Evaluating Plan Service Providers

Nicholas Zaiko, CIMA®

Investment Consultant

Bridgebay Financial, Inc.

www.bridgebay.com

Selecting a service provider for a 401(k), 403(b), or 457 retirement plan is one of the most crucial decisions that an employer and plan fiduciary can make in determining the retirement outcomes for its employees.  

The Department of Labor (DOL) has indicated that a plan sponsor has a fiduciary duty to establish and follow a formal review process at reasonable intervals, generally 3-5 years, to ensure the caliber of the selected provider. A client service focused organization will tailor its services to the plan sponsor's needs and have an understanding of the key requirements of the plan sponsor.

The process starts with the Request For Proposal (RFP) which should address the provider’s services, expertise, client commitment and compliance experience at a reasonable cost.  The RFP provides a strong foundation for selection but is not the only factor.  The in-person finalist presentations should highlight the relationship services.

Provider Selection Sub-Committee

It is good practice, in order to facilitate the service provider search, for the plan sponsor to establish a Selection Committee with a range of members with different areas of expertise such as payroll, employee benefits, legal, compliance, investments/finance and technology/systems.  Each member should be responsible for evaluating the provider’s abilities in their respective key areas. 

Use of an Outside Retirement Plan Expert

Many plan sponsors engage an outside consultant to guide and advise them through a methodical process that is well-documented and clearly illustrates the reasons for the decisions made.  The consultant's role is to guide the plan sponsor in establishing goals and objectives, success metrics, and targeting performance standards. The plan consultant can screen candidates, customize the RFP to the plan sponsors needs, conduct the provider search, analyze or score the results and lead the finalists’ presentations.

The RFP consultant will pre-screen candidates based on specific plan sponsor requirements or a set of minimal capabilities.  A retirement plan consultant may expedite the selection process by searching its database of service providers to identify those candidates that offer services that best fit the particular plan's needs.  

The consultant can guide plan sponsors through a large universe of competent service providers and qualify a few candidates that are a strong match for the plan sponsor and the participants.  Service providers have different target markets, service levels and areas of expertise.  The RFP consultant can differentiate among providers and permit the plan sponsor to select the service provider that best meets their specific requirements.

Preparation of the RFP questions is critical for efficiency and thoroughness to prevent receiving vague responses.  Certain questions may serve as differentiators.  The consultant's expertise in understanding the nuances of different levels of service, identifying potential conflicts of interest and understanding the benefits or limitations of certain providers can be extremely valuable to a plan sponsor.  A key benefit in using an expert is that the consultant can provide invaluable insights from having worked directly with the numerous providers under consideration.

One of the best ways for a consultant to present the results of their evaluations is to provide side-by-side analysis and a scoring system to enable the plan sponsor to identify and understand the finalists they would want to interview.  

Service Provider Due Diligence

Nicholas Zaiko, CIMA®

Investment Consultant

Bridgebay Financial, Inc.

www.bridgebay.com

Selecting and effectively monitoring defined contribution plan service providers is an essential fiduciary duty of the plan sponsor which influences retirement outcomes for its employees.  The plan sponsor or Committee overseeing the defined contribution plan shares this responsibility for the prudent management of the plan for the benefit of the participants.

Fiduciary Reasons for Conducting a Provider RFP

In the ERISA Section 408(b)(2) fee disclosure rules, the Department of Labor (DOL) assumes that a prudent plan sponsor has a fiduciary duty to establish and follow a formal review process at reasonable intervals, generally three to five years, to ensure the caliber of the selected DC provider and that the services are being delivered at a "reasonable" cost.  Typically, a plan sponsor can conduct this due diligence review by issuing a service provider RFP.

Types of Service Providers

There are a full range of DC plan service providers that are either independent or affiliated with different types of institutions that include:  TPAs (third party administrators) or independent recordkeepers, mutual fund companies, insurance companies, banks, and brokerage firms.

Bundled or Open Architecture 

In order to properly operate a qualified DC plan, an array of services are necessary.  Those services include recordkeeping administration, trustee/custodian services, compliance testing, investments, legal update of plan documents, government reporting and participant education.  Bundled service providers offer the full spectrum of services necessary to operate a qualified plan under one contractual arrangement.  A bundled provider includes plan administration, recordkeeping, trustee, legal, investments, participant communication and education. Defined contribution plans, such as 401(k), 403(b) and 457, that are open architecture may use multiple service providers that perform each role.  In such a situation, the plan sponsor would issue RFPs for each of the various services.

Multi-Purpose RFP

A well-documented due diligence review enables plan sponsors to fulfill their fiduciary duty to prudently monitor their service plan providers.  A multi-purpose RFP covers the services of key providers necessary to operate a 401(k) or 403(b) retirement plan.  The design of the questionnaire is the first step in the evaluation process when benchmarking providers.

The process starts with the Request For Proposal (RFP) and should elicit information about the provider’s services, expertise, client commitment and compliance experience with clearly detailed costs.

Independent Benchmarking

The RFP process can be a benchmarking tool to assess the quality of the plan’s services, potential upgrades to the plan and serve as a resource to evaluate the reasonableness of plan fees.  Periodic, unbiased benchmarking documents the plan sponsor's fiduciary process to monitor the quality of plan services and fees.

Economic Review 1Q 2015

Nicholas Zaiko, CIMA®

Senior Consultant

Bridgebay Financial, Inc.

www.bridgebay.com

Global Central Banks

There are now 25 central banks that have eased, added substantial stimulus to their economies and lowered their target interest rates comparable to the Fed Funds rates.  Central bank support means international bond yields are likely to remain low, while they appear poised to rise in the U.S.  All of these accommodative efforts are designed to combat deflation but have also driven up the value of USD.  Diverging central bank monetary policies and political risk in Europe will lead to increased volatility in equities, fixed income and currencies.

Federal Reserve

The FOMC March 17-18, 2015 meeting minutes indicated differences as to the timing of rate hikes and the prevailing economic conditions.  Although some Fed members favored a June rate hike,   September-December is now expected with gradual increases to follow.  The Fed is focused on trade, economic growth, the strength of the USD and the effects of lower energy prices.  The Fed is monitoring the strong USD and its potential drag on exports and overall growth.

The Fed is positive about the underlying consumer spending over the medium-term, improvement in jobs, the wealth effect from improved house and stock valuations, stronger consumer balance sheets, lower energy prices and higher consumer confidence.  The Fed is tracking payroll gains, labor market slack with less emphasis on wage growth. 

Interest Rate Hikes

The FOMC lowered their interest rate forecast by 50 bps in 2015.  FOMC consensus now signals a September hike, followed by 100-125 bps of rate hikes in 2016.  The Fed lowered its forecasts and now expects growth to be 2.3-2.7% and core inflation to be 1.3-1.4% in 2015, below its 2% target. 

The USD has appreciated by 7% since December and 20% against global currencies over the last 6 months.  The Fed’s model indicates that a 10% increase in the USD reduces US growth by 0.7%, reduces core inflation by 0.4% and applies pressure to keep Fed Funds rate lower for longer.  

Banking Sector

Moody’s announced their updated bank rating methodology that incorporates several solvency and liquidity factors.  Their intent is to predict bank failures and determine how each creditor class may be treated when a bank fails.  The new methodology will focus on an enhanced Financial Profile which encompasses five solvency and liquidity-related financial ratios that are predictive of bank failures:

1. Asset Risk
2. Capital
3. Profitability
4. Funding structure
5. Liquid resources

This new approach reflects insights gained from the global financial crisis and the fundamental shift in the banking industry and its regulation.

European banks located in the EU, Norway and Switzerland, whose government support has been partially removed will be impacted by 3 ratings notches.  The effect of the new methodology takes a loss given failure approach and gives credit for available layers of subordinated liability when assigning ratings to senior debt.  This approach changes the focus from sovereign ratings to name-specific and quality of bank capitalization. 

Moody’s already implemented their ratings changes on US Banks when it removed its assumptions for government support.  Some holding companies of UK banks were negatively impacted by the (BRRD) Bank Recovery and Resolution Directive.  Canadian, Australian and Japanese banks were not affected by Moody’s methodology changes.

Fixed Income Markets

The search for yield and pension fund de-risking should flatten yield curves throughout 2015.  The market expects the Treasury curve to flatten and the dollar to continue to strengthen, but credit markets could see some temporary spread widening.

There may be a modest rise in Treasury yields along with some flattening of the yield curve as short-term rates rise more than long-term rates. The USD may continue to strengthen as monetary policy diverges between the U.S., Europe and Japan and credit spreads may initially widen.

The recent weakness in the U.S. data is partly weather-related and may have been influenced by the port shutdowns on the West Coast given the impact on the regional manufacturing surveys. At the present time, the Fed expects to increase interest rates by an average of one percentage point per year through 2017.

Such a gradual pace of rate hikes is not likely to derail the economic expansion nor should it have a lasting impact on risk assets.  As the Fed prepares to raise interest rates, it is expected to keep its target interest rate within a narrow band.  The top of the band will be the interest on excess reserves (IOER), which is the interest the Fed pays banks for the money they have on deposit at the central bank. This rate is currently set at 25 basis points (bps) and seems likely to rise to 50bps with the Fed’s first rate increase.  The lower end of the band will be the interest the Fed pays money market funds and other nonbank institutions for cash not on deposit at banks (overnight reverse-repo rate).  

The Fed’s projections show the long-term equilibrium Fed Funds rate may be 3.5% which is still historically low.