by: Virginia Munger Kahn
from:  Business Finance Magazine
October, 1998

Earlier this year, John Reardon, chief financial officer at Goldhirsh Group in Boston, which publishes Inc. Magazine, began a search for a new third-party recordkeeper for their new 401(k) plan.  The problem:  The former recordkeeper's service required participants to use a voice-response system, and Reardon thought they should have telephone access to human beings and account information on the Internet.

But in his search for better service, Reardon has been pleasantly surprised.  Not only can he get both high-tech and high-touch services for his plan's 200 participants, but he'll end up saving his plan thousands of dollars in recordkeeping costs.  By switching to Charles Schwab in San Francisco, expenses will fall from over $45,000 a year to under $10,000.

A few years ago, companies like Schwab were not interested in talking to plans of Inc.'s size, he said.  "Now these services are available for smaller companies."

In fact, dramatic cost savings are available to companies of all sizes.  Dresser Industries, the oil services giant, has consolidated all three of its 401(k) plans at one vendor and, in so doing, will cut its recordkeeping costs by two-thirds.

"The recordkeeping business is changing so much because of technology," said Karl Mayer, Dresser's director of employee benefits, Dallas.  "You should shop around."

Putting a plan up for bid is one of the most common ways to substantially cut the cost of running a 401(k) plan.  But the process is time-consuming.  What are the alternatives for plan sponsors trying to cut costs?

First, if it's been more than three years since you put your plan in place, ask your provider to bring recordkeeping costs into line with the market.  Because recordkeeping and administrative costs account for a relatively small portion of a plan's total expenses, about 20 percent, vendors are willing to give ground in this area, said David Huntley, principal at HR Investment Consultants in Baltimore.  In many instances, "if you have your facts, you can get concessions," agreed Brian Ternoey, principal at Mercer Investment Consulting, Princeton, N.J.

At least once a year, meet with your plan provider to reconsider the way you do business.  Businesspeople are used to working within their companies to cut costs by changing the way they work.  Take that same tack with your plan provider, said Michael T. Daley, senior vice president at Cigna Retirement & Investment Services, Hartford, Conn.  "It can be eye-opening."

Next, work with your vendor to convert a paper-based recordkeeping system to an electronic one, said Daley.  Electronic data feeds and paperless loan administration and processing are cheaper than exchanging paper.  By the same token, use the Internet to deliver information.  If a plan provider can move from a platform dependent on legions of telephone representatives to one based on the Internet, costs will come down, said Daley.

If you're trying to cut supplemental fees - those costs associated with regulatory filings, compliance tests and other special tasks - deal with them as a single package, said Ternoey.  Plan providers don't want to deal with pricing each service independently, and even if they do agree to lower prices, plan sponsors often find their bills don't reflect these individually negotiated rates.  Instead, "keep the whole group of services together and negotiate that," said Ternoey.

Finally, consider changing the frequency with which participants can transfer money among investment options, said Roxanne Fleszar, president of Financial Resources Management Corp., a registered investment advisor and consultant to pension plans in Peabody, Mass.  Providing daily switches is expensive.  Some of Fleszar's clients allow only quarterly transfers between investment options rather than daily switching.

Investment Management Fees
Negotiations are tougher when it comes to the biggest expense in 401(k) plans - investment management fees.  Mutual fund expenses, for example, are set by prospectus and cannot be altered.  However, fees can be negotiable on group annuity contracts, separate accounts and trusts such as those underlying stable value options.   Moreover, several retail mutual fund companies have introduced so-called institutional shares in an effort to lower costs for large customers.

Before considering investment management alternatives, however, it is critical that plan sponsors address a key question, said Fleszar.  Do you want to stick to retail mutual funds, or are you willing to go the institutional route?  Institutional funds tend to be cheaper than retail funds, but they do not carry brand-name cachet.

Plan sponsors that want participants to be able to track their funds in the daily newspaper can consider institutional shares of well-known mutual funds.  This class of shares is cheaper than retail shares, but they require much higher minimums, typically ranging from $1 million to $10 million.

Institutional classes of shares are not available on all well-known funds, and in some cases, such as at The Vanguard Group, Valley Forge, Pa. a plan sponsor will need to set up a separate recordkeeping agreement to gain access to the institutional class.

Another option for reducing investment management fees is to structure your plan around index funds rather than more expensive, actively-managed portfolios.  "If you believe in indexing, you can cut your expenses quite a bit," said Ternoey.  Many of Vanguard's clients, for example, provide participants with a core offering of passively-managed funds around which they sprinkle more aggressive or esoteric, actively-managed portfolios, noted F. William McNabb, managing director at Vanguard.

Also, consider simply switching high-cost funds for reasonably priced funds.   International funds, for example, have wide ranges of expense ratios, noted Huntley.  Substituting a lower-fee fund can help lower overall costs.

If you're willing to forgo high-profile funds for low expenses, consider mutual funds offered by institutional money management firms.  These firms specialize in managing money for traditional pension plans.  Among those that provide institutional mutual funds are Miller, Anderson & Sherrerd; Pacific Investment Management Co. (PIMCO) and Dimensional Fund Advisors.  The minimums for these funds typically range from $1 million to $5 million.  The average expense ratio on an institutional-class domestic equity fund is 0.93 percent, according to Morningstar.  By comparison, the expense ratio on the average domestic retail fund is 1.52 percent.  by dealing with a single pension or retirement plan rather than hundreds of individuals, these money managers can provide services at a lower cost.

Plan sponsors looking for a multi-manager approach should consider mutual funds offered by consulting firms such as SEI Investments, said Fleszar.  SEI has pooled a number of institutional money managers into more than a dozen mutual funds ranging from conservative asset-allocation portfolios to investment-style-specific funds, such as large cap growth or small cap value.  The average expense ratio on these funds is 0.89 percent.  There are no minimums as long as a plan is introduced to SEI through a financial advisor.  To buy directly, a plan should have $10 million in assets.

Mid-sized to large plans can also consider setting up private label funds.  This involves approaching a mutual fund company, bank or other financial services firm to set up an individual fund for the plan sponsor.  These used to be known as trust funds at banks, and were valued monthly or quarterly.  Today a plan sponsor would ask that the trust be valued daily, according to Ternoey.  "We have quite a few of these projects in the works now," he added.  Typically plans need to bring $100 million in any single asset class to the table, although Ternoey said he has seen some accounts set up for as little as $50 million.  These accounts can be even cheaper than institutional funds with expense ratios typically falling under 50 basis points, he said.  One concern Ternoey has is that, unlike a typical pension fund account, the money managers running these trusts need to be able to handle the cash inflows and outflows caused by dozens of small investors.

Large companies also have moved to establish separate accounts for their 401(k) assets.   Separate accounts are set up at firms that manage money for traditional pension plans.  Minimums are comparable to what it takes to set up a private fund, said Ternoey, but many separate accounts are not valued daily and their returns are not reported publicly.  "We didn't feel we could get a handle on performance," said Reardon.

Some large companies have merged their defined benefit plans with their 401(k)s.   This so-called unitization of plans or master-trust combination requires substantial assets and can be complex to set up and administer.

Once a plan sponsor has gotten a handle on fees and expenses, how much information should be shared with participants?

Many plan providers and sponsors agree that fees directly impact the participant's account - investment management fees and loan origination and remittance fees - need to be disclosed fully at least once a year.  But some plan sponsors and consultants also argue that participants should be aware of total plan expenses.  "People don't value what they think they're getting for free," said Mary Ellen Higgins, director of retirement marketing at John Hancock Retirement Services, Boston.  "Participants should have some ownership of these costs," agreed Goldhirsh's Reardon.

In January, John Hancock will offer plan sponsors the option of giving participants a letter that outlines all fees associated with 401(k) plans.  The letter, which will be customized for each plan, will also discuss how the expenses get taken out - whether as a charge to investment performance, deducted directly from a participant's account or paid by the plan sponsor.

Vanguard not only provides participants with fact sheets and prospectuses detailing all the fees associated with the management of its funds, but it suggests that recordkeeping fees for which participants are responsible also should be disclosed annually.   "There is no business I know of where you don't tell the buyer what the price is," said McNabb.

The benefit of doing all this work - getting a handle on fees and disclosing them to participants - is that plan sponsors can sleep better at night.  "Your fear of fiduciary liability should be minimized," said Daley.  If there's ever a problem, added Higgins, "you can point to your disclosure and say, 'we did due diligence on fees, and we took steps to provide that information to employees.'"