The new fiduciary standard mandated by the Department of Labor prohibits advisors from making recommendations that will cause compensation for their services to be more than “reasonable.”
This measure, part of the new fiduciary standard’s best interest contract exemption (or BICE), means advisors and others have to figure out how to best define reasonable compensation by April 10, 2017.
Some are likely to calculate an average or median compensation benchmark, according to Lou Harvey, CEO of the consulting and auditing firm Dalbar.
“This will inevitably lead to unlimited compression of compensation – death by benchmarking – for some parts of industry,” Harvey said in an interview with our sister site, ThinkAdvisor.
But there is another option – one that lets advisors used a cost-based strategy to earn their fees, which is what many lawyers, doctors and other professionals use. “This can insulate advisors from the fee compression,” he explained.
On Wednesday, Dalbar introduced the Profit-Based Pricing Model Calculator, which it says goes beyond “traditional assets under management pricing in which clients are charged an arbitrary basis point fee that is independent of the cost of servicing that client.”
Model in action
Instead, advisors can set fees for clients (and profits for themselves) based on the skills, costs, time, expense, overhead and risks of managing the portfolio.
“The calculator means you are leapfrogging over” benchmarks, according to Harvey.
Fee benchmarks under the new DOL rules haven’t emerged yet, he says. But they currently exist for the retirement plans regulated by the DOL’s 408(b)(2) requirement of 2012, which mandated that certain plan providers disclose compensation to fiduciaries.
Advisor who want to switch to a service-oriented pricing plan, Harvey says, would be moving in line with the new DOL rules.
“It’s like being a lawyer who charges $350 an hour vs. $250 and you can identify what you are doing for the $350,” he explained. “It is totally more transparent and enables you to raise fees to the level that is commensurate with what you do.”
Dalbar offered three examples in which advisors could offer different levels of service to clients and charge different fees. For a $1.5 million portfolio, the firm set up these three scenarios for advisors:
Low maintenance (entailing 10 hours of advisor time per year) with an associated yearly fee of $6,660, 0.44 percent of AUM or 44 basis points;
High maintenance (40 hours per year) for $31,279, 2.09 percent or 209 basis points:
High service for ERISA plan (20 hours per year) for $23,459, 1.7 percent or 170 basis points.
The calculator is now included in Dalbar’s training course on BICE, and a stand-alone version is planned for release later this year.
“There is no reason for advisors’ compensation to decline just to remain compliant. Section II(c)(2) requires ‘reasonable compensation,’ not benchmarked compensation,” said Cory Clark, DALBAR’s head of research and due diligence, in a statement.
The company’s calculator lets advisors account for the time and resources involved with providing services to clients and the basis for pricing they can present to clients, Clark adds.
“Implementing the [Dalbar] calculator makes every client profitable, replacing the current practice of having winners pay the way for unprofitable clients,” the company stated in a press release.