Study Shocker: 9 of 10 401k Plans Exposed to Increased Conflict-of-Interest Risk
Just in time for the DOL’s new Fee Disclosure Rule, Deloitte Consulting LLP has completed a report for the Investment Company Institute (ICI). Issued in November 2011, Inside the Structure of Defined Contribution/401(k) Plan Fees: A Study Assessing the Mechanics of the ‘All-In’ Fee, offers some expected results, at least one shocking revelation not reported elsewhere in the media and, unfortunately, a typical misrepresentation that might just invalidate some of the most publicized conclusions.
One must keep in mind the relevant disclosures when reading the results of this survey. First, the results don’t reflect the actual data, but a weighting of the actual data. Also, since some plan sponsors did not answer all questions, cross-tabulation between questions does become problematic, but that should be reflected in the associated statistics. Finally, while the survey collects quantitative fee data, it acknowledges it does not attempt to evaluate either the quality or value of the services associated with those fees. While measuring qualitative information is difficult, the DOL allows significant leeway with regard to paying higher fees for additional value.
Here are a few interesting tidbits about the survey sample. The fast bulk (i.e. 56%) of the respondents had less than $1 million in assets while only 7% of the respondents had greater than $1 billion in assets. As odd as that sounds, the actual DOL 401k plan universe exhibits even greater skewness. According to the DOL, 71% of the plan universe has assets of less than $1 million and a mere 0.1% has assets in excess of $1 billion. The survey sample is also skewed more to the midwest and less to the south.
This new survey confirmed three key findings from the ICI’s 2009 Fee Study, all of which would have been expected from anyone the least bit familiar with the 401k industry. First, there are many different types of fee structures and arrangements for the many different 401k plans. Second, the number of plan participants is inversely related to plan costs (i.e., the more participants, the lower the costs as a percentage of plan assets). Third, plans with bigger account balances also tend to have lower fees (again, based on a percentage of plan assets).
More interesting, however, are the results many would not have expected. The first is, two-thirds (67%) of the plans have not had a competitive review within the last three years. Roughly one in five plans between $10 million and $500 million have had a review within the last year. The most frequently shopped plans, however, were those with more than $1 billion, of which 30% have had a competitive review within the last twelve months. Strangely, plans between $500 million and $1 billion are the worst in terms of reviews, with the fewest number having reviews within the past year (6%) and the largest number of plans having had no reviews within the last five years (59%).
The survey surprisingly reports 91% of the respondents say they use the recordkeeper’s proprietary investment options. We’ll quote directly from the report. This means “ABC mutual fund company is the recordkeeper and the plan offers ABC mutual funds, ABC commingled trusts, or ABC separate accounts; DEF bank is the recordkeeper and the plan offers DEF mutual funds or DEF commingled trusts or DEF separate accounts; XYZ insurance company is the recordkeeper and the plan offers XYZ mutual funds or XYZ separate accounts or XYZ commingled trusts.” Proprietary bundling like this would seem to offer the classic recipe for a conflict-of-interest problem, which would further seem to indicate there exists a greater potential for conflicts-of-interest in nine out of ten plans. Other reporters appear to have overlooked this particular fact, but it stands out as the most shocking aspect of this survey. It might also explain both the need for and the opposition to the DOL’s new Fiduciary Rule.
Many plan sponsors would be interesting to know the typical employee contributes 6% of their salary. The illustrative plan offers 14 investment options, with 96% of plans using mutual funds, of which 93% use equity investment options. In addition, only 23% of the respondents offer auto-enrollment, down from 45% in the 2009 Study. Deloitte says this reflects the greater portion of smaller plans responding to the latest survey, but it also calls into question weighting techniques used in either this survey or the 2009 Study.
Finally, here’s the biggest problem with this survey: the “all-in” fee. The study’s fee analysis is predicated on an aggregation of all fees. It does not break out its analysis by service provider category (unlike the 401k Averages Book), which might have been more helpful to plan sponsors. By using the “all-in” fee, the survey inadvertently encourages a “bundled” service provider approach which other commentators have suggested might lead to higher fees. Worse, the methodology includes mutual fund expense ratios as part of the plan fees when these “expenses” are already (and more accurately) reflected in a fund’s performance reporting. The DOL recently amended its Individual Participant Advice Rule to avoid emphasizing fund expense ratios without incorporating fund performance. Unfortunately, by including mutual fund expense ratios, the survey enables misrepresentations far too prevalent and may invalidate – or at least make meaningless – most of the results revolving around its “all-in” fee analysis.
Using the “all-in” methodology can lead one to conclude plans where assets are invested mostly in stable value options are “less expensive” compared to plans invested mostly in equity options. For a long time, policy-makers, plan sponsors and service providers felt plan investors were too conservative and needed to invest more in equities and less in stable income options. The 2006 Pension Protection Act addressed this concern specifically. By including expense ratios in “all-in” fees, analysts only encourage the continuation of this type of behavior. The study does provide average expense ratio data by asset class. In doing so, it indirectly admits the problem of including expense ratios in its analysis when it says a plan’s asset allocation can impact its “all-in” fees.
The report, however, does not bring up the same point with regard to index funds. Plans using raw index funds appear “less expensive” than those offering actively managed or lifestyle funds. Despite periods of poorer performance, index funds may be fine for employees brave enough (and with the time to) determine their own asset allocation. Many employees, on the other hand, don’t want to worry about making asset allocation decisions and would prefer the peace of mind of having professional management make these decisions. This, of course, brings us back to the question of the value one gets for the fees paid. In the case of investment products, that value – which can be different for everyone – cannot be measured with certainty, but its relevance sometimes trumps fees.
Readers interested in this article might also want to read “Great Info for Every 401k Plan Sponsor: Review of 401k Averages Book.”