Friday, October 09, 2009

The "Free Education" Fallacy

Why most financial education programs in the Public School 403(b) and 457(b) world are really just covers for commission-based product sales.

A question that I continue to hear from Public School employers these days is “how do we best educate our participants?” Several companies that work in the 403(b) and 457(b) world have begun to develop and market “education programs” that purport to “raise financial literacy across the entire workforce.” I am all for financial literacy, in fact I think it is imperative that financial literacy is incorporated into our public school curriculum, however it is clear that financial education in relation to defined contribution participants (401(k), 403(b) and 457(b)) has failed.

There is plenty of evidence to support the failure of participant education:

Many participants are eligible for a match (free money) and fail to take advantage

The average participant account balance underperforms

The average participant couldn’t tell you the difference between a stock and a bond

More than 60% of participants don’t participate (about a third in 401(k)’s)



If you look at the dispersion of who is contributing to their 403(b) or 457(b) by age group those who are closer to retirement make up the overwhelming majority. These facts do not support the notion that participant education is working.

Participant education in Public School 403(b) and 457(b) retirement plans is very different than in 401(k) plans. In 401(k) plans there typically is a single plan and signing up is relatively easy, an advisor holds a plan meeting, provides some “education” and then helps people enroll or directs them to a website. This is not the case in 403(b) and 457(b) government retirement plans.

Most 403(b)/457(b) Public School retirement plans are “multi-vendor,” which means that the employer doesn’t have a single provider for their plans, they may have five or ten or in California, up to 76. Not only do these employers have multiple vendors, but many of these vendors also offer multiple products. In many districts in California its possible to have nearly 300 different products available to a participant. Each of these products may be sold by multiple agents, meaning that the number of choices between vendor, product and sales agent are almost too numerous to figure.

Imagine being an employee in one of these plans, you would be completely overwhelmed.

California has a website, www.403bcompare.com in which each of the 403(b) products are disclosed in terms of fees and returns, yet it is unreasonable to expect the average employee to actually analyze all the available options. Its tough enough for the average 401(k) participant to analyze the twenty-to-forty investment options available to them, imagine the school teacher who has to manage nearly eighty vendors, nearly three-hundred products and potentially thousands of investment options within those products and then finally choose from whom she wants to purchase that 403(b). No amount of “participant education” or “increased financial literacy” will enable the average participant to fully understand what is being offered to them.

It is the “multi-vendor” environment that feeds the perceived need for more “participant education.” The sheer number of options overwhelms people and pushes them either into paralysis or into the arms of a commission-based salesperson, who shows up on campus under the guise of “education.” If the education was truly unbiased and not related to commission-based products, there might be an increase in participants making the right choices, however there is no evidence there would be an increase in the number of participants overall.

The true reason behind the push for “participant education” in the 403(b)/457(b) School District retirement plan world is commissions.

While many firms represent that they only want to provide “unbiased” financial education, they are lying. Think about it for a second, can you think of any non-profit financial education companies that are not tied to product manufacturers in some form or fashion? You can’t, its because they don’t exist. When someone comes to your workplace to provide “education” on a 403(b) plan (in a multi-vendor environment) it is for one reason and one reason only, they want to sell you a product in order to earn a fee or commission. They are not interested in protecting your best interest, they have no duty of loyalty to you and they are not providing the “education” in order to increase your financial literacy. Financial education is a front for product sales. There is a reason that the Department of Labor is making changes to the highly conflicted regulations under ERISA that allowed for salespeople to give investment advice.

A few Third Party Administrators (TPA) for Compliance in California sell their “free” services and wrap them in the blanket of “free financial education.” Even worse, some charge for their compliance services and then offer to provide “free financial education.” This is dangerous for both the employer and the employee. Free financial education, if offered without commission-based product sales is fine, but that is not what is offered. The TPA essentially is acting as an agent for the employer - to the employee the TPA appears to be “endorsed” by their employer (either implicitly or explicitly) and this leads to the assumption (right or wrong) that the representatives of that TPA are selling products that have been approved by the employer.

Essentially the employees are trusting the employer made the right decision and they transfer that trust to the TPA representatives, this is exactly what the TPA Representatives want. Once the TPA and its reps have the confidence of the employees (based on the implicit employer endorsement) they need only to get in front of them to sell commission-based products. The means to get in front of them is “participant education.” The TPA is simply a front for the sale of high-cost, commission-based financial products that are rarely in the best interest of participants.

These education conflicts can be avoided by not hiring a TPA or provider of 457(b) plans that earns a commission or a hidden fee for selling financial products. They can also be avoided by not allowing sales agents on campus to “provide education.” There is no evidence this education works and it only facilitates an employee providing a commission to a sales person who has no duty of loyalty to that employee.

If you doubt me, simply ask the TPA sales organization to put in writing that all of their sales representatives will act as a Fiduciary (under ERISA) at all times when working with your employees, none of them will do this.

So what is the solution to the education problem? That’s a story for another time.

Full Disclosure: I am a consultant to the CalSTRS 403bComply and Pension2 service offerings. CalSTRS provides financial education and does NOT receive commissions or fees in exchange for the sale of financial products.
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