YOU HAVE FOUND OUR OLD WEB SITE. BE SURE TO CHECK OUT OUR NEW AND IMPROVED SITE!     Note: This story is a rebuttal to In Defense of Hold Harmless Agreement by Mark Fischer, CFA. A Hold Harmless agreement is a legal contract that some school districts require financial providers sign in order to sell 403(b) products. Insurance companies have been more willing than mutual fund companies to sign these agreements. Mutual fund companies have said they object to language in many of these agreements that hold the financial institutions responsible for oversight they have no way of controlling. Many believe that insurance companies are more willing to sign these agreements because their higher operating expenses (often 1% to 2% higher than mutual funds) make the risk more worthwhile. Whatever the reason, most 403(b) plans offer an overwhelming majority of insurance-based investments at the expense of mutual funds.     The Case for a Reasonable Hold Harmless   by Scott Dauenhauer, CFP     While I appreciate the well-written article by Mark Fischer (supporting the need for "strong" hold harmless agreements), it fails to explain all sides of the debate. Let me first define the context of this rebuttal: 403bwise is open to anybody wanting to learn about the 403(b), but was started initially to educate k-12 school employees. I will address the hold harmless as it applies to a non-ERISA plan (since this is the case for most k-12 educators). Secondly, most people understand the need for a document such as the hold harmless. We all understand the concept of risk management; meaning school districts in exchange for offering the 403(b) as a benefit should not have to assume huge amounts of liability. Thirdly, our fight is not against the hold harmless but against the high cost of ownership of the products available to teachers. This is my context, and what follows is what I see as the truth.   First, let me address the compliance issues.   The first issue mentioned in Mr. Fischer's article — MAC calculations — are basically a non-issue beginning January 1, 2002. At this time calculating the contribution limit will be extremely simple. Catch-up provisions have been greatly simplified as well. These improvements greatly reduce potential liability. Most of the large excess contribution problems have come from colleges where professors are usually higher paid. For k-12 educators overall, the pay is much lower thus it is much more difficult for them to contribute the maximum, thus less excess contribution problems. In addition, excess contributions will not disqualify an entire plan per the Small Business Job Protection Act of 1996.   Universal availability — While many districts may be out of compliance in this area, this isn't hard to correct, and if it were the only problem the IRS would be hard pressed to disqualify the plan. Districts are becoming more compliant in this area everyday. Besides, how does a hold harmless agreement protect the district from this problem? Surely a vendor will not accept any liability because a district failed to offer the plan to all employees. There is not a vendor out there that will indemnify the district for an error such as this. It's highly unlikely that districts are being disqualified for this reason. In fact I have never heard of a case. This doesn't mean it doesn't happen, simply that the hold harmless won't prevent it. If this is such a credible threat, I would be interested in seeing the number of districts disqualified for this reason.   Hardship and loan provisions — This may be a problem with some fund companies and even insurance companies, however, there are plenty of quality no-load low cost mutual fund companies that are fully compliant with the provision of the 403(b) as it relates to hardships and loans. Many mutual funds do not allow for loan provisions making loans a moot point.   Mutual funds in non-compliant custodial arrangements — doesn't happen often, won't even address it.   The last compliance issue is 70 1/2 Required Minimum Distribution notifications. New simplified rules announced earlier this year have taken care of this problem. By law, any person in an IRA, 403(b), or 401(k) must be sent by the company holding their funds a notification stating how much must be withdrawn. Once withdrawn, a 1099 is always issued (by law). The new laws have made this issue a moot point. By the way, the IRS actually wants you to miss your RMD (required minimum distribution); it means huge additional revenues to them (50% of the required amount). Lastly, by age 70 1/2, many 403(b) participants have either rolled over their accounts to IRA's or transferred them (via 90-24) to another investment provider; under both of these situations the employer is exempt from liability.   Of the seven compliance issues mentioned, four of them are completely irrelevant (MEA Calculations, Loans, Required Minimum Distributions & proper tax reporting); one does not apply at all to hold harmless agreements (Universal Availability); another one hardly ever happens and in most cases will not disqualify an entire plan (Mutual funds in non-compliant account); and the only one that does apply, Hardship distributions, is not hard to comply with — the government lays out specific rules to follow, if not followed then the district is at risk. Quality no-load mutual fund companies will accept responsibility if they screw up, they just won't accept it when they are held responsible for screw-ups by the district.   Mr. Fischer states, "A strong hold harmless agreement will protect the employer and employee from non-compliance arising from the vendors' actions. The agreement will require the vendor to take responsibility for their errors of commission and omissions. Most insurance companies choose to take responsibility; most mutual funds, however do not. The mutual fund industry's position is that they do not administer 401(k) plans for free, and are not willing to administer 403(b) plans for free. Thus, most mutual funds are not approved products in plans where employers require strict hold harmless agreements."   What I feel needs to be addressed is the fact that a "regular" hold harmless agreement can both protect an employer just as much as a "strong" one, and equally important, be palatable to low-cost providers. Our fight is not to bankrupt our districts or unnecessarily expose them to liability, but simply for them to realize that compliance and low-cost provider options are not mutually exclusive. The problem with a "strong" hold harmless agreement is that it goes far beyond taking responsibility for "errors of commission or omission," it requires the vendor to indemnify the district for mistakes the districts make as well.   Many hold harmless agreements require vendors to take responsibility for acts of negligence or misconduct on behalf of the district (only when the acts can be proved to be "Gross" negligence or "willful" misconduct will a vendor be able to skirt responsibility). Imagine being asked to take responsibility for something that you have no control over? Would you expose yourself to that risk? You couldn't unless you charged a lot more money for your product. My problem is not with the hold harmless agreement; it is with hold harmless agreements that are so restrictive that they are only acceptable to high-cost vendors.   Mr. Fischer goes on to say "Most insurance companies choose to take responsibility; most mutual funds, however do not." This simply isn't so. While it is true that up to this point most mutual fund companies have not actively pursued the 403(b) market, it really does not matter. It doesn't matter because the companies that people want the most are involved with the 403(b) market (Vanguard, Fidelity, T Rowe Price, and TIAA-CREF, to name a few). These companies have no problem taking "responsibility" for their own actions. They have signed countless hold harmless agreements that are reasonable. However, these companies rightfully object to signing agreements that expose them to liability that is out of their control. The truth of the matter is that a "strong" hold harmless becomes a prison for teachers as it acts to lock out low cost options.   Another example in Mr. Fischer's paper compared hold harmless agreements to life and death situations. Need I say more? At best, comparing the hold harmless to a father going without life insurance does not provide an accurate description of what is going on in most districts; at worst, it is a reckless comparison. Yes, I agree districts need to be protected from liability, but they can do so with a hold harmless that is agreeable to low cost vendors. The real issue is vendor quality. The "strong" hold harmless idea was originally proposed by the insurance industry to protect their turf, it is now being proposed by benefits companies so they can become administrators (of which I have no problem with — if they allow low cost providers). The reasoning for a hold harmless agreement is sound, however, the reasoning for a "strong" or overbearing hold harmless is not. There simply is no good reason, except to protect the insurance industry and hurt educators.   I would like to address the "bogus" claim made at the end of Mr. Fischer's paper when he states: "To close, the question should not be why an employer should have strong hold harmless agreements in place? The real question is: why do companies that hold themselves out as 403(b) provider refuse to accept responsibility for complying with the applicable laws?"   There may be companies that don't want to accept responsibility, but we don't care — we don't want those companies anyway. If the companies we want access to (Vanguard, Fidelity, T Rowe Price, and TIAA-CREF, to name a few) are available in other districts (which they are), it means they have accepted responsibility for complying with applicable laws. Mr. Fischer has asked the wrong question. The question that should be asked and needs to be addressed is: "Why are Teachers subject almost exclusively to high cost products in their 403(b) and who is responsible for this?"   In other comments not mentioned in his paper Mr. Fischer remarked; "Not a single private sector plan allows the employee to dictate the fund choice and plan structure. In a way it is hard to believe that there exists the attitude that my employer should put itself at risk, just because I want to invest directly in Vanguard."   My response is the remark is simply not based on fact. Many 401(k)'s are now offering a "brokerage window" which allows a participant to invest in almost any fund they choose (including low cost). Progressive companies will always solicit employee input when designing a plan. In addition, private sector plans are governed by completely different rules than the 403(b). In most private sector plans the employee has his/her contributions matched, not so in most 403(b) arrangements. Despite the differences there are a similarities, namely: both plans if subject to high fees will have a lower return. I find it interesting that Mr. Fischer thinks educators are the one who need to change their "attitude," considering that educators are the ones who are subject to paying high fees. An employer can offer low-cost options and not put itself at risk. The employer must simply make an effort. Clearly, it is the employer who needs an attitude change.   Mr. Fischer's solution is a Master Custodial plan offering thousands of mutual funds. This is actually a decent proposition, as long as low-cost options are offered and there are no transaction fees. However, at this point the Master Custodial is not an option for most teachers. Again, employers have failed to provide a decent option. The reality is that teachers do have a choice — high-cost variable annuity, high cost fixed-annuity, or high cost mutual funds. There needs to be a balance so that teachers are allowed to contribute to low-cost funds if they so desire.   In conclusion, should we be defending the hold harmless agreement? I don't see any reason to. I understand its purpose. However, in most cases the agreement goes too far and it is to the determent of educators. What would be more noble is to defend the rights of educators to accumulate savings without the burden of heavy fees. I have no problem with an agreement that protects the district if a vendor messes up. I do have a problem with a district that asks a vendor to take responsibility for mistakes out of its control — which is the way most hold harmless agreements are written.   Let me leave you with one parting thought: the average variable annuity will have expenses around 2.5% (including transaction costs). Over the long run stocks have averaged about 10% (assuming a 100% stock portfolio), do you think it is fair that an insurance company keeps 25% of your returns? This is why we fight for change.   Scott Dauenhauer, CFP, is the President of Meridian Wealth Management. Scott is a fee-only Certified Financial Planner specializing in helping Educators with retirement and financial issues.     Home | Disclaimer | © 2001 403(b)wise. All rights reserved.