Monday, August 27, 2012

PRPP Costs (Redux)

A while back I was trying to figure out if PRPP rules would permit PRPP administrators to offer inducements to employers at the expense of plan participants. The idea was to determine whether employers are likely to choose administrators who offer the employees the best deal or whether the choice would be based on the best kickbacks flowing to the employers.

Shawn Patton pointed me to recently published PRPP regulations. Here are the sections on permitted inducements and low cost requirements:

19. An administrator may give, offer or agree to give or offer to an employer and an employer may demand, accept or offer or agree to accept from an administrator, as an inducement to enter into a contract with the administrator in respect of a PRPP
(a) a product or a service on more favourable terms or conditions than the administrator would otherwise offer if the inducement is for the equal benefit of the employees of that employer who are eligible to be members of the PRPP; or
(b) in relation to a transfer of assets into the PRPP administered by the administrator, an amount no greater than the employer’s costs associated with the transfer of assets into that PRPP.


20. The following criteria shall be used to determine whether a PRPP is being provided to its members at low cost:
(a) that costs are to be at or below those incurred by members of defined contribution plans that provide investment options to groups of 500 or more members; and
(b) that costs are to be the same for all members of a PRPP.
Suppose that the costs incurred by defined contribution plans to groups of 500 or more members is 1.5% of participant assets each year, but that a PRPP could be run profitably at 1% per year. Suppose further that a PRPP administrator sets its “standard” costs at 1.5%, but then offers a special deal to all potential employers: we’ll kick back 0.25% to the employer and reduce the employees’ costs by 0.25%. This seems to meet the conditions in the regulations, but diverts half the cost reductions to employers rather than having plan members enjoy the full savings.

It’s not clear that the savings even need to be split. If the “standard” costs are set at 2%, could the PRPP administrator offer 0.5% to the employer and a 0.5% discount to employees? The actual costs to the employees would then be 1.5% per year even though the never-used standard cost level is set at 2%.

Note that if a low-cost PRPP administrator offered a competing plan at a cost of 0.75% per year, this would be the best deal for employees, but employers would have a strong incentive to choose a PRPP that offers a kickback.

Potential objections to this kickback scheme:

1. PRPP administrators and employers would never do such a thing.

Grow up.

2. What’s the big deal if a measly 0.5% goes to employers?

That 0.5% compounds year after year. Over the course of 40 years of saving, 0.5% per year drag would reduce total plan member savings by about 9%.

3. PRPP Administrators and employers couldn’t get away with this for legal or other reasons.

I want this to be true. Please explain why they can’t get away with this.


  1. One advantage of this is that smaller employers may get kickbacks but they wouldn't be the same scale of incentive that they would at a large firm.

    Say a company has 10 employees, each paid $50,000 on average, and they can put in 5% of their salary and have it matched by the company. That means that each year the total plan contributions are up to $50,000 ($25,000 provided by the employer). After 5 years this would add up to $250,000.

    0.5% of this would amount to an extra $1,250/year ($125/employee) going the employer, growing at $250/year ($25/employee). That's not even enough to make a dent in the employer matching. If there are indeed offerings that have lower fees for the plan members I would go for that to give them the most value (although they might not recognize it).

    Like everything related to employment it gets calculated into the total cost (which could still help employees when there are kickbacks), but here it seems too small to make a meaningful difference to the cost of hiring.

  2. @Simply Rich Life: I think you're missing the compounding effect of the 0.5%. Your numbers work for the first year, but that 0.5% applies to all savings every year, not just the new savings. So, the kickback the second year is roughly double, then triple the third year, and so on.

    Another thing to consider is that this kickback arrangement would make the PRPP marketplace competitive based on kickback size rather than participant costs. So, the PRPP administrators would end up charging higher net fees than they would if there were no kickbacks. In effect, the PRPP administrators would be taking extra money from participants and splitting it with the employers. This means that looking at employers plus employees collectively, they are worse off in a scenario that has kickbacks.

    Overall, I think that kickbacks would be very bad for employees, roughly neutral for employers, and good for PRPP administrators.

  3. Unless you're transferring a lot of assets into the plan or 15 years into it, it seems like anything fee-related will grow linearly for the first decade or so (or slightly faster if total payroll is growing). So after that, look out :)

    One thing I didn't consider is companies that provide an expensive plan but don't have a big enough kickback to match that gap. That could create a gap in fees that go directly to the manager, but any price difference that isn't returned in some form makes it less competitive. The choice between two providers with equal kickbacks but different fees should be clear unless someone really believes in the managers/marketing on one side.

    Of course anything going back to employees is good, and anything that is returned to the employer could still benefit employees because it makes it slightly cheaper overall to pay them.

    As you said a lot of employers probably won't make the right choice. Personally I wouldn't see such a kickback as a large amount unless the assets were into the millions, and even then it would be a small percentage of the ongoing payments unless the plan's been in operation for 15-20 years. I wonder if there will be a provider that restricts choices to index funds...