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Best Practices for 401(k) Fiduciaries

Presented by:

Lisa ArkoMay 6, 2008

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Copyright © Watson Wyatt Worldwide. All rights reserved

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Focus is on Managing Risk

Focus is on managing and reducing risks associated with 401(k) plans– Fees– Employer stock – Litigation– Compliance requirements– Retirement adequacy

A recent survey found a significant percentage of sponsors are focusing on fiduciary issues

– 35% are likely to review their governance structure or hire a third party to review investment options

– 55% plan to review fund operations, including expenses and revenue sharing

– 29% are planning investment fund changes in an effort to reduce fees

• Hewitt survey of 2008 planned activities of 190 mid- to large-sized employers


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Framework for Managing Risk

Human Resources

Finance

FinancialManagement

AssetManagement)

PlanDesign

Administration/Communications

Compliance

Emerging best practice - strengthen/enhance governance system and use as an integrated framework to manage all risks

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Governance


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What is Governance?

“Governance is how plan fiduciaries organize themselves to manage the legal and financial risks associated with plans while providing

plan participants with promised benefits”

Governance is:

– The way in which people are organized within a company to manage their responsibilities

– Managing the legal and financial risks associated with a retirement plan

The end product is a:

– Clear mission

– Developed skill and resource

– Delegation of responsibilities

– Accountability and monitoring

Good governance is about:

– Having an appropriate structure

– Following the right processes

– Using the processes efficiently


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How Do I Get There?

Create a structure– Identify what needs to be done– Identify who should do it

Appropriate organizational level Appropriate people within each level

Make sure it is done and done right – Delegation– Policies– Oversight

Performance reviews and measures


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Create a Structure – Identify What Needs to Be Done

Focus on all plan management areas– Financial Management– Asset Management– Plan Design– Compliance– Administration– Communications


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Create a Structure – Identify Who Should Do It

Board of Directors or Board Committee

Benefit Finance Committee Employee Benefits Committee

Trustee Record Keeper Tax & Accounting Finance HR Legal

Governing

Managing

Operating


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Appropriate Organizational Level

Example: Allocations between the Board (Governing) and the Employee Benefits Committee (Managing)

Is the decision both settlor and strategic (e.g., of significant economic, cultural, or behavioral impact)?

If “yes”, allocate to the BoardIf “no”, allocate to the Employee Benefits CommitteeExamples:

Board of Directors Employee Benefits Committee

Plan design and design changes

Establish or terminate a plan with a financial impact of ___%

Larger/unusual plan mergers

Funding (above minimum, below maximum)

Plan amendments to maintain tax qualification or for administrative convenience

Small and routine plan mergers

Create a Structure – Identify Who Should Do It


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Make Sure it is Done and Done Right

Policies– Provide the decision framework

Set objectives Provide constraints

– Require periodic reporting by delegates Performance measurement

– Often overlooked aspect of governance– Separates supervision from execution – Forces establishment of objectives and measurable results


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Make Sure it is Done and Done Right –Policies to Support Governance Structure

Sample policies– Selection policy for appointees to committees– Orientation and ongoing fiduciary education policies – Investment policy– Plan expense policy (guidelines for paying fees from plan

assets) – Compliance policy

Establish at organizational level with ultimate responsibility (governing or managing) and enter into appropriate committee’s minutes

Committee members should fully understand policy rules and follow them


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Make Sure it is Done and Done Right –Performance Management

Areas for performance measurement– Financial Management– Asset Management– Plan Design– Compliance– Administration– Communications

Tailor performance objectives and measures to plan’s specific requirements

Report results to appropriate stakeholders to facilitate monitoring responsibilities


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Sample Governance Framework

Board Committee - Governing

Tasks Appoints Committee Members Approves strategic plan amendments May appoint and remove trustee May approve investment and funding policies Monitors Committees

Policies Plan mission statement Code of conduct Independence policy Selection/education policy

Employee Benefits Committee - Managing Benefit Finance Committee - Managing

Tasks Plan design Compliance Administration CommunicationPolicies Mission statement Human capital strategy Compliance Policies Benefits Administration Policy Communications Policy

Performance Measures Benefit adequacy Impact on human capital Operational review Participant investments

Tasks Financial Management Asset Management

Policies Plan expense policy Investment policy

Performance Measures Administrative and investment fees Absolute and relative investment performance Actual risk experienced Periodic review of expenses paid by plan

Human Resources - Operating Legal - Operating Finance - Operating Tax - Operating

Tasks Day-to-day administration Communications Supervises delegates

Tasks ERISA & Code compliance Approves QDROs Advises on claims appeals Committee secretary

Tasks Implements investment policy Monitors investments and managers Risk management Directs payment plan expenses

Tasks 5500s Tax withholding Corporate deductions

Agents & Advisors


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Understanding of fiduciary responsibilities Clear mission in all plan management areas Appropriate and clear delegation of responsibilities Accountability Performance management through ongoing monitoring using

appropriate measures

Agility to quickly identify concerns and modify accordingly

A Strong Framework Leads to Risk Reduction


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Governance Best Practices

Written policy framework Detailed committee charters Documentation of all decisions and oversight activities Ongoing fiduciary education and training Periodic comparison with best practices Performance measured in all plan management areas

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Vendor Management


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Vendor Management


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Service Contract

Ensure you have a copy of most recent service agreement or statement of work

– How is responsibility delegated?– Revise, update if necessary

Fees and services should be fully articulated Understand service model and administration team structure

– Where are hand-offs? Proactively address renewals a year in advance of expiration or

as plan make-up changes substantially– Monitor total asset growth– Assess changes in participant counts


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Compliance

Trust, don’t entrust Thorough administration manuals and processing calendars

should be part of standard agreement Never assume that everything is being done in full compliance

– Ask the question, have it be proven Random vendor-initiated reviews should be expected and

included in the contract Operational reviews should be undertaken periodically to

ensure overall compliance


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Service Level Agreements

Ensure that promised service levels are relevant and meaningful to your objectives

Expect granular data in addition to summaries– There should be standard reporting

Treat service level goals as incentives, not penalties– Both parties should have vested interest in meeting service levels

– Incentives for goals exceeded? Gain understanding of circumstances that create missed levels

– What is the root cause of service issue?

– Ultimate goal is to avoid service issues going forward, not to continue to collect penalties


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Ongoing Vendor Communication

Develop a regular meeting schedule to stay current

Weekly/monthly– Standing check-in with project team– Updated issues list/project plan

Quarterly– Face-to-face meeting– Review of Service Level Agreements – Work plan for upcoming quarter

Annually– Review business plan against performance – Develop business plan for upcoming year– Identify opportunities for improvement– Adjust Service Level Agreements, if appropriate– Staffing review and feedback


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Vendor Fees

2008 401(k) fee survey of plan sponsors performed by Chatham Partners reports

– 79% of plan sponsors participating in survey report that understanding their plan costs is important

– 77% of sponsors say that current disclosure levels are sufficient BUT

58% feel confident they understand their plan costs 34% say their plan fees are easy to compare to those other

providers would charge 38% of respondent’s vendors disclose revenue sharing to

them 42% report that their plan fees are transparent

Under Diversified Investment Advisors’ “Report on Retirement Plans - 2007, ” 42% of sponsors report they are unaware of their plan fees


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Vendor Fees - Mutual Fund Expenses and Revenue Sharing

Sample Equity Fund:

Management Fee: 0.70%

+ 12b(1) Fee 0.30%

+ Other Expenses 0.20%

= Total Expense Ratio 1.20%

Investment decisions

SUBADVISORS

Flow of fees from participant accounts to retirement plan service providers

Plan services, recordkeeping,

proprietary revenue, commissions, etc.

PLAN RECORDKEEPERS

Management Fee

12b(1) Fee

Other Fund Fees

EXPENSE RATIO

Sub-Advisory Fee

12b(1) Fees

Other Revenue Sharing

FUND COMPANY

Administrative: trading, accounting, fund

board expenses, etc.

Investment management

Marketing: 12b(1) fees - advertising,

shareholder services, etc., which are rebated back to recordkeepers because no

broker is involved

Additional revenue sharing: Negotiated fee which can vary

among plan recordkeepers based on contract with fund

management company

Investment Admin Fee


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Vendor Fees – Revenue Sharing Considerations

The absence of explicit fees has allowed many to view administrative services as “free”

“Proprietary” options typically pay more revenue sharing Revenue sharing may create a windfall for vendors when

assets rise absent renegotiation of services and/or changes in investments

Can create inherent potential for inequitable allocation of fees


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Vendor Fees – Revenue Sharing Considerations

An example of the potential impact of revenue sharing on administrative service fees

Plan assets Year 1 with Vendor: $120 million Plan assets Year 8 with Vendor: $175 million Participants – 2,000

YEAR 1YEAR 8

Explicit administration fee ($0/ppt) -- $ 0 $ 0

Revenue sharing (average .20%) -- 240,000 350,000

Transaction-based fees -- 2,000 2,000

Administrative service fees $242,000 $352,000

Adm. service fees per participant $121 $176


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Vendor Fees –Fee Categories

Service fees– Fees received by the record-keeper for ongoing

administration and employee education/communication services

Investment management fees Transaction-based fees

– Fees associated with a specific type of activity (e.g., loans, withdrawals, distributions)


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Vendor Fees – Sample Benchmarking of Administrative Service Fees

Administration, employee education and communication costs plus transaction-based fees

Costs generally paid via

– Hard dollar fees

– Revenue sharing

Service fees benchmarked with plans that have similar

– Number of participants

– Average account balances

– Complexity

– Employee education and communications

Example of Plan Cost Ranges - Per Participant

$120

$36

$75

$117

$0 $100 $200

Services

High $117

Median $75

Low $36

Company $120

Services

Representative sample from WW benchmarking study


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Vendor Fees – What should you do?

Understand– What you are currently paying– How your fees compare to current market practices for

similarly situated plans Service fees Transaction-based fees Total plan fees

Consider – Benchmarking plan fees every 3 years– Going through RFP or RFI process every 5 – 6 years

lisa arko - watson wyatt worldwide

Business

plan assets compliance

plan fiduciaries

plan participants

right policies

strategic plan amendments

policy rules

appropriate structure

promised benefits governance