One of the most unique, flexible, and underutilized investment platforms in the 401(a) marketplace is the insurance company variable “pooled separate account” (the “PSA”). It may be the least understood investment platform, being buried in group annuity contracts-which makes them an anathema to large segments of the adviser and broker dealer community. The fact that an insurance agent license is required in order to sell them also limits their popularity.
Why they are worth a look is because of the current discussions on MEPs and their alternatives, and the growing popularity of collective trusts. The market is looking to provide the smaller end of the market with the “scale” which can give plans access to well-priced investments, along with access to large numbers of unrelated funds and fund managers, which otherwise would not be available to them. PSAs do this, while providing “frictionless” trading. What I mean by “frictionless trading” is that the transactional costs and opportunity for breakage are minimum, because trades can directly be performed through the insurance company’s own platforms without having to go through third party clearinghouses.
They provide scale to the small plan market by being able to cost effectively consolidate the investment assets of an unlimited number of unrelated 401(a) plans the same manner of a collective trust (without having to comply with 81-100 rules); they can invest in virtually anything whose value can be unitized; though they invest in mutual funds, they have the ability to manage the PSA in the same manner as a mutual fund without the attendant costs of a mutual fund; they can hire any investment manager to run the investments, including mutual fund managers who run large case investments; and they simply, and inexpensively, daily unitize the plan’s investments. In the 401(a) market, they enjoy exemptions from security law registration, a cost saving advantage over mutual funds. PLEASE NOTE: 403(b) PLANS MUST USE A SPECIAL TYPE OF PSAs WHICH ARE REQUIRED TO BE REGISTERED UNDER SECURITIES LAWS.
They are also flexible enough to handle a variety of lifetime income designs as well.
From a compliance standpoint, a plan’s deposit to a PSA is the legal equivalent of a deposit to a trust: in a trust, the trustee may own title to the assets, but they only do so on behalf of the plan-those investments purchased with a plan’s deposits are still, legally, the plan’s assets. PSAs are treated the same way: the insurance company may own title to the assets, but they do so only on behalf of the plan. PSA investments purchased with plan assets are still, legally, the plan assets. Like a trustee, the insurance company is a fiduciary in their handing of those assets (though, technically, the insurer is not a trustee, it is treated as such under Code Section 401(f)). This is why the insurer files the PSA as a Direct Filing Entity, and gives plans a Schedule D with their Form 5500 report. Without that, a plan would have to list all of the assets in the PSA on the list of investment assets on their own Form 5500. Each PSA has an investment policy statement, as well, and the NAIC’s model law requires the insurer establish and follow a “statement of the essential features” in running the PSA.
Most importantly, state law protects the assets designated by the insurer as PSA assets from the claims of the insurer’s creditors, while attributing to the plan all of the gains and losses of the separate account investments. This means the plans are protected in the event of the insurer’s insolvency.
PSAs enjoy special favor under ERISA, in addition to exemption from securities laws. They are exempt ERISA’s bonding requirements, and from certain prohibited transactions under their own class exemptions. They also have flexible pricing. Unlike a mutual fund, with its fixed management fees and other costs, pricing on a PSA can actually vary from contract to contract (to the extent the insurer’s state filings permit them to do so). Insurers seem to becoming more and more transparent and responsive on the pricing related to these products, addressing some of the historical concerns on their costs.
If they are so great, then, why are they not more flexibly used? At one time, prior to the explosion of mutual funds in the 401(a) market, they were. They acted a lot like collective trusts, actively managing and unitizing equities in the same manner as mutual funds. However, without the brand name (and the published daily value) of the mutual fund, they sorely lost market share. Technology has changed all this now, and has become a great equalizer. Participants can now easily have access to the PSA unitized value, and fund sheets seem now to be available on most such PSAs.
PSAs are by no means perfect, and fiduciaries will need to review their terms carefully before investing in them. For example, both Principal and TIAA ran into serious liquidity (and related legal) difficulties when they established real estate separate accounts (with unitized values), and the real estate market quickly collapsed. But as long as insurers are willing to properly price these funds, I suspect we should see their growing use.