Can existing 403(b) providers survive in the ERSA market?

[Guest Yanikoski]

I am wondering what is going to happen to 403(B) product vendors if the Bush proposal passes. The write-ups I have seen so far say that ERSAs will be modeled on 401(k) plans. I have not seen any specifics on the funding mechanisms, though.

If taken literally, the 401(k) model would mean that ERSA accounts would no longer be owned by participants, as 403(B) accounts usually are. Therefore, it seems to me, just as the insurance companies lost the 401(k) market in the 1980s, they will lose what is currently the 403(B) market in the coming decade (if not in the coming 6 months!!).

Conversely, if ERSA funding was left flexible so that, say, at the election of the employer, the funding could be EITHER via individual accounts OR via trusteed 401(k)-type funds, there could be open competition not only in the public school and not-for-profit markets, but in the current 401(k) market as well.

As always, the devil is in the details -- and this is no minor devil!! Any insights out there on how this might play out?

[Demosthenes]

I do not believe that the creation of ERSA's will have a major effect on the 403(B) space.

My reason for making this statement is that the root of the problem seems to lie with States, Counties, School Districts etc. who specify the permissable vendors or who make it unrealistic for most vendors to compete for participants.

The 403bwise.com site has devoted a lot of time and effort to this issue and is an excellent place for additional information and opinions that, I'm sure, are much more informed that mine.

[MWeddell]

Of course, this discussion assumes that the Bush administration savings plan proposal becomes law.

The providers who have specialized in 403(B) plans will face increased competition. Boundaries between 457, 403(B), and 401(k) markets will no longer formally exist, so it'll be easier for providers who have specialized in 401(k) plans to compete for what used to be 403(B) plans. The investment restrictions that apply to most 403(B) plans (only mutual fund custodian accounts and annuities) will be gone so medium and large plan sponsors should gradually demand diversified stable value funds for their low-risk options, not undiversified guaranteed accounts offered by providers. The legal rules creating an incentive for multiple 403(B) providers will disappear. Grandfathering old providers may not be allowed if Treas. Reg. 1.401(a)(4)-4 applies to 403(B) plans without something like Notice 89-23 preventing this. Elimination of average benefit testing for defined contribution plans may cause some additional plan consolidations and provider movements among larger employers.

However, these changes will be gradual. The cultural legacy of having providers on site often (because they used to have to compete for assets at the participant level not the plan sponsor level in multiple provider 403(B) situations) won't disappear overnight. We'll finally have a fair race between the high-touch high-cost approach versus the low-touch low-cost approach. Obviously, only a small portion of the plan sponsors will select new providers each year and of that group, many will continue to prefer the high-touch approach. Furthermore, assuming that there's nothing in the bill that gives the plan sponsor the right to transfer assets for what previously was regarded as non-ERISA 403(B) assets, a plan sponsor essentially has a start-up plan and won't immediately be an attractive prospect for a low-cost approach provider.

[mbozek]

The 403(B) providers that have a strong brand identification and provide superior performance will continue to dominate the 403(B) market by generating customer loyalty. 401(k) providers frequently have a difficult time in the np market place because they charge fees for routine services which are absorbed by the larger 403(B) providers. Also the door swings both ways- the 403(B) providers will be able to offer the trading of securities and stable value funds to 403(B) participants on the same level that the 401(k) providers do. There has been no indicaton that the selection of 403(B) providers for np will not be subject to the same ERISA restrictions for prudent investing that exist now which will allow denial of access to inefficient or expensive providers. In the public market most state ORPs already allow the same financial families that provide 401(k), 403(B) and 457 plans to compete for employee accounts so there will be no change in access. Also the largest 403(B) providers are already in the non 403(B) market place throughout the country through designation as state 529 plan providers to take advantage of the state tax deduction and they now will be able to cross sell to their customers who are participants in qualified plans. I would expect that some 403(B) wrinkles will continue such as the 5 year catch up for making an additional $3,000 contribution although it will be of interest to a smaller group of participants.

The largest 403(B) providers will be positioned to invade the qualified DC plan market because the regulatory playing field will be the same for all plans if they can provide superior service at a lower cost. Some will provide free retirement planning services to participants. What will happen is that there will consolidaton as the lower tier 403(B)/401(k) providers leave the market or are acquired because they cant compete on the same economies of scale for all customer financial assets as the larger providers in the same way as banks and brokerages houses have combined in the last 10 years (e.g., MHT +Chem. Bank+ Chase + JP Morgan = #2 US bank). The winners will the providers who can gather the largest amount of financial assets of all types.