Reform School

The regulations governing 403(b) plans are poised to reinvent the defined contribution plans offered by tax-exempt entities such as K-12 school systems, higher education institutions, and nonprofits. Each of the three distinct employer groups has certain unique characteristics, with varying demographics, needs, and expectations. For advisers, the expanding 403(b) market represents a significant business opportunity, but it would be a mistake to assume blithely that you need only redirect your 401(k) practice to the tax-exempt space.

Old School

Of the 403(b) plan segments, the K-12 market, with its traditionally decentralized administrative structure, is arguably undergoing the biggest change under the imposition of new Internal Revenue Service regulations (see “403(b) aware,” PLANADVISER, Fall 2007).

In order to sell “into” this space, an adviser considering entering the K-12 market segment first needs to appreciate how these programs have operated traditionally. Linda Segal Blinn, Vice President, Technical Services at ING, notes that, before the regulations, the K-12 market was different from the rest of the 403(b) world. It was effectively a free-for-all where employees had one-on-one relationships with, in some cases, just about any provider with which they were inclined to do business. Providers—more precisely their adviser representative/advocates—would meet with the teacher/participants in the school cafeterias or faculty lounges, and sometimes outside the workplace, with very little interaction with employers, who primarily served to facilitate payroll deductions to the various providers.

Because of this one-on-one relationship with participants, many K-12 403(b) programs have had dozens, even hundreds, of plan providers. Chris DeGrassi, Assistant Vice President, Education Market at Security Benefit, a company with 67% of its business in the 403(b) market, adds that it also resulted in a broader scale of investment choices than the typical 401(k) plan, ranging from annuities to no-load mutual funds.

Due to their governmental employer tax-exempt status, these 403(b)s have never been subject to the Employee Retirement Income Security Act (ERISA) and, as a result, many of these plan sponsors have not been required to have, and thus do not have, a written plan document.

Traditionally, any 403(b) business for an adviser was referral-based, DeGrassi says. It also was individual participant-focused. As an example, he says a local adviser might have a client whose spouse is an educator and the adviser would recommend the 403(b) for additional savings to the couple. Marketing consisted of payroll stuffers, slips in teacher mailboxes or in teacher newspapers, or a benefit fair among current contacts, he notes.

In addition, K-12 403(b) plans generally have low participation rates, between 25% and 30%, according to Kevin Watt, Vice President of Business Development at Security Benefit. Of course, for many of those eligible to participate in a K-12 403(b), the plan is supplemental because teachers also are eligible for pensions, some of which also are employee-contributory. Since the 403(b) program was a voluntary supplemental savings program—a third leg in what for these partic­ipants is still a three-legged retirement preparation stool—there has not been a real plan sponsor push behind participation.

Partially because of this supplementary status, DeGrassi adds that, especially in the K-12 segment, employer contributions rarely are used as an incentive for participation. Employers frequently already are making pension contributions for these participants.

Another segment difference is unions, which have a bigger presence in the K-12 market segment than in other 403(b) markets. Union politics with school boards and providers have great influence on plan decisions, plan design, provider offerings, and participant perceptions of providers, notes William Beale, Director, Henderson Brothers Retirement Plan Services, which has about $60 million in 403(b) plan assets, about 80% of which is through K-12 plans.

Beale’s colleague, Peter J. Valotta, adds that plans in the K-12 market lack trustees, so, with no decisionmaker or CFO, it is very difficult to lead a change for a better benefit throughout the organization. In addition, Valotta says union employees have a sense of entitlement that they have the power to dictate how a plan is administered with little reasoning or support, and they usually assume a change without union input would reduce the benefit.

New School

In that these programs are less likely than other 403(b) sponsors to have a written plan document in place, one of the biggest issues for the K-12 segment has been complying with the new IRS rule that it be in place by the end of 2009, Segal Blinn says. In order for school districts to adopt a plan, they must get authorization from their school boards. Segal Blinn says ING is hearing from the IRS that it will be looking to see if proper authorization was acquired in audits, investigations, and compliance checks. K-12 districts are, therefore, looking for specimen plan documents which are being made available now by providers, she notes.

In addition, Segal Blinn points out that K-12 school districts do not usually have a dedicated human resources (HR) department or contact, so an adviser most likely will be dealing with the school business official who is in charge of not only benefits, but also purchasing, transportation, and other tasks. As a consequence, she says school systems will now look to advisers for help with juggling tasks and providing knowledge.

An adviser should partner with a product vendor that not only offers quality investment products, but also provides administrative support, suggests Segal Blinn. For example, ING offers planwithease.com, which can assist sponsors with: review and approval of participant requests for loans, hardship withdrawals, and qualified domestic relations orders; transfer of assets between plans or contract exchanges among investment providers; annual notification about the plan and how employees can contribute to the plan; and annual contribution limit monitoring. The Web site also can assist participants with complete salary reduction agreements online; salary reduction contribution changes for each investment provider; and initiating withdrawal requests and receiving the required approval of those requests.

Watt says advisers will see many changes in the K-12 market segment going forward. Under the new regulations, the employer will have more responsibility and greater oversight for the plan, and that is expected to result in a reduction in the number of providers for most plans (see “Failing Grades,” below). That could set in motion a new wave of competition for those fewer slots and, while that could squeeze some advisers out, it also could provide a greater opportunity for qualified advisers to expand their reach. Additionally, with new, and perhaps different, fund choices, and with a new structuring likely to accompany the new document requirements, advisers certainly will find themselves with additional education opportunities.

Advisers to 403(b) plans will no longer be salespersons as before, but now will have an opportunity to be both a consultant and educator to the participants, providing information to make reasonable decisions and choices, according to Watt. New adviser business models will be developed to keep a thriving business, and to keep a business thriving.

On the participant level, Beale says, there will be much facilitation going on at first. Participants will need help getting their money into the new plan. Afterward, advisers can do education, he says.

Watt asserts that advisers will see over a period of time that, under the new environment, 403(b)s will become more of a mainline savings vehicle than ever before. Simplicity may be an incentive to participate, he says, because teachers now will have more clarity about what the 403(b) is, and there will be more reasons for school district employers to show the benefit of the 403(b) plan.

David Hinderstein, President, Strategic Retirement Group, an NRP member firm, with 80% of its business in the tax-exempt employer market, agrees there will be a shift in the marketplace. Although there still will be advisers representing products, now districts will need an adviser who does not necessarily provide any particular products but can serve in an administrative or consultative role. Hinderstein also says larger school districts or consortia will get together to share an adviser instead of each hiring its own, noting this has already happened in Florida and Oklahoma. For example, in Florida, a coalition of K-12 education associations developed a 403(b) Model Plan for educators through a partnership with Gallagher Benefit Services.

The 403(b) adviser’s role may emerge over time from a represen­tative for a particular product to match that of advisers to 401(k)s who consult on investments and TPA choice and take on fiduciary responsibility, Watt says. For this reason, an adviser should be aligned with a provider or providers that can meet the needs of clients or they may be pushed out, he warns.

Adviser Advice

According to DeGrassi, when evaluating a new business line, the first thing advisers should do is research the business opportunity. He suggests joining the national tax-sheltered accounts association to learn about opportunities, the capabilities of the best providers, and the role of advisers in these programs. With independent advisers, it is more important than ever before to have relationships and alignments with product providers; researching providers who meet the specific needs of the K-12 market segment is vital, he says.

Hinderstein suggests advisers enter the space with a solution that offers something different, whether an investment product or service product.

Advisers must understand that the role of unions and the decisionmaking process are unlike other market segments, Beale says; unions might not be responsible for hiring the adviser or provider, but they are a factor to contend with when an adviser pitches a solution for the plan. Instead of having a shortlist of those who need to be involved in final decisions, in the K-12 segment, there are multiple layers from which to gain approval, including those involved in the day-to-day operation of the plan, school boards, superintendents, and unions representing plan members. The adviser may have to repeat his proposal several times and, even after the new 403(b) model has been put in place, deal with the politics of a union.

Being an adviser to the K-12 market segment takes real commitment, Beale adds. There will be a lot of hand-holding at first, and actually getting assets into the plan can require involvement from advisers, both with the plan and with individual participants. Advisers should ask if they will take on the task themselves or if there will be a team. Beale says it will be very difficult for a single person to do more than just a couple of districts because of the amount of hand-holding required.

Valotta says that, in the past, advisers often were seen as predators taking advantage of employees with little experience in investing. “Many participants have had poor experiences and [advisers] looking to be successful should position themselves as knowledgeable, trustworthy, and honest,’ he suggests.

“If financially you can’t wait this out, it’s not for you,’ Beale says. He notes that the payback on that time investment can take time, but could pay off in millions of dollars in several years. As the K-12 segment becomes more sophisticated and more sponsors move toward a single vendor model, as is anticipated, the business will be easier for advisers. In addition, plans’ assets will grow as participation increases and participants move balances to new providers, he adds.

The payoff of getting in now will be establishing trusted relationships and establishing a reputation. Advisers that do will get referrals, from school districts they serve and possibly states, to new clients.

Segal Blinn adds: “The K-12 market segment has been well-versed in the implications of the IRS’s final 403(b) regulations, including the need for a school district to permit only those vendors that are approved to provide funding vehicles for the school’s 403(b) plan.” As school districts come up with that list of approved providers, advisers affiliated with those authorized vendors will have the access and the opportunity to provide services to their K-12 clientele.

As Watt says: “We are a strong believer that an adviser plays a very important role to participants in these plans, and an adviser who is educated on 403(b) rules has a strong relationship with a provider and who serves in a consultative role with sponsors in getting employees to participate will be in business for the long term in this space.’

Failing Grades?
Teachers, unions resist taking away 403(b) options.

Although the new 403(b) regulations have led many plan sponsors to pare their vendor roster, some are running into resistance from participants—and their unions. Teachers in New York, Maryland, and Virginia, among other areas, are pushing back against their administration’s efforts to limit their choice of 403(b) plan vendors or financial advisers.

For example, in the face of strong teacher protest in Newport News, Virginia, the school board decided last November to delay moving forward with an exclusive contract with Lincoln Financial Group as its 403(b) vendor, according to The Daily-Press in Newport News. The district previously had six vendors whose contracts expired in 2008. According to published reports, school employees inundated board members with complaints and threats to leave the district.

Similarly, in October, the Baltimore County school board voted to drop its plans to consolidate choices in light of protest from hundreds of employees and the district’s five labor groups. About 300 people gathered at the school system headquarters to protest the possible vendor program change, leading the board members to unanimously oppose the recommended contract, coincidentally also with Lincoln Financial Group.

Opposition to One Adviser

The consolidation of providers is not the only type of change that has run into opposition. In November, a union official in Utica, New York, informed the school board there that the union would try to block a decision on limiting school employees’ choice to that of a single recommended financial adviser.

Utica Teachers’ Association President Larry Custodero said the board’s recommended choice of Confidential Planning SmartChoice as the exclusive third-party adviser did not leave room for the union to have its say. Business Official Maureen Albanese recommended Confidential Planning because it would not charge the district for its services when other vendors would. The board was then forced to schedule presentations from other vendors before making a decision about what adviser to offer to teachers.

Although school boards may have the say ultimately, the unions are making their cases heard and union politics with school boards and providers will continue to have significant influence on plan decisions, plan design, and provider offerings. –PA

Illustration by James Yang