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Chapter 2

…the tragedy begins, not when there is misunderstanding about words, but when silence is not understood. –Henry David Thoreau

The Decades Old 403b Silence Is Broken

Sunday, January 18, 1998 the Los Angeles Times syndicated financial columnist, Kathy Kristof, published The Fourth “R.” She wrote: “The Fourth R is retiring, and for many teachers, the arithmetic of narrow investment options in their 403b is unsatisfactory. But be persistent, you may be able to get your employer to broaden your plan choices.” She featured my quest to include a low-cost mutual fund company, TIAA CREF or Vanguard, on my employer’s approved list. Kristof continued, “For teachers, many of whom complain about the sorry investment options their districts provide through 403b plans, Schullo’s story may prove instructive.”

The professionals she interviewed supported my experience. David Ganz with the Los Angeles County Department of Labor said, “employers are not paying enough attention to fees.” Cathy Cleveland a legal consultant to a national benefits consulting firm responded, “… [403bs] are little more than do-it-yourself retirement programs in which workers are given little direction [from employers] on how to participate and sometimes are not even informed about what their investment options are.” Kathy Kristoff’s article was a monumental opening of the secretive world surrounding LAUSD’s policy.

One Informative Letter

Robert Wildermuth, a retired industry consultant, wrote an explanation of the hold harmless “gross negligence” language. He described the motive for employers to internalize the illusory liability? LAUSD kept low-cost 403b options out of the public eye by hiding the department responsible and then only spoon-feeding options when employees beg. With Mr. Wildermuth’s insights and professional experience I learned the history behind the bizarre conduct displayed by the deduction unit staff. This behavior was not about compliance, but something deeper.

Mr. Wildermuth’s wife taught in La Canada, a wealthy suburb west of Pasadena. She confronted the same 403b problems in the 1970s as I had 25 years later. Robert was effusive with his comments and insights. He shared information he believed useful to reform 403b. He knew why K12 districts were hypersensitive to liability. One primary cause of this mess was the school district’s interpretation of an obscure California state insurance code—770.3 and a coordinated coup on the psyche of school district legal counsel, the Board of Education and superintendents. To grasp the depth of the district’s 403b behavior, a little background about the regulatory system is in order. First 770.3.

California Insurance Code–Section 770.3

Every state has an elected insurance commissioner who regulates insurance products and services. The regulations passed by the state government guide the business of life, disability, home, auto and other insurance needs. The California Insurance Commissioner regulates 403b plans under the code 770.3.

1955-1974

The 403b began as an insurance product. Five insurance industry opportunities listed below led to the predominance of insurance retirement products with PreK-12 educators:

• In 1955 California teachers rejected inclusion into Social Security (SS) by a 4 to 1 margin (California teachers have had a defined benefit, pension plan managed by California State Teachers Retirement System, CalSTRS, since 1913).
• The insurance industry lobbied Congress to pass the 403(b) in 1958 allowing the IRS to set up tax-sheltered accounts.
• In 1961 the insurance industry was ready to introduce their brand-new product— the Tax-Sheltered Annuity (TSA).
• TSA is much more than just an acronym for the Tax-Sheltered Annuity. Marketed into brand name and trademark “replacing” the original IRS code label, “403b.”
• From 1961 until 1974 annuities were the only products available for the 403b.

TSA Success

The TSA evolved into the voluntary retirement complement to CalSTRS for the state’s hundreds of thousands of educators. TSAs became a huge sales success, attributed to the fact that for the first 13 years, TSAs were the only supplemental retirement plan available.

The correct label “403b” was as foreign as a Martian culture for 99% of educators (I didn’t know this until I was 45 years old). The distinction was crucial if the insurance industry were to capture this huge market. Presentations by insurance agents might mention 403b but they had to sell the idea that their insurance company offered the tax advantage. When mutual funds became available in 1974, the 13 year-old TSA label was paramount for keeping the new competition out of the 403b market. In 2014, 53 years later, most educators fail to recognize that the 403b comes from the original tax-deferred code.

SEC’s Annuity Warning

The U. S. Securities and Exchange Commission issued a public warning about variable annuities (which include some mutual funds): “If you invest in a variable annuity through a tax-advantaged retirement plan (such as a 403(b) plan), be aware that you receive no additional tax advantage from the variable annuity” (Bold in the original). Associated Press and many newspapers reported that, “The SEC is warning, for example, that bonuses offered by some companies selling variable annuities to lure investors may be outweighed by higher expenses.” Vast majority of Individual Retirement Accounts (IRA) 401k, 403b, and 457b workplace plans offer tax-deferment without insurance company fees. The tax shelter offered by insurance companies is an expensive sales pitch. The Prek-12 TSA is the most notorious and expensive sales pitch around. There you have it, straight from the SEC—nothing more will be said about the terrible price my colleagues and other investors are paying.

1969 Amendment to 770.3

During the 1960s, insurance companies sold TSAs to teachers throughout the nation. However, California’s insurance code 770.3 restricted competition by allowing only one vendor for each school district. LAUSD contracted with a firm based in Pasadena. Competing insurance companies were left out. The competition wanted access to LAUSD’s and other big districts’ lucrative markets. These companies pushed California State legislation to require school districts to accept more than one company. They wanted this “monopoly” ended, arguing for more choice and control for educators. Thus, the state legislature amended the insurance code to allow employees to select a company of their choice.

The code was amended as shown here:

…employee shall have the right to designate the licensed agent, broker, or company through whom the employee’s employer shall arrange for the placement or purchase…. of the tax-sheltered annuity. …which the employee has designated an agent, broker, or company, the employer shall comply with that designation….

In 1993, twenty-four years later my employer did not “comply with that designation,” my request.  I persisted with letters and meetings to get Vanguard on the list. The CFO invited me to talk with him and his staff. When I arrived at LAUSD headquarters, he apologized for being unable to see me. I was escorted by his staff to a meeting room. The ensuing “conversation” with his staff went something like this:

·       I asked, “is my request to have Vanguard or Fidelity a good idea?”

·       They said, “yes but not without signing the hold harmless agreements. The hold harmless agreement makes vendors feel they are under the gun not to make mistakes.”

·       I said, “wait a minute? What hold harmless agreement is going to prevent anybody making mistakes even if people are under the gun? People make mistakes. I talked with Invesco and they reported no mistakes with LAUSD’s 2000 employees over many years?”

·       They admitted, “Very few mistakes have been made, but it’s because of the hold harmless agreement. The companies are more alert in their calculations.”

·       I said, “Invesco said that you, LAUSD, made no mistakes with millions of dollars in transactions. Vanguard and Fidelity object to LAUSD’s hold harmless agreement which would make Vanguard and Fidelity responsible for your mistakes. How can any vendor be “more alert with their calculations” about your errors of which vendors have no control? By the way I think your department should be awarded with your error free work!”

·       They were not amused as they admitted to my face: “Vanguard is a fine company.” “We have nothing against Vanguard.”  The wonks repeated, ad nauseam and had the last word, “if we accepted these companies as an option without signing our hold harmless agreement the district’s general fund would be at risk, leaving less money for instruction.”

I was outta that Homer Simpson dialogue in a flash. Wouldn’t you split too rather than listen to a room full of frightened little people, bullying one of their own obscure elementary teachers who simply wants Vanguard with his money? Their condescending and barbarous remarks were meant to trivialize my legitimate request and to give up.

The staff’s unyielding justification was their interpretation and subsequent acquiescence to the insurance industry scare tactics. Allow me to repeat and emphasize the amended code:

“…employee shall have the right to designate… company through whom the employee’s employer shall arrange….”

Obviously the code has been interpreted to the insurance industry’s advantage and not to the participants’ best interests.

ERISA’s Threat to the Insurance Industry’s 403b Market

Congress created an oversight board administered through the Department of Labor called The Employee Retirement Income Security Act of 1974 (ERISA). The new federal law sets standards to protect individuals for most voluntary established pension and health plans. ERISA allowed the establishment of 403b (7) “custodial” accounts with mutual fund companies (annuity contracts were identified as 403b (1)).  The new federal legislation had no legal jurisdiction in the administration or protection of public sector workers. Still, it broke the insurance industry’s dominance of the 403b market.

The insurance industry had to create a failsafe plan which would keep the new threatening mutual fund companies out of their lucrative 403b market. Since the amended 770.3 directed districts to allow “all willing vendors,” how in the world are they going to keep “willing” mutual fund companies at bay? After the 770.3 amendment and about the time ERISA created 403b (7) (mutual funds) the insurance industry collaborated and a “clever tactic” resulted.

Mr. Wildermuth explained (in the quote below) that the insurance carriers took unusual liberty with the hold harmless agreement legal language to make districts believe they are more liable than they actually are. In my opinion, it was a coordinated coup and it worked.

“When legislation broke [name withheld] control of California’s 403b market, [name withheld] resorted to a new and rather clever tactic. He called together his carriers (life insurance companies) and a contract was devised which exploited the unrealistic possibility that the IRS would hold a school district and their school board members liable for improper teacher payroll reductions and contributions for 403b investments. The old [name withheld] employees still laugh at the success of this very questionable, hold harmless agreement and what it has accomplished for the life insurance industry.”

What do you think about Wildermuth’s explanation?

Sure sounds like a coup d’état to me. According to Mr. Wildermuth’s allegation, hold harmless agreements with the “gross negligence” language were created by the insurance industry. In my opinion the industry offered the “new hold harmless” to school districts, knowing that mutual fund companies would not sign these outrageous agreements. Districts would eagerly accept the near universal liability protection. This brilliant and massively effective relationship between districts and insurance companies was solidified four ways:

1. Low-cost mutual fund companies would not sign the agreement because of the additional cost and risk.

2. District officials happily signed these agreements—no more liabilities from each vendor who signs the “gross negligence” protection!

3. Collective bargaining units never challenged district policy. Recall in Chapter 1 when I asked UTLA (my union) for help, “UTLA does not have the authority to require different legal protections and guidelines.”

4. Finally the California Attorney General (1974 AG Opinion) confirmed that school districts’ hold harmless agreements are justified when the AG wrote:

“So long as the imposition of such rules does not unreasonably discriminate against any insurer or interfere with the district employees’ freedom, pursuant to Insurance Code section 770.3, to designate qualified insurers, such rules would be permissible.”

But it did interfere with my “freedom” to choose Vanguard. To my knowledge I was the only one complaining with my interpretation vs. the insurance industry’s interpretation: so my request went nowhere. Did the AG’s Opinion leave a legal loophole regarding Mutual Funds, since mutual funds are not an insurance product? Then mutual funds can be kept out by districts legally. Few can argue against the convincing evidence that the 1969 amendment to 770.3 was intended to give more control and choices to California educators but ended-up protecting the insurance monopoly of 403b providers.

The ERISA law only galvanized the insurance industry against the low-cost mutual fund companies. It was a dazzling tactical move because the insurance industry knew there was no genuine liability at the extreme they were claiming, otherwise they would have never signed such an absurd agreement either.

If the regulators had good intentions for educators, it backfired. Insurance companies manipulated the legal landscape whiplashing PreK-12 school districts to demand over-the-top hold harmless agreements, controlled the TSA market and product sales, from the Boards of Educations to individual school sites and right into classrooms and teachers. After all, insurance companies are in the liability, marketing and sales business and low-cost mutual fund companies are in the investment business. Guess which business prevailed?

I understand why my plea for Vanguard did not happen in this fantasy environment,  supported by powerful bureaucratic and cultural myopia. The benefit staff probably never knew or questioned why these ancient policies existed. Consequently, these delusions of the fear about fiscal errors and excess liability were permanently in place.

Much of 770.3 is intact since it was amended 44 years ago. It is so outdated it qualifies to be on the national list of dumb and outright stupid laws (website: http://www.dumblaws.com/ Two attempts to modify this egregious code have failed. Chapter 7 and 10).

TSA Product Promotion, Sales and Delivery

What does the insurance industry get in return? PLENTY. Access and total control of 403b information in one-to-one conversations with a naïve and trusting clientele. Teachers have nowhere else to go for objective information. The agents are free to march right into the schools with no oversight or transparency about costs of the products nor other options.

The insurance industry will take 100% liability and 100% control over 403b information and delivery of TSAs directly to the classrooms, teacher cafeterias and union halls at no charge to the district or the unions. In the real world the situation of an agent who only represents TSAs talking to individuals about what is best for their retirement planning would surely fall under the category of conflict of interest. But the 403b world is not the real world.

The board of education and the unions want to offer these plans “free” and no risk. Most important, district legal counsel was happy to inform school administrators they were protected from (fictitious) liability—and unions never challenged this. Heck, every district administrator and union boss in California has been happy with the decades-old status quo. LAUSD had up to one hundred fifty 403b vendors with no liability. To have contracts with millions of dollars in transactions annually at stake and have zero responsibility must have been any K12 school district’s legal counsel and benefits administrator’s wet-dream.

The conflicts of interest surrounding this tightly bound scenario involving insurance agents with millions of educators who have wholly different financial needs is 100% opposed to fundamental best practices in retirement planning. The entire financial world knows that people have different financial needs and goals. Yet in the TSA world, one-size-does-fit-all is a permanent retirement planning practice, hiding under the umbrella of “choice.” It doesn’t matter whether the client is a 25 year-old married male teacher or a 55 year-old female principal. All that matters is a sale to a warm body and that commission. Easy pickin’s for the sales force.

Historical Review Table

• 1955—California teachers opted out of Social Security (SS).
• 1958—Congress allowed the IRS to defer income taxes with the 403b plan.
• 1961—The insurance industry introduced and marketed the “TSA” to the state’s educators as the supplemental savings plan in place of SS.
• 1961-1968—California school districts each had only one 403b vendor.
• 1969—Insurance industry amended California Insurance Code 770.3 to allow more vendors to sign with the state’s PreK-12 districts. Districts must allow “all willing vendors.”
• 1961-1974—only annuities were allowed in 403b (1) plans. Commonly known as the “TSA.”
• 1974— Congress passed ERISA allowing mutual funds as a choice for the 403b (7).
• Early 1970s—The California insurance industry created the “gross negligence” language to hold harmless agreements and introduced it to school districts. This agreement prevented mutual funds from competing for the PreK12 market and it gave the district a huge back door to excuse themselves from any responsibility for oversight, publicity of choices, cost transparency and retirement planning education. The illusory fear of liability for “improper teacher payroll reductions and contributions to 403b investments” (Wildermuth) resulted in an inflexible and permanent policy with PreK-12 school districts.   

Summary and A Call to Action

Creating the gross-negligence language was a dazzling and shrewd calculated move by the insurance industry. Their primary purpose? Keep the competition out of their market and make profits with TSAs. The strategy worked flawlessly—the overselling of high-cost, low performing, “never-lose-money” annuities and loaded mutual funds over low-cost alternatives continued unabated.

I have never heard of a 403b vendor coughing up money for an employer to comply with a hold harmless agreement or to correct the employers’ fiscal errors. INVESCO reported no problems with LAUSD. By demanding this agreement, school districts become unwitting co-conspirators who discriminate against quality, low-cost mutual fund companies that offer higher returns over time. 770.3 is to blame.

California has a reputation for bulldozing new ideas and encouraging social activism—but certainly not in 403b plans. For nearly one million PreK-12 California educators 403b has been a permanent fixture in the Flintstone’s backyard since 1961. How could school districts and insurance companies have gotten away with this lunatic policy for decades with nobody in a leadership position coming forward to challenge this travesty?  Think about the money involved: LAUSD educators alone contribute about a conservative $100 million a year by 25,000 employees. With the 700 other California school districts combined we are talking about billions over time. How is it that the 403b oversight has been given a pass at all levels of leadership?

The insurance agents selling expensive and inappropriate TSAs have a right to take care of themselves. We forget, as consumers, we also have a right to take care of our best interests. We owe it to our loved ones, our colleagues and the retirement planning system. With the addition of mutual funds the 403b improved dramatically and is now a powerful and effective retirement plan. We know how and why the potential of our powerful benefit has been hijacked. The retirement planning system is for our benefit, not the insurance industry. We need to improve the options.

Thanks to Kathy Kristof, Robert Wildermurth and subsequent articles from other newspapers and trade magazines, perhaps we can get enough publicity with rank-and-file educators to make 403b viable.  While there are complaints about the district run-around, they have not yet reached a critical mass. A colleague said she got the same run-around as I did, but her conversation escalated into a shouting match with a clerk, slamming down the phone and giving up. Kathy Kristof received emails from teachers complaining that their story was worse than mine. My colleague walked away frustrated because she didn’t know others felt the same way. Educators are complaining—this is a widespread problem.

The good news is that you are not alone. There are educators, colleagues and fellow employees who did not go away frustrated. A dozen wonderful LAUSD colleagues organized an informal self-help 403b group which took the message of hope straight to our colleagues.

 

Check for yourself how fees eat into your 401k, 457b or 403b: http://401kfee.com/how-much-are-high-fees-costing-you/