W. Scott Simon
As a complement to my current multipart series analyzing the contract between a K-12 public school district and a giant insurance company providing investment options for a non-ERISA 403(b) plan, I thought it would be interesting to hear from someone who has long been in the trenches fighting the good fight against the many abuses that typically characterize 403(b) plans in the K-12 marketplace.
Steve Schullo was an elementary schoolteacher with the Los Angeles Unified School District (LAUSD) for nearly 25 years. In his retirement, he has just written another book titled “Fighting Powerful Interests: Educators Challenge Tax-Sheltered Annuities and WIN!” which can be downloaded (as a PDF) for free. Steve is also a blogger at Late Bloomer Wealth.
Steve has a unique perspective on the nature of the investment options typically offered by insurance companies to participants (teachers, psychologists, counselors, substitutes, custodians, nurses, et al.) in the 403(b) plans established and maintained by K-12 school districts.
I cannot think of anyone else today that has the same in-the-trenches experience and insight gained from fighting against a powerful and entrenched industry as well as decades of indifference demonstrated–regrettably–by the vast bulk of the teaching profession. One result of this has been a general reluctance to even publicly discuss reformation of the poor investment options typically offered to employees in K-12 403(b) plans. The perplexing apathy of teachers unions and the general ignorance displayed by administrators and teachers at many K-12 school districts continues today when it comes to their 403(b) plans.
Steve’s efforts at bringing to light the awful shortcomings of K-12 403(b) plans is offered to help others in their own attempts at reform. No one in the K-12 leadership hierarchy is going to look out for the best interests of educators without the educators themselves stepping up and demanding reform of their 403(b) plans.
The following interview was conducted via email and has been edited.
Scott Simon: Steve, thanks very much for consenting to this interview.
Steve Schullo: My pleasure.
I’ve got lots of questions for you so let’s dive right in. When and where did you begin teaching?
In 1984 with the Los Angeles Unified School District.
When did you first invest in the retirement plan at LAUSD?
In 1985, I began investing in a 403(b) fixed annuity with the Great American Life Insurance Company. I remember that the $200 deducted monthly from my paycheck was a lot of money for a starting salary of $19,000 a year. I had always had a savings habit but never with a tax-deferred retirement plan. I liked the idea of tax deferment, and started saving and planning for retirement.
When did you first get interested in reforming the 403(b) plan at LAUSD?
My advocacy started about 1994 when I found out that the interest rate to be paid on my two annuities dropped from 12% to 3%. When I tried to get out of the annuities, I found out that there was a $6,000 surrender charge! Nobody had ever informed me about that little detail. That really ticked me off, and I vowed to write a book about that troubling experience.
Can you provide some general background on the LAUSD 403(b) plan?
Sure. As you know, an annuity sold through a 403(b) plan is an individual contract between a teacher and an insurance company. For years, insurance companies sold annuity after annuity with few complaints while delivering a product to teachers in their classrooms, union halls, school cafeterias and at district-sponsored professional development locations. They were everywhere! Insurance companies even told school districts that they would assume all legal responsibility for record-keeping, presentations, enrollments and delivery of products. The insurance companies guaranteed that they would fix all accounting errors made by district staff so they could pass IRS audits. That must have been music to the ears of the district’s legal counsel. And remember, this was all supposedly free of charge! Imagine a smooth- talking insurance agent up against a helpless, naive teacher in a private one-on-one meeting. What was even worse was when the insurance agents were ex-teachers or moonlighting teachers in the very same school as the targeted teacher/prospect. Wow, talk about a seminar in trust-based selling!
Another factor that must have thrilled the insurance salesforces was that there was no objective oversight of them whatsoever. I know that a lot of people say that insurance companies are heavily regulated, and I suppose that’s true. But at ground zero– in the school lunchrooms, where you see up-close the egregious sales practices engaged in by many agents–it just seemed like it was the Wild West out there.
This is the world of 403(b) plans at K-12 school districts. It’s appalling even at the LAUSD, the second-largest public school district in the entire country. Out of the $2.5 billion in assets invested by 60,000 active and retired employees in the LAUSD 403(b) plan, only about $211 million (or 8.5%) is invested in low-cost mutual funds made available by such entities as California’s terrific Pension2 (offered by CalSTRS, the California state teachers’ retirement system), Vanguard, USAA Investments, and TIAA- CREF. $2.3 billion (or 91.5%) is invested primarily in low-performing annuities that feature punishing surrender fees or in mutual funds with excessive advisory fees sold by broker/dealers.
Were the agents who sold the insurance products fiduciaries?
Are you kidding? The incentives involved are just way too tempting for insurance agents to ignore, which is why you wind up with a lousy, conflict-ridden system that hurts public school employees. If they took away the tempting financial incentives to do wrong in the first place, I believe that the system would right itself, whether or not fiduciaries were involved. The difference would be like night and day.
Did the regulations introduced by the Internal Revenue Service in 2007 help improve the situation?
No, they actually make things worse. The few mutual fund companies that offered no- load, low-cost mutual funds offered in 403(b) plans dropped out in most districts. They couldn’t absorb the added expenses of the IRS requirement that each product vendor must share every participant’s plan contributions with the district, which allowed the IRS to audit for over-contributions, loan compliance and dozens of other compliance issues. This required more paperwork from these fund companies as well as their allocation of extra personnel to work with school districts, so many of them simply dropped out of the 403(b) plans. The usual suspects–insurance companies offering high-cost 403(b) annuities and a handful of mutual fund companies peddling mutual funds with excessive advisory fees sold by broker/dealers which could afford the expenses–were the only options left.
Didn’t the teachers’ union go to bat for you?
Fat chance. For years, a union committee screened potential 403(b) vendors for selection as “union-approved.” The only entities that ever made it onto this list were insurance companies with high-cost annuities and mutual fund companies offering mutual funds with excessive advisory fees sold by broker/dealers. These entities were required to make their products available to all union members without any cost to the union, and they had to be willing to make donations, or supply door prizes or free dinners at union-sponsored conferences or meetings where tables of the union-approved vendors would be lined up all across the meeting rooms. Those meetings were held all over the school district. All members were invited to attend, but it was usually the union stewards from each school who attended. Once these vendors were “union-approved,” they were turned loose on union members. There was never, to my knowledge, any oversight process in place to handle member complaints or even kick out egregiously bad insurance companies. It just never happened. My union, United Teachers Los Angeles, finally stopped this union-approved policy in 2008 due to the new regulations issued by the IRS in 2007. The union did not want to be in a position to be held legally responsible.
So are you saying that your union at LAUSD was corrupt?
No, not at all. In my opinion, in order to be corrupt, the union bosses had to be worldly and smart, and they were neither. The union just never did anything with the 403(b) plan. The insurance salespeople were way more intelligent and on the ball compared to the union leadership. They ran circles around them. Often the salespeople were cozy with the union bosses, school principals, and office managers, and some were even personal friends with them. This salesforce flourished in a professional culture that accepted them, without question, for decades. LAUSD now has a policy that no 403(b) vendors are allowed on school campuses to sell products, and yet the sales agents knowingly violate this policy with impunity and continue to see teachers, make presentations, offer the usual stale donuts and continue to enroll people on campuses. I’m a member of the LAUSD’s Retirement Investment Advisory Committee, and we get reports about the 403(b) plan showing that about 20,000 LAUSD employees continue to contribute $100 million a year to expensive annuity products.
So how did the unions help make the LAUSD 403(b) plan better for their members?
That’s what I’m saying–they did nothing. How could the union leadership know anything when there was never any ongoing public conversation about the retirement plans? The union bosses knew nothing–I repeat, nothing–about investing, high costs, how the insurance companies were ripping off the union membership with inappropriate products, etc. Ironically, a few union staff did understand the problem, so the editors at my local union newspaper allowed me to publish investing articles, for example. But the bosses never publicly showed any understanding of the problem themselves. Given the complete lack of a union-initiated ongoing public discussion about the shortfalls of the LAUSD 403(b) plan, union members who wish to contribute to that plan remain locked in to a menu that features only inappropriate, high-cost products.
Is it true that LAUSD had something like 125 vendors of insurance companies on their “approved” list at one point?
Yes, but they also had 25 mutual fund companies on that list with almost all featuring funds with excessive advisory fees sold by broker/dealers. California, by virtue of Insurance Code section 770.3, is one of only six or seven “open vendor” states–I know that Texas is one too–whereby a school district such as the LAUSD must, at least according to the insurance companies that have convinced the school districts of this, allow a vendor to sell its insurance products to participants in a 403(b) plan, as long as the vendor agrees to comply with the 2007 IRS regulations. There’s a lot of junk being sold by many vendors to unsuspecting teachers, and it’s terribly confusing to them to boot. So you could say that the ultimate authority that determines what product vendors will be on the LAUSD’s approved list is section 770.3 of California’s insurance code.
What do the union-approved vendors have to do with the list of vendors approved through the state insurance code?
Before the IRS issued its regulations in 2007, the insurance code was moot as far as unions were concerned because the school districts issued their lists of approved vendors, which included companies such as TIAA-CREF and Fidelity that offered low- cost products. To my knowledge, currently the two biggest teachers unions in California are not approving specific 403(b) vendors. But in the past, United Teachers Los Angeles, the teachers union in the LAUSD, only selected as union-approved, insurance companies or mutual fund companies with their high cost broker/dealer salespeople. By the way, this approval process was always conducted in secret. To this day, unions believe that teachers need a lot of “hand-holding,” which is terribly insulting because it means that teachers need someone to point them to the signature line and then the sales agents disappear. Is that “hand-holding?” Of course not. It’s an institutional rip-off. United Teachers Los Angeles, as well as many such unions across the country, have no idea what they’re doing! Unions don’t want to educate their members about retirement plans that include true fiduciary consultants, and they continue to fall for the same old sales pitches made by the insurance companies every time. An excellent example of this involved the American Federation of Teachers, the second-largest teachers union in the country. AFT’s trade magazine, American Teacher, published a devastating critique detailing how insurance companies–even calling them predatory sharks–have virtually ruined 403(b) plans with the terrible products they offer to public school employees. Yet when it came time to grant a “union-approved” label to a particular company, ATF just caved to another insurance company. Can you imagine? The second-largest teachers union in the country! [Chapter six of Steve’s free PDF eBook “Fighting Powerful Interests!” details this incident.]
Could you please describe the kind of 403(b) plan that the National Education Association (NEA) offers to its members?
There have been many complaints about it for 15 years, but nothing has ever changed. And yet, the NEA sponsors an excellent 401(k) plan for its own 700 employees! It’s so good I wrote a blog about it. By the way, the California Teachers Association is supposed to be coming out with a 403(b) product, but nobody knows the details about it yet. One thing that has leaked out is that the third-party administrator is a broker/dealer that sells high-cost mutual funds. Oh brother, here we go again.
My interview with Steve Schullo continues next month.
W. Scott Simon is an expert on the Uniform Prudent Investor Act, Restatement (Third) of Trusts and Title I of ERISA. He provides services as a consultant and expert witness on fiduciary investment issues in depositions, arbitrations and trials as well as in written opinions. Simon is the author of two books including The Prudent Investor Act: A Guide to Understanding. He is a member of the State Bar of California, a Certified Financial Planner® and an Accredited Investment Fiduciary Analyst™. Simon received the 2012 Tamar Frankel Fiduciary of the Year Award for his “contributions to advancing the vital role of the fiduciary standard to investors, capital markets and to society.” The author’s views expressed in this article do not necessarily reflect the views of Morningstar.