We in the retirement plan industry should take with the utmost seriousness our duty to adhere to our oath as fiduciaries. For example, the hurdles presented in a multi-vendor consolidation strategy are many, but not insurmountable and worth the effort.
The changes in the ERISA world have begun to affect the large market 403(b) and 457(b) plans. The retirement industry as a whole has largely neglected the small- to mid-market governmental 457(b), 403(b) and other non-ERISA plans.
Now is an opportune time to shift our attention to these underserved segments of this market. Its antiquated products, high fees, restrictions and surrender penalties should soon be a thing of the past.
Like any other product or service in a capitalist marketplace, ERISA has guided the 401(k) world into an open and transparent system in which vendors competitively bid for business based on the merits of their organizations and price structure. For the most part, all vendors are playing with the same tool box. Vendor A has access to the same universe of investment options and mutual funds as vendor B. There are exceptions, but an organization will rarely choose a platform provider based solely on their proprietary investment options.
As consultants, our goal is to use platform providers as a foundation on which to construct our retirement plan. We need to be willing to customize the options to most effectively meet the needs of our clients. That requires skillful navigation around obstacles such as surrender charges, recordkeeping and varying degrees of liquidity as we tackle unwinding of a lot of individual contracts.
Why consolidate vendors?
In several states, non-profit organizations are required to offer multiple vendors to participants. This is based on the assumption that since many of these products are annuity based, have different features and living benefit riders, members are offered a greater diversity of choices in their retirement plans.
Annuities provide greater security for those who desire that above all else, and have a place during the distribution phase of retirement. But they are not the most efficient way to grow wealth during the accumulation phase of retirement planning. The high fees and surrender penalties associated with annuities cause them to be less attractive than other options. The Department of Labor points out, "The 1% difference in fees and expenses would reduce your account balance at retirement by 28%."
Besides these drawbacks, a little-discussed feature of annuities deserves our attention. Annuities do not offer a strict layer of investment oversight, as the issuing company is unable and unwilling to act as a fiduciary on the contract. This means that the investment selections available are not determined by thoughtful consideration of what is in the best interest of the contract holder, but by which investment company has negotiated a spot on the investment lineup for that insurance company. In this scenario, underperforming investment options are not necessarily removed. Instead, new investments are added to the platform, causing the investment menu to be a giant and complicated toy box without any rhyme or reason and no fiducially oversight.
ERISA got it right by pushing for fee transparency and accountability for retirement plans. This resulted in 401(k) plans becoming the most efficient structure for planning success and its single investment menu maximizes participants' outcomes.
This single investment menu is made possible when vendors can be consolidated. Perhaps the biggest benefit of consolidating the products is that negotiations can address the entire asset, rather than prepackaged bundles. In a hypothetical scenario of an organization with 10 vendors, each with a proportionate share of a $25 million asset, the purchasing power of each block would be $2.5 million. Having 10 individual vendors negotiating costs for recordkeeping services on a $25 million asset can make an enormous difference in overall plan pricing. According to 401k Averages Book, it would have an impact to the plan cost, resulting in a total bundled administration/investment expense 0.34% less for the larger asset. This 0.34% translates to $85,000 per year in direct infusion of cash into the plan.
Challenges
The word most often used to describe the consolidation process is "messy." Some higher-ed 403(b) plans have as many as 30 different vendors with assets in the plan. It is important to partner with a provider that has data aggregation capabilities that can provide a single dashboard for the administration to pull all of these moving parts together. As many providers rush to create their own dashboards that can sort out their menus, we are seeing a technological arms race. These developing technologies to better enable vendor consolidation are yet another proof that consolidation is the direction the entire market is heading.
Even with activity, a few vendors have refused to embrace this as a positive change and have been reluctant and sometimes even combative when faced with competitively bidding for business. When you have very large and powerful organizations facing the prospect of reducing profit margins 50% or more, you can understand why they have dedicated time, resources and political energy to block the changes. In one sample case of ours, the vendor company had nearly $5 million in annuity contracts with roughly $800,000 in flow going into the plan. Our analysis showed that the vendor alone charged nearly $75,000 annually in fees just to administer the plan before any investment or other expenses were accounted for. The on-site representative earned nearly $80,000 per year in gross compensation without even showing up to work. And this did not include ancillary sales. When a medium-sized plan such as this can generate that type of a profit margin to an organization with very little work, it's easy to understand the reluctance to accept the inevitable.
Also consider that some of these contracts could have 10-year rolling surrender charges that reset on each contribution, which effectively handcuffs the participant to these contracts. As an industry response to this problem, some providers are offering load buy-out programs to organizations and build this bucket of money into pricing for the plan. While this concept isn't new in the insurance world, this application is a way to immediately offer participants a way to get out of contracts that may otherwise take as long as a decade to unwind.
Without addressing the political implications any restructure of benefits can cause, it is helpful to consider the arguments against vendor consolidation. Most objections from the rank-and-file center on the argument that their choices are being taken away when the company consolidates to one vendor. It should be noted that once the decision is made to transition to an open architecture, the playing field is leveled. All of the vendors are working with the same options, so in essence, no choice is being taken away from participants.
Vendor A, vendor B and vendor C all have access to the same universe of investment options, so there is in fact no loss of choice on a plan level. It only changes who sends the statement. If there is anything that behavioral finance has taught us over the past decade it's that fund menu design is as important as choosing the investments themselves. In a world of multi-vendor solutions, there is no unified voice driving construction and design.
We should not ignore an important factor: the relationships that many of the members and participants have with the on-site representatives who enroll them and serve as their advisers. Because these sponsoring agencies are spread throughout large areas, onsite representation is needed to support enrollment and education initiatives. Sponsors beware; many of these representatives are highly trained commissioned salespeople who have very high revenue quotas based on ancillary products.
While many of these financial professionals are accomplished and highly qualified advisers, any appearance of a potential conflict of interest could create a fiduciary liability for trustees. As we have seen in recent years, it only takes one disgruntled participant and one ambitious attorney to expose a potential conflict. Many vendors now sign agreements that no products will be sold to participants by on-site representation and if a plan sponsor partners with the right consulting firm, these services can be provided by a third party to eliminate this potential conflict.
The change agent
While they are late to the party, government, not-for-profit, and higher education organizations are moving toward the open-architecture retirement plan model. The infrastructure is now in place to implement this on a large scale. Nobody is free from blame for this reluctance to do what is in the best interest of the plan for the benefit of the participants.
Many consultants will avoid any involvement because the move is not lucrative to them personally and complicated to execute. Sponsors have avoided the change because of the administrative complexities and the fear of being the guinea pig in the process. But transitioning to vendor consolidation is the right step for plan sponsors to make; it is prudent and morally responsible. What is needed is a change agent to make it happen.
Dopp, AIF, is a senior consultant at Cafaro Greenleaf.
