Managing Vendors and Vendor Contracting

By Gary R. Thornton, SPHR, CEBS

            !           Outsourcing can relieve you of the need for in-house staffing, but it will not relieve an employer or its plan administrative committee of fiduciary obligations under ERISA.

            !           Try to rely on outsourcing to serve a strategic goal of the employer (such as long-term cost cutting, or avoiding the need to hire in-house experts over the long run), rather than as a short-term fix to an urgent problem.  If you have engaged a vendor out of a desperate need to solve an immediate problem, you are less likely to make a decision that will work for the long term.

            !           Set up the internal systems necessary to oversee the vendor and designate the  employee(s) responsible for that task at the beginning of the process.

           

Selecting a Vendor

            Things to Watch For.   Selecting a vendor should be a competitive process - involving at least two or three vendors -  that will allow you to compare prospective vendors on the basis of available services, proven quality, and price.   At a minimum, each vendor should be able show/provide:

            !           A proven record of consistent, reliable performance

            !           Experienced, knowledgeable staff

            !           A record of timely and accurate preparation of management reports

            !           Capability to analyze the impact of new laws on your benefit plans

            !           Employee communication materials and assistance

            !           Eligibility determination and enrollment support

            !         Regulatory and compliance assistance (Form 5500s, nondiscrimination testing, etc.)

            !           Assurances of Y2K compliance

            !           A well-written proposal addressing the foregoing points

            Although price is often the deciding factor in selecting from among equally qualified vendors, the key to a successful vendor relationship goes beyond price.  Your vendor partner needs to be sensitive to your culture and your specific individualized needs and must be able to work well with the other members of your benefits support team (including accountants, attorneys, and others). The person or persons making the selection should review written proposals carefully.  If you can't understand the proposal, or if it isn't't well organized, that may give you a hint as to the quality of the vendor.  You may need to ask for follow up submissions to make sure you will be in position to compare the vendors on the same terms  (e.g., some vendors may build in the cost of quarterly reports while others build in the cost of monthly reports).  Finally, ask for references and call them to find out whether others have been satisfied with the quality of the vendor's work and its ability to work as part of their benefits team.

            Key Legal Issues.  The selection of an outside vendor by an employer or plan administrative committee to provide services to an ERISA plan is generally considered a fiduciary act, even if the vendor itself may not be considered a fiduciary.  That means that the individual(s) selecting the vendor must (at a minimum) follow the well-known "prudent person" rule that is the baseline for measuring compliance with fiduciary duties under ERISA.  ERISA also requires plan fiduciaries to (1) make decisions based solely upon what it is in the best interests of plan participants and beneficiaries, and (2) avoid self-dealing.  Thus, if an employer selects a sub-standard vendor because the vendor is owned by the spouse of one its owners, the employer may be exposing itself to a breach of fiduciary duty claim if the vendor's conduct causes the plan to suffer an economic loss.

            Remember, if a vendor makes a serious mistake that results in economic losses to an employer plan and/or plan participants, the employer will be held liable by the Department of Labor and Internal Revenue Service and will be blamed by the employees.  The fiduciary duties of an employer and plan administrative committee in selecting vendors and overseeing their work will be the focus of the legal issues discussions in this outline.

Contracting

            Things to Watch For.  The relationship between an employer and the selected vendor should be formalized in a written agreement.  Typically, the vendor will have a form of agreement that it will present to the employer.  Remember, the agreement is subject to negotiation even you are presented with an agreement that has already been signed by the vendor and even if the vendor tells you that the agreement is just a standard form.  The vendor should be willing to make reasonable modifications requested by the employer.  If it isn't, you sign the agreement at your peril because: (1) it may not accurately describe all of your expectations, and (2) that may indicate how responsive the vendor will be to your needs and any special requests during the term of the agreement.

            At a minimum, the agreement should set forth in clear terms the services to be provided to the plan(s), any deadlines by which particular services are to be provided, any specific duties of the employer, provisions addressing contract amendment and termination, and the fees to be paid to the vendor.  Sometimes the services and fees are contained on a schedule at the end the agreement.  Both parties benefit when the employer's expectations, and any limitations on the ability of the vendor to meet those expectations, are clearly stated.  Therefore, a more detailed description of services is better than a general description.  For example, a 401(k) plan recordkeeping agreement states that quarterly reports will be provided to participants.  But it would be even better for the agreement to require the recordkeeper to provide the reports within 30 days after the end of the quarter.  That way, both the employer and the vendor will know whether the employer's expectations are being met.  In most cases, time spent hammering out a good vendor contract should become time saved in handling misunderstandings down the road.

            As one might expect, vendor-provided agreements generally contain a good deal of self-serving language designed to protect the vendor.  Often, the vendor agreement will contain a specific disclaimer of fiduciary responsibility under ERISA.  Such disclaimers may be appropriate in the case of a vendor who will be providing very limited, ministerial services.  However, in the case of investment managers and other vendors who provide significant services that involve exercising authority or discretion over plan assets or benefits, such disclaimers are not appropriate (and may not even be enforceable).

            Key Legal Issues.  The substantive terms of the vendor service agreement will vary depending on the services being provided.  An investment management agreement for a 401(k) plan will have terms that are completely different from those of a COBRA administration agreement, and so on.  But at least one key term is common to almost all vendor service agreements -  the indemnification of the vendor by the employer against liability if certain standards of care are met.  The indemnification provision will be the one that the vendor is least likely to consider negotiable, but your attorney may be able to suggest ways to limit the scope of the indemnity that the vendor will find acceptable.  At a minimum, the indemnity should clearly state that: (1) it is not intended to relieve the vendor from any responsibility or liability that it may have under Part 4 of Title I of ERISA (which contains the rules regarding fiduciary duties), and (2) it does not cover any loss, cost, etc. arising solely out of the vendor's negligence, misconduct, or bad faith.  In analyzing the scope and effect of an indemnity provision, your attorney will also pay attention to another common provision, which states that the vendor is entitled to rely on all directions,  information, or data received from the employer.  Those provisions present their own set of issues - particularly in 401(k) investment management agreements that add instructions received from participants regarding the investment of their accounts - which go beyond the scope of this outline.

            One final note.  If the vendor's fees are to be paid - directly or indirectly - out of plan assets,  fiduciaries must bear in mind the limitations established by the Department of Labor for using plan assets.  At a minimum, fees must arise out of the administration of the plan and  they must be reasonable.  Plan assets may not be used to pay "employer" expenses even if they relate to the plan (such as the cost of establishing, amending, or terminating the plan).  Recently, the Department of Labor has increased its scrutiny of fees charged to 401(k) plans by plan service providers.  The Department takes the position that employers administering 401(k) plans have a fiduciary duty to know the amount of fees being assessed against their plans.  The Department has indicated (informally) that it will be increasing its scrutiny of fees charged to 401(k) plans by plan service providers, because it suspects that many employers are either oblivious to the fees being assessed or are allowing plans to pay fees for services that are never utilized.

Monitoring the Vendor Relationship

           Things to Watch For.  Using the service agreement as a baseline, the in-house human resources person(s) in charge of plan administration should regularly assess the performance of plan vendors.  Don't wait until participants begin to complain about slow claims processing, incorrect statements, poor investment performance, or other faulty service.  By then employees will have begun to loose faith in their employer's ability to administer its benefit plans and, in the worst case, will begin to actively look for problems in plan administration.  Review carefully all reports and statements that you receive from vendors to make sure that they are accurate.  Pay close attention to fee statements, particularly where fees are being paid out of plan assets.  In the case of investment managers, make sure that their investments are consistent with you written investment policy and then compare their performance against the performance of mutual funds or market indexes.  Someone in your company's finance department should be involved in the process.

            Key Legal Issues.  Here again, the key for employers and plan administrative committees is to take their fiduciary duties seriously.  It bears repeating that if an error is made by a plan service provider that adversely affects the plan or its participants, the blame will be laid at the feet of the employer.  As implied by the discussion above, fulfilling fiduciary duties under ERISA is primarily a matter of process.  If a committee interviews a number of vendors, investigates the background of the selected vendor, enters into a reasonable agreement, and monitors the vendors performance, that committee will be in a good position to defend a claim of breach of fiduciary duties in the event of a serious mistake is made.  The person(s) charged with monitoring the performance of a vendor should, if at all possible, have the necessary expertise to evaluate the vendor's work.  But at a minimum, vendors should be held to the terms of their agreements and vendors who consistently fail to meet an employer's expectations should be terminated.

            Several different types of insurance advisors are available to Human Resource professionals. They range from insurance agents to fee for service insurance consultants (not many of which are licensed in Maine).  Most employers that require assistance in accessing insurance markets enlist the services of an insurance broker.  A broker is someone who is capable of delivering insurance products from a wide variety of markets.  Brokers are to be distinguished from agents, who generally are allied (in one form or another) with one or more insurance carriers and provide access only to their products.  The remainder of this section will provide some tips about how to get the most out of your insurance broker or advisor.      

      What services should the broker provide?  The ability of your insurance broker to find the right insurance carrier for you and then negotiate a good deal on your behalf should be your minimum expectation. (If your broker can't deliver that, then you might as well have found your own carrier and selected an agent to access its products.)  A competitive bidding process should be used to assure that your quality and cost objectives are met.

            Cost is an important factor, but not the only factor in structuring your benefit program.  Value added services from the insurance broker are also necessary. Your insurance advisor should be able to provide analysis of your programs and costs, helping you identify "cost drivers" and alternatives so that you can make informed decisions.  A good insurance advisor should be able to provide at least some reliable guidance on regulatory matters and highlight major compliance issues, so you can factor that into your decisions on what kinds of benefits to offer.  Insurance advisors need to provide strategic thinking so that plan renewals and associated costs are anticipated, thereby eliminating the need to react hastily to large rate increases. Finally,  insurance advisors should provide human resources support in the areas of enrollment and communication, marketplace research and development, competitive benchmarking, and sound advice to management.

            Service contracts.  Depending upon the type of insurance advisor you select, you may need to sign a service contract.  A service contract can help you measure performance  and hold them accountable.  This agreement may also include performance clauses, which provide for compensation reductions or enhancements for service that falls short or exceeds expectations.

            Compensation.  As always, compensation levels for your insurance advisor should be agreed upon in advance.  Compensation often takes the form of commissions payable by the insurance carriers to the broker and disclosed to the client. In the case of licensed insurance consultants, compensation is often paid on a fee basis directly from the client to the insurance professional.

            Revisit your needs and your advisor's performance. Depending on the size, complexity, and changing needs of your employee benefit plans, the level of expertise and assistance required from your insurance advisor will vary and will change over time. You should reevaluate your service needs and your advisor's performance on a regular basis to make sure that your advisors are keeping up with your growth.