Client Service April 18, 2018

Two-Thirds of DC Consultants Charge Fixed Dollar Fees

This is down from three-quarters last year, a PIMCO survey found

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Sixty-seven percent of defined contribution (DC) consultants charge fixed dollar fees, down from 75% last year, according to PIMCO’s Defined Contribution Consulting Support and Trends Survey. Basis-point arrangements increased from 24% to 32%. The average revenue, as a percentage of total revenue, derived from DC plans is 50%, up from 47% last year.

DC consulting firms tend to offer many similar services—with the top six being investment manager selection and monitoring (100%), investment menu design (99%), total plan cost/fee studies (99%), investment policy development/documentation (97%), governance reviews (96%) and recordkeeping searches (96%).

At the median, the firms are staff with 10 DC-dedicated employees consisting of five consultants, two research analysts, one non-research analyst and two administrative support people. Last year, however, the firms were staffed with 12 people.

Twenty firms have non-U.S. DC-dedicated specialists, including 16 with specialists dedicated to the Canadian market, 10 to the U.K., six to Asia, four to Australia, four to Europe ex-U.K., and three to Latin America. Last year, 24 firms reported non-U.S. DC-dedicated specialists.

Asked which services have grown the most over the past year, the top five are: total plan cost/fee studies (65%), recordkeeping searches (49%), discretionary oversight of investment selection and monitoring (45%) and investment menu design (41%). Ninety-nine percent of firms said they are willing to act as a 3(21) fiduciary, and 52% as a 3(38) fiduciary, both on par with responses in last year’s survey.

Respondents said that 11% of their clients, on average, use their discretionary services, the top five of which are: deciding when to replace managers and conducting manager searches (85%); deciding on the investment default and investment menus (79%); measuring, monitoring and negotiating fees (77%); monitoring recordkeepers (61%); and developing white label or multi-manager portfolios, including a custom glide path for the target-date funds (TDFs) in the qualified default investment alternative (QDIA) (49%). However, the DC consultants expect that by 2020, 20% of their clients will be using their discretionary services.

Last year, respondents said that they expect 12% of their clients to implement outsourced chief investment officer (OCIO) services in the next three years, but this year, that grew to 24%. Asked why sponsors are increasingly interested in this, the consultants said it is to mitigate fiduciary risk (90%) and because they do not have adequate internal investment expertise (85%).

The respondents also expect an additional 16% of their clients will use custom TDF services in the next three years and that 26% will implement multi-manager/white label strategies in that timeframe.

Asked what types of communication/education services they are providing to their clients, 38% said written materials explaining the benefits of participating in the plan, 34% said group participant meetings, 25% said one-on-one meetings, and 19% said web or video participant meetings.

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Asked what they think their clients or prospects value in hiring or retaining their services, 95% said it is personal relationships, 94% said investment research, 93% said it is the experience of their staff, 93% said thought leadership, 93% said shared philosophies, and 90% said pricing competitiveness.

Ninety-six percent recommend auto enrollment, and 93% auto escalation. Additionally, 42% recommend auto catch-up. At the median, respondents recommend a starting deferral rate of 6%, and 41% recommend escalations up to a 10% cap.

Fifty-nine percent do not recommend a brokerage window. At the median, the income replacement goal they recommend is 80%. However, if participants expect to receive Social Security, the average income replacement goal is 65%.

At least two-thirds recommend a client consider re-enrollment upon a significant investment menu redesign (89%), a plan merger (80%), a new QDIA being put in place (77%), or the recordkeeper being changed (67%).

At the median, the consultants said that 10% of their clients had conducted a re-enrollment, and they expect that in the next three years, an additional 10% will do so.

What drives sponsor decisions

Asked why their sponsor clients had decided on changes to their retirement plan, 52% of the consultants said it was to meet participant retirement goals, followed by managing litigation risk (40%).

For plans with more than $1 billion in assets, 29% of the consultants recommend that the employers pay the fees out of pocket, and 28%, a flat dollar fee per participant. However, among plans of all sizes, 83% of the consultants said it is not likely for the employer to cover the investment costs. For non-investment costs, 86% of the consultants said it is at least somewhat likely the employer will pay out of pocket to cover costs.

Eighty-seven percent of the consultants recommend a TDF as the QDIA. When selecting a TDF, the top five factors the consultants said they consider are: fees (83%), glide path structure (82%), the probability of meeting participants’ retirement income objectives (65%), the quality of the underlying funds (56%) and market risk mitigation (44%). For plans with more than $1 billion in assets, 53% of consultants recommend custom TDFs.

On average, 48% of consultants’ clients either actively seek to retain retired participants’ assets (19%) or prefer retaining those assets but do not actively encourage retirees to do so (29%).

PIMCO’s full report can be downloaded here.

Compliance April 18, 2018

Court OKs Northern Trust DB Plan Change

A federal appellate court affirmed a lower court decision that a change to Northern Trust's DB plan benefit formula does not violate ERISA or the Age Discrimination in Employment Act (ADEA).

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In a case involving an amendment to the defined benefit (DB) plan benefit formula for Northern Trust’s DB plan, a federal appellate court agreed with a lower court decision that the change does not violate the Employee Retirement Income Security Act’s (ERISA) anti-cutback rule or the Age Discrimination in Employment Act (ADEA).

According to the opinion from the 7th U.S. Circuit Court of Appeals, prior to 2012, Northern Trust had a DB plan under which retirement income depended on years worked, times an average of each employee’s five highest-earning consecutive years, times a constant. As an example, the court noted that 30 years worked, times an average high-five salary of $50,000, times 0.018, produces a pension of $27,000.

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In 2012, Northern Trust amended the plan benefit formula so that it multiplies the years worked and the high average compensation not by a constant but by a formula that depends on the number of years worked after 2012. Recognizing that shifting everyone to the new formula would affect the expectations of workers who had relied on the prior formula, Northern Trust provided people hired before 2002 a transitional benefit, treating them as if they were still under the prior formula except that it would deem their salaries as increasing at 1.5% per year, without regard to the actual rate of change in their compensation.

The plaintiff alleges that the 2012 amendment reduced his “accrued benefit” because he expected his salary to continue increasing at more than 5% a year, as it had done since he was hired in 1998.

The appellate court pointed out that the plaintiff concedes he would not have a complaint if, instead of amending the plan in March 2012, Northern Trust had terminated the plan, calculated the plaintiff’s accrued benefit, and deposited that sum in a new plan with additions to come under the new formula. The 7th Circuit found that what actually happened is more favorable to him—he gets the vested benefit as of March 2012 plus an increase in the (imputed) average compensation of 1.5% a year for pre-2012 work for as long as he continues working.

The court said the expectation of future salary increases is not an “accrued benefit” and the only benefit that had “accrued” at the time of the DB plan formula change was the sum due for work already performed. The court pointed out that if the former formula had remained, but Northern Trust had decided that an employee’s salary could increase at a rate no more than 1.5% a year, that would have had the same effect on the formula as the amendment. But a reduction in the rate of salary increases could not violate ERISA, which does not require employers to increase anyone’s salary. “Curtailing the rate at which salaries change would not affect anyone’s ‘accrued benefit,” the court wrote. “Since that is so, the actual amendment also must be valid.”

The plaintiff also alleges that the plan’s administrator violated ERISA because it did not furnish all participants with a writing that described the 2012 amendment “in a manner calculated to be understood by the average plan participant”. The 7th Circuit noted that Northern Trust provided its staff with an online tool that showed each worker exactly what would happen to that worker’s pension, under a number of different assumptions about future wages and retirement dates, and under both the pre-2012 formula and the amended formula. “A precise participant-specific summation is hard to beat for clarity and complies with ERISA,” the court said.

Benefit formulas under the ADEA

The plaintiff in the case contends that the fact that the high-five-average compensation feature of the prior benefit formula was most valuable to older workers approaching their highest-earning years means that the 2012 amendment produces a disparate impact that violates the ADEA. However, the appellate court expressed skepticism about the proposition that curtailing a benefit correlated with age, and coming closer to eliminating the role of age in pension calculations, can be understood as discrimination against the old.

The 7th Circuit pointed to Section 623 of the ADEA, which provides that “[n]othing in this section” prohibits an employer from “observing any provision of an employee pension benefit plan to the extent that such provision imposes [without regard to age] a limitation on the amount of benefits that the plan provides or a limitation on the number of years of service or years of participation which are taken into account for purposes of determining benefit accrual under the plan.” The court found that Northern Trust’s DB plan, both before and after the 2012 amendment, complies with Section 623.

Benefits depend on the number of years of credited service and the employee’s salary, not on age. Because salary generally rises with age, and an extra year of credited service goes with an extra year of age, the plan’s criteria are correlated with age, but this differs from age discrimination. “An employer would fall outside the §623(i) safe harbor if, for example, the amount of pension credit per year were a function of age rather than the years of credited service, or if pension accruals stopped or were reduced at a firm’s normal retirement age,” the court said in its opinion.

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