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Stephen Schullo is backing the mutual fund industry in its tussle with insurance companies. Who is Schullo? A third-grade teacher at the Leo Politi Elementary School in Los Angeles who would like more fund investment choices and a chance to save a few bucks in fees each year as he builds his retirement nest egg. "The time has come for quality low-cost 403(b) plans," says the 19-year veteran of the public school system.

Schullo's retirement savings go into the $550 billion 403(b) pool that makes up roughly one fifth of the country's $2.78 trillion in defined contribution assets. The 403(b) money consists of $110 billion from employees of nonprofits, $302 billion from college and university employees and $138 billion from school administrators and K-12 teachers like Schullo.

TIAA-CREF has long dominated the market for higher-education 403(b) plans, with a 70 percent market share, but insurers claim about 80 percent of K-12 teachers' defined contribution assets. Mutual fund companies, relatively new entrants into the K-12 marketplace, receive the rest, according to Cerulli Associates, a Boston-based financial services consulting firm.

Schullo and his fellow teachers, however, are beginning to demand that their 403(b) plans look more like the 401(k)s that predominate in the corporate sector. Unlike company workers, who typically invest in mutual funds through programs overseen by their employers, educators are frequently presented by their school districts with a list of approved vendors -- a whopping 145 in the case of Los Angeles. There is no single sponsor of a 403(b) plan, which leaves fiduciary responsibility with the providers. Absent a plan sponsor, individual teachers and administrators choose their plan providers and their investment options, usually in concert with insurance agents. The three basic investment options are a fixed annuity, a variable annuity or a custodial account of mutual funds. School districts rarely offer matching contributions to these 403(b) plans, which supplement the union-negotiated defined benefit retirement systems most teachers participate in.

The insurance company investment products that most teachers select through their 403(b) plans are more costly than the mutual fund options available to corporate employees. For instance, annuities, both fixed and variable, carry hefty sales loads, from 4 percent to 8.5 percent; ongoing administrative fees of roughly 2 percent a year; and surrender charges that typically start at about 7 percent and decline as the holding period lengthens.

By contrast, mutual fund loads rarely reach the legal limit of 8.5 percent, and annual expense ratios range from 20 basis points for an index fund to about 150 basis points for an actively managed stock fund. Annuities, of course, frequently include load mutual funds as part of the package.

There are moves afoot, however, to reform the 45-year-old 403(b) system. In recent months both California and Texas, the states with the biggest K-12 student and teacher populations in the country, proposed legislation, later watered down, that would have given mutual fund companies an opening to expand further at the expense of insurers. Both states, however, are expected to revisit these options. "The pieces of the puzzle are now in place to break the stranglehold [that insurers have over 403(b) plans], but those pieces are not united," says educator Schullo. He argues that school districts and unions are not providing enough information about the shortcomings of insurance products.

Certainly, mutual fund companies are fighting for greater access. "The question is, will the 403(b) marketplace evolve to take advantage of the best practices of the corporate world?" says Gerald Mullane, who heads up institutional sales for Vanguard Group, which has about $11 billion in 403(b) assets under administration out of its total $186 billion in defined contribution assets.

Says John Murphy, executive director of RopeOrg.org, which lobbied on behalf of insurance agents to defeat California's 403(b) reform legislation, "When we found out about this bill, I strapped on my six-shooter and got involved." Murphy and his colleagues say that TIAA-CREF and other mutual fund companies are "trying to legislate market share" and steamroll insurance agents.

Insurers have an advantage in the 403(b) marketplace in part because they have been at it longer than anyone else. First authorized by a change in the Internal Revenue code in 1958, 403(b) plans predate both the 401(k), which was introduced in 1981, and the subsequent rise of mutual funds. Despite a change in the legal structure of 403(b) plans in 1974 permitting the investment of the savings assets in mutual funds, the plans still carry the hallmarks of an insurance product.

Marketing of 403(b) plans to teachers is controlled by individual school districts, following rules and regulations set at the state level.

But Schullo and others would like to see the plans include more mutual fund options. The Los Angeles Unified School District, which currently accounts for about $1 billion in assets and approximately $125 million in annual 403(b) contributions, has 145 approved vendors but only about 25 mutual fund companies.

Most states limit their school districts to far fewer than 145 vendors. According to researchers at the Spectrem Group, public K-12 school districts average 9.8 providers; private districts have only 3.5.

Until recently, mutual funds were reluctant to push programs for teachers too hard because legal quirks in states like California and Texas made them risky. Both states require every 403(b) provider to sign a "hold harmless" agreement, absolving the school districts of liability for either investment-related or administrative problems with defined contribution plans.

What's more, administering 403(b) plans was a labor-intensive process. Until the Economic Growth and Tax Relief Reconciliation Act of 2001, determining contribution limits required the use of a cumbersome formula. Now straightforward contribution limits are in effect. "Calculating the formula was complicated, so it became a service that we simply did not provide," notes Vanguard's Mullane. As a result of the 2001 tax act, 403(b) contribution limits now track those of 401(k) plans.

The new contribution limits make signing a hold-harmless agreement less daunting to 403(b) providers, who had previously worried about their liability if participants overcontributed and the tax-deferred status of the plan was called into question. Fidelity Investments and Neuberger Berman, for example, became Los Angeles school district providers in 2002 as some of the uncertainties were cleared up.

But it's the proposed legislative changes that have most whetted the appetites of mutual funds. Earlier this year the California state legislature took up a bill that would have created a vendor selection process for 403(b)s similar to that used for 401(k) plans -- competitive choice, with a consultant helping to compare the vendor proposals. This would have essentially put the school district into the role of a plan sponsor, vetting the proposals of various vendors, without having to assume fiduciary responsibility for the plan.

Closer control might have reined in what sometimes seems like a chaotic situation in certain school districts. "It's the Wild West out here," says Richard Shafer, who heads TIAA-CREF's West Coast office in San Francisco. "Some 145 vendors have the right to sell to Los Angeles teachers, and for the most part, the teachers' choices are being driven by commissioned agents who are offering load mutual fund products in annuity wrappers."

The insurers prevailed in the California legislature, however, staving off the key change that had been proposed, which would have required competitive requests for proposals in choosing vendors. Instead, a modest change in disclosure rules was passed.

In Texas a class-action suit brought by teachers against National Western Life Insurance Co., an Austin-based insurer, resulted in an $11 million settlement in 1999 in which the insurer agreed to increase the floor on the interest on the payout phase of its 403(b) annuities from 0 percent to 3 percent. What's more, the Internal Revenue Service began auditing 403(b) plans in Texas.

Responding to both the lawsuit and the IRS audit, the Texas state legislature in 2001 passed a law that gives the Teacher Retirement System of Texas the responsibility of selecting 403(b) vendors. The new law, which took effect in June 2002, also bans exclusive dealing arrangements and kickbacks to school districts, which had previously not been explicitly outlawed. However, the regulations setting the vendors' permissible expense ratios reflects the insurance industry's practices, with up-front charges of up to 6 percent, annual expenses of up to 2.75 percent and surrender charges through the 12th year.

"The Texas retirement system wimped out and came up with standards for expenses that exceed any reasonable threshold," says one executive. Of course, he's not a disinterested source: His fund company employer is trying to crack the state's market and hopes additional changes will be implemented. In California schoolteacher Schullo has created an organization known as 403(b)Aware and is looking for a new sponsor to introduce legislation. Clearly, this battle isn't over yet.