403(b) service provider issue

[Guest TroyRiley]

There is a company that has been engaged by a large number of California public schools to act as third party administrator for the schools' 403(b) plans. In order for the investment product provider (insurance company) to offer its products to these schools, the TPA is requiring that the provider pay the TPA a monthly participant fee. Is the payment of this fee a "rebate" in violation of state law or ERISA? Basically, you have to pay to play. Thanks for any input on this issue.

[Guest Yanikoski]

Others can weigh in with more authority than I on this issue, but unless the facts and circumstances of the case are more outrageous than you are letting on, I would be surprised if there is any legal problem.

Anti-rebating laws are intended to prevent payments in the OTHER direction: the product provider may not offer rebates to the client, in essence bribing the client to give business to the provider.

On the contrary, third party administrators generally ARE paid for their services, and deserve to be paid. Many product vendors will provide some level of TPA-like service without charge, in order to get the opportunity to sell their product to the participant group, but that is more in the nature of offering a loss leader than it is in the nature of a rebate. TPA services have intrinsic value, and there surely is nothing illegal about paying or being paid for them.

Whether this arrangement is a actually good one or not is a matter of judgment. My own philosophy on these things is that there is no free lunch. Either these services are NOT performed, which is problematic, or else they ARE performed. In the latter case, SOMEBODY pays for them. The payor is either going to be the plan sponsor (as in the the model you inquire about), the plan participant (via higher fees in the product or by hiring a private financial advisor for them), or the product vendor (by under-pricing the product, a temporary solution at best). If the product vendor can offer a better-performing product to the participants by having the plan sponsor pay the administrative costs, where you stand on this probably depends on where you sit. If you are a plan participant, it's the next best thing to a free lunch. If you are a plan adminsitrator or a taxpayer, however, you may feel that this is not such a great idea.

I think you'll have a lot of trouble making a legal case against the arrangement, though.

[Ellie Lowder]

Incidentally, school districts in other states (albeit, still pretty limited) are beginning to pass TPA charges along to providers - e.g., the State of Hawaii as one example. Some providers will pay; others might not. However, the costs will unfortunately ultimately probably be passed through to the participants depending on the extent of the charges. I have receive a number of calls from various providers about this.

[Guest TroyRiley]

Ellie,

How are providers avoiding payment of the fee? The agreement that I saw didn't provide an option. It said either you pay the fee, or you don't have access to the participants for whom we provide third party administration.

[Ellie Lowder]

Troy, it varies (generally by state). I have seen situations where providers simply refused to pay fees if they were relatively substantial to protect the integrity of the pricing of the products offered - and, the employer was then forced to either abandon use of the TPA, or ask employees to pay the costs. California Code does not permit employers to charge administrative costs to the participants - hence, I am not sure how this one will play out, since this is a fairly new development in your State. I have received some calls from providers about that issue - however, have not yet heard of any that have flatly refused and withdrawn from that employer.

It has been reported to me that, in the Hawaii situation, most providers agreed to pay the fees but I have not independently verified that.

[Guest scottyd]

The real problem is that low-cost providers are basically kicked out. They will not sign onto a system that will guarantee them a loss. I have spoken to almost every low cost provider and so far none of them will sign up with the TPA Troy mentioned. They cite the $3 fee as the main reason. This is problematic because it basically reverts the 403(b) back to pre-EGTRRA days when very few low cost providers would even think of signing on. Ultimately this hits the educators in the pocket book and forces them to use an agent to contribute to their 403(b).

Another problem with the situation mentioned is the many conflicts of interest that exist with the TPA. The TPA also owns a commission based financial services company which he uses to sell 457 plans. A 457 requires education and guess who provides it? You end up stuck with two plans that are both high cost and riddled with conflicts of interest - it makes you wonder how the plans can say that they have taken any fiduciary responsibility.

This development is bad for vendors, but eventually it is bad for teachers as they will ultimately pay the price through higher fees and forced savings through higher cost providers.

ScottyD

www.403bretire.com

[joel]

It takes millions of dollars to operate a union the size of the New York State United Teachers with its 500,000 members. Unions are always looking for sources of revenue to augment their reliable dues flow. Recognizing that pre-tax retirement savings plans funded through convenient payroll reduction is by far the most popular fringe benefit offered to teachers by the 620 school districts in the State, the union saw an opportunity in 1989 to use section 403(b) of the Internal Revenue Code as a means of raising revenue. All it had to do was find an investment provider willing to buy advertising space in the union newspaper, the New York Teacher. Once it found a willing investment vendor it would be more than willing to “endorse” its products.

At first glance one might assume that the "Opportunity Plus" and "Opportunity Independence" plans must be outstanding programs lest it would never get the union’s “endorsement”. To the contrary, the union’s “endorsement” means they are inferior programs. One just has to look at the expense ratios of the 50-60 investment funds (sub-accounts) to see how expensive the program is. Nearly all of the funds have expense ratios of 1-2 percent that include the notorious 12b-1 fees. All of the funds charge a sales commission on withdrawals made within 5 years of purchase (contingent deferred sales charge). In addition to the expenses charged by the individual investment funds the teacher is charged 1 percent for insurance expense by the Separate Account maintained by ING. With such a large number of investment options you would think pre-arranged portfolios would be readily available. They are not. Remember, all of the expenses to maintain the investment are paid for by the teacher/investor, not the school district and not the union. Expenses translate into smaller account balances and less retirement income.

Why didn’t the union negotiate with a superior low cost investment provider along the likes of Vanguard, T. Rowe Price or TIAA-CREF? Low cost (direct distribution) providers cannot afford to pay for advertising along the lines of high fee vendors like ING because the fees they charge are much less. So being hell bent on using section 403(b) to enhance its revenue stream the union was fast to partner with ING who in return for a union endorsement agreed to use some of the high fees collected from teachers to pay for advertising "Opportunity Plus" and "Opportunity Independence" in the New York Teacher. It is an outrageous and immoral use of unbridled union power and arrogance. Let’s do some arithmetic to knock the point home. A low cost investment provider like the Deferred Compensation Plan of the City of New York charges its participants .34 percent or $102 a year to manage $30,000. Assuming a 2.20 percent expense ratio (1.2 percent paid to the investment fund plus 1 percent paid to the Separate Account of ING) it costs the "Opportunity Plus" participant $660 a year, or 6.5 times as much, to have $30,000 managed by ING. If we start with an initial investment of $30,000 (with no additional contributions) and earn an average 8 percent a year for 30 years the Citywide Deferred Compensation Plan participant sees his $30,000 investment grow to $274,633 while the Opportunity Plus/ING plan participant sees his $30,000 grow to $162,814. The difference of 1.86 percent in the expense ratios (2.2 percent minus .34 percent) results in a 40.7 percent smaller account balance. An expense ratio in excess of 1.5 percent makes pre tax investing inferior to after tax investing. Opportunity Plus participants would be better off to forego their high cost tax-deferred annuity investment in favor of investing after tax dollars in a tax efficient no-load mutual fund.

Peace,

Joel L. Frank