Regulatory issues not foremost on the minds of executives

Defined contribution plan executives have plenty to do in 2017 without contemplating the impact of the next president, the next Congress or the next set of regulatory agency chiefs.

From fee negotiations to plan design changes, sponsors — as well as service providers and asset managers — will work on practices and confront challenges independent of Washington's influence or interference, consultants said.

“Fees can't be ignored,” said Ross Bremen, a partner at NEPC LLC, Boston, whose firm's annual surveys have shown a steady overall decline in plan investment fees in recent years. The latest survey, published in September, found that average fees dropped to 42 basis points in 2015 — down 8.7% from 2014.

“When we have conducted our surveys, plan fees are at the top of everyone's agenda list, and 2017 will be no different,” Mr. Bremen said.

Look for plan executives to conduct more fee benchmarking studies, focus more on per-head fee contracts rather than asset-based fee contracts with record keepers and, in some cases, move away from revenue sharing, he added. “Sponsors want more transparency and fairness.”

Mr. Bremen and other consultants said plan executives should beware of emphasizing fees in a vacuum. “The focus on fees may have gone a bit too far,” said Liana Magner, a Boston-based partner for Mercer. “This is not a race to the bottom. Sponsors should consider fees in the overall context of what they are trying to accomplish.” DC plans might lose out on certain services if they simply choose the lowest-fee provider, Ms. Magner said.

Fees affect not only plan costs but also investment options. For example, Mr. Bremen said the push for lower fees — and fears of litigation — will push some plans to emphasize passive investments over actively managed ones. The executives might believe passive investments are “safer” from a litigation perspective and “more appropriate” from a management perspective, he said.

Among NEPC clients and in NEPC surveys, Mr. Bremen has detected “an uptick — not a tidal wave” — for managers using more passive strategies, adding the practice will continue in 2017.

Asset managers must make adjustments because “we will continue to see fee compression,” said Joel Lieb, director of advice for defined contribution at SEI Inc. Oaks, Pa. “The biggest impact will be on active money managers. The challenge to them will be how to highlight value.”

Active managers of large-cap domestic equity will be particularly vulnerable to the push for lower fees, Mr. Lieb said, adding that some international equity strategies will be under pressure, too.

A desire to cut costs also will play a role in how sponsors deal with record keepers. Christopher Lyon, a partner at investment management consultant Rocaton Investment Advisors LLC, Norwalk, Conn., predicts sponsors will continue to seek contracts in which record-keeping fees are based on a fixed amount per participant rather than on the size of participants' retirement accounts.

The sponsors' efforts are a combination of seeking greater transparency and greater fairness to participants, as well as moving away from revenue sharing in some cases, Mr. Lyon said.

He predicted more sponsors will issue RFPs for record keepers in 2017. “Sponsors should focus on value,” Mr. Lyon said, echoing comments from other consultants that the cheapest record keeper isn't necessarily the best. “You get what you pay for. There comes a point where the economics don't work.”

Mr. Lyon expects continued consolidation among record keepers, noting that as profit margins are squeezed, scale becomes more important. “Sponsors want to know if there's a long-term commitment by their record keepers,” he said.

Consultant David O'Meara also predicted more mergers and/or acquisitions among record keepers, prompted by fee pressure and the need for greater scale. As record keepers try to retain and gain clients, they must become more flexible and creative, said Mr. O'Meara, a New York-based senior investment consultant for Willis Towers Watson PLC. For example, more record keepers will allow more than one managed account provider on their platforms now. Previously, the usual practice was allowing only one managed account provider for a specific record-keeper platform.

Managed accounts could play a bigger role in the DC arena as sponsors consider creating hybrid qualified default investment alternatives that combine target-date funds and managed accounts, said Robyn Credico, the Arlington, Va.-based defined contribution practice leader for Willis Towers Watson. Target-date funds are by far the most popular QDIA; managed accounts trail far behind.

Although more sponsors are offering managed accounts, participant acceptance has been modest due to costs and complexity.

Ms. Credico and other consultants believe the hybrid approach could appeal to sponsors looking for a QDIA that takes into account the changing demographics of plans' respective workforces. Young participants could start investing in a target-date fund QDIA, then shift to a managed account as their age and account balances increase.

“It's a cool idea,” Ms. Credico said, adding the managed account industry could help itself by reducing costs to participants. Some surveys have found that cost is the biggest hurdle to participant acceptance.

One DC plan using a hybrid approach is Bertelsmann Inc., which offers a target-date fund series from Fidelity Investments and a managed account from Financial Engines. In Bertelsmann's plan, participants who had been defaulted into the target-date fund now are defaulted into the managed account QDIA when they reach age 45. Participants can opt out. Erika Kirchner, vice president of human resources, recently won an Excellence & Innovation Award, sponsored by Pensions & Investments and the Defined Contribution Institutional Investment Association, for the company's hybrid QDIA.

No discussion of defined contribution these days would be complete without mentioning litigation. Concern over lawsuits will prompt more DC plan executives to become more vigilant in managing risk, said Alison Borland, senior vice president and head of defined contribution at Aon Hewitt, Lincolnshire, Ill.

“Sponsors will be responding to both litigation and the fiduciary rule,” which is scheduled to take effect in April, Ms. Borland said. “The fiduciary rule creates a new level of visibility and focus.”

Although the 401(k) industry has become accustomed to fiduciary lawsuits, the 403(b) industry got a rude awakening earlier this year when the St. Louis law firm of Schlichter, Bogard & Denton filed a series of lawsuits against large private universities criticizing fees, plan management and/or investment option selection.

Plan executives must work harder to “protect themselves from fiduciary errors and lawsuits,” said Jeffrey Levy, a New York-based partner of the Cammack Retirement Group Inc. consulting firm.

Even though 403(b) plan executives have been aware of greater responsibilities since the 2009 issuance of IRS regulations, “it didn't come home to roost until they saw the (Schlichter firm) lawsuits.”

Mr. Levy said 403(b) plan defenses against litigation include extensive documentation, benchmarking fees, reducing the number of funds and offering lower-price funds when possible.

He added many 403(b) plans have been building fiduciary protections over the years. For those that haven't done so, “you can't wait any more,” he said. n