Retail mutual funds gained market share in 403(b) plans last year, while the use of once-popular group fixed annuities fell sharply, a survey by Cerulli Associates, Boston, shows. The firm also predicted mutual funds will play an ever-increasing role in these plans.
Retail mutual funds were responsible for 26.4% of assets in 2010, up from 21% in 2009, according to the survey of 20 providers accounting for more than 80% of 403(b) assets. Institutional mutual fund assets edged up to 18.4% from 18.1%.
“The 403(b) market is still about three to five years behind the 401(k) market” in embracing institutionally priced mutual funds, said Bing Waldert, a Cerulli director, adding that moving to institutional mutual funds from group fixed annuities is an evolutionary process for sponsors.
“They are still taking baby steps,” he added. “The organizations may not know the pricing power they have. This reflects the relative immaturity of the 403(b) market relative to 401(k)s.”
Group fixed-annuity assets plunged to 9.3% last year from 20.3% in 2009, a decline spurred by low interest rates, said Alessandra Hobler, a Cerulli analyst. The group fixed-annuity market share also was affected by increased assets flows into mutual funds and variable annuities, she said. Assets in group variable annuities, rose to 24.7% of total 403(b) assets from 22.7%.
Total 403(b) assets reached a record $750 billion last year, up from $700 billion in 2009. The gain was largely due to market appreciation, Ms. Hobler said. The previous peak was $734 billion in 2007.
The growing popularity of mutual funds in 403(b) plans is due in part to structural changes in the industry caused by Internal Revenue Service regulations that demanded greater fiduciary responsibilities of sponsors, such as more thorough plan-document preparation and closer scrutiny of hardship withdrawals and loans.
The regulations have prompted some 403(b) sponsors to consolidate services to a single provider or a few providers. The Cerulli report said some plans have had as many as 50 providers.
“As the 403(b) industry moves from an adviser-sold retail environment to a more 401(k)-like institutional one,” mutual fund sales will increase, the report said. “It will be increasingly difficult for variable annuities as distribution (of investment options) becomes more institutional. Fixed annuities have experienced little growth during the last year due to the less than advantageous interest environment.”
All of the survey’s respondents increased mutual fund sales to 403(b) plans last year, while only 40% increased variable-annuity sales and 29% increased fixed-annuity sales, the report said. Also, 40% of respondents reduced variable-annuity sales while 29% cut back fixed-annuity sales.
The report said the requirements of the IRS regulations have led more 403(b) plans to become subject to the Employee Retirement Income Security Act. Last year, 40% of 403(b) plans were ERISA plans compared with 17% in 2005, the report said. A precise number of all 403(b) plans was not immediately available.
But despite the regulatory requirements and structural changes, 403(b) investment strategies won’t change uniformly because the industry “remains very much in a state of transition,” the report said.
Each major 403(b) market has different characteristics and circumstances that could accelerate or retard the shift to mutual funds from annuities, the report said.
• Higher education accounts for $372 billion in assets, or about half of the market. Although some colleges still offer defined benefit plans, they are becoming increasingly rare. That means 403(b) plans are emerging as the “dominant savings vehicle,” the report said. Mutual funds and open architecture are becoming increasingly popular, according to the report.
• Health care, which represents $141 billion in assets, should be the fastest-growing market over the next five years, providers told Cerulli. Thanks to the freezing of DB plans in the industry, “the 403(b) is positioned to replace DB plans and act as the primary retirement savings vehicle for many employees in this segment,” the report said. With 65% of health-care plans subject to ERISA, plans in the health-care field are characterized by “a prevalence of mutual funds,” offering greater opportunities for open architecture.
• The market for kindergarten to 12th grade education for both public and private schools accounts for $109 billion in assets. This will be the most difficult market for mutual funds because it is characterized by many commission-based advisers who sell annuity products to individual participants, according to the report. Replacing a retail focus with an institutional approach will be a slow process.
• Charitable, church and other non-profit organizations account for $115 billion. Church plans in particular are “significantly different” from the other plans, so it is difficult to determine how IRS regulations will affect them, the report said.
The Cerulli report predicted that aggregate 403(b) assets will grow steadily to $1.1 trillion by 2016.