Executives of 403(b) plans are beginning to push their service providers to make these staid, mature plans more closely resemble the newer, more innovative 401(k) plans.
As a result, mutual fund companies are grabbing some of the market share traditionally held by insurance companies that serve 403(b) plans, tax-deferred annuity and defined contribution plans available to public schools and tax-exempt entities.
At the same time, the insurers are upgrading their own offerings to include more options.
Among the innovations:
Educational efforts are convincing employees to move away from fixed income. The problem, however, is many plans feature back-end surrender charges making it hard to move existing assets out of older options. Most asset allocations to new mutual fund or equity options are made from new contributions, leaving a large chunk of assets in fixed and variable annuity vehicles.
Plan sponsors are reducing the number of vendors they approve to offer 403(b) plan services.
Sponsors are renegotiating contracts with existing vendors and are getting tougher with new providers, aiming for better service at lower costs. Among them, unlimited transfer capabilities among all investment options, which requires rewriting contracts with insurers and their subsidiaries.
In the future, consultants say, more 403(b) plans will have a single benefit statement, showing asset allocations by a participant to all relevant vendors, requiring more coordination of information from multiple providers.
Disclosure of plan documents and use of discrimination testing have increased, the result of Labor Department 404(c) regulations and a recent rash of plan audits by the Internal Revenue Service.
Mutual fund inroads
While the $245 billion 403(b) market sees little new plan formation, Access Research Inc., Windsor, Conn., predicts an 8% to 9% average growth rate during the next five years, as balances get higher and investment returns show the benefit of diversification into equities.
That bodes well for mutual funds. According to Access Research, mutual funds captured 6.3% of the direct custodial 403(b) market as of Dec. 31. That's up from 4.8% in 1991, but small when compared with the 26% share of the 401(k) market held by mutual funds. Fidelity Investments Retirement Services Co., Boston, reported a 42% growth last year in assets under management from 403(b) plans and a more than 50% growth in new cash flow.
Jeff Close, a spokesman for Access Research, said mutual fund companies actually hold a larger share in the 403(b) market than the figures indicate. Data on the amount of 403(b) assets managed by mutual funds for variable annuities aren't available, said Mr. Close, but most insurance companies offer externally managed mutual funds to defined contribution plans.
"There is much crossover of employees from the corporate 401(k) environment to the not-for-profit sector, where 403(b) plans predominate," said Tony Cotton, a consultant in the Seattle office of Godwins Booke & Dickinson, an employee benefits consulting firm. "I definitely see a move by plan sponsors to eliminate confusion and provide what employees are increasingly demanding - 401(k)-style plan design for 403(b) plans."
"This is a consumer-driven change, bubbling up to the surface," said Richard G. Malconian, president of Fidelity Institutional Retirement Services.
"Plan participants are accustomed to managing their own private savings money 24 hours per day with totally unlimited access and transfer capabilities in mutual funds and banks.
"Why shouldn't they have this freedom within their 403(b) plans, which are, after all, often totally voluntary savings plans? Participants are talking to their employers who are beginning to question why their employees don't have full control of their retirement plan assets.
"We expect the market to grow geometrically over the next year," said Mr. Malconian.
Particularly attractive to service providers is the higher education portion of the 403(b) plan market, said Glen Casey, a consultant at Cerulli & Associates Inc., Boston.
"The deferral rates are generally fairly high, and often are matched by the employer. Account balances are large and the highly educated work force, with low employee turnover, is inclined to leave assets parked within the 403(b) plan until retirement," said Mr. Casey.
The shadow of TIAA-CREF
The dominant player, of course, is the New York-based Teachers Insurance and Annuity Association-College Retirement Equities Fund. But firms like Fidelity and Vanguard Group, Valley Forge, Pa., increasingly are competing with TIAA-CREF for university business.
There, younger academics are pushing for greater portability of assets and the introduction of mutual funds, generally as alternative providers to TIAA-CREF, Mr. Casey said. That, in turn, has forced TIAA-CREF to expand its fund offerings and upgrade its participant education and communication services.
John McCormick, executive vice president for pension and annuity services at TIAA-CREF, said the addition July 1 of a managed growth fund and an indexed equity fund will complete efforts to provide a fully diversified investment lineup. The lack of such options in the past prompted harsh criticism of the near-monopoly player in the university 403(b) market.
The not-for-profit insurer now offers seven investment funds through CREF and two guaranteed fixed-income options through TIAA. A new customer service center in Denver, an enhanced voice-response system and development of PC-based participant educational software will help TIAA-CREF retain market share, said Mr. McCormick.
Following the example of TIAA-CREF, most insurers have responded to market competition from the mutual fund managers by expanding product lines and actually enlisting mutual fund managers to provide fund vehicles within annuity contracts.
Michael Footer, a principal in the Richmond, Va., office of William M. Mercer Inc., said nearly every insurer now contracts with major mutual fund companies to offer separate account clones of well-known or strong-performing funds as investment options in their variable annuity contracts.
"The mutual fund companies are winning on both sides in the 403(b) market," said Mr. Footer. "If they aren't winning the business outright, they're getting it through the insurance companies, which merely charge higher load fees and tack their fees onto those of the mutual fund manager.
"The move is a smart one by the insurers, because they're using the high visibility of the brand-name mutual funds to attract participants to the variable annuity."
One such insurer is VALIC, Houston, which later this summer will expand the mutual fund options available to 403(b) and other defined contribution plan clients to 18 through its variable annuity programs.
VALIC is the leader in the public school sector of the 403(b) plan market.
In the final approval stage at the Securities and Exchange Commission is a diverse series of new 13 mutual funds, some managed by VALIC and some by external managers.
VALIC decided to use outside managers to make its product as competitive as possible with mutual fund managers, said Joe Osborne, senior vice president of marketing.
Part of the move to expand fund options was to provide clients with the means to comply with 404(c) regulations. Also in response to 404(c), VALIC is developing a new participant education program that will focus on one-on-one personal counseling from VALIC field representatives, using a proprietary, PC-based asset allocation modeling program, said Mr. Osborne.
In contrast to the non-competitive public school and university market segments, which are characterized by a large number of long-term, well-educated employees, the health-care market is under such intense competitive pressure that changes to the way retirement benefits are provided frequently is seen as a way to cut costs, Godwins Booke's Mr. Cotton said. The quality of benefits also might help retain high-quality staff.
In the 403(b) market, plan fees generally are paid by the employer, a practice that has come under intense scrutiny as health-care organizations try to economize, he said. And, many hospitals are terminating defined benefit plans and introducing 403(b) plans as replacements. Or, they are renegotiating contracts with insurance company providers for lower fees.
Hospital associations are frequent "bulk buyers" of 403(b) services, said Mercer's Mr. Footer, clubbing together to offer member hospitals better deals from service providers.
The Missouri Hospital Association in St. Louis, for example, just endorsed MetLife Resources, a division of Metropolitan Life Insurance Co., New York, as its first preferred provider of retirement and employee education services. Michael Dunaway, executive vice president for the hospital association, said the move was a way to encourage both superior investment management and a real emphasis on education programs for participants in member hospitals.
In a more dramatic move, the Greater Cleveland Hospital Association just introduced Option 21, a full-service, bundled program for its own member hospitals and other non-member defined contribution plan clients.
Under Option 21, 200 mutual funds are available through Charles Schwab & Co.'s One Source service. Metropolitan Life will provide a GIC pool and Hampton Pension Services, Akron, Ohio, will provide record keeping and administrative services.
The CHAMPS Healthcare Management Programs, a unit of the hospital association, will provide employee education and communications.
"Our member hospitals were basically getting sick of being shackled by insurance company variable annuity products," said John T. Rukosky, marketing coordinator for the hospital association. "They were getting sick of sales fees and sick of their participants not being able to transfer their assets between options in an unlimited manner.
"We designed Option 21 to give our member hospitals what they want - a fair and flexible product."
Participants have complete liquidity and investment transfer capabilities under the Option 21 program, said Mr. Rukosky.
"It's totally open, totally flexible and works just like a 401(k) plan. Plan sponsors are really clamoring for this kind of program."