Final Report          Pension and Welfare Benefits Administration   STUDY OF 401(K) PLAN FEES AND EXPENSES   Contract No. J-P-7-0046, Task Order 1               April 13, 1998             Submitted to:   Department of Labor Pension and Welfare Benefits Administration 200 Constitution Avenue, NW, Room 5718 Washington, DC 20210     Submitted by:   Economic Systems, Inc. 5514 Alma Lane, Suite 400 Springfield, VA 22151 (703) 642-5225 Tel (703) 642-5595 Fax Table of Contents     SECTION TITLE   I INTRODUCTION AND BACKGROUND 1.1. Significance of 401(k) and Other Defined Contribution Plans   II CHARACTERISTICS OF 401(k) PLANS 2.1. Introduction 2.2. To What Extent are 401(k) Plans Used? 2.3. What Features are Found in Typical 401(k) Plans? 2.4. Types of 401(k) Plan Investments 2.5. 401(k) Plan Asset Holdings 2.6. How is the Administration of 401(k) Plans Structured? 2.7. How Are 401(k) Plan Services Delivered   III 401(k) PLAN FEES AND EXPENSE STRUCTURE 3.1. Introduction 3.2. Basis for Computing Fees 3.3. Typology of 401(k) Fees and Expenses 3.4. Approaches Used to Assess these Expenses 3.5. Issues Affecting Expenses 3.6. Who Pays 401(k) Administrative Fees and Expenses? 3.7. Are Plan Sponsors and Participants Adequately Informed About Fees and Expenses   IV COST ANALYSIS FINDINGS   4.1. Introduction 4.2. Components of Plan Expenses 4.3. Summary of Total Plan Expenses 4.4. Summary of Findings   V SUMMARY AND CONCLUSIONS   5.1. Summary 5.2. Characteristics of 401(k) Industry 5.3. Conclusions about Current Issues       APPENDICES TITLE   A Bibliography B Sample Disclosure Forms     TABLES TITLE   II-1 Employers Sponsoring Single-Employer Retirement Plans II-2 Employers Sponsoring Single-Employer Retirement Plans II-3 Distribution of Assets in 401(k) Plans II-4 Typical Mutual Funds Categories II-5 Major Categories of 401(k) Investment Options   III-1 Who Pays Plan Expenses III-2 Plan Expenses Paid by Participants Only III-3 Plan Expenses Paid by Participants Only III-4 Future Payment of Administrative Fees Only   IV-1 Average Expense Ratios, U.S. Mutual Funds, By Fund Category IV-2 Expense Ratios for Year Ending October 31, 1995 IV-3 Mutual Fund Expense Ratios and Separate Account Management Fees IV-4 Average 401(k) Plan Administration Costs, 1996 IV-5 Comparison of Estimated Total Plan Costs IV-6 Projected Total Annual Plan Fees IV-7 Illustrative 401(k) Plan Fees: Schedule of Charges IV-8 Illustrative 401(k) Plan Fees: Total Fees   Acknowledgments   This is the report of a study funded by the Office of Policy and Research, Pension and Welfare Benefits Administration, Department of Labor. The study was conducted by Economic Systems, Inc., with the assistance of The HayGroup. The principal researchers participating in this study include the following:   Economic Systems, Inc.   Frank M. Alley, Jr., Scientist George A. Kettner Senior Scientist Karthikeyan Nagaiyan Research Assistant Michael Sullivan Scientist   HayGroup   Michael Gaffney Scientist Edwin Hustead Senior Scientist Cindy Krieger Support Assistant The research for this study was conducted by the authors. The opinions and conclusions are those of Economic Systems, Inc., and of the HayGroup and do not necessarily reflect the views of the Department of Labor. SECTION I   INTRODUCTION AND BACKGROUND     This study was sponsored by the Office of Policy and Research of the Department of Labor's Pension and Welfare Benefits Administration. The purpose of the study is to examine the incidence, structure, and magnitude of fees and expenses charged to sponsors of and/or participants in 401(k) plans. It encompasses issues and information addressed at public hearings held by the Department of Labor on November 12, 1997.   The findings of this study include a description of the various mechanisms used to provide administrative and investment management services for 401(k) plans. The study describes differences in fee structures faced by plan sponsors when they purchase services from outside providers. Where possible, the study describes the range of expenses resulting from those fee structures, including differences in costs by size and type of investment as well as plan size. The study is limited to a review of the available literature and secondary data sources, not original survey research.   SIGNIFICANCE OF 401(k) AND OTHER DEFINED CONTRIBUTION PLANS   Employer-sponsored retirement plans customarily are classified into two major categories: defined benefit and defined contribution. In defined benefit plans (DB), the employer promises to pay specific benefit amounts to retirees who meet certain eligibility criteria. In its most typical form, a DB plan pays a lifetime monthly benefit to retirees who fulfill specific age and service requirements. Benefits are usually linked to the amount of service and based on final average salary. Employees during their careers, and as they approach retirement age, can reasonably rely on a known and expected benefit level; although protection against post-separation inflation is usually limited and/or uncertain. The plan sponsor may also provide an alternative lump-sum "cash- out" of the defined benefit entitlement. Until relatively recent times, the DB was the dominant form of employer-sponsored retirement program.   The most recent data show that approximately 41 million private sector active, retired, and separately vested workers are covered by defined benefit plans (U. S. Department of Labor, Pension and Welfare Benefits Administration). These plans are funded by investments that in 1996 totaled $1.7 trillion dollars. The Employee Retirement Income Security Act (ERISA) mandated the creation of the Pension Benefit Guaranty Corporation that monitors the funding of DB plans and insures their obligations (subject to certain maximums) through premiums paid by plan sponsors.   In defined contribution (DC) plans, the employer uses a tax-deferred qualified plan to invest employer and/or employee contributions. The terminating employee receives the proceeds in a current or deferred lump sum or annuity. Since the benefit is not defined, the retirement outcomes are not known in advance. This study deals with DC plans established in part under section 401(k) of the tax code.   In 1978, section 401(k) of the Internal Revenue Code authorized the use of a new type of DC retirement savings plan for the benefit of employees of most private firms. 401(k) plans offer advantageous tax-deferred status to employee and employer contributions.   401(k) plans have proven to be popular with employees for several reasons. The tax deferral is obviously high on this list of reasons. Others include the increased portability of this plan, employer matching contributions, and the increased control associated with self-direction of investments (Fink). As a consequence, the plans established under section 401(k) have been a major factor in the restructuring of employer-sponsored retirement benefits during the 1980's and 1990's. The advent of the 401(k) plan, coincident with changes in employment patterns and increased Federal regulations of DB plans, influenced a decline in the relative importance of DB plans to the retirement income security of American workers. The absolute number of workers covered by DB plans has been in the range of 39 million to 41 million since 1983 (EBRI Issue Brief 190); however, the growth in the size of the labor force has resulted in a substantial reduction in the percentage of workers covered by DB plans. (The percentage of full-time workers covered by DB plans in medium and large firms declined from 63% in 1988 to 54% in 1995.) (Bureau of Labor Statistics, July 1997) Further, the number of firms offering DB plans has shrunk, and the incidence of DB plans in small and medium firms is low.   There has been a corresponding increase in the importance of defined contribution plans to retirement income security. Assets held by DC plans totaled $1.2 trillion in 1996, and it is estimated that they will grow at a rate of 20-22% annually for the next five years (Access Research). For participants in 401(k) plans, the level of fees and expenses may affect the potential growth of retirement account savings. At issue is whether the wide range of 401(k) plans' administrative and investment management fees that has been observed substantially erode the size of account balances for retirement age 401(k) plan participants in some plans (Wang, April 1997; Rowland)? Furthermore, when fees and expenses are paid by an employer, the issue is a concern for stockholders. However, the study will demonstrate that a substantial portion of 401(k) plan fees and expenses are charged against the account balances of plan participants and that this trend is increasing (Hewett Associates, 1997).   Expenses of operating and maintaining an investment portfolio that are debited against the participant's account constitute an opportunity cost in the form of foregone investments in every contribution period. The laws of compound interest dictate that these small reductions in investment are magnified greatly over the decades in which many employees will be 401(k) plan participants. Observers have concluded that some plan providers are charging as much as 100 basis points in fees and expenses over the prevailing average rates (Benna; Butler, November 12, 1997). The effect of such higher levels of expenses would be to reduce the value of potential future account balances for these participants.   An example in Forbes Magazine shows this effect. Two employees each contribute the same amount annually into mutual funds. The funds each return 9% annually, but one has an expense ratio of 0.2% while the other has an expense ratio of 1.2%, a difference of 100 basis points. At the end of 35 years, the less expensive fund has a balance 23% higher than the other (Baldwin).   Some observers postulate that some plans are paying fees and expenses that are too high. Evidence for this conclusion is offered by studies that show extraordinary variance in price quotations given by providers for essentially comparable services (Wang, April 1997; Butler, November 1997). It has been argued by these observers that, when a plan incurs higher fees and expenses, the plan sponsor has not exercised adequate care in selecting and monitoring the plan's service providers.   A second issue of concern to many observers is that sponsors (and participants) lack adequate information on the structure and extent of fees and expenses to make informed choices about service providers and investment options. Thus, the inadequate disclosure of information may be a factor in the existence of the large variance in fees and expenses of 401(k) plans.   This study reviews available data and analyses regarding the level and structure of 401(k) plan fees and expenses. It is important to know more about how these plans operate, how much they cost to administer, and how costs are paid, in general and among various segments of the universe of plan sponsors. The scope of this study does not allow for original survey research, the study relies on existing sources of data for information about the relative levels of fees and expenses being charged to 401(k) plans. The study will seek to answer the following questions: What is the range of fees and expenses being charged to 401(k) plans? To what extent are the costs of administering and managing 401(k) plans being passed on to plan participants, as opposed to being paid by plan sponsors? To what extent is information about fees and expenses being disclosed to plan sponsors and participants? SECTION II   CHARACTERISTICS OF 401(k) PLANS   2.1. INTRODUCTION   The structure of fees and expenses borne by 401(k) plans and their magnitude are dependent in part on the nature of these plans, their features, assets, and the organizational arrangements plan sponsors choose to manage them. This section will offer an explanation of the characteristics of 401(k) plans. The following issues will be discussed:   • To what extent are 401(k) plans used? • What features are found in typical 401(k) plans? • 401(k) plan investments • 401(k) plan asset holdings • How is the administration of 401(k) plans structured? • Who are the providers of 401(k) plan services?   The popularity of 401(k) plans results almost entirely from their origin in the tax code in 1978. They offer both employees and employers the ability to defer current income from federal and state income tax liability. This tax deferral increases the magnitude of funds available for investment. (There is a ceiling on the amount of before-tax deductions that an employee can elect to contribute to a 401(k) plan each year. This ceiling is adjusted periodically to reflect rising earnings. In 1997 the ceiling was $9,500. In 1998 it is $10,000.) Employee contributions are matched in many firms by employer contributions, by a percentage formula as a share of the employee's contributions or through a variable profit-sharing basis.   These funds, which include the deferred taxes and employer matching contributions, are invested in a variety of instruments that provide compounded earnings until the participants' accounts are distributed. The effect of compounded earnings, applied to the deferred taxes and employer contributions, provides a substantial leverage to the employees' contributions and a substantial incentive to participate in this retirement plan. Generally, upon separation from service, employees may withdraw the proceeds of their accounts in a variety of modes. If done in conformance with the tax code, these withdrawals are then taxed at ordinary income tax rates in the years received.   2.2. TO WHAT EXTENT ARE 401(k) PLANS USED?   Between 1975 and 1993, the number of qualified private sector DC plans rose steadily from 208,000 to 619,000 (U.S. Department of Labor, Pension and Welfare Benefits Administration). Over the same period, the number of private sector DB plans rose from 103,000 in 1975 to 175,000 in 1983, then began to decline sharply to a total of only 83,000 plans in 1993. Thus, DC plans increased from 67 percent of private sector plans in 1975 to 88 percent of plans in 1993. Undoubtedly the emergence of 401(k) plan options in the 1980s played a major role in the general expansion of DC plans.   During the same 1975-1993 period, the number of participants in private sector DC plans increased from 12 million to 44 million (U.S. Department of Labor, Pension and Welfare Benefits Administration). The number of participants covered under DB plans rose from 33 million in 1975 to 40 million in 1983. This number then fluctuated modestly from 1983 to 1993, within the range of 39 million to 41 million.   Of particular interest is the extent to which a DC plan is the only employer-sponsored retirement plan. In these instances, the growth potential of employees' accounts, and the effect of fees and expenses on that growth, are especially significant for future retirement income security.   The General Accounting Office compiled important historical findings based on Department of Labor analysis of IRS Form 5500 data. Among all private sector employers sponsoring single-employer pension plans, the portion sponsoring only a DC plan increased from 68 percent in 1984 to 88 percent in 1993. Of all participants covered under these plans, the portion covered only by a DC plan rose over the same period from 27 percent to 45 percent.   More detailed data illustrate that this overall trend toward sole reliance on DC plans extended widely across different categories of employers. The table below shows the movement toward DC plans from 1984 to 1993 among employers of different sizes.     Table II-1 Employers Sponsoring Single-Employer Retirement Plans   % of Employers Offering only a DC Plan   Number of Employees 1984 1993 Change 2-9 69.0 88.8 +19.8 10-24 73.6 91.2 +17.6 25-49 71.1 91.6 +20.5 50-99 67.8 91.8 +24.0 100-249 58.4 88.9 +30.5 250-499 51.7 84.1 +32.4 500-999 40.7 78.7 +38.0 1,000-2,499 27.2 62.4 +35.2 2,500-4,999 24.4 52.6 +28.2 5,000-9,999 12.6 52.0 +39.4 10,000-19,999 18.2 47.4 +29.2 20,000-49,999 13.5 33.5 +20.0 50,000 or more 12.0 54.7 +42.7 (Source: GAO, 1996)   As these figures demonstrate, the prevalence of sole reliance on DC plans continues to be strongest among smaller employers. However, the general growth of the DC-only practice spans all employer sizes. It reflects an especially dramatic shift in retirement plan sponsorship among larger employers, where the movement toward DC plans is recent and significant. The broad reach of the movement toward sole reliance on DC plans is also evident when employers are categorized by industry.   Table II-2 Employers Sponsoring Single-Employer Retirement Plans   % of Employers Offering only a DC Plan   Industry 1984 1993 Change Agriculture 77.9 88.2 +10.3 Mining 64.0 82.4 +18.4 Construction 72.2 92.3 +20.1 Manufacturing 56.8 82.5 +25.7 Transportation 63.1 88.5 +25.4 Communications and Utilities 44.6 71.1 +26.5 Wholesale Trade 68.7 89.7 +21.0 Retail Trade 72.8 93.4 +20.6 Finance, Insurance, Real Estate 61.7 83.4 +21.7 Services 70.5 92.5 +22.0 Tax-Exempt Organizations 44.9 58.2 +13.3 (Source: GAO, 1996)   These findings indicate, again, that the general movement toward sole reliance on DC plans is pervasive throughout the U.S. retirement system. Defined benefit plans continue to play a substantial role. However, the extent to which a DC plan is the only source of employer-sponsored retirement income, is significant and growing.   GAO reported an interesting pattern within this overall growth of DC plans. Only three percent of all private sector employers sponsored both a DB and a DC plan in 1993. This low overlap would seem to suggest that the growth of DC plans represented a virtually universal use of DC plans among newly established private sector firms, coupled with some substitution of DC plans for prior DB plans among older, established firms (U. S. General Accounting Office).   However, the GAO also found that among employees offered any retirement plan at all, 43 percent were covered under both a DB and DC option. This fairly high figure, compared to the three percent of employers offering both options, indicates that the combined use of DB and DC plans is concentrated among a relatively small number of larger, older firms.   In general, this rapid growth in the use of DC plans has been particularly significant among newer, smaller, and non-unionized private sector firms. Conversely, DB plans continue to have a substantial presence among older, larger, and unionized firms. DC plans also have become somewhat more common among public sector employers, although government retirement systems still retain a strong DB orientation.   The universe of DC plans includes both taxable and tax-deferred plans. According to Access Research, the number of qualified 401(k) plans was 228,000 in 1995, the last year surveyed (Barneby). These plans contained approximately 22.3 million participants. The larger plans may contain most of these participants; however, the majority of 401(k) plans are offered by some of the 1.8 million small (less than 100 employees) companies in the United States (Richardson, May 1996).   2.3. WHAT FEATURES ARE FOUND IN TYPICAL 401(k) PLANS?   The specific design features of 401(k) plans vary widely within a generally universal plan structure. Virtually all plans are based on particular employer choices spanning several major plan elements. The following highlights are drawn from recent studies of employer-provided or employee benefit programs (Buck; Foster Higgins; HayGroup; Hewitt, Willette).   The HayGroup survey data capture a wide range of information about benefit design practices from 1,043 respondents, 723 of which reported sponsoring a 401(k) plan. The survey encompasses detailed features of plan design. The Hewitt survey captures 401(k) plan practices and trends among 460 employers as of the summer of 1997. The plans in the Hewitt survey include about 2.8 million participants and total assets of $177 billion. The Buck report reflects the practices of 668 respondents offering 401(k) plans. Data collection occurred in June and July of 1997. Almost two-thirds of the survey respondents were firms with 1,000 or more employees.   The Foster Higgins report includes responses from 743 organizations surveyed in June 1996. While the Foster Higgins report includes some DC plans without a 401(k) feature, 90 percent of the respondents provided 401(k) plans. For employers offering multiple savings plans, responses were based on the largest plan, and for 86 percent of the responses this was a 401(k) plan.   In a recent survey published November 24, 1997 (Willette), USA Today reported on the key plan design features of 401(k) plans among the 100 largest U.S. employers. Through an initial questionnaire and subsequent follow-up consultations, this survey provides a full and consistent snapshot of current practices among the very largest 401(k) plans.   2.3.1. Eligibility Age. Among employers reporting a minimum age for 401(k) plan participation, the age range was from 18 to 21. The mean was 20.6 years, suggesting that age 21 is the most prevalent age minimum.   2.3.2. Eligibility Service. Employees generally cannot begin contributing to a 401(k) plan until they have fulfilled some minimum period of service with the employer. In the HayGroup survey, the range of reported service requirements was from one month to three years. Most employers require service waiting of six months, nine months, or one year, and the mean service requirement was 10 months. Willette reported that 32 of the 100 largest plans allowed immediate eligibility, 51 required a one year waiting period, with the remaining 17 imposing a waiting period of less than a year.   2.3.3. Maximum Employee Contribution. Under the IRS annual deferral limit, all 401(k) plans have a maximum dollar limit on employee contributions in any given tax year. Additionally, the overwhelming majority of employers incorporate plan-specific maximums, usually in the form of a uniform maximum percentage of each employee's compensation. The Buck 1997 survey reported that about two-thirds of plans have a uniform percentage limit for all employees. Among these plans, the limits usually fall in a range from 10 percent to 16 percent of pay. The average limit in the 1997 Buck survey was 13.9 percent. Willette found that among large plans, contribution ceilings vary widely, but are predominantly clustered in the range from 15-17 percent of pay.   2.3.4. Employee Contribution Subject to Employer Matching. The most common form of employer contributions in 401(k) plan takes the form of "matching" contributions, usually structured as a certain portion of the employee's contributions that is then matched at a certain percentage rate. Within the HayGroup database, the employee contribution subject to matching varies from one percent to 20 percent of compensation, with a mean of 5.5 percent. Five and six percent are the most common matchable ceilings, and the means across various employer size groupings fall within a narrow range from 5.3 percent to 6.2 percent. Willette's findings are comparable for the largest employers. Of the 100 plans cited, 43 provide matching on up to 6% of pay, 11 on a larger portion of pay, and 25 on a smaller portion of pay. The remaining 21 have no matching or match through profit-sharing formulas not directly related to the amount of employee contributions.   2.3.5. Matching Contribution Rate. The second part of the matching formula, the percentage rate applied, differs widely. However, the mean reported matching rate was 62.3 percent of the employee's contribution. Again, the mean values for different employer size groupings are fairly uniform, ranging from 53.3 percent to 65.0 percent. The vast majority of employers provide a matching contribution somewhere in the range from 50 percent to 75 percent of the employee's contributions. Combining the average matching rate with the average ceiling on employee contributions subject to matching, the average total match available is slightly more than 3 percent of compensation.   2.3.6. Number of Investment Options. Within the HayGroup survey, over 90 percent of respondents indicated that they offer employees four or more investment options for their 401(k) savings accounts. Foster Higgins reports an average of 7.7 investment options in 1996, more than double the average number offered in 1990. There is, among very large employers, evidence that this trend is continuing upward. Of the 100 largest plans, the median number of investment options is seven. However, 26 of the plans offer 10 or more investment options, with one plan reporting 137 participant choices. In addition, six of the plans offer self-directed brokerage options within the plan, effectively providing thousands of stock, bond, and mutual fund choices to their participants.   A recent General Accounting Office report expressed the concern that employers in recent years have been expanding the number of investment options. While this development may offer employees greater freedom in constructing their plan portfolios, it raises the issue of whether offering more funds makes the typical plan more expensive to administer. Adding new investment options — or frequently changing the available options — could increase administrative expenses in such areas as information and education services, open season administration, valuation of assets, processing of inter- fund transfers and preparation of account balance statements.   2.3.7. Opportunities to Shift Investments. Another plan feature that can affect administrative expenses is how frequently employees can change the allocation of their 401(k) accounts among the available investment options. There is a strong trend toward offering participants the opportunity to shift investments on a daily basis. The 1997 Hewitt survey reported that 64 percent of plans allow daily investment transfers, up from 41 percent in the 1995 survey. In the Buck 1997 survey, 61 percent of plans offered daily transfers.   2.3.8. Valuation of Assets. Among 296 respondents to the HayGroup survey who reported on their valuation procedures, there was a fairly even distribution among daily (28 percent), monthly (30 percent), and quarterly (38 percent) valuation of assets. It would seem that the more frequent the valuation of assets, the greater the associated administrative expenses. However, the use of mutual funds as plan investment options — with the costs of daily fund valuation already spread over many mutual fund investors — may reduce the extra marginal cost of offering more frequent asset valuation.   2.3.9. In-Service Loans and Withdrawals. The availability of in-service loans and withdrawals adds another category of administrative expenses, in the form of program communication, loan and withdrawal processing, collection of loan repayments, and tax-reporting requirements. According to Foster Higgins, 81 percent of plans have a loan provision, 90 percent allow in-service withdrawals in cases of financial hardship, and nearly two-thirds allow non- hardship withdrawals. Within the HayGroup sample, 91 percent of all respondents indicated that they limit in-service withdrawals to cases of documented financial hardship. About 82 percent permit employees to receive loans from their accounts. In another survey, Hewitt discovered that, in 1995, an average of 20% of plan participants had an active loan (Hewitt Associates). Foster Higgins estimated that about 4% of plan assets are in outstanding loan balances. Employers may face a double-edged sword in this area. On the one hand, loans and withdrawals make the plan more complicated and potentially more expensive to administer. They may also have the long-term effect of reducing employees' ultimate savings for retirement. On the other hand, the availability of loans and withdrawals may induce some employees to begin contributing, continue contributing, or contribute more over time.   2.3.10. Communications Services. Plans typically employ a range of information-sharing devices to improve employees' understanding of the 401(k) plan. Most employers view these devices as worthwhile for their positive effects on plan participation, contributions levels, and investment allocation decisions. Foster Higgins reported the following use of several key mechanisms: summary plan descriptions, 97 percent; newsletters/brochures, 91 percent; fund prospectuses, 88 percent; personalized statements, 86 percent; employee meetings, 91 percent; and integrated voice response systems, 61 percent.   The above are among the most important plan features in terms of their possible effects on plan administrative complexity and associated administrative expenses. It is clear that the growth in the numbers of options that employees and employers demand in their 401(k) plans, together with the reporting and recordkeeping requirements that sponsors must provide, are important factors in the magnitude of administrative costs. An important goal of the study is to capture and analyze available information regarding the variations in administrative costs that these plan features may generate.   2.4. TYPES OF 401(k) PLAN INVESTMENTS   Access Research estimated that the assets of 401(k) accounts had a total 1996 value of $675 billion (Barneby). The Investment Company Institute, the trade association of the mutual fund industry, has separately estimated this value to be $857 billion (Reid and Crumrine). The average account balance in 1996 was reported to be $32,000, with over 1.9 million individual accounts of $100,000 or more (Barneby). How are these funds invested?   • The typical 401(k) plan offers participants the choice of a variety of investments, and in many plans this choice includes investments from differing categories of financial instruments. (The selection of investment instruments influences the magnitude of fees imposed on 401(k) investment accounts, as will be discussed further in Section III.) Listed below are these investment choices. This is followed by a discussion characterizing these investment choices. • Mutual Funds   -- Retail Mutual Funds -- Mutual Fund Windows -- Institutional Mutual Funds   • Stable Value Accounts • Company Stock • Money Market Funds • Self-directed Brokerage Accounts   The allocation of funds in 401(k) plans, as measured by a 1997 RogersCasey survey, is shown in Table II-3.   Table II-3 Allocation of assets in 401(k) Plans (End 1996)   % of All 401(k) Type of Investment Plan Assets   Equities 47% Bonds 4% Balanced 13% Stable Value Accounts 19% Company Stock 10% Money Market Accounts 5% Self-Directed Brokerage Accounts 1% Other 2%   (Source: RogersCasey, 1997)   This distribution may not be an absolute indication of employee preferences among these investment options, because not all plans contain all of these investment choices. For example, in 1995, 95 percent of DC plans contained an equity mutual fund option while only 59% contained a stable value account option (Foster Higgins, 1996).   2.4.1. MUTUAL FUNDS In a mutual fund, contributions to the plan are used to purchase mutual fund shares on the same basis as an individual investor would buy the fund shares. These mutual funds may be retail funds, available to the general public and whose prices are quoted daily in the financial press or institutional mutual funds, available to a limited set of investors.   Mutual funds are pools of financial instruments that may include stocks, bonds, commercial paper, cash, and other instruments. Shares of mutual funds are bought by investors, including 401(k) plans. The shares represent an undivided common interest in the pool of investments. The share holders benefit by receiving the earnings of the investments in the form of additional shares and by a capital gain when the shares are redeemed from the mutual fund.   In 1996, for the first time, mutual funds became the largest segment of assets held in 401(k) plans, constituting just over 40% of asset value (Foster Higgins). However, for several years the inflow of funds to mutual funds had been greater than to other investment options. The shift of investment by 401(k) plans into mutual funds has been dramatic, increasing from 5% of assets in 1990 to 40% in 1996 (Reid & Crumrine).   2.4.1.1. Retail Mutual Funds   Mutual funds are marketed to a wide spectrum of investors including individuals. Mutual funds may be categorized by the type of underlying security — equity, bond, or mixed — and by the investment objective. Investment objectives are often expressed, at least in part, in the terms of the risk-return considerations. The following table illustrates the range of retail mutual funds that are likely to be found in typical 401(k) plans (Sheets, 1996).     Table II-4 Typical Mutual Fund Categories   Underlying Assets Investment Objective   Stock Funds Aggressive Growth Long-Term Growth Growth and Income Sector International/Global   Bond Funds High Quality Corporate Junk (high-yield) Government Mortgage Securities   The distribution and marketing of mutual fund shares is governed by the Securities and Exchange Commission (SEC) which prescribes how expenses of the fund must be disclosed. These expenses are expressed as an annual ratio of expenses divided by total assets. The expense ratio is debited from shareholders' assets as compensation for the fund's investment management services.   Retail mutual funds are widely advertised, and their expense ratios are published weekly in the financial press. About 80% of 401(k) mutual fund assets are in retail funds (Wang, April 1997). Expenses of retail mutual funds vary widely according to investment objective, whether or not actively managed, category of instruments held, sales commissions, and other criteria. The range of expenses in funds likely to be found in typical 401(k) plans begins at 20 basis points for the least expensive index funds to over 200 basis points (Fortune, December 23, 1996).   2.4.1.2. Mutual Fund Window   A recent development in the design of 401(k) plans is the addition of an option allowing participants to chose from a larger variety of funds. The mutual fund window provides access to one or several families of mutual funds. The mutual fund window can be either the sole investment vehicle for all options, or it can be one of many options within an array of investment offerings. In 1997, 3.7% of plans offered access to a mutual fund window, according to one survey of plan sponsors (Buck Consultants).   Fees and expenses for mutual fund windows are similar to those for other mutual fund options, and they will likely be the retail expense ratio. 2.4.1.3. Institutional Mutual Funds   Many of the larger financial service providers - banks, mutual fund families, stock brokers, or insurance companies - offer sets of mutual funds that are bought by institutions and are not available for sale to individuals. Among the purchasers of institutional funds are 401(k) plans, other DC plans, and the trustees of DB plans who might buy institutional mutual funds to fund their defined benefit liabilities.   Institutional mutual funds resemble retail funds. They display a similar range of investment objectives and may invest in similar ranges of securities — equities, fixed income, large capitalization versus small, U. S. versus international, etc. However, they are not sold through broker/dealers, and their performance is not generally displayed in the financial press.   Institutional mutual funds typically charge lower expense ratios than do the retail funds with similar holdings and risk characteristics. One estimate is that the typical institutional fund has an expense ratio that is 50 basis points lower than comparable retail funds (Wang, April 1997).   Larger 401(k) plans often obtain some savings in their investment management expenses by taking advantage of a type of institutional mutual fund known as the commingled account. In this arrangement, a set of established investment vehicles is available to a pool of participating plans. These institutional funds are similar to retail mutual funds, in that they typically reflect a range of broad asset allocation objectives. Many of them are provided by the major retail mutual fund families. Other major providers include the trust departments of larger banks and insurance companies.   However, these funds are only sold to larger investors, including 401(k) plans. Investment in any of the investment vehicles within the commingled account typically requires a minimum investment of $1 million to $2 million in the commingled account (Hack).   Very large plans can achieve even greater investment management savings by establishing separate accounts for their 401(k) assets. In such an arrangement, the sponsor can define its own investment objectives and target portfolios. The investments are administered either through an external investment manager or in conjunction with the sponsor's DB plan investment apparatus.   Separate accounts require substantial minimum investments of $15 million to $25 million per account. However, large plans typically, with total assets of over $500 million, can realize substantial savings through such instruments. Total investment management expenses can commonly be reduced to one-fourth of the expenses incurred through retail mutual funds (RogersCasey).   In general, direct use of retail mutual funds or the provider's institutional funds is the most common investment arrangement among smaller plans, those with assets of $50 million or under. Mid-sized plans, those with assets of $50 million to $500 million frequently add commingled accounts. Finally, separate accounts are found among very large 401(k) plans, those with assets over $500 million (Hack).   2.4.2. STABLE VALUE ACCOUNT   Stable value accounts represent the second largest class of holdings by 401(k) plans after mutual funds, constituting 19% of 401(k) assets in 1997 (RogersCasey). These contracts represent a claim on the future investment earnings of the seller's investment portfolio or on a segregated group of the assets in this portfolio. Stable value accounts include guaranteed investment contracts (GICs), typically offered by insurance companies and bank deposit accounts (BDAs). The investor in a stable value account receives a guaranteed rate of return over a specified period of time, typically three to five years. The yield on a stable value account is comparable to that of a high quality fixed income investment. In 1995 the average net return on GICs held by DC plans was reported to be 6.5% (Foster Higgins).   Stable value accounts are appealing to investors who are risk adverse. This investment shields the purchaser from the credit and interest rate risks to principal that would be assumed by the purchase of a fixed income mutual fund. These instruments also have low rates of return compared to the historical long- term returns on equities, and particularly compared to the recent performance of equity investments. The trend in recent years has been for increasing percentages of 401(k) contributions flows to be directed to equities rather than stable value accounts and other fixed income investments (Foster Higgins).   Administrative fees and expenses placed on GICs and BDAs are typically not disclosed directly to the purchaser. Investment management fees and distribution charges are incorporated into the computation of the guaranteed rate of return. Thus, there typically is no disclosure of these expenses to the sponsor nor to the participants (Hack).   When stable value accounts are provided by a full service provider from an outside source, there will be a separate charge to the plan for recordkeeping. This is typically a fixed charge.   2.4.3. COMPANY STOCK   Company stock may be an investment option for employee contributions to 401(k) plans. (However, some analysts view company stock as potentially very risky for an employee saving for retirement, since it represents a narrow, undiversified investment option and links future and current income to the same source.)   One survey of plan sponsors showed that 37% of plans offered this investment option in 1997 (Buck Consultants). In 1996, 9% of the assets of DC plans were invested in company stock (Foster Higgins). A 1997 survey of 401(k) plans reported 10% of total assets invested in company stock (RogersCasey). Company stock is also typically offered as part of the employer contribution to the plan or in a combined 401(k)/profit sharing arrangement. In 1997, 21% of the 401(k) plans making matching contributions provided company stock or a combination of stock and cash as the company match.   The bundled service provider typically charges a recordkeeping fee to plans that includes company stock as an investment option. These fees are charged in a variety of ways: per-capita charge, fixed fee, fixed fee plus per- capita charge, or stock commission.     2.4.4. MONEY MARKET ACCOUNTS   Money market accounts are actually mutual funds that invest in short term (typically 90 days or less), fixed income securities. As such, they are often considered as cash equivalents. In the unusual conditions prevailing in the mid- 80's, with an inverted yield curve, these accounts were widely used as prime investment instruments. However, in recent years, money market accounts are most often used as parking accounts for money waiting to be invested in other instruments, as sweep accounts for the collection of dividends, or by very risk averse investors. Money market accounts were offered by 58% of DC plans in 1996, but just 7% of assets were invested in these instruments (Foster Higgins). A 1997 survey of 401(k) plans reported 5% of total assets invested in money market accounts.   2.4.5. SELF-DIRECTED BROKERAGE ACCOUNTS   A small number of plans offer participants access to a self-directed brokerage account (1.6%, Buck Consultants; 4%, RogersCasey). This type of account is similar to a mutual fund window, but it offers the ability to purchase individual stocks and bonds in addition to mutual funds.   Self-directed brokerage accounts have appeared in response to demand from certain types of 401(k) plans. These accounts are generally appealing to companies where the typical individual account is large and the participants are financially sophisticated. Typical plans offering self-directed brokerages would be professional corporations such as law firms, accounting firms, and medical practices.   Providers are charging administration fees for self-directed brokerage accounts in a rather uniform way, generally on a per-capita basis. The range of charges is typically $50 to $100 per participant per year (Cerulli). Participants also pay the transactions charges levied by their brokers for trades in the accounts.   2.5. 401(k) PLAN ASSET HOLDINGS   The assets of 401(k) plans are generally held and invested in common under the control of the trustee of the plan. With the exception of the self- directed brokerage assets, the holdings of individual participants are not discretely identified except by accounting entries.   Contributions to the plan, by the individual participants and by the sponsor, are invested in accordance with the instructions of the individual participants and their accounts are annotated to indicate where the investments were made. Similarly, investment gains are apportioned among the individuals' accounts in the plan's portfolio of assets.   2.5.1. INSURANCE PRODUCTS   When the provider of 401(k) investment products is an insurance company, the plan's assets are often packaged in a characteristic insurance product, the variable annuity. Such a plan's asset holdings would contain a set of investment instruments similar to those in plans serviced by other providers. However, when wrapped into an annuity, usually by an insurance company provider, such an account then becomes an insurance product and is exempt from the Securities Act of 1933.   The group annuity wrapper qualifies the plan as an insurance product. This provides certain tax preferences and excludes it from the accounting and disclosure provisions that apply to regulated securities. (The tax preferences do not provide any advantages to 401(k) plans since such plans already receive tax preferences.) An advantage to the provider in this arrangement is that the fees are not subject to the SEC rules that apply to other 401(k) products (Hack). 2.5.1.1. Group Variable Annuity.   The group variable annuity is simply a wrapper placed around a bundle of other investment vehicles such as mutual funds and general account investment options. The wrapper consists of a set of guarantees that include:   • A minimum death benefit expressed in terms of the member's and firm's contributions, • A post-retirement rate of return, if the participant elects a pay-out in the form of an annuity, and • A guaranteed level of expense to be assessed against the assets of the account.   In a group annuity, each participant has an individual account, but the guaranteed annuities apply to every participant identically. The group annuity arrangement requires daily recordkeeping of accounts at the participant level.   Administrative fees and expenses are assessed on two levels within the group annuity (plus itemized expenses that may be charged directly to the plan). There are investment management fees assessed against the individual mutual funds and general account investments within the annuity wrap. In addition, there is a wrap fee assessed against the total assets in the annuity.   2.5.1.2. Individual Variable Annuity. This product is similar to the group annuity except that the individual accounts are separately designed and packaged for each participant. This adds to the administrative cost of recordkeeping and administration. The individual annuity is usually used for very simple, small (less than 25 participants) plans (Hack). A typical use would be in a company with highly compensated, professional employees such as a law or accountancy firm.   The administrative fee and expenses structure for individual annuity plans is similar to those for group plans, but the wrap fees are substantially higher. One estimate suggests that the mortality and expense fee (see Section III for a definition) plus distribution charges would total 200 to 300 basis points for individual annuities (Hack).   2.5.2. REPRESENTATIVE 401(k) INVESTMENT OPTIONS   A 401(k) plan sponsor typically will select a variety of investment options from which the plan participants may select targets for their contributions to the plan. These options are typically pre-defined retail mutual funds correlated to a particular category of financial instrument or to a general asset allocation objective. They may be also include institutional funds with specified objectives and investment parameters, with plan sponsors directing assets to these funds on a pooled basis through a commingled account, or on their own through a separate account.   However, as a background to developing assessments of typical plan investment costs, some notion of benchmark 401(k) plan portfolios should be defined. A recent and useful typology was offered by Pellish and Buehl (Journal of Pension Plan Investing). They articulate three prototype model portfolios that might be offered within a 401(k) plan. Within each of the three model portfolios, specific investment vehicles are listed in order, starting with those expected to have lower risk and lower returns over time, ending with those expected to have higher risk and higher returns over time.   2.5.2.1. "Core Options" Portfolio   A potential array of investment options for newly-forming plans, and/or plans with participants who are relatively unsophisticated about investment strategies is displayed below. This is a simple portfolio; relatively easy to shop for, purchase, and administer; and well-equipped to minimize participant confusion.   1. Stable value account (e.g., GIC) or short-term bonds 2. Balanced fund 3. Large cap U.S. equity fund 4. International equity fund 5. Smaller company U.S. equity fund   2.5.2.2. "Enhanced Core" Portfolio   This plan would diversify the options available at the low-risk/low-return end of the investment spectrum. It would also introduce pre-packaged "lifestyle funds" intended to provide a composite set of investments designed to achieve a particular overall asset allocation objective.   1. Money market fund 2. Diversified bond fund 3. Conservative lifestyle option 4. Moderate lifestyle option 5. Aggressive lifestyle option 6. Large cap U.S. equity 7. International equity fund 1. Smaller company U.S. equity fund   2.5.2.3. "Full Array" Portfolio   This model portfolio maintains the notion of a plan-defined array of specific options. However, it diversifies the options at the higher-risk/higher- return end of the spectrum, and introduces the use of mutual fund windows and/or self-directed brokerage approaches. These features typically are targeted to the demands of participants who consider themselves highly informed about investment strategies, and consider the traditional core offerings as unduly restrictive.   1. Money market fund 2. Diversified bond fund 3. Conservative lifestyle option 4. Moderate lifestyle option 5. Aggressive lifestyle option 6. Large U.S. cap equity fund 7. International equity fund 8. Smaller company U.S. equity fund 9. Emerging market equity fund 10.Mutual fund window 1. Self-directed brokerage   These prototypical sets of investment options illustrate the range of choices typically offered to 401(k) plan participants. Within each of the fund types, investment management expenses vary widely. Section IV presents information concerning the range of investment management expenses observed for different types of investment options in recent years. 2.5.3. ACTUAL 401(k) PLAN ASSET ALLOCATIONS   There are several factors complicating the attempt to draw reliable pictures of the actual investment of 401(k) plan assets. The available investment options vary widely from one plan to the next. These options are assigned to different definitional categories by different providers and observers. Employees' asset allocation decisions are constantly shifting over time.   The 1996 Foster Higgins survey provides useful data on typical 401(k) plan holdings. It addresses the dual issues of how often particular investment options are offered to employees and the share of assets that are invested in the various options when they are offered.   Table II-5 Major Categories of 401(k) Investment Options   % of Assets % of Plans in Option Option Offering Option When Offered GIC/BDA 59% 33% Equity, Actively Managed Growth 78% 26% Equity, Actively Managed Core 36% 21% Equity, Indexed 42% 15% Equity, International 56% 6% Money Market / Short-Term 58% 22% Company Stock 26% 12% Balanced 74% 16% Bond 60% 10%   2.6. HOW IS THE ADMINISTRATION OF 401(k) PLANS STRUCTURED?   The administration of any 401(k) plan is substantially prescribed by the provisions of law and Federal regulation. Current law requires the development of a plan document as a part of the set-up of the plan as well as the submission of annual reports (Form 5500) that require extensive recordkeeping and preparation. Additionally, the tax code requires annual nondiscrimination testing to ensure that highly compensated employees do not contribute in excess of their ceiling. In 1995 a survey found that 61% of 401(k) plans discovered that the contributions of highly compensated employees must be restricted or adjusted as a result of nondiscrimination testing (Hewitt Associates). However, recent legislation enables plan sponsors to determine the allowable contributions of highly-compensated employees on a prospective basis, eliminating the need to make ex-post account adjustments.   These administrative requirements impose a cost. ERISA and its interpretive regulations require additional recordkeeping including periodic account statements to plan participants, at some cost to plan sponsors, participants, or both. Many plan sponsors choose to purchase this administration from service providers in lieu of using internal staff. A survey disclosed that in 1996 less than 5% of plans were being administered in-house exclusively and only 30% by in-house staff supported by vendors (Spencer & Associates).   The administration of 401(k) plans is also driven by the set of services that plan sponsors provide as conveniences to their employees or as inducements to increased participation. Some of these services are the participant's ability to obtain a loan from the plan, daily valuation of account balances, education and the communication of information about the plan, the ability to transfer assets among investment options frequently, and call centers. Larger plans can provide these services at relatively low per-capita costs, but for smaller plans they can be very expensive (Stone).   2.7. HOW ARE 401(k) PLAN SERVICES DELIVERED?   Plan sponsors have adopted a variety of arrangements to provide 401(k) plan services to their employees. The service delivery mechanisms they select may potentially affect the level of plan expenses, the extent to which they are charged to the plan, and the degree to which they are disclosed to sponsors and participants.   2.7.1 FULL SERVICE PROVIDERS   The first type of providers are the full service providers. These are the "bundled" service providers that are able to provide the entire range of administrative services to a plan sponsor. Full service providers include mutual fund companies, larger banks and insurance companies. In one estimate there are just over 200 full service providers available to plan sponsors (Valletta, February 1997). However, they must control a large segment of the market, since in a recent survey, it was estimated that 59% of 401(k) plans use bundled services from full service providers (Spencer & Associates). This study revealed that the full service providers are mutual funds (50.4%), banks (24.4%), insurance companies (14.1%), consultant/TPA alliances (8.1%), and others (3.0%).   Relying on one full service provider to furnish all services to the plan appears to be the most common approach to 401(k) plan administration. Administrative expenses are revealed to the extent that they are invoiced to the plan sponsors. When any of those expenses are paid by the plan, they are recorded on the Form 5500 report and borne by the participants. In most cases, however, at least some of the fees are not reported directly but are netted in the annual performance results of the investments. In this case they are also borne by the plan participants. Bundled services are more prevalent among small and medium sized plans. According to one study, among plans with fewer than 250 participants, 85% rely on bundled services; among plans with from 250-1,000 participants, about 75% use this product (Fink). A smaller scale survey in 1996 estimated the percentage of plans using bundled services to be 59% (Spencer & Associates). (The latter survey may have been biased toward larger plans; the number of respondents was only 298.)   2.7.2. ALLIANCES   A smaller group of plans have taken an intermediate approach, receiving asset management and recordkeeping services from an alliance, while providing other services with in-house staff or independent providers. Spencer & Associates report that 6.1% of respondents to their survey use this approach. Another arrangement of this type would be one in which an ostensibly full- service provider out-sources the recordkeeping tasks, allocating 15-20 basis points from the investment management fee or expense ratio for this service (Rowland).   2.7.3. UNBUNDLED SERVICE PROVIDERS   Plan sponsors may provide services through a combination of in-house staff and independent service providers. In this approach the plan sponsor becomes the "bundler." This practice appears to be more prevalent among the larger plans that have adequate resources to manage such a plan (Tiemann). One study suggests that about one-third of plans (30.1%) use the unbundled approach with a combination of in-house and vendor resources (Spencer & Associates). An additional 5% provide services to the plan with in-house staff alone.   2.7.4. ACCESS TO 401(k) SERVICE PROVIDERS   The costs of 401(k) plan services are somewhat dependent on the information that a plan sponsor has about the range of prices in the marketplace that are charged by these providers. A search of the literature shows that gaining visibility of the universe of thousands of service providers would be difficult to impossible for any plan sponsor with limited resources. For example, Valletta (February 1997) estimates that there are in excess of 1500 third party administrators and over 3,000 firms offering asset management services to 401(k) plans.   The directories cited offer only a small segment of the available vendors, although the majority of the larger providers are displayed. For example, the 401(k) Provider Directory, one of the best known, only contains information about the 94 of the larger full service providers (HR Investment Consultants). The other directory located in the literature search, the (k)form Catalog, contains information about both full service providers as well as TPAs and alliances. However, the (k)form Catalog lists only 79 such providers. (The publisher states that these 79 providers service over 50% of 401(k) plans in the country.)   Information about service providers is also available from associations, advertising, and the Internet. In addition, the 401(k) plan provider industry is very aggressively seeking to make their services known, frequently through well structured sales networks. However, the plan sponsor relying solely on information furnished by those service providers that establish contact through a sales force, would have incomplete knowledge of the marketplace.   The foregoing discussion suggests that the market for 401(k) plan services is not particularly efficient for the plans that do not have the resources or interest to search for information that would allow a comparison of available services and prices. SECTION III   401(k) PLAN FEES AND EXPENSE STRUCTURE     3.1. INTRODUCTION   This section will categorize and describe the fees and expenses that are typically paid by or on the behalf of 401(k) plans. We will also cite the typical range of these expenses as revealed in the literature. In the next section we will identify the ranges and averages of expenses paid by plans of various sizes.   3.2. BASIS FOR COMPUTING FEES   One dimension that is useful in understanding fees and expenses is the basis for computing them (Tiemann). Asset-based fees are computed as an annual percentage charge on the total assets of the plan. Census-based fees are imposed on a per capita participant basis and itemized fees specify a fixed charge for a specific service.   A typical price quotation might show fees and expenses of all three types. For example, a mutual fund provider might charge an investment management fee as an expense ratio on the funds (asset-based), a per-participant recordkeeping fee (census-based), and a fixed charge for set-up and conversion (McNabb).   3.3. TYPOLOGY OF 401(k) FEES AND EXPENSES   A useful way to classify expenses and fees, for the purpose of this analysis, would relate directly to the services being provided to the 401(k) plan. Therefore the following set of fees and expenses is proposed that focuses on the functions related to each expense category.   • Set-up and conversion fees • Recurring administrative costs • Communications expenses • Investment management fees • Distribution fees • Mortality and expense risk fees     3.3.1. SET-UP AND CONVERSION FEES   There are one-time costs associated with the establishment of a new 401(k) plan or with the conversion of a plan's records to another administrator's custody. Set-up entails the preparation of a plan document, often by adapting a prototype document, and the enrollment of participants. It also includes entering the participant data on the service provider's computer system, reconciling the existing plan's assets (if any), and setting up existing participant loans.   Set-up costs are relatively fixed, although the typical provider charges a fixed amount plus a variable, participant-based fee. The range of costs for set-up is $500 to $3,000; however, many providers charge a lesser amount and recoup the difference from investment management fees (k(la), (k)form Catalog). In one sample of providers, the range of average set-up charges for plans of 25, 50, and 100 lives was $992, $1102, $1,202 (HR Investment Consultants, Averages Book).   3.3.2. RECURRING ADMINISTRATIVE COSTS   These fees cover trustee services, recordkeeping, compliance, distribution of account proceeds to departing participants, loan processing, and withdrawals.   Trustee expenses typically are the smallest component of the total set of expenses, representing about 3% of fees on a typical plan with 500 participants and assets of $10 million (Stone). Trustee services are often offered at no additional, separate charge when the provider's funds are purchased by the plan.   Compliance costs include the preparation of tax forms (Form 5500) and nondiscrimination testing. When administrative services are separately priced, the compliance expenses are typically included in the base charge rather than being separately priced.   Recordkeeping is the largest component of recurring administrative expenses. This expense category includes enrollment, contribution and investment election processing, loan origination and processing, withdrawal processing, individual account maintenance, and preparation and mailing of account statements and summary annual reports. The 401(k) provider industry has made the investment in computer equipment and software to provide this recordkeeping in an efficient and relatively low cost manner.   The recordkeeping expenses for a small plan can be quite high. Typically recordkeeping consumes about 14% of total expenses for a $10 million plan (Stone). However, providers make their margin on asset management, and where recordkeeping and asset management are done by the same provider, recordkeeping may be viewed as a loss leader, being included with the asset management fees. On a start-up plan, the provider may lose money for two to five years until the average account grows large enough so that the margin on asset-based fees is sufficient to cover the loss on recordkeeping (Richardson, May 1996). Larger funds experience substantially lower cost percentages. For a 500 life plan, for example, recordkeeping costs may be about 7% of total fees and expenses and may be even lower for a much larger plan (Valletta, November 12, 1997).   In bundled mutual fund arrangements, recordkeeping expenses are included in the expense ratios. Where mutual fund providers out-source recordkeeping to third party administrators (TPA) alliances, there is typically a 15-20 basis point transfer from the expense ratio to the alliance for this expense (Rowland).   3.3.3. COMMUNICATIONS EXPENSES   Communications services typically include meetings with employees, printed and video materials describing the plan features and encouraging participation, basic election materials, and newsletters. More elaborate services might include a call center, interactive voice response system, participant asset allocation software, and Internet access. Communications services are valuable to the sponsor in that they encourage employee participation in the plan. They also help satisfy the disclosure requirement contained in section 404(c) of ERISA.   For example, one typical, large full service provider offers all of the communications services listed above except participant software. There is no additional charge for these services except for a $500 setup, $6 per participant charge for the interactive voice response system support (HR Investment Consultants).   3.3.4. INVESTMENT MANAGEMENT FEES   The main purpose of investment management fees is to compensate the provider, who recommends the allocation of funds flowing into a particular 401(k) plan investment option from the universe of financial instruments available for this fund. For an equity mutual fund, for example, the investment management advisor selects the stocks that will be bought and sold. The investment management fee pays for the research that supports these buy-sell decisions. In addition, these fees compensate the mutual fund manager for the pro-rata operating expenses of the fund attributable to each 401(k) plan that buys shares. (These operating expenses include items such as rent, staff compensation, supplies, etc.) In practice, the distinction between investment management fees and other type fees is blurred.   Investment management fees are the largest charges assessed against the plans. In plans where the assets are invested in mutual funds, for example, the investment management fee has been found to exceed 80% of total fees and expenses of a typical plan ("Retirement Planning;" Stone). Valletta found that the investment management fees may be as much as 90% of the total (Valletta, November 12, 1997). However, as will be seen below, these statistics may include certain other expenses such as marketing and distribution costs that are not separately disclosed.   Other investment instruments, typically group variable annuities, include management fees in the "wrap." A wrap fee is an all-inclusive annual fee imposed on the value of total assets in an account. Wrap fees typically include expense elements other than investment management fees.   3.3.5. DISTRIBUTION FEES AND COMMISSIONS   Often, 401(k) providers rely on elaborate distribution networks to market their products. Distribution fees are charged to cover the expense of maintaining this network. For example, a large insurance, full service provider may market its products through one of three modes:   • In-house sales force, • A network of affiliated third party administrators, and • Unaffiliated broker/dealers.   Such a provider will establish commission schedules to compensate the sales force at all points in this network. When 401(k) plan investments are purchased through this distribution network, distribution fees are typically charged against the participants' accounts. Distribution fees compensate the distribution network participants for their labor.   In the case of retail mutual funds, the sales commissions are disclosed in the prospectuses. Sales commissions can be collected in two ways: as front-end loads paid on new contributions to the fund (Class A shares) or as 12b-1 fees (combined with deferred contingent sales charges) deducted annually based on the fund's assets and reflected in the fund's net asset value (Class B shares). These sales commissions, whether collected when contributions are received or charged over a number of years against assets, are in the range of 3-4 percent of contributions (Schultz; Tuczak). For class B shares, the mutual fund manager pays sales commissions to broker/dealers up front and then recoups these funds over a number of years in the form of 12b-1 fees (Tuczak). Since the SEC limits the 12b-1 expenses to 100 basis points annually, a contingent deferred sales charge is imposed on the shares, typically for five years, to ensure that the mutual fund can recapture the sales commissions that were paid. A contingent deferred sales charge is only collected when the shares are sole during the contingent period.   Insurance company providers (and other providers using a wrap fee) can collect distribution fees at two levels. On the first level, 12b-1 expenses are charged against the annual value of an individual mutual fund and transferred to the distributor. On the second level, part of the wrap fee imposed on the value of all instruments included in the group variable annuity may be used to pay for distribution costs. The amount of each 12b-1 fee is disclosed in each fund's prospectus, but the portion of the wrap fee that is devoted to distribution charges is not disclosed.   Sales commissions for insurance products, including group and individual annuities, may be structured with two components. Deposit commissions are paid on balances transferred from other providers as well as periodic contributions into the plan. Trail commissions are paid on assets under management, including the growth from investment returns, and continue as long as the plan continues with the same insurance provider. The direct and trail commissions are typically combined and incorporated as part of the wrap fee.   3.3.6. MORTALITY AND EXPENSE RISK (M & E) FEES   Insurance products, such as group and individual annuities, bear costs that are unique to these products and that reflect the insurance risk of each product. These risks include the mortality and expense guarantees inherent in the annuity contracts. (See Section II, Insurance Industry Products, for a discussion of these guarantees.) The M & E fees pay these costs.   M & E fees are highest for individual variable annuities, generally ranging from 100 to 200 basis points (Hack). However, since distribution fees are often grouped with M & E fees, the total wrap fee for individual annuities might be in the range of 200 to 300 basis points.   In the case of group variable annuities, the M & E fees are usually based on plan size (Hack).   • For very small plans, less than 50 participants and $500k assets, 100 to 200 basis points, • For small plans, more than 50 participants and greater than $500 k assets, 75 to 150 basis points, • For medium sized plans, greater than 500 participants and $5MM assets, 30 to 75 basis points, and • For large plans, greater than 1,000 participants and $15MM assets, less than 50 basis points. M & E fees are typically imposed as wrap fee based on the total assets in the annuity accounts.   3.4. APPROACHES USED TO ASSESS THESE EXPENSES   The preceding discussion related administrative fees and expenses to the functions that they support. The following subsection describes the structure of fee payment modes.   • Invoiced expenses • Sales charges • Expense ratios • Wrap fees • Net asset value computations   3.4.1. INVOICED EXPENSES   Invoiced expenses are generally for recordkeeping and administration. They are often charged on an itemized basis, and may be paid by the sponsor, by the plan, or shared. There should not be any issue concerning disclosure by service providers to plan sponsors, for the sponsor can read the charges from the plan contract or from the periodic invoices or statements from the provider. Examples of invoiced expenses that would be paid by the sponsor or the plan are start-up fees, annual base fees, trustee fees, tax form filing, and recordkeeping for company stock purchases. Examples of invoiced expenses that might be paid by individual participants (or the plan) are loan origination, loan maintenance, and distributions.   Some invoiced fees are census based, i.e., fees charged as amounts per participant. These fees are similar to itemized expenses in that they are charged for recordkeeping and administration and in that there should be adequate disclosure of their extent to sponsors. Census-based fees, charged as a fixed amount per participant, are typically paid from plan assets or by the sponsoring firm. Examples of census-based fees are a per-capita addition to the annual base fee, additional fees for communications options that are not in the basic package, adding investments from outside providers, and the use of non- electronic data inputs. Some expenses are charged as itemized expenses by some providers and as census based fees by other providers.   3.4.2. SALES CHARGES   Regulated securities, such as mutual funds, may impose sales charges on purchases and/or reinvested dividends. Where up-front sales charges are imposed, they are disclosed to the sponsors and participants in the prospectuses. Contingent deferred sales charges combined with 12b-1 expenses may be used to assess sales charges (as described above). These charges are also fully disclosed.   3.4.3. EXPENSE RATIOS   Mutual funds impose asset-based administrative fees and expenses that are disclosed in the form of expense ratios. Expense ratios, which are incorporated in the prospectuses and published in the financial press (for retail funds), show the amount of fees and expenses that are deducted from the assets of each fund annually. Since expense ratios reflect deductions from the assets of a fund, these expenses are borne by the individual participants in a plan by a charge against net asset value of the funds in their individual accounts.   The Securities Act of 1933 requires the disclosure of the magnitude of fees imposed on mutual funds. The industry has developed a standard display of expense ratios:   • Management fees • Marketing and distribution fees • Other administrative expenses   Management fees represent a percentage of the fund assets paid to the fund's investment manager. These fees include the costs of research, the manager's compensation, and the firm's profit margin, among other costs. The identity of items included in the management fees for any fund is typically not disclosed.   Mutual funds charge additional fees to support the marketing and distribution costs of the fund. These fees are authorized by the Securities and Exchange Commission as section 12b-1 expenses. They may not exceed 100 basis points. There is a trend, however, to use 12b-1 fees for other purposes. One such use involves the transfer of a portion of the marketing and distribution fees to consultants through 12b-1 fees; one author suggests that this may be as much as 25 basis points (Richardson, January 1997). Bundled providers are also observed to be out-sourcing recordkeeping services and charging plan sponsors 15-20 basis points in 12b-1 fees that are rebated to the recordkeeping provider (Rowland).   Other administrative expenses is a category that primarily includes the servicing of shareholder accounts, such as providing statements, reports, dispersing dividends, as well as custodial services.   The net effect of these expense ratios is that it is difficult to separate the investment management fees from the administrative fees using the published information. For example, there has been a dramatic increase, 44%, in the total expense ratio of the average diversified stock fund since 1980. However, if we look at the detail in the ratios, we see that the cause of this increase has been the shifting of sales charges from a front-end load to the 12b-1 segment of the expense ratio. "Other expenses" have fallen while the 12b-1 share of the expense ratio has increased. The real increase in investment management expenses (apart from marketing and distribution) since 1980 is closer to 17% than to 44% (Sheets).   3.4.4. WRAP FEES   A wrap fee is an all-inclusive annual fee imposed on the value of total assets in an account. Originally developed to use with separate account money managers to pay the manager's fee as well as transaction costs, wrap fees are often associated with funds that still have internal expense ratios (Stone). For example, one large insurance company provider offers a variety of mutual funds to smaller 401(k) plans. Each of these mutual funds contains its own expense ratio. In addition, this provider charges an asset based wrap fee on the overall value of all of the mutual funds in the plan participants' accounts (Ryan).   Wrap fees are typically charged by insurance providers, who package their 401(k) investments in the form of group or individual annuities. In these plans, wrap fees typically include M & E expenses and distribution fees in addition to the cost of plan services and investment management fees. Wrap fees may also be charges by some bank and investment management company providers. The magnitude of wrap fees (as a percentage of the 401(k) fund) is observed to be inversely proportional to the value of assets in the 401(k) plan (HR Investment Advisors).   The magnitude of the wrap fee in any plan is disclosed to the plan sponsor (and, in some plans, to the plan participants). However, information about the portion of the wrap fee devoted to the elements of expense (M & E, distribution, services, investment management) is generally not disclosed (HR Investment Advisors). Since the typical wrapped account is an annuity, it is qualified as an insurance investment and not required to be registered nor to disclose fees in the detail required of mutual funds under the Securities Act of 1933 (Hack).   3.4.5. NET ASSET VALUE COMPUTATIONS   Certain investment products do not directly disclose any of the fees and expenses imposed on the plan participants. Instead, these charges are netted into the periodic net asset value (NAV) computations. Stable value accounts, such as GICs and BDAs use this technique to impose fees. In such accounts the provider guarantees a specified annual rate of return on each account. However, the fees and expenses are converted into a percentage charge against the assets in the account and are built into the formula for crediting investment returns. The plan sponsors and participants will be provided with the NAV and may be given the net rate of return used to compute the NAV, but the percentage devoted to fees and expenses will not generally be disclosed (Hack). (This is in contrast to mutual funds where fees and expenses are netted into the NAV but where the magnitude of fees and expenses are disclosed in prospectuses.)   3.5. ISSUES AFFECTING EXPENSES   The plan sponsor seeking to minimize the fees and expenses imposed on a 401(k) plan is constrained by a number of issues that bear on the magnitude of fees and expenses. An important strategy for minimizing costs is to obtain competitive bids from a number of 401(k) service providers. Other considerations related to costs of services are:   • Plan size • Plan features and investment options • Behavior of plan participants • Portfolio turnover   3.5.1. PLAN SIZE   Plan size is clearly an important dimension in the amount of fees and expenses a plan will absorb. This is largely a result of the fact that there are certain fixed costs of providing services to a plan that are not highly sensitive to the number of plan participants, and the fewer the participants, the higher the per-capita expenses. More and more vendors, especially mutual funds, focus only on the larger plans, those with 200 or more lives (Richardson, July 1997).   Another consideration related to plan size is that many small plans are new accounts with few assets. Access Research is reported to be encouraging technology companies to set up automated service bureaus that would handle administration for multiple 401(k) service providers as a cost savings for small plans (Richardson, July 1997).   Some sponsors may remain too small to easily afford a 401(k) plan. For firms with substantially less than 100 employees, the SIMPLE IRA plan or a profit-sharing arrangement may be a more affordable solution. Also, those small firms with higher than average income workers may prefer the higher maximum contribution limits in 401(k) plans over the SIMPLE IRA.   3.5.2. SELECTION OF PLAN FEATURES AND INVESTMENT OPTIONS   Decisions by the plan sponsor have a considerable influence on the magnitude of fees and expenses that will be charged. These decisions involve the specification of services that will be provided to the plan as well as the selection of investment options that will be offered to the participants. An extensive set of services is available to 401(k) plans, and many of them are more elaborate than the minimum requirement mandated by law and regulation. When the plan sponsor chooses to include more elaborate services than the minimum requirement, albeit in response to employee demand, the administrative costs are increased. For example, the sponsor might specify that the plan allow employees to change their investments daily, and the service provider would quote an incremental price for this additional service (Quinn, January 1998). Increasing the frequency of compliance testing is an example of another service for which most providers would charge an additional fee (HR Investment Consultants, 401(k) Provider Directory).   Another significant influence of plan sponsors' decisions on plan fees and expenses is in the selection of the suite of investment options that will be offered to participants. The plan that offers a wide spectrum of investment choices is likely to include investment options that have a higher than average expense ratio. For some investment options, for example employer stock and instruments purchased from institutions other than the full service provider, the provider will charge an additional itemized or census-based fee (HR Investment Consultants, 401(k) Provider Directory). Finally, including investment instruments that impose sales commissions on their purchases will increase the expenses being charged to participants who select these options.   Plan sponsors influence the magnitude of fees and expenses when they select a service provider that only offers investments loaded with sales charges or that packages investment options in a group annuity. An example might be the typical major insurance provider that offers a set of investment options that feature choices among mutual funds. These funds are included in a group annuity wrapper and an asset-based wrap fee is imposed (except for the larger plans) (HR Investment Consultants, 401(k) Provider Directory). A similar set of investment options could be provided by a non-insurance provider, absent the group annuity. This does not suggest that the group annuity does not have value, only that it comes with an additional cost. Similarly, the plan sponsor that selects a full service mutual fund provider that offers only loaded retail funds, could find another provider that offers a set of no-load funds with similar risk- return characteristics.   3.5.3. BEHAVIOR OF PLAN PARTICIPANTS   Participant behavior directly affects transaction costs. The typical plan provider charges additional fees for transactions such as withdrawals and loans. In the case of loans, there are charges for both loan origination and monthly maintenance (HR Investment Consultants, 401(k) Provider Directory).   Participant behavior selection of the investment instruments also drives the level of fees and expenses. To the extent that participants understand the investment management fees imposed on alternative investment choices (mutual fund expense ratios, for example) they have the opportunity to influence the amount of expenses that will be charged to their accounts. This does not suggest that the rational choice is always the lowest cost fund.   The participant's selection of actively managed versus passive investments will have an effect on investment management fees. The average expense ratios for particular fund categories encompass wide ranges from low to high expense ratios across individual funds (Fortune, December 23, 1996).   One key factor in this wide range of expense ratios is the notable difference in expense ratios generally observed between indexed (or passive) funds and actively managed funds. In an indexed fund, the investment manager seeks to maintain a portfolio closely tracking an appropriate market performance indicator. For example, a U.S. large company stock fund might be benchmarked to the Standard & Poor's 500; a small company stock fund to the Russell 5000; an international stock fund to the Morgan Stanley EAFE (Europe, Australia, Far East) Index. Other fund categories have similar benchmarks meant to capture the overall performance of particular segments of stock and bond markets. In actively managed funds, the investment manager expends more costs on research, investment selection, and buying and selling.   Similarly, the choice of equity versus fixed income investments affects expenses. Inspection of mutual fund expense ratios reveals that bond fund expenses are significantly lower than are those for equities (Sheets).   3.5.4. PORTFOLIO TURNOVER Portfolio turnover is another factor affecting expenses. Higher portfolio turnover increases the transaction costs of buying and selling the individual securities in a mutual fund or other investment account. These transaction costs are not usually separately identified but are netted with the investment return, so it is difficult to observe them. Portfolio turnover results from decisions made by the investment manager, and is not under the direct control of the plan sponsor nor of the participants. However, portfolio turnover is often disclosed in the case of mutual funds and thus is indirectly controlled by sponsors and participants who select certain investment options in spite of the knowledge that the managers of that option are active traders. Portfolio turnover is an issue that should be considered by plan participants in choosing between actively managed and passive investments, as discussed in the preceding section.   3.6. WHO PAYS 401(K) PLAN FEES AND EXPENSES?   The evidence shows that the largest element of expense for 401(k) plans is the investment management fees that are imposed principally as expense ratios in the case of mutual funds or as wrap fees imposed on assets in group annuities. It has been shown that investment management fees typically range from 75% to 90% of the total administrative fees and expenses imposed on a plan. The participants in a typical plan bear the mutual fund expense ratio and annuity wrap expenses.   Recent surveys provide information showing that, apart from the investment management fees, participants are bearing a substantial fraction of the costs of administering 401(k) plans. Plan participants are more likely to pay non-mutual fund/group annuity investment management fees, while plan sponsors are more likely to pay other fees and expenses. Buck Consultants report that, in 51% of plans surveyed, participants paid all of the investment management fees; while sponsors shared in these fees in 19% of plans. The Profit Sharing/401(k) Council of America survey indicated that in 62% of plans participants paid all of the investment management fees. Hewitt Associates reported that, in 1997, participants paid 56% of non-mutual fund investment management fees.   The opposite is the case with administrative fees (non-investment management fees). RogersCasey reports that, on average, 54% of plan sponsors pay all of these administrative fees, while 28% share these costs with participants. Larger plans (>10,000 lives) are more likely to shift administrative fees to participants. The Profit Sharing/401(k) Council of America survey results mirror these findings.   The following table shows the results of a 1997 survey that asked plan sponsors how administrative fees and expenses are paid.   Table III-1 Who Pays Plan Expenses?   Percent of Plans1   Participant Employer Shared Pays Pays Expens e   Audit fees 24% 73% 3% Internal administrative staff compensation 4% 93% 3% Employee communication 14% 75% 11% Investment education: Seminar/workshops 9% 83% 8% Other media 10% 82% 8% Non-mutual fund investment management fees 56% 39% 5% Legal/design fees 9% 85% 6% Recordkeeping fees 35% 58% 7% Trustee fees 40% 55% 5% Other administrative fees 24% 61% 15% (Source: Hewitt Associates, 1997) 1 (441 plans reporting)     The trend in recent years has been for plan sponsors to shift administrative and non-mutual fund expenses of the plans to plan participants (Hewitt Associates, 1997). The following table illustrates this trend.   Table III-2 Plan Expenses Paid by Participants Only   Percent of Plans1   1991 1993 1995 1997 Survey Survey Survey Survey   Audit fees 16% 17% 18% 24% Internal administrative staff compensation 4% 3% 4% 4% Employee communication 5% 10% 10% 14% Investment education: Seminar/workshops -- -- -- 9% Other media -- -- -- 10% Non-mutual fund investment management fees 44% 50% 56% 56% Legal/design fees 9% 7% 10% 9% Recordkeeping fees 22% 27% 29% 35% Trustee fees 27% 32% 33% 40% Other administrative fees 14% 17% 18% 24% (Source: Hewitt Associates, 1997) 1 (656 plans reporting in 1991; 486 plans reporting in 1993; 429 plans reporting in 1995; and 441 plans in 1997)   Another survey research study conducted over a four year base yielded comparable results. Table III-3 displays the results of this study.   Table III-3 Plan Expenses Paid by Participants Only   Percent of Plans1   1992 1994 1996 Survey Survey Survey   General Recordkeeping 11.6% 13.1% 22.0% Compliance 10.4% 8.9% 12.3% Communications 5.2% 8.8% 13.8% Asset Management 35.8% 34.4% 53.9% Investment Education 18.7% Loans 46.4% (Source: Spencer Associates, 1996) 1 (229 plans reporting in 1996)   The evidence that there is a trend to shift expenses from plan sponsors to plan participants is reinforced by a survey conducted in 1996 that asked plan sponsors to indicate their intentions for the future. This survey indicated that a modest but significant number of respondents intended to pay a lower percentage of such fees in the future. Table III-4 displays the results of this survey.   Table III-4 Future Payment of Administrative Fees   Percent of Plan Sponsors   Participant Employer Shared Pays Pays Expens e In 1996 in 1996 in 1996   Company will pay a higher percentage of fees 1% 0% 2% Company will pay a lower percentage of fees 7% 15% 24% Company will pay the same percentage of fees 91% 85% 73% Number of respondents (82) (245) (128) (Source: RogersCasey)     3.7. ARE PLAN SPONSORS AND PARTICIPANTS ADEQUATELY INFORMED ABOUT FEES AND EXPENSES?   The adequacy of the disclosure of fees and expenses to both plan sponsors and participants has been introduced as an important issue. (This was the focus of the public hearing held by the Department of Labor on November 12, 1997.) It is clear from evidence in the literature that not all investment products disclose the fees and expenses charged to a 401(k) plan, nor are all of the fees and expenses charged by service providers disclosed. For example, we have demonstrated that the fees imposed on stable value accounts are not usually identified and that other charges, such as sales fees, are often not disclosed. Adequate disclosure of fees and expenses should be important to sponsors as they select 401(k) service providers and monitor their performance. The disclosure of fees and expenses is also important to plan participants as they select among available investment options. ERISA charges DC plan sponsors with a fiduciary responsibility to act in the best interests of the plan participants. This implies that plan sponsors will know the costs of the services they procure and will apply due diligence to minimize these costs in the light of the level of services desired.   There is evidence, however, that there is a lack of information about costs that may affect the level of some administrative fees and expenses. A Dalbar study in 1992 shows that 78% of plan sponsors did not know how much their costs were, largely because there are about 80 different ways in which vendors charge fees (Benjamin). Some observers have suggested that some plans absorb as much as 100 basis points in higher fees and expenses presumably due to ignorance about the extent of fees being charged (Butler, November 12, 1997). The logic supporting this assertion is that, absent knowledge of the fees and expenses, many plan sponsors will select a higher cost provider than would be selected with detailed cost information.   The existence of such a large number of service providers suggests that competition in the marketplace should serve to minimize 401(k) plan fees and expenses. However, some observers believe that sponsors are not especially price sensitive in their purchasing decisions (Butler, November 12, 1997). Perhaps this is due to a lack of knowledge about the total fees and expenses being assessed. It also appears that some segments of the market are more efficient than are others. It is asserted, for example, that competition makes the market for large corporation plans very efficient (Barry). However, a valid distinction can be made between competitiveness in the market for services to large and small plans. This suggests that smaller plans do not benefit from this price competition (Cronin).   Another issue related to whether sponsors need a greater disclosure of fees and expenses is the costs of the many plan features that are now characteristic of a typical plan. More services are being provided to plan participants today than was the case ten years ago — indeed — many did not exist ten years ago (interactive voice response systems, for example) (Saxon). The provision of these services is driven by demand. A valid question is: if participants knew how much optional features of their plans cost, would they demand so many (O'Brien). In a recent study conducted on the Internet, 85% of the 1000 respondents voted for greater investment returns versus more services from their plans (Butler, November 12, 1997).   The imperatives for a greater disclosure of fees and expenses to participants are less clear. In one opinion, given in testimony at the public hearing before the Department of Labor on November 12, 1997, additional information would not benefit plan participants (Barry). They have one of two choices to make among the inventory of options offered by their plan. These decisions are yes or no for each investment option, and all they really need to know is now disclosed including historical rates of return and investment objectives. This argument would be much more persuasive if the evidence showed that plan sponsors have complete knowledge of fees and expenses and are acting responsibly on this information to minimize costs.   An opposing view is that employees deserve the same access to information that the plan sponsors should be receiving when they select plan providers and investment vehicles. This argument starts from the construct of the DC benefit and especially of 401(k) plans in relation to an employee's retirement income security. Responsibility has been placed on employees to direct their own investments and to assume the risk of making bad decisions. Thus, they are entitled to all of the relevant information bearing on these decisions (Fink). Another factor arguing for the disclosure of information about plan costs to participants is that they have influence on the decisions of the plan sponsors in many firms. This influence may be exerted through employee advisory committees, their bargaining units, or through informal channels of communication. Thus participants deserve access to the information they need for informed participation in the sponsor's selection process.   ERISA requires that participants receive information about the amount of fees and expenses charged against their plan in the summary annual report. In addition, plans are encouraged by section 404(c) (the ERISA safe harbor provision) to provide full disclosure of fees and expenses. However, except for investments covered by the Securities Act of 1933, for which a prospectus must be furnished to participants, there is generally no requirement in the law or Federal Code for a complete disclosure of investment expenses to plan participants (Fink).   The disclosures required by plans seeking to comply with section 404(c) do not always display the full range of expenses charged to participants. Only that information relevant to the participant's capability to make rational choices among the investment options must be included. Thus, items such as the wrap fee and internal computations of the net asset values for stable value accounts would not necessarily be disclosed.   What do the stakeholders in the 401(k) universe think about the adequacy of available information about fees and expenses? Testimony before a public hearing held by the Department of Labor revealed differing perspectives on this issue by industry and advocacy group representatives. The mutual fund industry appears to be solidly for a full disclosure of all fees and expenses to both plan sponsors and participants (McNabb; Fink).   The Vanguard representative presented a model for a disclosure format that would appear to be acceptable to the mutual fund industry (McNabb; Fink; Tiemann). However, the industry's position on disclosure may be somewhat self- serving. The Securities Act of 1933 already requires them to disclose their administrative and investment management fees in a prospectus. Therefore, under current law, they are somewhat at a competitive disadvantage because they are subject to more stringent disclosure requirements than are insurance and bank investment products that are not similarly regulated and whose fees and expenses are often concealed in the net asset valuation computations. The Vanguard model disclosure would combine the asset-based, census-based, and itemized expenses into one "all-in" cost expressed as an expense ratio on total plan assets (McNabb). (This model disclosure is included in Appendix B, where several such models are displayed.)   Representatives for the banking industry stated their support for adequate disclosure of information about fees and expenses but believe that such information is now available (Barry; Dudley). Strong sentiment was expressed that no actions should be taken to mandate what fees and expenses could be charged (Barry). Such an action would disrupt the structures that have been created to service the 401(k) industry. There was additional comment opposing the establishment of mandatory disclosure requirements (Barry; Saxon).   The insurance industry was underrepresented at the hearing; the one insurance firm offering testimony operates in a niche market that offers mutual fund products wrapped in a group annuity to mostly small plans (Ryan). Anecdotal evidence was offered that some insurance companies would object to changes in their disclosure procedures that would separately identify their fees and expenses, such as distribution and M & E fees incorporated in the annuity wrap fees, to plan sponsors or participants (Butler, November 12, 1997; Snyder; Schultz).   Testimony from individuals representing participants in 401(k) plans strongly advocated the need to provide participants with detailed information on the fees and expenses being charged against their accounts (Benna, O'Brien, Snyder).   SECTION IV   COST ANALYSIS FINDINGS     4.1. INTRODUCTION   Systematic and reliable measurements of the fees and expenses incurred by 401(k) plans and their participants are difficult to establish. Within the 401(k) plan universe, the mechanisms through which recordkeeping and administration services are delivered, the manner in which expenses are charged for those services, and the expenses associated with the management of plan investments all vary widely. Additionally, there are difficulties in measuring the differences between the total expenses involved in administering plans and the expenses actually paid by the plan participants.   Most 401(k) plans purchase all or most of the essential plan administrative services from external providers, or alliances of multiple providers. For such plans, there are some data available regarding the structure and level of the fees quoted by the providers. However, at least three factors restrict the use of these data in this research effort.   First, complete quantitative documentation of the major service providers' fee structures is not available for this study. A limited sample of fee structures was presented at the Department of Labor's public hearings (Valletta, November 12, 1997).   Second, providers' fee quotes may reasonably be regarded as typical "asking prices" within the 401(k) marketplace. They do not necessarily reflect the actual "buying prices" that emerge after negotiations between plan sponsors and the providers.   Third, many plans purchase some plan services from outside vendors, but provide other services using internal staff and resources. While there is some limited survey data suggesting which types of services are more likely to be provided internally, there is no systematic basis for identifying the expenses incurred in doing so.   Another major difficulty in assessing the types and levels of major plan expenses results from the wide variations in products and fee structures. Two examples are particularly noteworthy. Providers may offer identical arrays of plan services – investment management, recordkeeping, loan administration, trusteeship, and so on – under very different fee arrangements. For example, one provider may offer comparatively low investment management fees, but charge separate and additional fees on a per capita or per transaction basis for all other services. A second provider may offer many administrative services at no charge, but generate revenue to finance these services by charging comparatively high investment management fees. As a result, it is difficult to establish benchmarks for individual fee components.   Information reported by plan sponsors on Forms 5500, 5500-C, and 5500- R provide a measurement of some of the plan expenses that are charged against plan assets. Here however, there are significant uncertainties about the significance and implications of the data. First, the expenses reported on the Form 5500 do not include investment management expenses debited directly from the earnings that accrue in participants' accounts. Depending on plan size and participants' asset levels, these "hidden" fees may comprise 75% to 90% of