframe systems. These traditional pension benefits were generally payable as an annuity at a future early or normal retirement date and the focus was on individual accrued benefits generally calculated once a year.”

Kevin Palm, retirement plan sales consultant with Kravitz and an enrolled actuary, based in Los Angeles, points out that this differs from cash balance plans. With traditional DB plans, the focus is on an annuity benefit and all other optional forms of distributions, including lump sums, come second; whereas with cash balance plans, the lump sum is presented first. “Cash balance plan software has to calculate a participant’s benefit similar to a DC plan style—opening balance, interest crediting rate, ending balance. An actuary calculates the distribution in the form of an annuity and joint and survivor benefit,” he says.

According to Kravitz, cash balance plan participants expect the same service and information from their pension plan as from a DC plan. “With a traditional DB plan, to find out the value of their benefit, participants call an 800 number and can get a statement,” he says. “The beauty of cash balance plans is they are much easier for participants to understand. Participants can go online to see their account balance. On the system we built participants can go online and see the value of their account daily, just like with a DC plan.”

Gallagher adds that while traditional DB plans are generally focused on an individual calculation at the time of a participant’s request or retirement, cash balance plans are focused on regular, recurring batch calculations for all pension plan participants. The focus is on a cash balance account that is updated frequently, at least monthly, and now that some cash balance plans are providing market returns, in lieu of a prescribed interest credit, they are being updated daily. “This level of transparency not only supports participant confidence but helps participants appreciate the value of their growing pension benefit,” she says.

Cash balance plan sponsors may also choose different plan designs. For example, Kravitz says when using market rate of return for the interest crediting rate, plan sponsors can apply different investments to different groups of participants—conservative investments for older participants and vice versa. He says this is based on rules finalized in 2014. Cash balance plans may also differ based on which interest crediting rate plan sponsors choose, and if they choose market rate of return, plans can differ based on how many and which investments are chosen.

When choosing an administration system, plan sponsors want to look for a firm that specializes in cash balance plans; for some companies, that is not their core focus, Kravitz says. In addition, some firms may offer only one cash balance plan design, and firms may not offer multiple investment solutions. According to Kravitz, a big thing to look for is that the firm has actuaries on staff; some outsource actuary work. Kravitz says larger and mid-size plan sponsors have a strong desire to use market rate of return as their interest crediting rate and that requires special expertise.

In addition, Gallagher says, web-based and mobile capability is extremely valuable for cash balance plans now, but not generally a priority for a traditional plan where the accrued benefit is only updated annually. Since cash balance plans allow lump-sum distributions, technology advances providing increased self-service are important.  “Participants want the ability to go online to start and complete their retirement, or their lump-sum benefit distribution, process. Avoiding snail mail on both the front end (i.e., initiating the process) as well as on the back end (i.e., uploading required documentation) saves time and allows participants faster access to their benefits/money,” she says.

According to Gallagher, newer web-based technology, rather than traditional mainframe systems, provide plan sponsors with these mobile and online capabilities as well as other technology enhancements, including better transparency for plan sponsors too, allowing increased oversight of outsourced administration. Additional plan sponsor enhancements include direct access to call recordings, cases/case management system, participant data and key dashboard information (e.g., status of retirements/benefit distributions in-flight).  “An added benefit for plan sponsors, is that new web-based technology is more cost-effective than legacy systems to both build and maintain and therefore, translates to lower ongoing pension administration costs,” Gallagher says.

Palm states that cash balance plans have some room to catch up to the DC plan website experience, and that will be the next wave of software improvement.

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