Understanding CAP Management Fees
Why fee reviews are an important step for plan sponsors
October 29, 2018
I looked at the mechanics of undertaking a fee review in a previous blog post. The focus of this article is the way fund manger fees, advisor record keeping, and advisor fees are determined.
How Fund Manager fees are determined
It is important to understand how the fund manager portion of the investment management fee (IMF) is determined. The fund manager portion of the IMF is not set by the fund manager: the record keeper establishes the fee for each fund manager based on specific factors.
In defined benefit (DB) plans a fund manager’s fee depends on the amount of money managed: the more money invested in a fund the lower the fees. This also applies to CAP fund managers on a platform: the more money in a specific fund on the platform the lower the fees paid to the manager. Also keep in mind that the IMFs that each pension plan pays are not the same – it depends on the amount of the assets in each plan. If possible, check with sponsors with similar sized plans to get an idea what their IMFs are.
The fund manager fee however is only one part of the overall IMF. The record keeper collects the fund manager fee and remits an amount to the fund manager monthly. You will not be told how much the fund manager gets: it’s a ‘secret’ buried in the IMF.
In a fee review you should therefore compare record keepers’ IMFs for any specific funds you wish to continue to use or to add as investment options. You can also ask the record keeper to give you the breakdown of the IMF, i.e. record keeping, fund manager and advisor fees for each investment option. The difference in IMFs between record keepers, is often significant.
Record keeper proprietary fund fees are arbitrarily set by the record keeper since the money goes to the record keeper or an associated company. As a result, sponsors have a bit more room to negotiate or insist on lower fees on proprietary funds than is the case for third party fund manager fees.
If a sponsor provides an employee health benefit program using the same insurance company, there is an opportunity to negotiate IMF reductions as part of the combined business relationship.
If the plan offers guaranteed investment certificates such as CIAs or GIAs look at the interest rates and the premium paid above normal bank rates as part of the review. A premium should be paid because: a) the record keeper (financial institution) gets a guaranteed steady stream of low cost deposits and, b) the credit rating for the record keeper is usually less than for a bank, i.e. it is riskier and warrants a ‘credit risk’ premium. Most record keepers pay a premium of at least 0.25%.
Advisors usually receive a fee (trailing commission) based on the total CAP asset value. In most cases the advisor doesn’t interact with the plan members and doesn’t provide them with investment advice but simply assists the administrator (sponsor) in overseeing the plan and investments. The plan document will tell you who is responsible for administering the plan. The role of an advisor in a CAP is also quite different and less onerous than their role in acting as an advisor to a client in a mutual fund.
The rate the advisor receives as part of the IMF is not set by the record keeper: it is negotiated between upon the Plan Administrator and perhaps the CAP Committee and the advisor. The fee is a single rate applied to all funds. It is communicated to the record keeper who collects the fee and remits monthly to the advisor. The advisors automatically get more money as the amount of the members’ assets increase regardless of whether any addition effort or services are provided.
If the advisor is primarily assisting the sponsor in administering the plan, the sponsor should consider negotiating a flat fee and paying it vs. collecting it from the members. This gives the company more control over the costs, as is the case with its other business contracts. It minimizes potential conflicts of interest and fiduciary risk and it would provide the members with a significant additional benefit over time.
Record keeper Fees
The record keeping portion of the IMF is set by the record keeper based on a variety of factors: the amount of the Plan assets, the number of plan members, level of service provided, etc. The number of proprietary funds used in the plan can also be a factor in how much money the record keeper earns overall from the business. Larger insurance companies for example have the advantage of scale with regards to offering lower fees.
Record keepers are reluctant to disclose their portion of the IMF, despite the fact it is a large portion of the IMF; however, it can be estimated if you know the advisor and fund manager portions of the IMF. This allows you to compare it to other record keepers.
Fiduciaries, administrators and pension committee members must act in the members’ best interests: proper oversight of fees is an obvious part of their responsibilities.
Fees are a critical factor in saving both before and after a member retires and need to be considered in both situations. Communicating information about fees and their impact to members is critical.
A comprehensive formal fee review process should be part of a governance process to minimize the risk of litigation. It will satisfy many aspects of good governance ‘killing many birds with one stone’. To protect their legal position, plan members should also be aware of the impact of fees and not be shy about questioning the amount they are forced to pay both before and after they retire.