Single vs. Multi-Vendor --The Critical Decision in 403(b)
Of all the fallout from the new IRS 403(b) regulations, probably the most important and pressing decision the regulations created for not-for-profit plan sponsors is how many active service provider relationships they want to have. The argument has been framed as a choice between exclusive single vendor relationships versus multiple vendor relationships. While plan sponsors struggle over this decision and examine the relative merits of both arrangements, plan providers are actively lobbying for an outcome that aligns best with their own solutions.
Some in the industry consider the multi-vendor relationships a carry forward from a bygone era, a time when in order to offer investment choice a plan sponsor had to hire additional providers. These providers would be either mutual fund companies or insurance companies, and in many cases both, since all providers only offered recordkeeping for their own stable of investment options. As the market evolved and “open architecture” investment platforms emerged and became the standard bearer, the necessity for multiple vendors to achieve that choice has been eliminated. With few exceptions, leading service providers now recordkeep most investment options available to 403(b) plan sponsors and participants.
Just as a new era of open investment architecture has gotten underway, the IRS and Department of Labor have begun to eliminate differences between 403(b) and 401(k) plans, actively encouraging 403(b) plans to be administered consistent with 401(k) plans. Private sector 401(k) plan sponsors have never utilized multi-vendor relationships to maximize investment choice for their participants. The 401(k) plan is considered to offer some of the best efficiencies and economies to participants, with significant competitive, regulatory, and public pressure to provide more. For some this begs the question, why maintain multiple vendor relationships anymore?
Not-for-profit plan sponsors are aware of the requirements of the new IRS 403(b) regulations and the burden of compliance that now rests squarely on their shoulders. The days of simply being a “payroll conduit” and sending deferrals to different providers with no further liability are over. Beginning this year, plan sponsors face new compliance requirements that carry significant penalties from the IRS for non-compliance. Whether a plan is covered under ERISA, is ERISA-exempt, or is hoping to maintain a non-ERISA status, the new rules behoove a plan sponsor to take them seriously and employ a fiduciary process providing a documented audit trail that clearly delineates how and why decisions were made.
Whether it be non-discrimination testing, monitoring loan limits, severance and hardships, or complying with the new information-sharing requirements, plan compliance will be difficult. If sponsors permit participants to make deferrals through multiple vendors, they can expect compliance and ongoing due diligence work to increase exponentially by the number of vendors they have existing relationships with under the new 403(b) rules.
Furthermore, if a plan is covered by ERISA [and has at least over 100 plan participants at the beginning of the plan year], the plan sponsor will generally be required to file a complete 5500 on an annual basis for plan years on or after Jan. 1, 2009; if the plan covers at least 100 participants an annual audit of the plan will generally be required. Extra work and extra time (therefore extra fees) will be required for that audit for these (100 or more participant) plans with multiple vendors.
There are providers in the marketplace that would have you believe that their aggregator/gatekeeper/common remitter solutions solve plan compliance issues. Do they? That question remains to be answered as these regulations are new and these solutions haven’t been properly tested. As a plan fiduciary, a sponsor must ask if this is a risk worth assuming. It is an important question and one that should be thoroughly evaluated. Regardless of the model, plan sponsors will have to be involved when it comes to certain participant transactions (e.g., loans, hardship withdrawals).
The simplest method to comply with the new regulations would be to utilize a single vendor and consolidate all of the plan assets with that vendor. That way, information-sharing agreements would not be necessary as all records, etc., reside in one place. Is that practical? Yes and no. It depends on the vendor contracts or custodial agreements and how the rights of those agreements are vested—with the participant, with the plan sponsor, or some combination that provides for an authorized agent (in many cases the plan sponsor) to act on behalf of the participant. With respect to contracts that vest the rights of the participants, a single vendor solution doesn’t solve all of the problems, but it goes a long way in doing so. In a single vendor environment, plan service providers are more willing to assume additional risk because they know what they are getting.
Investment or benefit committees greatly simplify their fiduciary due diligence process when one investment line-up is used. In a multi-vendor environment, investment oversight increases in direct proportion to the number of investment options offered under the plan. If plan sponsors are working with an independent advisor, they can expect the advisor’s fees to increase to reflect the additional work required to properly evaluate fund offerings over time. What should not be lost in all this are the findings among different surveys that more choice leads to lower plan participation and lower deferrals.
The most compelling reason to go with a single vendor service model is to enhance the participant experience. The multi-vendor model can impact the participant experience in a variety of adverse ways including education, planning tools, transaction efficiency, reporting, compliance, and, most importantly, cost.
In a multi-vendor environment, service providers compete with one another for each participant account, both for contributions and for the existing account balance. In many cases, they are competing for voluntary products unrelated to the retirement plan, such as long term care insurance, life insurance, and other similarly profitable products sold by commission-based sales forces. In fact, many firms consider the retirement product to be a loss leader that gives them access to a relatively closed community—the employee base—to sell their other products. Plan sponsors should be more concerned with those models as there can be an implied approval of these outside-of-plan products.
Simple transactions, such as loans and exchanges among investments, are greatly complicated in a multi-vendor model for the participant who has balances among the different vendors. For example, the participant who has $50,000 with Vendor A, $40,000 with vendor B, and $10,000 with Vendor C, and desires to take a maximum loan might be required to take $25,000 from A, $20,000 from B, and $5,000 from C (due to 50 percent rule), thereby initiating three separate loans with separate amortization and repayment schedules. If the plan sponsor’s 403(b) plan permits only one or two loans at a time, the participant might not be able to take out the full $50,000 unless he/she did a contract exchange from one vendor to another. If that vendor charged back-end loads or surrender fees, this transaction becomes less likely.
With assets at multiple vendors, a participant typically has to do a lot of manual entry of data to get the full use of all the planning tools available from the different providers. They also have the challenge of trying to interpret data from multiple account statements in multiple formats. Investment redundancy becomes more likely as many providers offer similar (if not the same) investment options in common asset classes. It takes the expertise of an investment advisor to ensure asset allocation decisions across different providers’ investment options are not duplicated. And, as referenced above, more choice is not better for participants. They become overwhelmed and are more likely to either not participate at all or to under-participate; they won’t engage in planning exercises, will defer too little, and will be improperly allocated.
Participant costs are higher in a multi-vendor than in a single vendor arrangement. In a multi-vendor arrangement, each vendor gets only a piece of the ongoing contribution and has to estimate what that piece will be. Additionally, they know every day they are competing with other providers to not only gather assets, but to protect and retain what they have. Penalties are built in as a form of protection to keep assets in-house through plan features such as surrender fees. The costs of these additional risks are reflected in higher prices at the participant level.
Participant education can be significantly affected in a multi-vendor environment. Since vendors need to compete with one another at the participant level, the onsite environment becomes driven by sales, not education. Any education that happens is a by-product of a sales pitch from one vendor competing with another for the employees’ accounts.
Due to the economics of a multi-vendor arrangement, vendors need to reduce services to participants to minimize costs, resulting in decreased participant (employee) satisfaction. The perception of many plan sponsors is that it’s better to stay with a multi-vendor approach because employees will become upset if their vendor is eliminated. What mitigates or eliminates this concern is when an employee is presented with a best-in-class investment line-up, complemented with a breadth of planning tools and clear education, all wrapped up in a competitive fee arrangement. Combined with the possibility a participant could receive a credit to his or her account for excess revenue earned by the service provider, this concern disappears.
One of the most important outcomes at the participant level from participant education is a fully-funded retirement. A vendor configuration that eliminates ambiguity for the employee and focuses on a consistent effort of employee engagement and active planning is ideal. A single vendor model does that.
The only way to truly leverage the economies of scale in a retirement plan is to bid the plan out in its entirety to prospective vendors, where all assets (both contributions and current balances) are awarded to the new provider. As it relates to current balances, many providers’ contracts vest contract rights with the participant so plan assets can only move at the discretion of the participant. Regardless, it is infinitely more attractive to prospective vendors to bid on that type of relationship versus a relationship where the provider quite literally has to guess how much they will receive in contributions and contract exchanges. Many providers in the 403(b) market will not bid on multi-vendor relationships for this reason alone.
Beginning with this plan year and thereafter, many 403(b) plans covered by Title 1 of ERISA will have to file a 5500 form, similar to those filed by 401(k) plans and those with 100 or more participants at the beginning of the plan year will generally require an annual plan audit. The plan audit is largely a time-based expense and more vendors equal more time and therefore more expense.
The Department of Labor has advised [Fed. Register Vol. 72, page 64736b, 11/16/07] that it is its view that 403(b) plans eligible to file as a ‘small plan’ [under DOL Reg. 2520.103 ? 1(d)] for the 2008 plan year and that have participant counts of less than 121 at the beginning of the this plan year, can file as small plans under the new filing rules. Small 403(b) plans generally should be able to meet the conditions for being exempt from the audit requirement and be eligible to file the proposed Short Form 5500 for this plan year.
Plan sponsors, their advisors, and providers will no doubt debate the pros and cons of both relationship models for some time to come. Those debates should never lose sight of the intended benefactor of these discussions? the plan participant.
Whether it is plan compliance, the gatekeeping of participant records, the experience and education of plan participants or economies of scale, at each juncture plan sponsors should ask themselves which vendor relationship model presents the fewest obstacles and represents the most opportunity for their plan participants to save for retirement. When all the facts are weighted the likelihood is sponsors will choose the single vendor relationship.
David Ray is vice president and national practice leader for not-for-profit and public sector markets for Diversified Investment Advisors, a national investment advisory firm specializing in retirement plans. In that capacity, he leads the company’s not-for-profit sales and product development efforts.