Insurance companies play an outsized role in delivering 403(b) plans. COVID-19 may change that.
COVID-19 continues to upend many facets of pre-pandemic life and, in some ways, it seems premature to speculate on what will change once we emerge “on the other side” of the pandemic.
On the other hand, there are helpful insights that can be developed as we begin to anticipate some of the changes that might emerge from COVID-19. This blog post will discuss one of those potential changes–the role of the on-site “plan” representative in the 403(b) market.
Background
Although 403(b) plans — offered by nonprofit entities–are very similar to their corporate cousin, the 401(k) plan, there are some fundamental differences. Prior to ERISA, 403(b) plans could only invest in annuities and, despite the fact that mutual funds have now been available for 45 years, annuities continue to represent a significant portion of 403(b) plan assets–over 75% according to some reports.
The presence of annuities in 403(b) plans has many financial implications for participants. Although these financial implications are worth understanding, they are not the focus of this blog. But, if you are interested, here are two resources to get you started:
- Funds, Fees, and Annuities–A Guide to 403(b) Investment Options
- How 403(b) Plans are Wasting Nearly $10 Billion Annually, and What Can Be Done to Fix It
Rather than focus on these financial differences, this blog will focus on how 403(b) plans are currently delivered to participants–and how that could change in the post-COVID 19 era.
Very Different Delivery Models
As a starting point, it is important to understand that insurance companies play a far greater role in delivering 403(b) plans than in the 401(k) market. For example, while four of the ten largest 401(k) recordkeepers (by total assets) are insurance companies, eight of the ten largest 403(b) recordkeepers are insurers. And, not coincidentally, the insurers that dominate the 403(b) recordkeeping market also tend to be the leaders in annuities sales (based on premiums).
Insurance companies focus on the 403(b) market for a very simple reason–recordkeeping a 403(b) plan with annuities is far more lucrative than recordkeeping a 401(k) plan dominated by mutual funds. Insurance companies issuing annuities have a variety of different ways to make money. Variable annuities make money through mortality and expense fees, expense ratios of the underlying investment units, spread revenue generated from fixed interest options, fees for guaranteed income riders and revenue related to account annuitization. Fixed annuities make money on the spread revenue between the insurance company’s return on assets and the annuity payouts for years or decades. These different fees are opaque and lucrative–and neither employees nor plan sponsors can conduct the same kind of apples-to-apples comparisons available when considering mutual funds.
However, the annuity business has one key challenge, best summarized by the industry expression that “annuities are not bought–they are sold.” In a market where plan sponsors are becoming increasingly sensitive to fees and participants are more familiar –and comfortable–with mutual fund investments, success in the 403(b) annuity market hinges on the ability of the recordkeeper/insurer to provide on-site “plan” representatives. These representatives are a common feature of the 403(b) market– with representatives offering information (and the occasional donut) to plan participants.
There are several aspects of this delivery model that are worth noting:
- 401(k) plans are successfully delivered to participants without the need for such an on-site presence. 401(k) recordkeepers and sponsors have built robust participant systems using on-line technology and phone centers. And yet, the on-site representative model persists in the 403(b) market.
- These on-site “plan” representatives do not necessarily represent the plan. These individuals are employees of the recordkeeper/insurer–and not of the plan sponsor. If one digs deeply enough into the activities of these representatives, one often finds that education about the plan takes a back seat to promoting products of the recordkeeper/insurer–including promoting non-plan (proprietary) products and services during active employment and promoting proprietary rollover products when a participant has a distributable event.
- These “plan” representatives, as employees of the recordkeeper/insurer, may actually be compensated through a bonus or commission structure that rewards the sales of the recordkeeper/insurer’s proprietary products. These compensation practices are particularly pernicious because participants simply do not realize that the recommendations they receive are not based on their best interest.
And, even if 403(b) sponsors push for open architecture mutual fund platforms, annuity issuers have a strategy in place to protect the annuity business. Under this strategy, the insurers can offer lower margin mutual fund platforms (in-plan) while providing incentives (in the form of bonuses or commissions) to plan representatives who successfully advise participants to transfer assets from the lower margin mutual fund offering into higher margin products–especially upon a distributable event. This provides multiple benefits to the recordkeeper, including (i) reducing or eliminating the amount of salary that must be paid to plan representatives and replacing salaries with the opportunity to generate commissions, (ii) retaining the client assets and the relationship in a product that is not subject to employer-directed transfer to another recordkeeper, (iii) increased revenue in higher margin annuities or managed accounts, and (iv) a lucrative model that supports the recruitment of registered representatives.
The Times They Are A Changing?
As noted above, 401(k) plans have been very successful without these on-site representatives. COVID-19 may create the opportunity for 403(b) plans to move in this direction:
- During this period of social distancing, consumers have been forced to rely more heavily on web-based resources. It is widely anticipated that this reliance on on-line resources will continue after the pandemic recedes.
- The largest segments of the 403(b) market are education (both higher education and K-12) and healthcare. Interestingly, both of these sectors have been in the forefront in replacing face-to-face interactions with on-line tools. In effect, if any segments of the workforce have been driven to rely on on-line tools, it is educators and healthcare professionals.
- Independent participant communication and education (“C&E”) providers represent a proven, field-tested alternative. These providers, with a product-agnostic service model and a delivery model that does not rely on face-to-face “sales,” are available to provide participant support that is free of the potential conflicts that arise when plan representatives are compensated for the sale of proprietary products.
A Word of Advice
The author is not advocating that participants be left on their own. Rather, the new habits being formed during the pandemic can be used to improve the service model utilized to support plan participants.
Recordkeepers, whether insurers or not, have the capability to service the plans and participants they serve. However, to the extent that recordkeepers (and their on-site representatives) have a financial interest in leveraging access to participants and participant data to promote these opaque (and lucrative) products, sponsors and participants must be guarded in their evaluation of the real purpose and utility of these services.
These factors may all come together in providing 403(b) sponsors an opportunity to move toward a delivery model that is better able to eliminate or mitigate the conflicts of interest that currently undermine participant retirement savings.COVID-19 will change many things and, perhaps, some of these changes can be improvements over past practices. 403(b) sponsors would be well advised to consider whether this awful experience provides an opportunity to change the delivery model for participant services for the better.
