How Does Your Retirement Plan Compare? Why Benchmarking is Important.

benchmark (noun) \bench-märk\
Something that serves as a standard by which others may be measured or judged.

Benchmarking is common in the financial industry as a means of gauging progress or measuring success. Investment performance is often benchmarked against a financial market index, such as the S&P 500. The skill of a portfolio or mutual fund manager can be judged by comparing the returns they achieve against a benchmark like a peer group average.

Retirement plan sponsors should understand benchmarking and integrate a regular practice of benchmarking into their fiduciary duties. It’s important not only to benchmark the performance of your plan’s investment options, but also the fees plan participants are paying on those investment options.

Of significance for a plan sponsor, benchmarking of fees and expenses is spelled out in the ERISA code as a fiduciary requirement. Here’s the relevant ERISA section:

Section 404(a)(1), 29 USC 1104 – a fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and—

(A) for the exclusive purpose of:

(i) providing benefits to participants and their beneficiaries; and

(ii) defraying reasonable expenses of administering the plan;

The key word in the code language is “reasonable”. How is a plan sponsor to know what’s reasonable when it comes to expenses? There are no parameters to help a fiduciary know what’s reasonable and what’s not. This language creates a grey area that can confuse plan sponsors when trying to fulfill their fiduciary duties as defined by ERISA law.

That’s why it’s important to benchmark. As a plan fiduciary you should compare the fees paid to the various service and investment providers in your plan with the fees paid by plans similar to yours. The challenge is, there are different ways to benchmark. Many vendors offer to provide benchmarking services to plan sponsors. Before you hire them to help you benchmark your plan, it’s important to understand the methodology these firms use to build their benchmark and perform their analysis.

For example, a benchmark may compare your plan’s expenses against industry norms. But those “norms” may be based on publicly-stated pricing, not actual pricing. As you likely know, plan sponsors can negotiate for lower prices or additional services, so the fees they actually pay are lower than the “retail” price for the services they receive. Consequently, you might perceive your plan to have competitive pricing when in reality that is not the case.

A better way to benchmark is to conduct a fee-only RFP (request for proposal). The outcomes of this RFP can help a fiduciary compare current plan fees against what they could command on the open market. I recommend doing this mini-RFP pricing review annually, with a full RFP conducted every three years.

In a fee-only RFP review, start with a comparison of services and related fees. The importance of making sure you compare “apples to apples” across service providers cannot be overstated. If not done properly, you could end up making a misguided conclusion. Next, look at value added services and determine if the extra costs are worth the benefits to the plan and the participants.

Keep in mind, benchmarking for fees may not require a change of providers. If anything, the process may help you verify that your plan’s fees are reasonable for the services provided. If you do find a vendor is charging you a higher fee relative to the results of the fee-only RFP, you can use this information to negotiate a better price if you are otherwise satisfied with their service. However, be prepared to make a change in providers if the incumbent service provider won’t reduce their fees. Having formal information regarding lower fees for similar services in an “apples to apples” comparison with reputable service providers and not acting on it would be a breach of fiduciary duty.

For all plan fiduciaries, benchmarking plan fees is appropriate for following a process of prudence, for creating an audit trail for fiduciary oversight, and most of all for ensuring the best interests of your plan’s participants continue to be served.
If down the road you face an audit or worse yet a lawsuit regarding excessive fees, benchmarking and the related documentation will be invaluable for defending your selection of the plan’s service providers and actions as a fiduciary.