Determinants of Profitability

The retirement industry is in a state of flux. Consolidation is everywhere, from recordkeepers to advisers. A complex litigation landscape is also putting new pressure on plan advisers to show their work and provide a heavily documented process for how decisions about a plan get made. For firms tasked with plan administration, these challenges make it that much harder to stay profitable. 

Core Services Under the Microscope

Plan advisers typically offer one of two types of fee models. The first is a flat-fee fiduciary arrangement that is based on head count and the size of the plan. The second option is more bespoke and can consider head count and size of the plan, plus other services provided, including financial advice or emerging benefits such as financial wellness programs. 

Plan advisers say the core defined contribution retirement services such as 401(k) and 403(b) plans are extremely price-sensitive offerings whether an adviser requests a flat fee or a more customized fee. 

Phil Webb, vice president and senior plan adviser at RPS Retirement Plan Advisors in Austin, Texas, says much education has to go into explaining pricing, especially as retirement needs—e.g., for lifetime income—have become more complex. RPS has both flat-fee and custom-price clients. Often, the firm helps clients convert to a flat-fee arrangement from something that is more customized. Webb says there are pros and cons to both models, and choosing the right model depends on specific plan needs. That is a nuanced discussion, and price sensitivity means advisers have to be able to show their work in significant detail.

“The challenge is that even when you give a client a flat fee, the evaluation process is ongoing,” Webb explains. “If a plan has grown significantly and we don’t revisit the fee, then we could end up spending more to advise the plan than we’re making back. So you have to go back and show how the plan has changed over time.” 

That discussion can work the other way, too, he adds. If a plan shrinks significantly, fees should be reevaluated. 

The retirement industry has responded by settling on what are acceptable fee limits, but some argue this does not go far enough. Michael Kozemchak, Bloomfield Hills, Michigan-based managing director at retirement consultant Institutional Investment Consulting, says best practices require an annual review of the fee disclosures for a plan compared with plan attributes and statements of work. Full benchmarking requests for proposals should be conducted every five years—no exceptions. But those are the table stakes.

“We segregate recordkeeping from asset management, target-date funds, stable value funds and managed accounts,” he says. “Many firms won’t get that granular, but you really do need to. If we see a plan move more than 25% plus or minus, that will also trigger a discussion. If you have a major workforce reduction, for example, it’s worth starting a dialog with the vendor about fee arrangements so those are in line with the new smaller plan. If you aren’t breaking these things out and staying on top of changes, you could risk a claim.”

Firms such as RPS and Institutional Investment Consulting work to be as comprehensive as possible in terms of what their fee arrangements include. Webb says, whether it is a flat fee or a more customized pricing structure, the quotes his firm provides are essentially all-in fees based on the requirements of the plan at that time. 

Still, the combination of price sensitivity and growing complexity can make it difficult to stay competitive while still being profitable. That reality affects adviser firms of all sizes. Holly Verdeyen, partner and U.S. defined contribution leader in consulting firm Mercer in Chicago, observes that the benchmarking process will continue to require more resources, to keep up with ever-increasing offerings of new plan features. “Over just the past few years, we’ve seen new product innovations,” she says. “For example, within target-date funds, you see more customization of the glide path, so that adds a layer of complexity to a benchmarking study. Or on issues such as cybersecurity that are constantly evolving, it requires substantial engagement to stay on top of best practices and be able to evaluate a plan within a broader context.” 

Taken together, all of these factors require advisers to continually improve capabilities and have resources in place to be able to provide solid and fairly priced services. At one level, sources say, these trends are helping to drive consolidation so firms can capitalize on economies of scale. At another level, they are also leading some firms to decouple services as they look for sustainable sources of revenue.

Paying for Success

Innovation in the retirement space is not just leading to new menu offerings such as customized TDFs, as Verdeyen notes. It also shows up in add-ons such as financial wellness programs or retirement lifetime income solutions. Advisers spoken to for this story say Employee-Retirement-Income-Security-Act-approved services, including 3(21) fiduciary investment advice or 3(38) outsourced-investment-manager relationships, are also becoming more common. Firms are taking a closer look at what is included in their fees. Some are choosing to break up services into tiers, supplying a premium menu that sponsors may pick from to improve plan offerings and, in the case of financial wellness, potentially increase plan participation.

“Firms are taking a closer look at what is included in their fees and in some cases choosing to break up services into tiers …”

“When you look at the past several years, the fee compression we’ve seen on the recordkeeping side and on the advisory side is a real issue. I believe that’s ultimately what has led to this decoupling of services,” says Jeffrey Petrone, managing director at retirement consultant SageView Advisory Group LLC in West Palm Beach, Florida. “Recordkeepers and advisers have to be competitive, but they also have to find a set of services that will keep them in business. What we’ve seen is that plan sponsors, investment committees, are interested in these additional services, and they’re willing to pay for them if it will lead to a better offering for participants.”

While splitting up services might lead to profitability, it does put more pressure on advisers to be granular in their fee structures and documentation. “The retirement industry is faced with a pretty significant benchmarking challenge at present,” says Petrone. “We’re seeing costs shift from an all-inclusive retainer fee to a fee structure that might include some of these add-on services. When you look at benchmarking data right now, the questions it answers are: What is the base recordkeeping fee? And what is the base advisory fee? But the data [typically] doesn’t break down far enough to include all these other things. I think we’re going to see a process of fee optimization and enhanced disclosure evolve to account for these changes, but it will take time to fully work itself out.”

For plan sponsors then, it becomes critically important to engage with advisers, consultants and recordkeepers to get as much information as possible. Petrone notes that ERISA is a process-driven doctrine, so, to the extent that all parties involved in plan decisionmaking can show, with strong documentation, that they chose services that appeared to be competitively priced and well-managed, then the plan sponsor met its fiduciary requirements involved in adding on these services. 

Early indications are that plan sponsors see the value of engaging in additional due diligence for services such as financial wellness programs because these can improve plan participation and better position individuals to enter retirement. Jonathan Price, senior vice president and national retirement practice leader at retirement consultant Segal in New York City, says plan sponsors increasingly consider total cost over the anticipated lifetime of a plan. 

“With services such as financial wellness or retirement income solutions, you can actually bring down costs or keep them lower because you’re improving plan participation,” Price says. “If the starting point is financial wellness and you’re putting participants on a path that will help them with financial solutions over their lifetime, that ultimately improves the sustainability of a plan and also leads to better participant outcomes.”