Insurance Company 401k Mutual Funds: The Poor Man’s Derivatives

Along with investment banks, large insurance companies are major providers of 401k and 403b funds for employee retirement plans. Perhaps you have a plan with one of them.

A few years ago, I discovered a shocking secret about the mutual funds offered in insurers’ retirement plans. They are not mutual funds at all. They are proprietary derivatives based on mutual funds. I learned I’d been investing in derivatives!

401k and 403b derivatives: how I discovered I owned them

I had a 403b plan with a major life insurer. Like a 401k, a 403b* is an employer retirement plan, but it’s strictly for employees of non-profit organizations. A few years after leaving employment with a nonprofit, I decided to look into my 403b investments. I wasn’t happy with what I saw.

I’d just taken a financial workshop and learned about NAVs, “net asset values,” of mutual funds. Net asset value (NAV) is the value of an entity’s assets less the value of its liabilities. At that time you could see the NAV for any mutual fund by looking in a major newspaper.

I began tracking my 403b mutual funds NAVs in the newspaper. Prices reported for my 403b funds and those printed in the papers weren’t jiving. And the difference wasn’t in my favor.

My 403b fund only reported NAVs quarterly, so comparison wasn’t simple. Nevertheless, I could see that over time the same funds in the newspaper were paying out a significantly higher amount than I was getting from my 403b life insurance company plan. I wasn’t pleased to discover this. So I called my insurance company.

“Are you charging extra fees on my mutual funds?”

“No, we don’t do that,” said the company rep.

“Then why are all the mutual funds you offer in my plan paying less than what I see in the papers?” I asked.

The flustered woman on the other end of the line hemmed and hawed, then said haltingly, “Well, these aren’t mutual funds, exactly.”

“What do you mean, ‘not exactly’?” I demanded. I was getting pretty agitated.

“Well, our funds are based on all the mutual funds you see named in our prospectus, but our funds contain a slightly different mix of stocks and other assets,” she replied.

Furious, I informed her I was going to roll over my 403b to an IRA and buy the real things. They paid better! She quickly said she’d send me the papers for the transfer.

Transparency concerning derivatives

A derivative is an investment that is based on another investment. Derivatives are “proprietary” products created by investment banks and insurance companies. The failures of some types of derivatives issued by Lehman Brothers and AIG, an insurance company, set off the financial crisis in 2008.

I didn’t know the word, “derivative,” back when I talked with my insurance company about my 403b funds, but I knew enough to know I’d been hoodwinked. As far as I can tell there was, and still is, no “transparency” about mutual fund derivatives included in insurance company 401k and 403b plans.

Dangers of derivatives

Why is it important that these were mutual fund derivatives? Perhaps you  think other derivative mutual funds paid better than mine. Maybe they did. But a derivative carries an extra danger called “counterparty risk.”

Counterparty risk is the possibility the other party to a financial transaction might not be able to come up with the funds to pay. They may default. There is more probability of counterparty risk if an insurance company does not have the capital reserves to pay up on its derivative mutual funds in your 401k.

I recently went online and looked through the current sales brochure from my 403b insurance company. The brochure went into precise detail about different types of mutual funds and their risks. But nowhere did it say anything about the particular funds it offered let alone discuss risk if they were derivatives.

I feel strongly that life insurance companies should be required to disclose all derivatives and proprietary products in their 401c and 403b employer-sponsored retirement plans.

If financial regulators are insisting on more transparent disclosures to protect “sophisticated” investors from losses on CDO and CDS derivatives, surely they should offer the rest of us equal protection from being misled by mutual fund derivatives!

*A similar retirement plan for government employees is called a 457b plan.

Copyright © 2010 Nancy K. Humphreys  All rights reserved. You are free to use material from Brucenomics in whole or in part, as long as you include attribution to Nancy K. Humphreys followed by a live link to

1 comment so far ↓

#1 Exchange Traded Funds (ETFs): Safe? or Risky Derivatives? | Brucenomics on 05.25.10 at 7:46 pm

[…] ETFs also have a major disadvantage compared to mutual funds. Last time we looked at insurance company mutual funds in retirement plans. We saw they were “derivatives” of mutual funds. One danger of all derivatives, including ETFs, is that they can vary in value from whatever investments they are based on. You learned about this danger as well as one other major disadvantage of derivatives in my post, “Insurance Company 401k Mutual Funds: The Poor Man’s Derivatives.” […]

Leave a Comment