by: Robert Pruter
from:  Employee Benefit Plan Review
October 1999

When an employer decides to switch 401(k) plan providers, it confronts a plethora of difficult issues, problems, and administrative tasks, starting with the request-for-proposal (RFP) process and continuing through the transition to the new plan. An employer making a switch also should use the move as a time to reassess the features to include in the plan, the level of employee education to provide, the kinds of communications to use, the provider fee structure, the available investment choices, and whether to use a bundled or unbundled arrangement.

An employer can make a vendor changeover less treacherous and more useful by asking the right questions and following certain steps. In this article, two investment consultants – Dawn Bennett, senior vice president-certified investment management analyst at Legg Mason Wood Walker in Washington, D.C., and Roxanne Fleszar, principal of Financial Resources Management Corporation, in Peabody, Mass. – offer guidelines for plan sponsors and provide insights gained from working with a variety of small and large employers that went through a vendor switch.

THE RFP PROCESS

In the RFP, the plan sponsor should clearly lay out – not only for prospective providers but also for itself – what the employer wants in the 401(k) plan. Ms. Fleszar recommended that an employer organize the RFP into a defined series of numbered questions so that when the answers come back, they can be easily compared in a matrix, whereby vendors are listed in columns and the numbered questions are listed in rows. This method is particularly useful for comparing fees, because of their myriad origins within a plan that make direct comparisons difficult.

As Ms. Bennett explained, "Right now we’re competing for a $30 million plan. What the employer has done is what most larger corporations should do, as should most smaller firms: It has the same list of questions in an RFP format that everyone has to answer, and the questions are numbered one, two, three, four, and so forth. This way, the employer can make apples-to-apples comparisons for each potential provider."

Ms. Bennett is a strong believer in a uniform RFP process, and recommends its use in every single case. "That way, everything is on the up-and-up and there aren’t any guesses," she said. "Nobody is making political choices: that is, the company people are not going with a certain provider because he is their golfing buddy."

NAILING DOWN SPECIFICS

In the RFP process, employers often do not ask enough specifics to make adequate comparisons among plans, Ms Fleszar commented. In comparing fees, the employer should ask for an explanation of each fee and how it is billed, in order to understand what services the recordkeeper includes as part of the basic service, she said. Also, the employer must know whether the investment adviser’s fee is a percentage of assets or commission-based, and whether fees will increase or decrease as plan assets grow. If no fee is disclosed in the proposal, she suggested this may be a sign of a commission-based fee structure, which she characterized as a "common tool used by large providers to hide fees."

In comparing vendors’ services, Ms. Fleszar suggested that the employer inquire into the qualifications of the individuals who will present a plan’s education program, especially their investment experience. "Most presenters are in their 20s and do not have a vast amount of investment experience," she explained. "They learn a precanned presentation. They all have the minimal National Association of Securities Dealers (NASD) license – a number six license – but they don’t have a lot of depth of experience for investment education."

Ms. Fleszar also stressed the need for follow-up education. Since the heart of the employee education problem for many companies is workers’ different levels of experience with 401(k) plans and with investing, Ms. Fleszar suggested that an employer ask for education programs that break the population into different groups – for example, a group for those employees who need the basics and a group for those employees who need more sophisticated education, such as regarding investment strategy.

INVESTMENT FUNDS

Many employers give insufficient attention to the appropriateness of the investment funds in their Sec. 401(k) plans, and fail to sufficiently engage the prospective provider with investment fund questions. Often a company simply is not equipped to deal with investment issues. Ms. Fleszar related the story of a company that had internally selected 18 mutual funds for its 401(k) plan, among them an array of sector funds. Sector funds, which cover certain sectors of an industry, "have a lot more volatility, and unless the participants understand that, they can get into trouble," she said. This particular employer failed to provide the investment education necessary for employees to understand the nature of sector funds.

Other investment-related questions that Ms. Fleszar suggested include (1) how do the investments’ performance, risk levels, and expense ratios stack up against the offerings of other providers; (2) what criteria does the provider use for choosing investments; and (3) who is responsible for ongoing monitoring of funds, and how much flexibility is provided for investment changes.

Ms. Fleszar suggested that a plan sponsor consider employing a consultant for help on investment issues. She added that, among midsize to larger firms, about half are working with investment consultants.

Ms. Fleszar also stressed the need for the employer to request the provider’s investment policy statement (IPS), which is a blueprint that takes into account the procedures a company should undertake to protect its employees’ investments. An IPS can help reduce employer liability, and "gives comfort to the participants." She noted that the Department of Labor asks to see IPSs during audits.

BUNDLED OR UNBUNDLED

When changing providers an employer must decide whether to employ one provider for all aspects of the 401(k) plan – recordkeeping, investment management, communications, and financial counseling – or to have separate providers for various plan functions. Ms. Bennett commented, "People think the bundled approach is far easier, with the one-stop-shopping. But the bundled approach is not always the most inexpensive approach. A lot of times, there is not full disclosure of costs."

With the bundled approach, an employer usually gets only the provider’s mutual funds, and many times the mutual fund houses are known for a particular expertise and a particular asset class, Ms. Bennett commented. She stressed that the unbundled approach offers the freedom and flexibility of working with a number of mutual fund houses. Ms. Fleszar commented that she was favorably disposed towards bundled arrangements as long as the mutual fund house provided some outside investment funds from other houses.

An unbundled system also provides a built-in check and balance system, whereby the administrator is not a part of the investment house. "One hand is watching the other, as opposed to potentially one hand covering up the other," she said.

Lastly, Ms. Bennett noted too often in bundled arrangements an employer – particularly a small employer – will get a "cookie-cutter" approach to plan design.

NUTS AND BOLTS

In making the transition to a new provider, the employer needs to ensure that the human resources information system is properly converted for the new plan. Ms. Bennett emphasized the necessity of conducting test runs of the back office, including check receiving, wiring, Internet, tapes, and any other systems areas. "Make sure all the bugs are out, so that when the conversion finally takes place, everything works," she said.

Most vendor transitions involve a "black-out period" or "down time," during which the plan’s system is down to allow the old plan to be taken out and the new plan put in place. The length of this time period, Ms. Bennett said, depends on the complexity and size of the group, but she suggested that if "the administrator ran clean books and everything was done in an efficient way, then probably 60 days would be a typical length for a midsize to larger-size company."

Ms. Bennett related the experience of an employer with 500 to 600 participants, that had told participants that their new plan would be up and running in 60 days. Instead, five to six months elapsed before employees could conduct any transactions. Causing the breakdown down were an administrative process that was not maintained on a regular basis, a new provider that was not as prepared to handle the program as they had sold themselves to be, and other factors.

A plan sponsor, however, can avoid having their plan become some consultant’s horror story by adhering to certain common sense guidelines. Namely, conduct an RFP process that provides information that can be easily compared, ask detailed questions, understand the underlying investments in the plan, and conduct all the requisite systems testing. Do these kinds of things, Ms. Bennett concluded, and a typical plan sponsor "will do fine" when switching plans.