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Best Practices for 401(k) Fiduciaries
Presented by:
Lisa ArkoMay 6, 2008
k:\mktg\2008\presentations\FMC_draft 3_26.ppt
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Focus is on Managing Risk
Focus is on managing and reducing risks associated with 401(k) plans– Fees– Employer stock – Litigation– Compliance requirements– Retirement adequacy
A recent survey found a significant percentage of sponsors are focusing on fiduciary issues
– 35% are likely to review their governance structure or hire a third party to review investment options
– 55% plan to review fund operations, including expenses and revenue sharing
– 29% are planning investment fund changes in an effort to reduce fees
• Hewitt survey of 2008 planned activities of 190 mid- to large-sized employers
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Framework for Managing Risk
Human Resources
Finance
FinancialManagement
AssetManagement)
PlanDesign
Administration/Communications
Compliance
Emerging best practice - strengthen/enhance governance system and use as an integrated framework to manage all risks
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Governance
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What is Governance?
“Governance is how plan fiduciaries organize themselves to manage the legal and financial risks associated with plans while providing
plan participants with promised benefits”
Governance is:
– The way in which people are organized within a company to manage their responsibilities
– Managing the legal and financial risks associated with a retirement plan
The end product is a:
– Clear mission
– Developed skill and resource
– Delegation of responsibilities
– Accountability and monitoring
Good governance is about:
– Having an appropriate structure
– Following the right processes
– Using the processes efficiently
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How Do I Get There?
Create a structure– Identify what needs to be done– Identify who should do it
Appropriate organizational level Appropriate people within each level
Make sure it is done and done right – Delegation– Policies– Oversight
Performance reviews and measures
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Create a Structure – Identify What Needs to Be Done
Focus on all plan management areas– Financial Management– Asset Management– Plan Design– Compliance– Administration– Communications
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Create a Structure – Identify Who Should Do It
Board of Directors or Board Committee
Benefit Finance Committee Employee Benefits Committee
Trustee Record Keeper Tax & Accounting Finance HR Legal
Governing
Managing
Operating
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Appropriate Organizational Level
Example: Allocations between the Board (Governing) and the Employee Benefits Committee (Managing)
Is the decision both settlor and strategic (e.g., of significant economic, cultural, or behavioral impact)?
If “yes”, allocate to the BoardIf “no”, allocate to the Employee Benefits CommitteeExamples:
Board of Directors Employee Benefits Committee
Plan design and design changes
Establish or terminate a plan with a financial impact of ___%
Larger/unusual plan mergers
Funding (above minimum, below maximum)
Plan amendments to maintain tax qualification or for administrative convenience
Small and routine plan mergers
Create a Structure – Identify Who Should Do It
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Make Sure it is Done and Done Right
Policies– Provide the decision framework
Set objectives Provide constraints
– Require periodic reporting by delegates Performance measurement
– Often overlooked aspect of governance– Separates supervision from execution – Forces establishment of objectives and measurable results
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Make Sure it is Done and Done Right –Policies to Support Governance Structure
Sample policies– Selection policy for appointees to committees– Orientation and ongoing fiduciary education policies – Investment policy– Plan expense policy (guidelines for paying fees from plan
assets) – Compliance policy
Establish at organizational level with ultimate responsibility (governing or managing) and enter into appropriate committee’s minutes
Committee members should fully understand policy rules and follow them
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Make Sure it is Done and Done Right –Performance Management
Areas for performance measurement– Financial Management– Asset Management– Plan Design– Compliance– Administration– Communications
Tailor performance objectives and measures to plan’s specific requirements
Report results to appropriate stakeholders to facilitate monitoring responsibilities
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Sample Governance Framework
Board Committee - Governing
Tasks Appoints Committee Members Approves strategic plan amendments May appoint and remove trustee May approve investment and funding policies Monitors Committees
Policies Plan mission statement Code of conduct Independence policy Selection/education policy
Employee Benefits Committee - Managing Benefit Finance Committee - Managing
Tasks Plan design Compliance Administration CommunicationPolicies Mission statement Human capital strategy Compliance Policies Benefits Administration Policy Communications Policy
Performance Measures Benefit adequacy Impact on human capital Operational review Participant investments
Tasks Financial Management Asset Management
Policies Plan expense policy Investment policy
Performance Measures Administrative and investment fees Absolute and relative investment performance Actual risk experienced Periodic review of expenses paid by plan
Human Resources - Operating Legal - Operating Finance - Operating Tax - Operating
Tasks Day-to-day administration Communications Supervises delegates
Tasks ERISA & Code compliance Approves QDROs Advises on claims appeals Committee secretary
Tasks Implements investment policy Monitors investments and managers Risk management Directs payment plan expenses
Tasks 5500s Tax withholding Corporate deductions
Agents & Advisors
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Understanding of fiduciary responsibilities Clear mission in all plan management areas Appropriate and clear delegation of responsibilities Accountability Performance management through ongoing monitoring using
appropriate measures
Agility to quickly identify concerns and modify accordingly
A Strong Framework Leads to Risk Reduction
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Governance Best Practices
Written policy framework Detailed committee charters Documentation of all decisions and oversight activities Ongoing fiduciary education and training Periodic comparison with best practices Performance measured in all plan management areas
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Vendor Management
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Vendor Management
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Service Contract
Ensure you have a copy of most recent service agreement or statement of work
– How is responsibility delegated?– Revise, update if necessary
Fees and services should be fully articulated Understand service model and administration team structure
– Where are hand-offs? Proactively address renewals a year in advance of expiration or
as plan make-up changes substantially– Monitor total asset growth– Assess changes in participant counts
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Compliance
Trust, don’t entrust Thorough administration manuals and processing calendars
should be part of standard agreement Never assume that everything is being done in full compliance
– Ask the question, have it be proven Random vendor-initiated reviews should be expected and
included in the contract Operational reviews should be undertaken periodically to
ensure overall compliance
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Service Level Agreements
Ensure that promised service levels are relevant and meaningful to your objectives
Expect granular data in addition to summaries– There should be standard reporting
Treat service level goals as incentives, not penalties– Both parties should have vested interest in meeting service levels
– Incentives for goals exceeded? Gain understanding of circumstances that create missed levels
– What is the root cause of service issue?
– Ultimate goal is to avoid service issues going forward, not to continue to collect penalties
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Ongoing Vendor Communication
Develop a regular meeting schedule to stay current
Weekly/monthly– Standing check-in with project team– Updated issues list/project plan
Quarterly– Face-to-face meeting– Review of Service Level Agreements – Work plan for upcoming quarter
Annually– Review business plan against performance – Develop business plan for upcoming year– Identify opportunities for improvement– Adjust Service Level Agreements, if appropriate– Staffing review and feedback
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Vendor Fees
2008 401(k) fee survey of plan sponsors performed by Chatham Partners reports
– 79% of plan sponsors participating in survey report that understanding their plan costs is important
– 77% of sponsors say that current disclosure levels are sufficient BUT
58% feel confident they understand their plan costs 34% say their plan fees are easy to compare to those other
providers would charge 38% of respondent’s vendors disclose revenue sharing to
them 42% report that their plan fees are transparent
Under Diversified Investment Advisors’ “Report on Retirement Plans - 2007, ” 42% of sponsors report they are unaware of their plan fees
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Vendor Fees - Mutual Fund Expenses and Revenue Sharing
Sample Equity Fund:
Management Fee: 0.70%
+ 12b(1) Fee 0.30%
+ Other Expenses 0.20%
= Total Expense Ratio 1.20%
Investment decisions
SUBADVISORS
Flow of fees from participant accounts to retirement plan service providers
Plan services, recordkeeping,
proprietary revenue, commissions, etc.
PLAN RECORDKEEPERS
Management Fee
12b(1) Fee
Other Fund Fees
EXPENSE RATIO
Sub-Advisory Fee
12b(1) Fees
Other Revenue Sharing
FUND COMPANY
Administrative: trading, accounting, fund
board expenses, etc.
Investment management
Marketing: 12b(1) fees - advertising,
shareholder services, etc., which are rebated back to recordkeepers because no
broker is involved
Additional revenue sharing: Negotiated fee which can vary
among plan recordkeepers based on contract with fund
management company
Investment Admin Fee
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Vendor Fees – Revenue Sharing Considerations
The absence of explicit fees has allowed many to view administrative services as “free”
“Proprietary” options typically pay more revenue sharing Revenue sharing may create a windfall for vendors when
assets rise absent renegotiation of services and/or changes in investments
Can create inherent potential for inequitable allocation of fees
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Vendor Fees – Revenue Sharing Considerations
An example of the potential impact of revenue sharing on administrative service fees
Plan assets Year 1 with Vendor: $120 million Plan assets Year 8 with Vendor: $175 million Participants – 2,000
YEAR 1YEAR 8
Explicit administration fee ($0/ppt) -- $ 0 $ 0
Revenue sharing (average .20%) -- 240,000 350,000
Transaction-based fees -- 2,000 2,000
Administrative service fees $242,000 $352,000
Adm. service fees per participant $121 $176
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Vendor Fees –Fee Categories
Service fees– Fees received by the record-keeper for ongoing
administration and employee education/communication services
Investment management fees Transaction-based fees
– Fees associated with a specific type of activity (e.g., loans, withdrawals, distributions)
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Vendor Fees – Sample Benchmarking of Administrative Service Fees
Administration, employee education and communication costs plus transaction-based fees
Costs generally paid via
– Hard dollar fees
– Revenue sharing
Service fees benchmarked with plans that have similar
– Number of participants
– Average account balances
– Complexity
– Employee education and communications
Example of Plan Cost Ranges - Per Participant
$120
$36
$75
$117
$0 $100 $200
Services
High $117
Median $75
Low $36
Company $120
Services
Representative sample from WW benchmarking study
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Vendor Fees – What should you do?
Understand– What you are currently paying– How your fees compare to current market practices for
similarly situated plans Service fees Transaction-based fees Total plan fees
Consider – Benchmarking plan fees every 3 years– Going through RFP or RFI process every 5 – 6 years
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