Longboat Retirement Solutions LLC

The Big Loophole in the DOL Fee Disclosure Regulations October 28, 2012

BY: Chris Tobe, CFA October 26, 2012


401k fee disclosure has a big loophole in one of the largest asset classes. Stable value, or

guaranteed funds, typically constitute 10-40% of assets in most 401(k) plans and have varied

and complex structures which complicate fee disclosure. Billions of dollars in what I call spread

based fees remain undisclosed under the new DOL fee disclosure rules.


Last month I saw my wife’s statement from Lincoln. It showed the stable value or fixed

product with 0% in fees, when I know they may make as much as 2% or 200 basis points (bps)

in spread profits based on my nearly 7 years experience as an officer of insurance companies. I

was recently quoted in the Wall Street Journal’s Marketwatch “These excessive profits, even if

called spread, act like fees and are used like fees,”


Insurance companies are manipulating loopholes for excessive profits. While they may

disclose some fees, it may only tell 25% of the story as they make the majority of their profit on

the spread. Even if the DOL continues to ignore this loophole I believe their hidden spread

fees will probably put them in danger of class action lawsuits. In addition they continue to pay

commissions out of the hidden spread which drive even more sales.


Currently if the insurance lobby gets their way these higher risk and higher fee bundled

products will appear to have lower fees (and higher returns) compared to a diversified

low risk low fee product, like the Vanguard Stable Value collective trust. In this scenario

an advisor with an insurance license can get a kickback in commissions for a product he can

show is DOL approved with higher yields and no fees.



We need to look more closely at the loophole that the insurance companies are using. “ The

preamble to the participant-level disclosure regulation provides that designated investment

alternatives with fixed returns are those that provide a fixed or stated rate of return to the

participant, for a stated duration, and with respect to which investment risks are borne by an

entity other than the participant (e.g., insurance company). 75 FR 64910”.


I believe insurance companies are twisting and manipulating this rule.

I believe that the intent is to exempt a traditional GIC which functions like a bank CD, 3% rate

for 3 years that is sold in a competitive bidding environment. For example Vanguard in their

stable value plan has had a 20% allocation to a diversified basket of traditional GIC’s. When

they purchase a GIC which is never over 5% of their total holding they go to 5 or more insurance companies and get bids to get the highest rate for a GIC of say 3 years. This process

eliminates the excessive fees and the diversification eliminates excessive risk. Vanguard

discloses a management fee, but does not add any additional fees for the internal spread of insurance company.


Insurance company General Account products are usually part of a bundled arrangement.

There is no competitive bidding so they essentially set their own rates and their own profits

without any disclosure. Historically they have been allowed to vary their rates at the will of

the insurance company depending on their thirst for profit. However, I think in their attempt to

manipulate this loophole they will try to keep rates more constant to appear to fit the exemption

which states fixed or stated rate of return. The other qualification for the exemption is a

stated maturity or duration, and none of the insurance products I have seen do this and should

be eliminated from exemption based on that alone.


The insurance industry and its lobbyists have this spin on the loophole. “For general account

products or fixed income products, the Department of Labor (DOL) acknowledges that for a

product with a stated rate of return and term, it is not pertinent to have some type of expense

ratio related because the real driver of income is the rate being offered” I have never heard

this directly from the DOL, but neither have I heard them deny it. Again I think this applies to

diversified product in a competitive bidding situation, not in a captive bundled product.



One of the reasons this loophole exists is because the vast majority of the largest plans

abandoned insurance products for their liability, risks and excessive hidden fees 10 to 20 years

ago. To understand this I think it is helpful to split the $4.5 trillion 401(k) market.

The top $3 trillion (68% of assets) is large fortune 500 type plans account for only 1% of the

plans and for the most part do not use single entity general account products iv However the

bottom $1.5 trillion is spread over 650,000 plans (99%) ranging from small Dr’s offices to midsize

manufacturers. The battleground for fee disclosure will be in bundled insurance company

products in small to midsized plans.


The financial crisis allowed some room for growth of these products to some larger firms as

reported in the Wall Street Journal in May 2010. Amid the shortage of wrap insurance, though,

some firms are seizing an opportunity to reintroduce older types of stable-value products that

are backed by a single insurer and carry considerable risks. OneAmerica Financial Partners

Inc.’s American United Life Insurance Co., for example, last month launched a stable-value

product backed by its own general-account assets. In such products, investors are taking on the

risk that this single issuer could go belly up.


In 2008 Federal Reserve Chairman Ben Bernanke said that “workers whose 401(k) plans had

purchased $40 billion of insurance from AIG against the risk that their stable-value funds

would decline in value would have seen that insurance disappear.” 


Many investment professionals believe that a plan sponsor is taking a severe fiduciary risk by having a single contract with any one entity such as AIG. The only counter to this relies on assuming that the

single insurance company backing the stable value option is too big to fail and has an implied government guarantee which is problematic on its face.


The National Association of Government Defined Contribution Administrators,

Inc. (NAGDCA) in September 2010 created a brochure with this characterization of general

account stable value that got beyond the high risks and right to fee disclosure. “Due to the fact

that the plan sponsor does not own the underlying investments, the portfolio holdings,

performance, risk, and management fees are generally not disclosed. This limits the ability of

plan sponsors to compare returns with other SVFs [stable-value funds]. It also makes it nearly

impossible for plan sponsors to know the fees (which can be increased without disclosure) paid

by participants in these funds—a critical component of a fiduciary’s responsibility. It is hard

to comprehend why the DOL lets these products escape disclosure.



1. High hidden stable-value spread fees are subsidizing administrative costs.

Revenue from general and separate account stable value options have typically

subsidized administration costs, making some participants pay higher

administration costs than those in mutual funds, and making products appear

competitive in requests for proposal that look at per head administrative costs.


2. Fees and commissions are not being fully disclosed. Insurance companies are

still fighting not to disclose any spread profits. These excessive profits, even if called spread,

act like fees and are used like fees. Commission kickbacks to consultants with insurance

licenses are common in plans with general and separate account stable value.


3. The structure creates a higher level of fiduciary duty for vendors and risks for plans. Since

general and separate account stable-value assets are on the balance sheet of the insurance

company, this creates an inherent conflict between the fiduciary care of pension investors and

company shareholders. If the firm needed more income they could get it by lowering rates paid

to plans since they are in captive non-bid bundled arrangements.


Most stable value products (IPG) provided in bundled insurance company products do not fit

this exemption in my opinion since its fixed rate is variable and the duration is variable. If the

DOL continues to listen to the insurance lobby higher risk and higher fee bundled products will

appear to have lower fees (and higher returns) compared to a diversified low risk low fee product like the Vanguard Stable Value collective trust.