PLANSPONSOR - April/May 2020 - 52

EXECUTIVE SUMMARY
A Cost That Pays
Asset-based fee schedules may fuel plan success
F
or centuries, incentives have been used to obtain results
when success is in the balance. The efficacy of successbased
compensation depends on the extent to which results
can vary and the likelihood that what is desired can be obtained.
When dealing with a mechanic, for example, the result is
quite binary: Either the car gets fixed or goes back to the shop.
In this case, the ability to make the repair was a prerequisite; the
customer doesn't pay for the degree of success at achieving the
result; he pays for the time and materials that yielded a working
car. Whether what you pay is " reasonable " will be based on cost.
Was the hourly rate within industry norms? Were materials
marked up fairly?
Motivation for Results
For a retirement plan, success in achieving retirement income
is anything but a foregone conclusion, and there are infinite
degrees to which one can succeed or fail. A plan participant is
not paying for the costs of the service-such as materials and
time when a car is repaired-so those should not be the variable
assessed to determine what fee would be reasonable. What
the participant is paying for is results, for success in securing
adequate retirement income. Therefore, it's impossible to assess
reasonableness of plan fees without having success as the cornerstone
of the analysis.
If it's success plan sponsors are after for their participants,
the ideal provider-fee-structure is one that motivates efficacious
behaviors and discourages behaviors that diminish plan
success. Fees based on cost provide less incentive to produce
results and more incentive to increase costs. This is not to say
a provider would purposely increase costs, but it is far less
likely to lower them. This cost bias occurs most frequently
in compensation paid for processing of loans, hardship withdrawals,
investment advice, etc.
Under an asset-based fee, a service provider or adviser that
can bring successful results more efficiently is rewarded, and
this breeds ingenuity and ultimately increases the success of
the plan-and industry.
Still, the incentives that exist in an asset-based fee schedule
can create distortions that need to be addressed. There are greater
incentives to pursue employees who make maximum contributions,
versus the employees who do not, and to favor investments
that have the greatest growth potential.
52 PLANSPONSOR.COM April - May 2020
Bring 'Reasonableness' Into Focus
If a sponsor factors the success of the plan into a determination
of reasonableness, it acknowledges that greater success can justify
greater compensation, regardless of cost. This is exactly the case
with an asset-based fee. As participants' account balances rise,
compensation to the provider will rise. Therefore, as the success
of the plan rises, so does the threshold of reasonableness.
That brings us to the nebulous question of " What is reasonable? "
The answer, as I see it, isn't " Reasonable is at or below a
benchmark " or " at or below what an RFP [request for proposals]
process yields. " These all too common approaches are antithetical
to the success-based approach, which embraces an asset-based
fee and rejects benchmarking that ignores a plan's success.
A success-based approach could look like this: Start-don't
end-with an asset-based fee, which could be derived from
benchmarking or an RFP. From there, apply appropriate positive
weighting to outcomes that increase plan success and support your
fees' reasonableness. Examples include: income replacement ratio,
default deferral rate, participation rate and deferral escalation.
The process must also apply negative or zero weightings
to factors that hinder successful outcomes, such as: premature
withdrawals-particularly taxable withdrawals; use of predictably
low-yielding investments; portfolios inconsistent with
participants' goals or situations; and low levels of contributions.
This approach requires an additional layer or two of analysis
by plan fiduciaries, but the process results in superior plan governance
and puts a plan sponsor in the best position to mitigate risk.
By adjusting the threshold of reasonableness on positive or
negative factors, success becomes the key variable in the determination.
The net result? Successful plans are no longer held to the
pricing standards of unsuccessful plans, which are unable to hide
among their similarly priced, but more successful, counterparts.
Cory Clark is chief marketing officer at DALBAR Inc. Clark has
worked with retirement plan specialists, investment managers,
advisers, broker/dealers and insurance companies to optimize
their communications, compliance and business practices.
This column is to provide general information only, does not constitute
legal or tax advice, and cannot be used or substituted for legal
or tax advice. Any opinions of the author do not necessarily reflect
the stance of Institutional Shareholder Services or its affiliates.
http://www.PLANSPONSOR.COM
PLANSPONSOR - April/May 2020

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