How To Benchmarking

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1 Peer review: The case for benchmarking It s not just about measuring fees and avoiding litigation benchmarking can help plan sponsors understand the value they re receiving BY ZACHARY SHESS DCfocus Defined Contribution News and Trends from BlackRock This article was first published in the Summer 2011 issue of DCfocus

2 You probably think that the subject of 401(k) fees is something that would be of interest only to a handful of accountants. After all, how many people are interested in rooting around the small print of a typical financial table? Well, you might want to think again. Tom Kmak, CEO of Fiduciary Benchmarks Inc., a leading defined contribution benchmarking services and research firm, reports that a Google search on the phrase 401(k) fees too high received over 1.1 million hits, far more than any other related phrase. It s clear that more than a few accountants are interested in how much participants are paying for their defined contribution plan. When the market is humming along, delivering solid returns for retirement plans, participants are less inclined to dig deeply into the numbers behind their 401(k) selection. But when market performance sours and retirement savings are lost, participants take a closer look. And today, there are any number of attorneys specializing in lawsuits related to fees for 401(k) plans. Those lawsuits have proven costly. For example, in 2006, more than 30 significant lawsuits were brought forth claiming that employees and retirees were overcharged by millions of dollars in fees. Companies paid out settlements of millions of dollars and agreed to improve communication about 401(k) investment options and associated fees. Plan sponsors were also required to introduce fiduciary processes designed to ensure, among other things, that fees be reasonable. The challenge, of course, is determining what is reasonable. COMPARING APPLES-TO-APPLES Obtaining an independent benchmarking opinion that is, comparing fees and services against similar plans is an excellent, and increasingly accepted, way to make sure the fees associated with the contract for a service provider are reasonable. Kmak notes, An independent benchmarking service can help protect the plan fiduciary while at the same time helping participants by making sure the fees they pay are reasonable. Independent benchmarking can be an annual part of a sound fiduciary process that may help participants save thousands of extra dollars at retirement. Benchmarking creates a standard for plan sponsors and service providers to follow. It serves as the window into the reasonableness of a 401(k), helps gauge the plan s efficiency, determines if the fees are in line with their peer group and identifies what can be done to make any fixes, if required. But Kmak adds that it is not simply a matter of fees. There can be significant differences in the level of support, service and success achieved among providers, as well as in the benefits they ultimately deliver to participants. That s why questions of reasonableness are only properly answered by examining the value provided and should be a critical part of a benchmarking exercise. The first step is to gather information from comparable plans to obtain applesto-apples information. In fact, the term apples to apples has been used several times by the Department of Labor (DOL) emphasizing the importance of making similar comparisons. 1

3 Benchmarking creates a value standard for plan sponsors and service providers to follow. It serves as the window into the reasonableness of a 401(k). Following the establishment of a benchmarking group, Kmak says a review of fees at the plan level is a good place to start but you must understand fees at the service provider level since that is what the law requires. Looking only at total plan fees can mask that one service provider s fees may be low while another s are too high. You will need to see how much is being paid to the record keeper, consultants, investment managers and any other service provider, and measure them against the benchmarking group. Participant-paid transaction fees should also be considered. For example, participant-paid fees for loans, self-directed brokerage accounts and distributions should be considered apart from investment related fees since including these in a single bucket (which sometimes happens in the form 5500) will distort the results. BENCHMARKING CHECKLIST What information needs to be sifted through to determine if a plan is comparable? The checklist should include: Plan assets Number of participants Year the plan was bid or last reviewed Company industry Plan type Uses auto-enrollment Offers employee match Percentage of plan assets in indexed funds Percentage of plan assets in managed plans About Tom Kmak Tom Kmak is responsible for setting the vision and strategy for Fiduciary Benchmarks and allocation of the firm s resources and metrics, including financials, to achieve that vision and strategy. He is also the firm s primary contact for record keepers. He is former CEO of JPMorgan Retirement Plan Services where he started the RPS business in 1990 as a division of American Century. CURRENT POST CEO and Co-Founder, Fiduciary Benchmarks, Inc. EDUCATION Graduated Phi Beta Kappa, with a degree in Economics and Computational Mathematics from DePauw University DCfocus 2

4 How can plan sponsors determine value? Kmak suggests evaluating participant success by taking a look at how participants are planning, saving, investing and spending. VALUE IS PARAMOUNT In today s economic climate, consumers have become very value-minded. Those consumers are also plan participants and many of them are now carrying their new frugality with them to work. But even the most cynical consumer is willing to spend a little extra, if they see the value they will get in return. The same holds true for 401(k) fees. When 30% of the country doesn t participate in a defined contribution plan, how is lowering fees going to help? Kmak asks. They need to see the value of participating. Kmak points out that the DOL states that fees must be reasonable rather than low. In fact, the law emphasizes the quantity and quality of service in several places, clearly recognizing that not all service providers deliver equal value. According to Kmak, if a plan compares favorably in key participant success measures (see the sidebar Are you serving your participants? ), the plan sponsor can argue that even above average fees are justified in terms of the better retirement outcomes their participants are likely to achieve. Considering a plan s complexity is another good 401(k) benchmarking practice to further determine value. There is no right or wrong level of complexity since each plan is designed to suit the respective company s needs. But from a benchmarking perspective, learning about plan complexity can help determine if fees might be higher because of the extra time spent by service providers to help manage the plan for the plan fiduciaries. BUILDING A BENCHMARK: WHAT NOT TO DO Form 5500 filings are a ready source of plan information. But are they the right tool to use when building a plan benchmark? According to the General Accounting Office of the US Congress, Form 5500 may not be helpful. Why? They are often out of date: Form 5500 filings are due seven months and one day after the plan s fiscal year. An individual form can easily contain information a year and half out of date. They can be inaccurate: Double counting, differing transition costs, third party administration fees, and sponsor paid fees can create a substantial difference in fee reporting. Self-reporting can be inconsistent: Form 5500 includes self-assessments that may not be consistent from one provider to another, making true comparisons difficult. No value assessments: The data captured in the Form 5500 does little to help measure the value received for the services paid. 3

5 STRIKING THE BALANCE BETWEEN FEES AND VALUE Clearly, benchmarking a 401(k) plan is not an easy process; however, Kmak says plan sponsors and service providers are increasingly cognizant that the benefits extend far beyond simply avoiding litigation. The process helps plan sponsors understand what value is being delivered for the money spent. You can t set fees and not assess value, he explains. There are so many good reasons to benchmark a plan the avoidance of litigation, compliance with the law, making sure you and your participants are receiving a fair deal. That s why he recommends that plan sponsors make benchmarking an annual exercise as part of their fiduciary process to protect themselves, their participants and even their service providers. In other industries, benchmarking has led to the development of value standards that have propelled innovations and progress. In a similar way, the value standards being developed for the retirement industry as a result of benchmarking may lead to higher savings rates, better investing behavior, and more successful participant retirements. In effect, Kmak believes that plan sponsors who begin by monitoring fees in order to fulfill their fiduciary responsibilities will soon start to ask, What value am I getting in return for my fees? Such a question should help propel this important ARE YOU SERVING YOUR PARTICIPANTS? Even without comparing a plan to its benchmark group, measuring the following ten items can give you a good snapshot of how well a plan is meeting the needs of its participants. Current plan participant rate Average deferral percentage for non-highly compensated employees Average deferral percentage for highly compensated employees Percentage of employees maximizing company match Percentage of plan assets in automatically diversified options Percentage of eligible participants making catch-up contributions Percentage of participants using auto rebalance option Percentage of terminated participants not cashing out Percentage of participants with a personal retirement goal Percentage of participants on track to achieve their goal industry forward. DC DCfocus 4

6 BLACKROCK, INC. 400 Howard Street San Francisco, CA DCfocus Published by BlackRock, Inc. Please direct story ideas, comments and questions to: Tony Mastrogiorgio, Editor Telephone Facsimile CTF The information included in this material has been taken from trade and other sources considered reliable. No representation is made that this information is complete and should not be relied upon as such. Any opinions expressed in this material reflect our judgment at this date and are subject to change. This material is not intended to provide investment advice. No part of this material may be reproduced in any manner without the prior written permission of BlackRock, Inc. The strategies referred to herein are among various investment strategies that are managed by BlackRock, Inc., and its subsidiaries (together, BlackRock ) as part of its investment management and fiduciary services. Strategies may include collective investment funds maintained by BlackRock Institutional Trust Company, N.A., which are available only to certain qualified employee benefit plans and governmental plans and not offered to the general public. Accordingly, prospectuses are not required and prices are not available in local publications. To obtain pricing information, please contact a defined contribution strategist. Strategies maintained by BlackRock are not insured by the Federal Deposit Insurance Corporation and are not guaranteed by BlackRock or its affiliates. The LifePath Portfolio mutual funds are distributed by BlackRock Investments, LLC, member FINRA. BlackRock Fund Advisors (BFA) serves as investment adviser to LifePath Portfolio mutual funds, and the Master Portfolios, in which each LifePath Portfolio invests all of its assets and to the Underlying Funds in which the Master Portfolios invest. BFA is a subsidiary of BlackRock Institutional Trust Company, N.A. The LifePath products are covered by US patents 5,812,987 and 6,336,102. Investing involves risk, including possible loss of principal. Asset allocation and diversification models do not promise any level of performance or guarantee against loss of principal. An investment in the funds is not guaranteed, and an investor may experience losses, including near, at or after the target date. In Canada, this material is intended for accredited investors only. This material is provided for informational purposes only and does not constitute a solicitation or offering of shares or units of any fund or other security in any jurisdiction in which such solicitation or offering is unlawful or to any person to whom it is unlawful. Material prepared by BlackRock Institutional Trust Company, N.A., located at 400 Howard Street, San Francisco, CA BlackRock, Inc. All rights reserved. BlackRock is a registered trademark of BlackRock, Inc. DC-BENCHMARK PRD_v01MW_8/11 FOR INSTITUTIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION