In 2016, our U.S. Department of Labor stepped up to protect the fortunes of middle America from some segments of the financial services industry that were overcharging for retirement plan advisory services. Since all tax-qualified retirement plans such as 401(k)s and 403(b)s are retirement TRUSTS, they are required to have trustees overseeing the money who, in turn, are deemed “fiduciaries” because they are responsible for choosing financial products on behalf of the plan participants.
“Fiduciaries” are charged with making “all decisions in the sole interest of plan participants.” Those selling investment products to a plan could not be fiduciaries because they were clearly acting in their self interest. A fiduciary is required to offer products at the “best executed price — i.e. the cheapest available when compared with comparable investment types. Commissioned sales agents are conflicted.
Consequently, the financial advisory community has moved rapidly toward a business model that just charges a flat fee rather than selling different products paying varying amounts of commissions. A flat fee is transparent, negotiable and makes perfect sense — to consumers at least. Most of the industry has responded positively. Not so, however, with the insurance subset of financial services — a group largely selling annuities, rather than name-brand mutual funds.
To what should be our collective dismay, the Trump administration has decreed a roll-back and “further review” of the Labor Department regulation. In addition, Congress has now introduced legislation to allow annuities to continue to be sold in retirement plans. The now-delayed regulation had effectively ended them as evidenced by a letter from a major company to its agents saying that the company would stop paying annuity commissions after April. Then, with the rescinding of the fiduciary regulation’s effective date, the letter was countermanded and word came down saying, in effect, “it’s business as usual.”
Insurance company investment products are overpriced as evidenced by countless articles and studies illustrating the opaque fee structures, commissions and performance “guarantees” protecting against losses. Anyone with even the most basic understanding of stocks, bonds, and market history could determine that these guarantees are offset by substantial hidden costs — costs impossible for the average person to figure out.
Take, for example, the popular Guaranteed Investment Contract known as a “GIC.” This is not a stock or a mutual fund. It is an investment created by, and backed by, an insurance company that promises a fixed amount of income as well as the principal. Today’s 4 percent return on GICs may sound good to some people who don’t know that a GNMA fund invested in government guaranteed mortgages would have paid about what national mortgage rates have been over the last several years with minimal fluctuations in capital value and with the mortgages themselves backed by the U.S. government. Meanwhile, that GIC, supposedly paying 4 percent, would have been reduced by about 1 percent in annual administrative fees charged by the typical retirement plan, so the real return could have been 3 percent. Switching investments by choosing another investment in the plan can cost as much as 4 percent unless the move is spread out over five years — and so on.
Then, there’s the “market valuation adjustment” that kicks in if the money is withdrawn due to a “termination, layoff, sale, merger, consolidation, reorganization, spin-off” or more — all of which are out of the participant’s control. This “MVA” is based on a calculation of how much the underlying bonds supporting the GIC might have lost during a spike in interest rates. This is “disclosed” in the marketing materials by the suggestion that the participant request a copy of, for example, a 29-page contractual agreement that his or her employer can provide upon request.
Finally, there is no mention of the fact that the “guarantee” in “GIC” is only as good as the solvency of the underlying insurance company. A Google search cites one article in 2008, titled “Where did Hartford Go?” which covered the insolvency of that financial giant. Fortunately for those nail-biters with Hartford GICs, their money was bailed out over time by us fellow taxpayers. Those who had Mutual Benefit or Executive Life in years past were not so fortunate. Ask the Pacific Lumber Company employees who were wiped out.
Thanks to the McCarran-Ferguson act, California can set its own rules for the insurance industry, and we can ban these products if we so choose. As with many other issues such as emissions, environment, offshore drilling, etc., we don’t have to participate in the rest of the country’s race to the bottom. Meanwhile, employers with these plans can take matters into their own hands considering more conventional plans offering direct investments in SEC-regulated investment products.