Thursday, April 19, 2012

Did new 403(b) regulations improve retirement plans in higher education?

It has been two years since the new regulations of 403(b)plans went into effect. As a result, on campuses across the country retirement plan committees were formed, consultants hired, and investment options examined. Have the new regulations had any effect? Are higher education retirement plans any better than they were before? The new regulations gave employers much more responsibility for the design and operation of their plans. Many plans are now subject to ERISA which assigns plan sponsors fiduciary duty in managing their plans “prudently.” This means closely monitoring the investment options offered in the plan, paying attention to costs, and participant education. How are employers doing? This article takes a brief look.

Cost
The new scrutiny of higher education retirement plans seems to have brought  about only a modest reduction in cost.  Some universities, for example Cal Tech, did this by adding the low cost mutual fund provider Vanguard. The reductions in costs are modest because the new provider manages only a tiny fraction of assets as it slowly accumulates new contributions. Other schools, for example Harvard University, eliminated the relatively high cost provider DWS from its menu of investment options. The existing balances were rolled over into other options. The impact is modest because the DWS’s was small to begin with.
Given that TIAA-CREF still dominates the higher education retirement market, any significant reduction in cost for higher education plans will have to be associated with changes at TIAA-CREF. TIAA-CREF’s share among the largest 30 retirement plans remains above 70 percent. The vast majority of those assets (around 74%) are in two vehicles: TIAA Traditional fixed annuity and CREF Stock variable annuity.  The expense ratios on CREF Stock and other variable annuities are the same as they were in 2005. The expense ratios on TIAA-CREF mutual funds, if anything, have gone up. For example, the hugely popular Large-Cap Value Fund retirement class had the expense ratio of 0.74 in 2010 compared with 0.48 in 2005.
The good news on the TIAA-CREF front is the introduction of the institutional class of shares on TIAA-CREF mutual funds in a number of higher education plans. The institutional share class has an expense ratio about 20 basis points lower than the retirement class. The TIAA-CREF institutional class index funds have expense ratios similar to those of Vanguard’s index funds – an industry leader in low-cost index funds. Unfortunately, the impact of the new class share is small for two reasons. First, most of the TIAA-CREF assets are still in its variable and fixed annuities, and the expenses on those have not changed. The second reason is that only the very largest of plans are able to offer the institutional class. Even among the largest plans, only some have the institutional share class. For example, the University of Pennsylvania, Georgetown, Carnegie Mellon,  Indiana University and Cal Tech each have about one billion in TIAA-CREF assets.  Perhaps as a result, they were able to negotiate the lower cost share class. As of the end of 2010, other large plans such as Cornell University and the University of Chicago still offered only the more expensive retirement class shares despite having as much in TIAA-CREF assets as the schools that now offer the institutional class. Hopefully, it is only a question of time until the fiduciaries of those plans successfully push for the lower cost options. How successful smaller plans will be in pushing for lower costs remains uncertain. It is similarly uncertain how successful employers will be in encouraging participants to consider shifting from the higher cost variable annuities to lower cost mutual funds. Still, the introduction of lower expenses on TIAA-CREF options is a significant step in the right direction.
Plan design
Despite the new attention to plan design, 403(b) plans remain far more complex than their 401(k) counterparts. Some observers hoped that the new regulations would force plans to streamline their design. This has not happened. The average number of investment options among the largest twelve 403(b) plans is over 160, and no plan has less than 30 investment options. This stands in sharp contrast to the typical number of investment options in the 401(k) world which is 14. Even IBM’s plan, which is the largest private sector defined contribution plan in the U.S. with 36 billion in assets and 200 thousand participants, has only 23 investment options.
There are a number of strikes against plans that offer a large number of options. First, breaking up assets into many options denies the plans the economies of scale associated with asset management. Consolidating assets would probably make more plans eligible for lower cost share class. Second, research shows that a large number of investment choices lowers participations as participants become overwhelmed. Certainly, participant education – a point emphasized in the new regulations – is much more difficult and probably ineffective when participants face hundreds of funds to choose from. Portfolio theory says people should be able to invest in various asset classes - it says nothing about the need to offer choice within each asset class. Therefore, offering five different large cap value funds seems superfluous. Finally, monitoring hundreds of investment choices must be costly for the plan sponsor. At a time where universities and colleges struggle with tight budgets, spending on investment monitoring seems wrongheaded.
As evidence of the need streamline higher education retirement plans, consider the plan of Financial Engines - a firm whose business is to advise plan sponsors and plan participants on defined contribution plans. Unlike faculty and staff at colleges and universities, the employees of Financial Engines are skilled investment professionals. Yet, their plan consists of only 17 index funds – each fund covering a major asset class. Other financial advisory firms have similarly simple plans. If anyone should be able to navigate hundreds of investment options it would be the financial professionals. That their own plan is so simple suggests that there is little value in offering hundreds of investment options. If financial experts can’t benefit from in a huge menu of investment options, it is doubtful that the faculty and staff at a university can.
Overall, the impact of the new regulations on the nature of higher education plans seems less than dramatic. Yet, there is evidence that universities are taking a look and making small changes in the right direction.


The 12 Largest 403(b) Plans in Higher Education

University (plan number)
Assets as of 12/31/10  (in billions)
Number of Participants (in thousands)
Assets per participant (in thousands)
Estimated number of investment options
Share of TIAA-CREF in Total Assets
Share of TIAA-Traditional and CREF Stock in Total Assets
Providers in addition to TIAA-CREF
Stanford University (001)
3.6
20
177
30
46
38
Prudential, Vanguard
Duke University (001)
2.9
28
104
385
35
25
DWS, Fidelity, VALIC, Vanguard
University of Pennsylvania (001)
2.9
20
144
97
70
53
Vanguard
Washington University (001)
2.7
20
132
97
81
60
Vanguard
California Institute Of Technology (002)
2.1
17
122
31
97
65
Vanguard and others
Emory University (001)
1.9
21
90
130
52
40
Fidelity, Vanguard
New York University (001)
1.8
12
145
88
78
58
TIAA-CREF, Vanguard
University Of Southern California (001)
1.6
22
73
350
65
47
Fidelity. Prudential, SunAmerica , Vanguard
University Of Chicago (001)
1.6
14
115
130
77
58
Vanguard
Boston University (002)
1.5
6
258
200
58
46
Fidelity, MetLife, Vanguard
Cornell University (001)
1.5
25
60
226
80
60
Fidelity, and others
Georgetown University (211)
1.1
5
237
250
70
55
Fidelity, Vanguard


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