New York Financial Services Regulator Starts Investigation of Annuities in 403(b)s

There have been several reports, starting with a Wall Street Journal article, announcing that the New York State Department of Financial Services is planning to investigate sales of annuities in the 403(b) retirement plan market.

403(b) plans were limited to investing in annuities until 1974 when the Employee Retirement Income Security Act (ERISA) allowed for investing in custodial accounts, permitting the plans to use mutual funds as investments. IRS regulations passed in 2007, requiring more plan sponsor involvement in their plans, led many 403(b) plan sponsors to move to a new model, reducing the number of vendors (or recordkeepers) used by the plan and stopping new investments in annuities. However, annuities still exist in the plans by legacy vendors since they are individually owned and require plan participant direction to move funds and often participants are charged surrender fees. The market segment that still most uses annuities for plan participants is the K-12 403(b) plan market.

The Wall Street Journal reported October 2 that the Department of Financial Services sent letters to a dozen major insurers requesting information about their sales practices. It is looking into whether agents are engaging in deceptive and unfair sales practices, such as failing to appropriately disclose product costs and merits.

403(b) plans governed by ERISA already have a duty to disclose fees and conflicts of interest. However, non-ERISA 403(b)s, such as those in the K-12 education market do not have these duties. In 2017, Connecticut passed a law requiring non-ERISA 403(b)s to disclose the fee ratio and returns, net of fees, for each investment offered to participants. It also requires service providers to disclose conflicts of interest. Connecticut decided to pass the law after Connecticut teachers regretted investing in certain products without being informed of fees and other charges.

The traditional design of 403(b) plans, allowing vendors to meet individually with participants to set up annuities resulted in many plans having an unwieldy number of vendors associated with the plan. Industry sources argue that not only is this administratively difficult for plan sponsors with the new rules for plan oversight, but it is more costly for participants, as mutual funds are a cheaper investment.

Plan sponsors cannot force participants out of annuities, but since the 2007 regulations, some K-12 403(b) plan sponsors have pared down the number of approved vendors for their plans or consolidated into one. However, some state laws, including a recent one in Pennsylvania, prevent a single-provider model for K-12 403(b) plans.

There’s been a tug of war, of sorts, over the best design for K-12 school district 403(b) plans, but some say they should strike a balance between old and new.

Sources cited in some news articles about New York’s investigation into sales of annuities in the 403(b) retirement plan market say it’s a positive step that will benefit plan participants. And, with New York being an influencer, some say it will prompt other states to do the same.