We attended a local law firm's annual employee benefits workshop this morning, where the first 90 minutes focused on retirement plans: Reductions in employer contributions, partial terminations, suspensions of RMDs for 2009, rollovers by non-spouse beneficiaries, DOL guidance on investment advice, and prototype 403(b) documents.
In addition to all that, there was one segment that had us listening very closely indeed: a discussion of Hecker v. Deere, the 7th Circuit's February disposition of which got some coverage from Stephen Rosenberg and our friends at BrightScope, among many others.
This morning, the discussion of Hecker got the crowd involved, producing several good questions and sensible observations (as well as a few curious ones), all of which led us to the following conclusions:
One of the fundamental shortcomings of the status quo in the 401(k) marketplace is the "bundled" approach itself, in which most plan expenses (i.e., the vast majority of costs borne by participants) are reflected in mutual fund expense ratios. We see two big problems with this practice.
First, the bundled approach is fundamentally non-transparent. Unfortuantely, wrapping everything up into one number (a number that's subject to change, and often at the most inopportune times) leaves sponsors and participants unable to know what they're paying for which services. Given ERISA's clear requirement that plan fiduciaries understand, monitor, and knowingly approve plan expenses, the bundled approach is a per se departure from ERISA's core principles. If you're a sponsor and the question is: What do your participants pay for recordkeeping services? The answer can't be "nothing" (because that isn't true, unless you're paying RK expenses with company funds, in which case you should know anyway) or "I don't know" (because the law requires you to know). The answer should be "20 basis points annually," or "$40 per person per year," or something concrete. (For most plans, we like the per capita approach, for reasons we'll explain in the next paragraph.) Bundled plans can be relatively expensive or relatively inexpensive. But because they aren't transparently priced, they're more likely to be more expensive for the simple reason that it's easier to roll a bunch of unnecessarily high fees into a number that doesn't itemize separate services and is paid entirely by (usually naive) participants. Transparency and low expenses aren't the same thing, but more of the former would be directly conducive to the latter.
Second, bundled plans don't share economies of scale with participants. If expenses scale up proportionately with assets (as they must when they're paid through the linear mechanism of mutual fund expenses), a $200 million plan will cost exactly 10 times as much as a $20 million plan, and 100 times as much as a $2 million plan. The simple truth, however, is that service providers' "cost of goods sold" doesn't come close to scaling up in such linear fashion. So a $20 million plan shouldn't cost exactly 10 times as much as that $2 million plan. There's no brightline formula for what that multiple should be, but it's perfectly clear--painfully obvious, even--that it should be less than 10.* The point here is that failing to share economies of scale with participants is inconsistent with ERISA's central concept, which states quite clearly that decisions made for the plan should serve the interests of participants and their beneficiaries.
To summarize: The absolute level of plan expenses (including, as always, the hidden costs of mutual fund ownership) should be reasonable, and the lower the better. But regardless of their level, expenses should be transparent, and should be structured in a way that shares economies of scale with the people who've earned them: rank-and-file participants.
No matter what happens with Hecker and its cousins, we need to get these things right: Less expensive, more transparent, easier access to high-quality investment disciplines. The destination is clear, but, alas, the path to get there is cluttered with entrenched interests. For conscientious sponsors, concerned participants, and fiduciary service providers, much work remains.
* One complicating factor here is the number of participants, where plans with more participants (or, more precisely, lower average account sizes) imply a higher "cost of goods sold" for service providers. But the beauty of the per capita model is that it accommodates this in a perfectly straightforward, economically rational, and legally defensible way.