Posted by Rich Lynch on December 04, 2013
>>>> Next week, fi360 is hosting a webinar on 408(b)(2), reasonable service arrangements, and benchmarking. In this post, fi360 President Rich Lynch takes a look at how CEFEX is helping plan sponsors assess their service provider arrangements and the criteria they are using to determine reasonableness using a benchmarking process.
It’s been almost 18 months since the 408(b)(2) regulation became effective and service providers became required to provide enhanced disclosures to their plan sponsor clients. It’s probably safe to assume that most if not all service providers are now delivering the required written information regarding their:
- compensation; direct and indirect (12b-1 fees, sub-transfer agency fees, and other forms of revenue sharing)
- fiduciary status; if assumed
So the service providers have done their part in providing the required information, although there appears to be work ahead in making these disclosures more straight forward and easier to understand.
So what does that mean for the plan sponsors? Technically speaking, the regulation does not change their obligation to prudently select the service providers. Fundamental to that selection and maintaining the relationship is a determination that the arrangement is “reasonable.” However, with the regulation that is meant to get them more complete information about their service providers comes an expectation from the DOL that they do something with it. In short, plan sponsors should be conducting some type of analysis to determine if what they are getting from their service providers (services) is aligned with what they are paying (compensation)? There should be documentation to demonstrate this is being done. Our sense is that many are not doing this, which presents advisors with an opportunity to help them do so.
There are two primary methods for making this reasonableness determination: 1) a request for proposals (RFP) process, or 2) utilizing a benchmarking service. The RFP process is more formal and results in numerous proposals that are consistent in how the information is provided. This allows for a straight forward, apples to apples comparison of fees and services that are available to the plan. However, it is also time consuming and expensive. Benchmarking is an acceptable and less formal alternative that, for many, is a more practical approach; primarily because it saves time and money.
Plan sponsors need help benchmarking their service providers and the advisor is in the ideal position to provide that help. The Centre for Fiduciary Excellence (CEFEX) has focused on how to conduct this analysis and developed two schedules for their analysts that are assisting plan sponsor clients with this reasonableness determination. The first schedule is a checklist of questions meant to evaluate the service provider agreement and ensure it meets the regulation’s disclosure requirements. The second specifically addresses the determination of fee reasonableness. Benchmarking is a critical component of this determination and a good service will compare several measures of the plan’s operations, including service provider compensation, against other plans. It’s important to compare against an appropriate peer group in terms of attributes like plan assets and number of participants. If the fees fall within a reasonable range of the peer group average (e.g., plus or minus 10-15%), one can probably conclude that the report alone supports a reasonable determination. Because the regulation has not yet been tested in court, there is no current legal basis for establishing reasonableness, other than professional judgment. Although not normally a concern, if the fees are more than 10% below the average you may want look for typical services that are not being provided. If the fees are more than 10% above the average, further qualitative analysis is necessary to justify paying up for the services provided. Additional factors to consider that might justify higher fees would include:
- Years of experience as a firm
- % of business devoted to ERISA plans
- Industry credentials
- Assumption of fiduciary status
- Assumed discretion for fiduciary decisions
- Services that exceed what is normally provided
- Assistance with participant services
- Assistance with measuring the success of participant services based on outcomes
- Provision of industry benchmarking services
- A service provider that invests in its business, implements or helps implement fiduciary best practices, keeps abreast of industry trends and does research to give its plan clients an advantage in helping participants achieve retirement security
Again, this reasonableness determination is a judgment call that needs to take place. The key is being able to demonstrate that service provider arrangements are being objectively evaluated before selection and periodically (we suggest every three years) thereafter.