Look to small firms for growth in retirement plan market.

There has been substantial attention given to the opportunities in management and distribution of defined-contribution retirement vehicles, particularly 401(k) plans.

The movement from defined-benefit to defined-contribution programs is well established. So is the related shifting of costs and asset allocation responsibility from the employer/ plan sponsor to the employee/ participant.

Based on company-level data from firms such as Access Research, it is also becoming well recognized that much of the growth of 401(k) assets over the next decade will be from newly established plans of smaller companies with under 500 participants, rather than from larger companies.

Foothold in the Sector

In one sense. banks are strongly positioned in the small-plan segment. The clearest example is where a relationship already exists with the employer company through other commercial bank product lines. The loan officer filing a growth company's financing needs has an enviable inside track for steering that company's retirement assets toward the bank's 401(k) offering.

As a result, certain banks are emerging as formidable 401(k) providers in their local markets. This general premise of cross-selling retirement products through existing regional relationships has also helped certain banks fuel their growth of 401(k) assets from middle-market companies with as many as 5,000 participants. NationsBank and Comerica Bank are two such examples.

Much of the middle-market activity takes place outside the retail registered representative's domain, however. Banks seeking 401(k) assets from large or middle-market employers/sponsors are almost virtually using institutional field sales personnel to identify, prospect, and close deals with these firms.

In the small-plan market, where registered reps are most likely to have a role, there are several issues being faced by banks to providers or distributors of 401(k) products.

The first is product structure. There are two basic forms of small plan 401(k) product: a group variable annuity, or a mutual-fund-based offering.

The annuity is by definition a packaged retirement product, and contains most of the necessary internal record keeping. The addition of plan-level information to an annuity record-keeping system creates a viable 401(k) product.

Several insurance companies, such as Nationwide, Manulif, and Principal, provide an attractive range of separate account investment options in their 401(k) annuities.

The largest drawback to annuity-based 401(k) products is often their cost. Expenses for death benefits and annuitization risk are borne by all participants, regardless of their desire for such features. Total annual expenses can run nearly 3% of assets and are often difficult to explain to the individual or the sponsoring company.

Insurance Channel

Variable-annuity-based 401(k)s are being sold most successfully to the smallest of 401(k) plans, usually under 100 participants, particularly through reps of insurance companies.

Outside the insurance channel, mutual funds are the small-plan investment options of choice. It is significant to note that Principal, which has the largest number of small-plan variable-annuity clients, recently announced that it will be providing a mutual-fund-based product in early 1994.

Mutual fund companies that have broker-dealer distribution are more visible in the small-plan market than those that distribute directly. Initially, these load mutual fund families appeared most often in small 401(k) plans through collaboration between brokers and outside administrators.

Fund families commonly involved in these collaborative efforts included American Funds, Colonial, Fidelity's Advisor series of funds, Kemper, Massachusetts Financial Services, and Putnam.

Packaged Programs

Increasingly, load companies are actively marketing packaged programs, and including a designated administrator. Examples are proliferating.

* In the two years since Kemper launched its packaged Preferred K product, roughly 300 plans have signed on. Kemper works in conjunction with Dun & Bradstreet for administration to offer the prototype turnkey mutual-fund-based program for the small-plan market.

* MFS has more recently brought out its Fundamental 401(k) program for small businesses. Administration is provided through Sun Benefit Services, a sister company.

* Putnam is in the midst of launching a new packaged program for small plans, referred to as "Putnam Level Three" in mailings being sent to registered reps. Touting "Full Service from a Single Source," it reflects that in-house plan administration is being offered.

* The direct marketer T. Rowe Price offers a 401(k) plan designed especially for smaller companies with up to 300 participants. Called the Century Plan, it is a turnkey product featuring integrated record-keeping systems and administration through Trust Consultants Inc.

* Capital Research and Management (manager of the American Funds) is readying a turnkey program for the small and midsize 401(k) market.

* AIM has very recently teamed with Godwins, Booke & Dickenson to offer a turnkey 401(k) program to a target market of 25 to 5,000 lives. With a stated focus of up to 5,000 lives, however, an emphasis on larger plans is expected.

Insurance companies have historically enjoyed a niche with small-company 401(k)s, partly because of the early emergence of variable annuities as a small-plan investment vehicle.

In addition, however, insurance companies with either captive or independent representatives have had the distribution advantage of providing small companies other employee benefit products not offered by competitors outside the insurance industry.

One of the largest issues in the 401(k) market is whether the employees are getting what they want and need.

A recent John Hancock/Gallup survey revealed that while 25% of the respondents wanted more investment options, half of them had no idea what options to suggest. Similarly, while wanting flexibility and options, fewer than 33% had made any account transfers within the last three years.

This level of ignorance was one factor behind the October 1992 clarification in the Department of Labor's 404(c) regulations, which extend limited liability protection to retirement plan sponsors that offer a larger array of investment options to their employees.

The recent clarification of 404(c) addresses two types of plans: In the first, the sponsoring company determines a limited investment mix for all 401(k) assets. This is similar in many ways to plans in the early '80s.

Menu of Choices Required

A firm electing to offer such a plan has an obligation to provide choices for the employees.

In this situation, companies often opt for too-conservative investments, such as government bond funds, or underdiversified ones, such as company stock.

The second alternative delineated for 404(c) reduces the fiduciary liability of the company by providing enough investment choices for the plan participants to diversify and manage their own 401(k) money.

At a minimum, they must include three internally diversified investment options (usually equity, fixed income, and money market), and allow for at least quarterly movement among choices.

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