403b | The CommonSense 401k Project

By Chris Tobe, CFA, CAIA

I want to applaud the Biden Administration on bringing Annuity Junk fees into the light of day to protect investors.

I want to focus on the effect of annuity junk fees in current ERISA protected defined contribution plans (I will address 401(k) and 403(b) and cover rollover junk annuity fees in another article.) While the White House release mentions the savings in current plans from index annuities, I think that fixed annuities savings could be much larger over $9 billion a year. (It is important to note that fixed annuities and index annuities in government defined contribution plans in both 457 and 403(b) are not protected by ERISA and add to many more billions of dollars.)

My $9 billion a year comes from industry figures on General Account fixed annuities at $386 billion and separate account fixed annuities at $76 billion in ERISA defined contribution assets. [i]

However, it is important to note that the largest provider of fixed annuities in defined contribution plans (governed by ERISA) is TIAA, which has substantially lower fees and commissions, than the other mainstream insurance providers

Fixed annuities for the most part do not disclose fees and are rate based. For example, when a similar competitive fixed annuity in a plan like TIAA pays 4% many insurers only pay 2% – pocketing the spread. Bloomberg quoted an insurance executive bragging about these hidden 2%+ in fees at a Wall Street conference.[ii] These hidden spread fees have the same negative effect on investors that disclosed mutual fund fees have.

HOW DO I KNOW THIS
I currently consult on excessive fees in insurance products. I spent 7 years making insurance products for Transamerica Life (TA), one of the largest U.S. insurance companies. I was an officer of seven different TA companies governed by four different states. I saw the need for federal intervention, as insurers had the ability to select the state regulator with the loosest regulations and lowest capital requirements.

RISKS
One of the most basic fiduciary principles is diversification. Annuities make a mockery of this principle with their single entity credit and liquidity risk. [iii]

After the first annuity risk crisis in 1992 the Federal Reserve wrote a major paper on the weakness of state regulations in the insurance area. [iv]

In 2008 Federal Reserve Chairman Ben Bernanke said about these annuity products “workers whose 401(k) plans had purchased $40 billion of insurance from AIG against the risk that their stable-value funds would decline in value would have seen that insurance disappear.”^{^[v]} Even when the federal government steped up to control risk in annuity products after the 2008 financial crisis, the insurance industry used its immense lobbying ability to thwart regulations and maximize profits. [vi]

ACCOUNTABILITY
In light of recent money market rates of over 5%, these low 2-3% annuity rates in 401(k)’s in far riskier products are especially troubling, costing investors billions of dollars in retirement savings while taking much higher risks.

Hopefully, these junk fee rules will slow the growth of these high fee high risk products inside of 401k plans. The latest con game is selling annuities under the guise of Guaranteed Income. [vii]

Hopefully, this junk annuity initiative will expose some of the 401(k) target date funds which are burying index and fixed annuities inside weakly state regulated Collective Investment Trusts (CIT)s. [viii]

Hopefully, 401(k) consultants who claim to be somewhat independent will be exposed by showing how they use their insurance licenses for additional backdoor commissions.[ix]

Hopefully, within 401(k) plans they will either replace fixed annuities with diversified lower risk synthetic stable value products or at the minimum pay competitive rates like TIAA. [x]

This Biden Annuity Junk Fee initiative will save retirement investors billions. Please do not let the Insurance Industry water it down to line their own pockets.

Chris Tobe, CFA, CAIA is a national expert on excessive fees in retirement plans. He has written 4 books and dozens of articles on transparency, excessive fees & corruption in investments. His own firm Tobe Consulting has advised on over 70 ERISA legal cases on behalf of investors who have lost money through risky and/or high fee investments. He serves as Chief Investment Officer for a minority woman owned pension consulting firm out of New Orleans the Hackett Robertson Tobe group

[i] https://www.stablevalue.org/stable-value-at-a-glance/

[ii] https://www.bloomberg.com/news/articles/2013-03-06/prudential-says-annuity-fees-would-make-bankers-dance#xj4y7vzkg

[iii] https://commonsense401kproject.com/2022/05/11/annuities-are-a-fiduciary-breach/

[iv] Federal Reserve Bank of Minneapolis Summer 1992 Todd, Wallace SPDA’s and GIC’s http://www.minneapolisfed.org/research/QR/QR1631.pdf

[v] Eleanor Laise, “ ‘Stable’ Funds in Your 401(k) May Not Be,” Wall Street Journal , March 26, 2009. Available at http://online.wsj.com/article/SB123802645178842781.html

[vi] https://www.stanfordlawreview.org/online/the-last-sifi-the-unwise-and-illegal-deregulation-of-prudential-financial/

[vii] https://commonsense401kproject.com/2022/02/10/401k-lifetime-income-a-fiduciary-minefield/

[viii] https://commonsense401kproject.com/2022/06/07/toxic-target-date-case-study-of-the-worst-of-the-worst/

[ix] https://commonsense401kproject.com/2022/03/09/conflicted-401k-consultants-should-plan-sponsors-fire-them-sue-them-or-both/

[x] https://commonsense401kproject.com/2022/02/28/stable-value-the-goood-the-bad-and-the-ugly-avoiding-litigation/

By Christopher B. Tobe, CFA, CAIA

The CFA Institute Pension Trustee Code of Conduct (Code) sets the standard for ethical behavior for a pension plan’s governing body. [i] It is a global standard that applies to both defined benefit (DB) and defined contribution (DC)plans, but I believe is consistent with ERISA fiduciary standards for 401(k) plans. The Code has 10 fundamental principles of ethical best practices. I am going to focus on 5 of them, the areas where we see many plans falling short of the standards.

Principle # 2. Act with prudence and reasonable care.
The point regarding seeking appropriate levels of diversification[ii] is typically followed with most larger plans; but, we do see a number of mid-size and smaller plans taking single entity credit and liquidity risk in annuities and other insurance products. [iii] A particular non-diversified insurance product, lifetime income, is trying to break into even the largest plans, but with little success. [iv]

Another point is that service providers and consultants be independent and free of conflicts of interest. [v] [vi] Again, most larger plans hire independent providers, but we do see a number of mid-size and smaller plans hire dually registered consultants who not only are registered investment providers, but are also registered as brokers or insurance agents, with the ability to get a commission. [vii]

Principle #3. Act with skill, competence, and diligence.
Ignorance of a situation or an improper course of action on matters for which the trustee is responsible or should at least be aware is a violation of this code. “Trustee” in this case refers to each individual on the 401(k) committee plus the plan as a whole. We have seen many 401(k) committee members lacking awareness of the investment details in options of the plan.

Specifically, this principle points out the need ror awareness of how investments and securities are traded, their liquidity, and any other risks. Certain types of investments, such as hedge funds, private equity, or more sophisticated derivative instruments, necessitate more thorough investigation and understanding than do fundamental investments, such as straightforward and transparent equity, fixed-income, or mutual fund products. [viii]

With investments that have non-SEC regulated securities like illiquid contract-based products like crypto, [ix] private equity,[x] annuities and other insurance products, [xi] many times the 401(k) committees are not aware of the risks and hidden fees and have not thoroughly investigated them on such matters, especially those buried in target date funds and in brokerage windows.

Principle #5. Abide by all applicable laws
Generally, trustees are not expected to master the nuances of technical, complex law or become experts in compliance with pension regulation. Effective trustees …consult with professional advisers retained by the plan to provide technical expertise on applicable law and regulation. [xii]

Principle #3 suggests that assets that are not straightforward and transparent securities, such as crypto, private equity and annuities/insurance products contracts, require additional legal scrutiny. I would assume that no crypto product would pass a good fiduciary law audit. I would claim that it would be the fiduciary duty of the plan going into any private equity or annuity contract (separate account or general account) – to have a side letter in which the manager/or insurance company agrees to take.

1. ERISA Fiduciary duty

2 Provide liquidity if the investment experiences difficulty. With insurance products, this can be done with a downgrade clause, i.e., “in the event that the insurance company’s debt is downgraded below investment grade by any major rating agency, the plan will be returned its contract value in cash within 30 days.”

3. “Most Favored Nation Clause, guaranteeing that the manager /insurance company does not provide a lower fee or higher rate to any other plans

Ownership of underlying securities is key to a plan’s risk exposure, especially liquidity risk, and when complex instruments are involved, it is the duty of the plan committee to get competent legal advice on these investment contracts.

Principle #7. Take actions that are consistent with policies
Effective trustees develop and implement comprehensive written investment policies that guide the investment decisions of the plan (the “policies”). Most of the largest plans have Investment Policy Statements (IPS). The Code expects any plan to have them.

I believe any plan without an IPS is in fiduciary breach. I believe many conflicted consultants, as discussed in Principle #2, recommend that plans do not draft an IPS since it would expose their own conflicts. Most of the riskier assets in Principles #3 and #5, like crypto, private equity and annuities, would not be allowed under a well written IPS due to the excessive risks and hidden fees involved.

Trustees should … draft written policies that include a discussion of risk tolerances, return objectives, liquidityrequirements, liabilities, tax considerations, and any legal, regulatory, or other unique circumstances. Review and approve the plan’s investment policiesas necessary, but at least annually, to ensure that the policies remain current. [xiii] Some plans may have an Investment Policy Statement (IPS), but do not regularly review it or apply it rigorously to their investments.

Select investment options within the context of the stated mandates or strategies and appropriate asset allocation. Establish policy frameworks within which to allocate risk for both asset allocation policy risk and active riskas well as frameworks within which to monitor performance of the asset allocation policies and the risk of the overall pension plan. [xiv]

While asset allocation is a major component of DB plans – US DC plans now have over 50% of their assets in asset allocated investments, primarily target date funds.[xv] In most plans, the target date funds are the Qualified Default Investment Alternative (QDIA), which makes it essential that each target date sleave be addressed in the Investment Policy Statement.

Principle #10. Communicate with participants in a transparent manner.
While the DOL forces some fee disclosure on each plan investment, it is not complete with non-securities like crypto, private equity and annuities as standalone options[xvi], in brokerage windows or inside target date funds. [xvii]

Revenue sharing is a shady non-transparent way some plans make their own participants pay for administrative costs; it does not hold up under these CFA standards in my opinion. [xviii]

Given the similarity between ERISA’s fiduciary requirements and the CFA Institute Pension Trustee Code of Conduct, 401(k) plan sponsors could greatly mitigate their litigation risk by looking at the Code. Furthermore, it is just the prudent and the right thing to do as a fiduciary.

Chris Tobe, CFA, CAIA is the Chief Investment Officer with Hackett Robertson Tobe (HRT) a minority owned SEC registered investment advisor and recently was awarded the CFA certificate in ESG investing. At HRT Tobe is leading up the institutional investment consulting practice for both DB and DC Pension plans. He also does legal expert work on pension investment cases.

Past industry experience includes consulting stints at New England Pension Consultants (NEPC) and Fund Evaluation Group. Tobe served on investment committee of the Delta Tau Delta Foundation for over 20 years served as a Trustee and on the Investment Committee for the $13 billion Kentucky Retirement Systems from 2008-12. Chris has published articles on pension investing in the Financial Analysts Journal, Journal of Investment Consulting and Plan Sponsor Magazine. Chris has been quoted in numerous publications including Forbes, Bloomberg, Reuters, Pensions & Investments and the Wall Street Journal.

Chris earned an MBA in Finance and Accounting from Indiana University Bloomington and his undergraduate degree in Economics from Tulane University. He has the taught the MBA investment course at the University of Louisville and has served as President of the CFA Society of Louisville. As a public pension trustee in, he completed both the Program for Advanced Trustee Studies at Harvard Law School and the Fiduciary College at Stanford University.

[i] http://www.cfainstitute.org/-/media/documents/code/other-codes-standards/pension-trustee-code-of-conduct-2019.pdf

[ii] http://www.cfainstitute.org/-/media/documents/code/other-codes-standards/pension-trustee-code-of-conduct-2019.pdf

[iii] https://commonsense401kproject.com/2022/05/11/annuities-are-a-fiduciary-breach/ and