Revenue sharing gets closer look by DC plan execs

David Toerge

Equalizing: Joe Masterson described revenue sharing as an issue of fairness.

Defined contribution plan executives are becoming more interested in trying to equalize the costs of revenue sharing among their participants, and the new fee-disclosure rules could make the practice more prevalent.

Under revenue sharing, all or most of a record keeper's fees are offset by investment management fees. Because fees for active management generally are higher than those for passive management, participants choosing actively managed investment options pay significantly more of the record-keeping tab.

Some service providers have been on the equalization bandwagon for a while. The inequality “has bothered me for years,” said Joe Masterson, senior vice president and chief sales and marketing officer for Diversified, Harrison, N.Y. “We explain to clients that they ought to apply fairness.”

Kent Peterson, director of investment services, Securian Financial Group Inc., St. Paul, Minn., said: “We always thought it was the right thing to do.”

Providers use terms like revenue leveling, equitable allocation, levelized pricing and fund revenue equalization to describe their strategies.

Muriel Knapp, a Mercer consultant in Washington, said one reason plan executives are more interested in equalization is the Labor Department's fee disclosure regulations. The regs “certainly have created more discussion,” she said. “We're getting a dramatic increase in clients seeking either actual equalization or something (close).”

The DOL rules could prompt greater efforts of “allocating revenue sharing back to the accounts of the participants who paid it,” added ERISA attorney C. Frederick Reish, a Los Angeles based partner at Drinker Biddle & Reath LLP.

“As more providers develop the technology to facilitate equitable, or even precise, allocation to participants, the cost will come down and the reasons for not allocating revenue sharing more equitably will be weakened,” he said.

DC plan executives resist because they “often hesitate to add to the complexity of already complex communications and decisions,” said Alison Borland, vice president for retirement product strategy at Aon Hewitt, Lincolnshire, Ill. Record keepers resist because “some systems are not sophisticated enough to do the calculations to rebate the revenue sharing and calculate the appropriate fees.”

The equalization strategies are most often found among providers servicing smaller 401(k) plans, such as Securian and Milliman Inc., Seattle. The typical Securian client has DC plan assets of $2 million to $10 million, although clients have plans as large as $500 million. The average Milliman client has just less than $50 million, although the firm provides services for sponsors with DC assets ranging from $20 million to $750 million.

Diversified's DC clients using its fund revenue equalization approach range from $20 million to $1.2 billion.

Avoiding complexities

Big DC plans can avoid the complexities of revenue equalization because their asset size helps them to avoid many complexities of revenue sharing. Larger plans “often use collective trusts, separate accounts and/or institutional shares with no revenue sharing to achieve the most value for cost,” said Ms. Borland. They pay record-keeping costs by charging participants a flat per-capita or administration fee based on a percentage of assets, enabling them to create a system “that is both simple and equitable,” she said.

To illustrate how Diversified tries to equalize fees, Mr. Masterson offered a hypothetical example in which Diversified charges a plan 30 basis points (based on the plan's asset size) for record keeping and the investment option revenue ranges from zero to 45 basis points. In order for all investors to pay the same 30-basis-point fee, Diversified gives participants paying the high fees a plan service credit. Those paying fees below 30 basis points are assessed plan service fees.

Diversified has offered this approach for about 18 months, originally on a client-by-client basis. Improvements in technology have allowed Diversified to offer a fully automated service since January, Mr. Masterson said. The fee credits and fee expenses are accrued daily and credited and assessed monthly.

Milliman's 16-year-old asset-based strategy is similar to Diversified's. “It's an idea that makes sense,” said Douglas Conkel, a Dallas-based principal and senior benefits consultant. “It's our most prevalent way of billing clients. It's a best practice from a fiduciary standpoint.”

For clients who want an asset-based fee, Milliman negotiates a fixed-rate record-keeping fee applied equally to all plan options. Participants in an option for which the revenue sharing exceeds the negotiated amount receive a credit for the excess; those in an option where revenue sharing falls below the negotiated amount are assessed a fee to make up the difference. Most of the credits and assessments are made on a monthly or quarterly basis, Mr. Conkel said.

Securian Financial began practicing what it calls its actual allocation methodology in 1993, when it decided to offer clients outside mutual funds as well as Securian's proprietary products, said Mr. Peterson. Securian returns all revenue sharing to the plans and participants in what officials call a daily passback.

This article originally appeared in the July 9, 2012 print issue as, "Revenue sharing gets closer look by execs".