Quality Plus Service Plus Value

The changing discussion about fee reasonableness.

Tom Kmak, co-founder and CEO of Fiduciary Benchmarks [FBi], spoke to PLANADVISER about how the Department of Labor [DOL] fiduciary rule evolves the concept of fee reasonableness—and the opportunities for advisers.

PA: How have the new fiduciary regulations changed the concept of fee reasonableness?

Kmak: We believe that the onus has shifted concerning the determination of fee reasonableness in the industry.

For IRAs [individual retirement accounts], there is no plan sponsor that sits between the service provider and the participant. It’s just the service provider and the participant. So, instead of the Department of Labor putting the onus on the participant to determine fee reasonableness in an IRA, the department has turned to the service providers and said, “For an IRA, you have to make sure your fees are reasonable.”

So providers now have to think about the reasonableness of those fees in terms of quality, service and value.

This has brought the IRA benchmarking business to Fiduciary Benchmark’s forefront. We’ve learned for nine years how to benchmark a retirement plan, and now we are going to take that same capability to simplify analyses and examinations of fees versus quality, service and value and apply it to the IRA market.

PAJA16-FBi-imagePA: What is the role for retirement plan advisers in helping plan sponsors understand this evolving fee reasonableness standard?  

Kmak: Aside from the opportunities around IRAs, on the qualified plan side, I think advisers should be careful to make sure that when they’re helping a plan sponsor benchmark its fees, they understand that there’s a legal high ground and a moral high ground to take. Most advisers we meet are trying to protect their clients. Even Labor Secretary [Thomas] Perez agrees. He has said the overwhelming majority of financial professionals are trying to do the right thing by their clients.

The DOL has provided the legal high ground whether in ERISA [Employee Retirement Income Security Act], in the DOL handbook on fees from 2010, the 408(b)(2) regulation or the recently issued Fiduciary Reg. The DOL has been very consistent—this isn’t about low fees, this is about reasonable fees and the factors that make fees reasonable like quality, services and value.

So advisers should also not make this a one-dimensional discussion, where you’re only considering fees. It should be: quality plus service plus value equals fees.

Look at the litigious environment we are in. There was a recent suit where a plan was being sued because its index fund cost 4 basis points [bps] and not 2 basis points. Two basis points on $50,000 is $10. That isn’t going to make the difference in how someone will retire. However, we’re getting to the point now where the plaintiff’s attorneys are getting incredibly creative with the suits they’re generating, and if you make this only about fees, you’re going to make their job very easy. Because it’s really easy to go, “Well, $20 is less than $30.” But if you go, “Well, the reason I paid $30 is because the quality was perfect, the services were above average, and the value they delivered to me as a fiduciary and to my participants was off the charts,” the plaintiff’s attorney has a much more difficult job.

If you really want to protect your clients, don’t make this only about fees. Make this about quality plus service plus value equals fees, and you’re going to make it a lot harder for your clients to get sued.

PA: How can advisers maximize that value?

Kmak: Advisers have two choices: They can become part of a race to the bottom and a discussion of efficiency, or they can determine that they want to be the Lexus or Cadillac for their clients—clients pay more but get more.

I’ll give you an example. We saw an adviser where the client was more than happy to pay an above average fee, because of these three statistics: No. 1, he had a 98% participation rate; No. 2, he had a deferral rate that was 2% more than the industry average; and No. 3, he had 95% of everybody in the plan in a portfolio that was automatically rebalanced and automatically diversified. Those three items taken together meant that the adviser was generating, by our calculations, about $80 million of additional long-term value for the plan sponsor and its participants. This adviser was paid substantially above the median, but the clients had no problem with it because he was generating so much value.

PA: How is Fiduciary Benchmark going to be able to help advisers?

Kmak: In our reports, we look at 30 different services that advisers provide, and each of those services has varying degrees of difficulty. When we began, our reports examined fees as an overwhelming part of the analysis—now quality, service and value is 75% of the equation and report. We can also offer different reports for different situations. For example, if an advisor was considering replacing an active large value fund, he could go into the FBi service right now and say, “What are other similar sized plans paying for a fund in this asset category, what percentage are paying revenue sharing and how much is the revenue share.”

We can also produce reports of varying lengths for advisers to take to clients. If an adviser is meeting with a $1 billion plan, that committee is going to want a lot of documentation, while a client with a $4 million plan will find our Executive Summary Report with the more concise output sufficient.

Furthermore, if a recordkeeper and adviser wanted us to perform McKinsey-like consulting on an entire book of business, just by using the benchmarking system, we can provide them analytics to determine fee reasonableness based on fees AND value.