FEE LEVELIZATION A FIDUCIARY PERSPECTIVE

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1 FEE LEVELIZATION A FIDUCIARY PERSPECTIVE Marie Swartzwelder VP, Intellectual Capital 2013 Prudential Financial, Inc. and its related entities. Prudential, the Prudential logo, the Rock symbol and Bring Your Challenges are service marks of Prudential Financial, Inc., and its related entities, registered in many jurisdictions worldwide For Institutional Plan Sponsor or Financial Professional Use Only. Not to be distributed to plan participants or the general public 1

2 Only when the tide goes out do you discover who s been swimming naked. ~ Warren Buffett 2

3 The National Retirement Risk Index Source: The National Retirement Risk Index (based on the Federal Reserve s 2010 Survey of Consumer Finances) 3

4 Retirement Confidence and Preparedness of Participants Source: Prudential Retirement Plan Participant Survey,

5 Fees under scrutiny 401k Plan Fees and expenses generally fall into three categories Plan administrative fees Investment fees Individual service fees 5

6 Plan Administrative Fees Revenue Required for Recordkeeping: Amount of revenue required to cover costs for recordkeeping services in a fully bundled environment How is it derived? 6

7 Recordkeeping Revenue Revenue can be derived from: Underlying investment options Per participant fee Basis point ( bp ) Flat dollar 7

8 Underlying Investment Options Current State Example Assumptions 2 Person Plan 3 Investment Options to Choose from Required Revenue Towards Recordkeeping = $240 Investment #1 Investment #2 Investment #3 Investment Management Fee 0.70% 0.60% 0.10% Revenue Share (towards recordkeeping) 0.40% 0.20% 0.00% Total Expense 1.10% 0.80% 0.10% Account Value Participant A $ 80,000 $ 40,000 $ 40,000 Participant B $ 160,000 $ 160,000 Expenses/Participant Total $ Total % Total $ Total % Investment Management Fee $ % $ % Revenue Share (towards recordkeeping) $ % $ % Total Expenses $ % $ % 8

9 Per Participant Fee Flat Dollar Fee Example ($120) Assumptions 2 Person Plan 3 Investment Options to Choose from Required Revenue Towards Recordkeeping = $240 Investment #1 Investment #2 Investment #3 Investment Management Fee 0.70% 0.60% 0.10% Revenue Share (towards recordkeeping) 0.00% 0.00% 0.00% Total Expense 0.70% 0.60% 0.10% Account Value Participant A $ 80,000 $ 40,000 $ 40,000 Participant B $ 160,000 $ 160,000 Expenses/Participant Total $ Total % Total $ Total % Investment Management Fee $ % $ % Revenue Share (towards recordkeeping) $ % $ % Total Expenses $ % $ % 9

10 Per Participant Fee Flat Basis Point Fee Credit/Debit Example (0.10%) Assumptions 2 Person Plan 3 Investment Options to Choose from Required Revenue Towards Recordkeeping = $240 Investment #1 Investment #2 Investment #3 Investment Management Fee 0.70% 0.60% 0.10% Revenue Share (towards recordkeeping) 0.40% 0.20% 0.00% Total Expense 1.10% 0.80% 0.10% Participant A $ 80,000 $ 40,000 $ 40,000 Participant B $ 160,000 $ 160,000 Expenses/Participant Participant A Total $ Total % Investment Management Fee $ % Revenue Share (towards recordkeeping) $ % Gross Expenses $ % 0.10% Rebate $ (160) -0.20% Total Expenses $ % Participant B Total $ Total % Investment Management Fee $ % Revenue Share (towards recordkeeping) $ % Gross Expenses $ % 0.10% Debit $ % Total Expenses $ % 10

11 Per Participant Fee Flat Basis Point Fee Example (0.10%) Assumptions 2 Person Plan 3 Investment Options to Choose from Required Revenue Towards Recordkeeping = $240 Investment #1 Investment #2 Investment #3 Investment Management Fee 0.70% 0.60% 0.10% Revenue Share (towards recordkeeping) 0.00% 0.00% 0.00% Total Expense 0.70% 0.60% 0.10% Account Value Participant A $ 80,000 $ 40,000 $ 40,000 Participant B $ 160,000 $ 160,000 Expenses/Participant Total $ Total % Total $ Total % Investment Management Fee $ % $ % Revenue Share (towards recordkeeping) $ % $ % Total Expenses $ % $ % 11

12 Is Your Current Structure in line with Best Practices? Do I understand how my DC recordkeeper is paid? Are my participants paying their equitable share? Does my program structure help get my employees to the goal line for retirement? 12

13 Guiding Principle In Field Assistance Bulletin , the DOL indicated that allocating plan expenses is a fiduciary decision that requires fiduciaries to act prudently. Whatever allocation method is used, the failure by fiduciaries to engage in a prudent process to consider an equitable method of allocation of plan costs and revenue sharing would be imprudent and a breach of fiduciary duty. Participant A contribution towards recordkeeping fee Required recordkeeping fee Participant B contribution towards recordkeeping fee 13

14 Trend or Transformation? Underlying Investment Options Bps or Flat Dollar 14

15 Increased Use of Cost-Effective Investments While the use of retail mutual funds in DC plans has dropped in recent years, more cost-effective investment vehicle usage has increased substantially. * * As presented in Victory Capital Management s Collective Trust Funds Resource Guide 2 nd Edition 15

16 Tibble v. Edison International, 2010 U.S. District Judge Stephen V. Wilson of the U.S. District Court for the Central District of California declared that Southern California Edison (SCE) and its plan fiduciaries violated the duty of prudence imposed by the Employee Retirement Income Security Act (ERISA) by not properly investigating the differences between selecting retail shares instead of institutional shares. Wilson s 82-page ruling in Tibble v. Edison International was significant because the court accepted an often-advanced claim in 401(k) excessive fee suits that fiduciaries violate their ERISA-imposed duties by not adding less-costly institutional shares to their plans. Sources: 1.Tussey v. ABB, Inc., et al, No. 2:06-CV NKL, 2012 WL (W.D. Mo. 2012), 2. Vanic, Mike, and Joe Faucher. "Tibble vs. Edision International: Excessive Fees Finally Go to Trial." Pension & Benefits Reporter. (2010): 9. Print. 16

17 Tussey v. ABB The court in Tussey v. ABB, Inc. noted that the participant s choice might change if he or she knew that the additional expense was going to the Plan s fiduciary in exchange for choosing that investment company to become one of the limited companies permitted to sell their products to Plan participants, or as an undisclosed way to subsidize the administrative costs of the Plan. Tussey v. ABB, Inc., Case No CV-NKL (W.D. Mo. 2008) 17

18 Tussey v. ABB, Inc. if a plan sponsor opts for revenue sharing as its method of paying for recordkeeping services, it must not only comply with its governing plan documents, it must also have gone through a deliberative process for determining why such a choice is in the Plan s and participants best interest. The court reasoned that the IPS required ABB to use its substantial purchasing power to negotiate rebates, either in the form of basis points or hard-dollar amounts, if the amount of revenue sharing generated exceeded the market value for services. ABB was unaware of the amount of income generated by revenue sharing or of the market value of it s recordkeeping services. Taibleson, Michael, and Arthur Phillips. "Tussey vs. ABB, Inc. - A Case Study in Breach of ERISA Fiduciary Duty." Fiduciary Counsel. 1.1 (2012): 3. Print. 18

19 What a Fiduciary Should Do Now? Understand the revenue sharing and fees paid by the plan and what services are received in return. Fee reporting as a result of 408(b)(2) can provide more transparency going forward. Weigh the pros/cons of a more equitable revenue approach Consider revising the plan Investment Policy Statement (IPS) to remove any detailed procedures that require specific actions based on certain events/triggers. ERISA does not require an IPS to administer a DC plan, so keep the language directional and generic. Contemplate hiring an independent financial intermediary that can provide expertise around the evolving retirement market. Periodically benchmark fees associated with retirement plan. Fiduciaries should understand how their particular plan compares to the marketplace. 19