In a recent expert column, I broke down the different components of fees for defined contribution plans. And now, I will explore the key fee drivers and strategies to help plan sponsors manage fee levels in DC plans. Managing these costs are imperative, as excessive fees may result in the significant impairment of DC member accumulations under your program.
The cost structures of record keepers are driven by the number of members in the plan. The support model is designed to support each member. The number of individual members will drive the number of accounts, the volume of transactions and the amount of member-decision support required for the capital accumulation plan.
As a result, the pricing models of most record keepers are driven by the average asset balance per member. Plans with high average asset balances per member will tend to generate higher profitability and, as a result, can be priced on a more attractive basis.
| Plan A | Plan B | |
| Plan Type | Group RRSP | Group RRSP |
| Plan assets | $1,000,000 | $1,000,000 |
| Plan Members | 100 | 10 |
| Average Assets per Member | $10,000 | $100,000 |
In the example above, you have two similar plans, group registered retirement savings accounts, with the same contribution formula and $1 million in assets. However, Plan B would be significantly more profitable for record keepers due to the significantly higher average assets per member in the plan. As a result, Plan B would likely be priced significantly more attractively than plan A.
A plan sponsor will negotiate the DC fee levels with the plan record keeper and in some cases the plan investment managers. The sponsor will use the aggregate plan assets to negotiate group fees. They may also leverage other DC plans and other corporate plans and assets (such as other defined benefit plans) to negotiate the fees under the capital accumulation plan. While the sponsor negotiates the fees, the members will normally pay the bulk of these fees in the form of asset-based fees on investment funds and spreads on guaranteed investment certificates.
As a fiduciary, a key responsibility of the sponsor is to ensure that the fees remain competitive, so that net after-fee plan investment performance is not unduly impacted by fees.
Recognizing the importance of the plan sponsors role in managing DC fees, Canadian regulators have released several guidelines over the last 15 years outlining the responsibilities of DC plan sponsor in managing and overseeing their DC plans, which would include controlling DC fee levels.
– Section 6 of the Canadian Association of Pension Supervisory Authorities Guidelines No. 3 requires CAP providers to monitor the plan investment options and record keeper using similar monitoring criteria to those used in the initial selection process. Section 2 of the Guidelines confirms that fees are a key selection criterion.
– Section 3 of CAPSA Guidelines No. 8 clarifies that the plan sponsor remains responsible for monitoring the third-party service providers utilized. Again, a key element of this monitoring would be ensuring that the fees paid by members remain competitive.
– Both CAPSA Guidelines No. 3 (Section 4.4) and No. 8 (Section 3.0) have requirements to clearly disclose all fees that are borne by members under the plan.
There has not yet been significant litigation surrounding DC plans in Canada. However, in the U.S., where 401k plans have been around longer, we have seen a significant amount of litigation around the issue of the reasonability and competitiveness of DC fees.
When a capital accumulation plan is initially introduced, the case typically is marketed broadly, ensuring that the initial fee levels are competitive. However, it is important to remember that, over time, the fees may become uncompetitive for the following reasons:
– A change in the competitive landscape: In different environments, competitive pricing levels may change. For example, there have been periods where a new DC recordkeeping competitor entered the market or and existing player looked to gain market share by reducing their pricing. In some cases, other competitors have followed suit, creating a more competitive pricing environment.
– A change in the plan financials: Over time the demographic shifts in a DC plan may make the plan more or less attractive then it was, when it was initially marketed. For a plan with a stable population, with low turnover levels, average asset balances will grow over time, making the plan more profitable for the record keeper. On the open market, this may attract a lower competitive fee quote.
For this reason, it is critical that the capital accumulation plan pricing be benchmarked periodically. The best practice is to benchmark fees, through some sort of limited marketing every two to three years, or sooner, where there is a material change to plan demographics (for example a merger or divestiture). Where the pricing is found to be uncompetitively high, it is a critical responsibility of the plan sponsor to renegotiate fees to ensure that members are not overpaying on fees.
While DC fees calculations are complex, a better understanding of fees, their drivers and the evolving competitive dynamics of plan can help plan sponsors reduce fiduciary risk and maximize the value of the program for employees.