BILL ANALYSIS �
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Date of Hearing: May 2, 2012
ASSEMBLY COMMITTEE ON INSURANCE
Jose Solorio, Chair
AB 1949 (Cedillo) - As Amended: April 25, 2012
SUBJECT : Teacher Retirement Savings: Deferred Compensation
SUMMARY : Permits a school district to restrict the investment
products offered in its "403(b)" plan based on a competitive
review process. Specifically, this bill :
1)Expresses legislative intent to allow a competitive bid
process in designing 403(b) benefit plans to accomplish the
following:
a) Full compliance with 403(b) regulations.
b) Enhance retirement savings opportunities for plan
participants.
c) Include retirement saving education programs for plan
participants.
d) Emphasize transparency and disclosure of potential
conflicts of interest in plan design.
e) Offer high quality investment options with the lowest
costs to plan participants, school districts, community
college districts, county offices of education, and charter
schools (public education employers).
2)Defines "403(b) product" as a payroll-deducted, tax-deferred
retirement investment product described in Section 403(b) of
the Internal Revenue Code.
3)Provides that public education employers may select specific
403(b) products offered by four or more vendors through a due
diligence and competitive review process (competitive review
process).
4)Requires the competitive review process to:
a) Prohibit communication by prospective vendors with the
public education employer except during an official meeting
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of the public body committee formed as part of the
competitive review process.
b) Prohibit payments by prospective vendors during the
competitive review process to any member of the governing
body of the public education employer or any member of a
committee formed as part of the competitive review process.
c) Disqualify prospective vendors that violate the
prohibitions above.
d) Require vendors selected in the competitive review
process to adhere to the policies adopted by public
education employers. Violation of an adopted policy by a
vendor shall result in the termination of the vendor's
contract.
5)Permits public education employers to allow employees to
continue to make contributions to a 403(b) product not
selected in the competitive review process if the employee
remains continuously employed with that public education
employer since the initial investment in the 403(b) product.
6)Requires public education employers with represented employees
that engage in a competitive review process to appoint a
committee to make recommendations to the governing body
regarding the vendors and products to be selected. The
committee membership must be at least 50% represented
employees designated by the exclusive representatives of the
employees.
7)Permits a public education employer with an average daily
attendance of 2,500 of fewer in the prior year to adopt the
vendor selections of another public education employer that
has completed a competitive review process as required by this
bill.
8)Permits a public education employer to apportion the costs of
a competitive review process to the selected vendors.
EXISTING LAW :
1)Permits, as a matter of federal law, employees to make pre-tax
contributions to tax-deferred retirement savings programs
commonly known by their section numbers in the Internal
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Revenue Code (e.g., 401(k), 403(b), 457). These plans are
commonly referred to as "defined contribution plans."
2)Permits, as a matter of federal law, public school employees,
employees of 501(c)(3) entities, and ministers to participate
in a 403(b) defined contribution plan.
3)Permits, as a matter of federal law, an employee to receive
distributions from a defined contribution plan at the age of
59 and one-half.
4)Requires, as a matter of state and federal law, distributions
from a defined contribution plan to be subject to the personal
income tax.
5)Requires school districts to permit employees to select any
investment product when making contributions to a 403(b) plan.
6)Requires any vendor offering investment products in a 403(b)
plan to complete a registration process for that product with
the California State Teachers' Retirement System (CalSTRS).
7)Requires CalSTRS to provide specified information (e.g.,
performance, product features, fees, charges, restrictions)
regarding registered 403(b) products offered on its website
for use by 403(b) participants.
8)Requires CalSTRS to offer a 403(b) plan that is available to
any member of the CalSTRS defined benefit program.
9)Requires CalSTRS to contract with a third party administrator
to operate its 403(b) plan subject to rebidding every five
years.
FISCAL EFFECT : Unknown
1)COMMENTS : Purpose. According to the author, the bill would
provide school districts the option to competitively bid and
screen the number of 403(b) vendors its employees may select
based on the quality, cost and services provided. It would
require a school district to select at least four vendors to
provide products to district employees in its 403(b) plan.
Current law does not allow school districts to take reasonable
action to sift through investment providers to create a more
effective, efficient and transparent system.
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2)Defined Contribution Plans. There are several types of
defined contribution plans, each one named for a section of
the Internal Revenue Code. The best known defined
contributions plans are:
a) 401(k) plans are typically a profit-sharing plan.
Both sponsors and participants are permitted pre-tax
contributions in 401(k) plans.
b) 403(b) plans are similar to 401(k) plans, in that
they typically permit both sponsors and participants to
make pre-tax contributions, but are designed for public
education entities and tax-exempt organizations that
operate as 501(c)(3) entities. Participants in these
plans are generally limited to investing in annuity
contracts issued by insurance companies and custodial
accounts invested in mutual funds.
c) 457(b) plans are also like 401(k) and 403(b) plans
in that they typically permit both sponsors and
participants to make pre-tax contributions. 457(b)
governmental plans are usually open to all employees at a
state or local government, and are similar to some other
defined contribution plans in that contributions are set
aside for the participants in a trust.
1)Tax Status. Contributions to defined contribution plans are
generally made through payroll deductions and are not subject
to either the state or federal the income tax. Contributions
(and earnings on invested contributions) are held in the
account tax free until funds are withdrawn from the account
(generally in retirement) when they are subject to both state
and federal income tax. By deferring the taxation of
contributions and earnings for decades, government is forgoing
income tax revenue that it would otherwise collect to
incentivize retirement savings. Government therefore now has
a financial interest in the performance of 403(b) investments
beyond to the immediate policy goal of increasing retirement
savings. The amount of revenue collected when funds are
withdrawn from a tax deferred account is directly related to
the earnings generated by the investments made by the
participant.
2)Investment Products. Defined contribution plans typically
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offer a range of products to plan participants including
mutual funds and annuities. A mutual fund is a pooled
investment in a portfolio of securities, managed by a
professional investment advisor. Investors buy shares in the
fund, which represents an indirect ownership interest in the
fund's securities. Types of mutual funds include: stock,
bond, and money market funds.
An annuity is typically a contract between a plan participant
and an insurance company, under which the participant makes a
lump-sum payment or a series of payments and the insurance
company provides a payout for an agreed-upon span of time.
Annuities may be purchased for groups or for individuals and
can be fixed or variable. Fixed annuities guarantee a minimum
interest rate on assets while the account is growing and also
guarantee periodic payments after the annuity is claimed.
Variable annuities guarantee periodic payments to participants
that vary based in part on the value of the investments
(typically mutual funds) that underlie the account.
3)GAO Report. The U.S. Governmental Accountability Office (GAO)
has published reports regarding fees in retirement savings
plans. In a 2009 report (GAO-09-641), the GAO found that
403(b) plan sponsors can:
"decrease fees charged to participants by combining or pooling
assets to access certain investment products, reduce fees, or
negotiate with service providers. For example:
Some investment products are available only to
large-size investors, like collective investment funds.
These "institutional" products often have lower fees than
other "retail" investments.
Other investment products are available to all types
of investors, but offer lower fees for higher volume
investments. For example, mutual funds often provide
"breakpoints"-the designated dollar amounts at which
management fees are reduced-for investors with higher
volume.
For annuity products, sponsors with pooled assets
can negotiate terms and fees for group variable annuities
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that individuals typically cannot.
Record-keeping service providers are likely to
charge less per participant for a group of participants
than for individual participants because pooling assets
results in "economies of scale," or efficiencies gained
through higher volume."
"Sponsors can also issue a request for proposal (RFP) to lower
costs and decrease fees charged to participants. In response
to an RFP, vendors submit bids describing their services and
fees to the sponsor. Sponsors may then choose vendors who meet
their participants' needs and may choose vendors with lower
fees. For example, one expert told us that a statewide plan
reduced total participant fees significantly because they
issued an RFP and chose service providers with lower fees."
The report goes on to explain that these strategies are
commonly used in other defined contribution plans (401(k) and
457 plans) where federal law requires the employer to assess
the reasonableness of fees charged as part of their fiduciary
responsibility to plan participants. There is no similar
requirement in federal law for 403(b) plan sponsors.
1)Participation Rates. A 2010 study found that nationally
approximately 30% of teachers participate in a 403(b) plan.
In three school districts where a single vendor was selected
to offer 403(b) products, the 403(b) plan participation rate
declined as much as 54%. In a Southern California district,
approximately 50% of workers stopped contributing to their
403(b) plans when their existing investment provider was no
longer available. Similarly, the number of participants
dropped by over 54% when a school district in Colorado went
from 55 investment providers to a single investment provider
model for its 403(b) plan. Nearly 40 percent of participants
ceased participating in a 403(b) plan at a school district in
Pennsylvania when the plan went from nineteen investment
providers to a single investment provider.
2)Preferred Vendors. In 2008, the Attorney General issued an
opinion (#06-408) that interpreted existing law to allow
school districts develop preferred provider lists if doing so
aids the district in administering its benefit programs, does
not unreasonably discriminate against vendors, and does not
interfere with the right of an employee to purchase investment
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products of their own choice. The same opinion found that
neither the district nor its employees may receive
compensation for the promotion of a particular 403(b) product.
However, a third party administrator operating a 403(b)
program on behalf of the district may receive compensation
from vendors if the compensation and organizational
relationship between the administrator and the vendor are
disclosed to both the district and plan participants.
Reportedly, many school districts hesitate to develop
preferred provider lists due to litigation threats from
vendors.
3)CalSTRS Programs. CalSTRS operates four programs related to
403(b) investment plans:
a) Vendor Registration - Current law requires all vendors
offering products in the 403(b) market to register their
products with CalSTRS. The registration process includes
sharing detailed information regarding the products being
offered, and the vendors pay a fee to cover the costs of
the registration program and the 403(b) compare website.
b) 403(b) Compare - This website is a compilation of
information collected during the vendor registration
process and is intended to provide teachers with
information regarding the individual vendors and products
offered to 403(b) participants.
c) 403(b) Comply - CalSTRS offers school districts services
as a third-party administrator for their 403(b) plans.
Third party administrators perform the program functions
required by federal law of employers with 403(b) programs.
d) Pension 2 - CalSTRS offers a 403(b) investment product
to teachers as well. Teachers contributing to a 403(b) can
choose Pension 2 as their product. Pension 2 was designed
by an investment company under contract with CalSTRS and is
composed of funds and annuities in which participants can
invest their contributions. CalSTRS reports obtaining
significantly reduced fees for the products offered in
Pension 2 through the vendor selection process.
1)Support. Supporters argue that the ban on competitive bidding
for 403(b) vendors in California law has resulted in
California teachers paying the highest average fees (2.11%) of
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any state in the country. They cite the experience of the
University of California, California State University, 40
other states and the private sector as evidence of the savings
that can be achieved in a competitive bidding process.
Experience with competitive bidding at the University of
California and California State University systems has found
that average fees are below 1%. Supporters point out that a
1% reduction in fees over a 35 year investment period can
increase earnings by approximately $100,000 under reasonable
assumptions.
Supporters also cite research that presenting investors
(including teachers) with too many choices can result in
paralysis, poor participation rates, and poor investment
decisions. Supporters point out that the bill is permissive.
The bill does not require school districts to engage in a
competitive bidding process if they are satisfied with the
status quo.
2)Opposition. Opponents argue that the bill would reduce the
number of investment options available to teachers, and
studies have shown that participation rates fall when
investment options are restricted. Opponents also cite
evidence that participation rates among teachers increase when
they work with an individual financial advisor. Restricting
the number of investment options will ultimately harm teachers
financially by discouraging additional retirement saving. In
addition, prior legislation established a vendor registry and
product information website operated by CalSTRS to provide
teachers with a central and impartial source of information to
guide investment decisions by teachers.
Opponents further argue that the vendor selection process
outlined in the bill would result in investment choices
limited to large investment companies with low-cost and
low-service products and exclude investment products sold
directly to teachers by agents. Additionally, the RFP process
lacks protections to prevent "pay-to-play" demands and would
permit the proponents to corner the market in 403(b)
investments. This would result in the loss of many jobs by
local financial advisors and the staff that support them.
Some opponents argue that the bill should focus more on
increased education around retirement savings and investments
for teachers and that IRS regulation changes have already had
the practical effect of significantly reducing the number of
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vendors in the 403(b) market. Lastly, the opponents question
the problem being solved by this bill. They note the absence
of widespread unhappiness among teachers participating in
403(b) programs in California.
3)Possible Amendments. The Committee may wish to consider a
number of amendments to address some of the concerns raised by
the opponents:
a) Require that the following services be offered by at
least one vendor among those selected: proprietary agent
services, independent agent services, toll-free phone
access to agents, and internet self-service.
b) Prohibit gifts from prospective vendors to the public
education employer, members of the governing body, and
employees involved in the competitive review process.
c) Prohibit payments or gifts from prospective vendors to
the consultant assisting the district with the competitive
review process.
d) Require the school district to select vendors based on
cost, performance, and service level criteria.
e) Require the RFP to include fixed annuity, variable
annuity, and mutual fund products.
f) Require the vendors to offer a brokerage option allowing
plan participants access to investment products from a full
range of vendors.
g) Require vendors to include investment education programs
to plan participants in their bid submissions.
h) Specify that employees who purchased or invested in a
403(b) product prior to the conclusion of the competitive
review process that is not selected may continue
contributing to that product so long as the employee is
employed by that public education employer.
REGISTERED SUPPORT / OPPOSITION :
Support
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Antelope Valley Community College District
Association of California School Administrators
California Federation of Teachers
California State Teachers' Retirement System (if amended)
Community College League of California (League)
Faculty Association of California Community Colleges
Glendale Community College District
Great West Retirement Services
Kern Community College District
Los Angeles College Faculty Guild
Los Angeles Community College District
North Orange County Community College District
Peralta Community College District
Prudent Financial
President of the Sierra Community College District
Riverside Community College District
San Jose-Evergreen Community College District
Small School Districts Association
United Teachers Los Angeles (UTLA)
South Orange County Community College District
The Hartford
TIAA-CREF
VALIC
West Kern Community College District
Yosemite Community College District
Opposition
American Fidelity Assurance Company
American Society of Pension Professionals
California Teachers Association
Financial Services Institute
MidAmerica Administrative and Retirement Solutions
National Association of Insurance and Financial Advisors of
California
National Tax Sheltered Accounts Association
Retirement Options for Professional Educators
Small School Districts' Association
Numerous individual financial advisors and their clients
Analysis Prepared by : Paul Riches / INS. / (916) 319-2086
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