Business of Benefits : Employee Benefits Lawyer & Attorney : Law Office of Robert J. Toth, Jr. : 403(b) Plans, Annuity & Insurance Law : Business of Benefits Blog

One of the most maligned and misunderstood,  yet  one of the most valuable (and one of my favorite), DC plan investments is the the insurance company general account investment-typically referred to as the "fixed fund," the "guaranteed fund," or even sometimes the "stable value fund"(in some of its iterations).  These funds guarantee principal and a certain rate of return over a stated period of time.  These funds usually (except in an inverted yield environment) provide a much higher rate of return over money market funds, while providing a measure of security of which money market funds can only dream. if the insurance company properly balances liquidity with the rate of return, it is an invaluable offering.

The downside to these funds is that the higher rate of return is often keyed to liquidity restrictions.  Dick Van Dyke, in a song from the classic movie "Mary Poppins," actually does a great  job of describing why this must be,  in "Fidelity Fiduciary Bank." He tries to describe to his employee's son, Michael, the value of these investments:

You see, Michael, you'll be part of  

Railways through Africa

Damns across the Niles

Fleets of ocean greyhounds

Majestic self, amortizing canals

Plantations of ripening tea. 

I've included the entire clip from the movie, below.

Its tough making a short term payout from an investment in an "amortized canal." You see, insurance company general accounts are truly  great  capital investment vehicles. U.S. life insurers (who offer  these investments)  held in 2008, according to the ACLI, some $4.6 trillion-12% of which are invested directly in such things as planes, trains and automobiles, and other things upon which the development of world's infrastructure seriously relies, while also purchasing (at much greater levels) the bonds which allow these infrastructure investments to be built.  Investing in these general account funds is truly taking part in an unusual sort of investment in which most plans-or even the majority of mutual funds-do not have the scale, wherewithal or structure, to partake. These are, in short, pretty cool investments.

Bur insurers have often mishandled the balance between liquidity and return, often not paying sufficiently for the long term lock up, or sometimes by the application of seemingly  mystical rules to the application of "market value adjustments" when cashing out early. The good funds still provide relatively high returns, while maintaining substantial liquidity. 

So what does 408(b)(2) have to do with all of this? Arguably, everything.  Ignoring the issue of insurer solvency for a moment,  in a world where the lack of transparency translates into higher costs to plans, and where there is concurrently serious consideration being given to increased use of insurance guarantees (including those found in general account investments) to provide greater retirement security, the regs are eerily silent on insurance transparency. With all the discussion of being concerned with things like "indirect compensation" and trying to figure just how much revenue a party to the plan is generating from the plan, an important piece is missing.

Technically, how the regs accomplish its silence is by way of 2550.408b-2(c)(1)(iii)(A), which specifically excludes investment products under which the underlying investments are not considered plan assets under 2510.3-101.  The DOL provided a good explanation on how this works in an information letter in 2004, explaining something called "guaranteed benefit policies."

This silence really is not the fault of the DOL reg writers.  It is just that the standard manner in which we have grown to evaluate equity investments over the past couple of decades just does not match up well with centuries' long, valuable practices of pooled capital investment of insurance type of entities.

We do need to devise a useful way under which plans and their fiduciaries can shop these products, to understand whether the plan is being paid sufficiently for its risk in accepting liquidity restrictions, and generally what sort of revenue (note, not profit) the insurance company expects to generate over time from the plan.  Here, the risk is not so much insurer insolvency, but being locked into a relatively poor (meaning, not competitively priced for a similar investment)  portfolio rate-yes, these general account managers do sometimes screw up, though the state regulatory structure helps minimize catastrophic errors. It is a risk for which the plan should be properly paid. Where there is not adequate consideration for that risk, the plan's contract  needs to notify the plan of changing rates, and the ability to reasonably get out of the contract if the rates go south. 

From the fiduciary side, it would seem appropriate to be paid for a long term interest rate risk. If there is insufficient return for that risk, then the contract purchased needs to provide liquidity. 

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In the following "Mary Poppins" clip, Michael opts to spend his tuppence on feeding the birds-an option that, if taken by a fiduciary,  would not likely be well received by Tim Hauser at the DOL's Solicitor's office or by Phyllis Borzi's staff.....

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Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.   

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 Its going to be a demanding year for fiduciaries of retirement plans, particularly of those in the small and mid-market which are not particularly accustomed to paying close attention to them. I have blogged earlier on the increased fiduciary demands related to the new data provided to fiduciaries under the 2008 Form 5500 Schedule C and Schedule A. But there is another unusually dicey issue that is soon to land on their laps: voting proxies on stocks and mutual funds following an economic collapse.

On October 17, 2008, the DOL issued a new Interpretive Bulletin, 2509.8-2, on the manner in which a fiduciary needs to deal with the voting of proxies on stocks and mutual funds held as assets of plans. It was generally seen as a reaffirmation of the EBSA's long held views on shareholder activism, and the need for a plan to make proxy decisions based solely on the plan's own economic interests.  

But the I.B. is especially rich in describing the fiduciary processes that is required of a plan in dealing with proxies.  It notes that the fiduciary responsible for voting the proxies must

1.  vote the proxy, or
2. monitor those who are voting proxies and review the basis for their votes, or
3. if proxies are not voted, make an affirmative decision that the burden of doing a proper review is too high given the benefit to the plan; and
4. of course, document all of this.

None of this is really news to any one who has advised fiduciaries. But the problem of "paying attention" to these rules is a very real one given the financial collapse of the past year.

The anger at the leaders of financial institutions of the collapsed titans is very real, and well documented; there is great outrage at the amazing recovery (and related executive compensation quickly paid) within those organizations while the massive  "collateral damage" and personal trauma throughout the world continues;  and the continued befuddlement is palatable at the lack accountability of corporate board members, where it seems to be quickly becoming "business as usual."

The IB strongly warns us that, from the fiduciary's view, any attempt to use proxy voting to apply any sort of sense of "economic justice" would be mislaid and be a fiduciary breach.  But the IB ALSO strongly warns us that that same fiduciary must  follow a process and take proxy voting (which has typically been seen as a "throwaway" sort of "bother") seriously and, particularly this year, consider whether their vote is in the best economic interests of the plan.

I would suggest that this likely means, that when voting for Board members (for example) or on other proxy issues, a fiduciary needs to address whether the current Board candidates and compensation schemes serves the plans best interests: that is, the continued financial strength of the stock held by the plan.  For mutual fund boards, the question would be more of a process question: how active where the mutual fund boards in overseeing the voting the proxies on the shares owned by the mutual fund.

This sounds like an awful lot of work, particularly if the fiduciaries themselves are struggling to keep their own businesses going. So, what's a fiduciary to do? Perhaps the following:

1. Find out who has the duty to vote proxies under the plan. The I.B. does a good job of helping a plan sponsor work through this.  
2. Make whatever decision is made on the proxy voting process part of the  Investment Policy statement.
3. Research (or get someone to research), within reason, the the proxy issues-noting, particularly that voting on Board members is not a simple "throwaway."
4. If there will be no vote, establish that it is too burdensome for the plan to do all those things needed to make an informed vote.
5. Of course, document all of this.

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 Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.  

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The Swagger

I had the privilege to speak on a 403(b) panel at the recent DOL/ASPPA "DOL Speaks" seminar,   with Lisa Alexander and Susan Reese of the DOL.  Our own panel went very well, with Susan and Lisa both speaking directly to and recognizing the transition problems related to this new 403(b) world. As Lisa repeatedly pointed out, many of the rules causing the challenges have always been there, but not given much attention by 403(b) employers or their advisors. The audience showed some frustration, but that arises from there not being answers to a lot of the tough questions we now face.  But our take away is that the DOL is spending time and smart effort in recognizing the difficult issues now being raised, and is considering ways to approach them.  You will from time to time see in this blog me disagreeing with their chosen approach, but it will never be a criticism of the seriousness of their choices nor of the professional manner in which they are being handled.

This conference was my first serious view of the direction of the EBSA under Phylis Borzi, and it is already showing some swagger under her leadership. My first clue came from the EBSA's staff's position with regard to the material being presented. We are all very used to the typical government staff comment during most such seminars that any comments of staff in their presentations reflect their own personal opinions, not that of their employing agency.

Well, at this seminar, the DOL took accountability. None of their speakers issued this disclaimer. My own presentation material was reviewed with the view that in a seminar labeled "DOL Speaks", it couldn't very well disclaim what its staff members were saying. So the staff statements took on an import we have little seen at other such conferences. This was a rare act of bureaucratic courage.

Phylis's comments about the EBSA's priorities sounded a more hardened approach to enforcing the public policy underlying ERISA.  It reminded me some of my favorite line from one of the all time great movies, "Mr. Smith Goes to Washington". A "little bit more of looking out for the other guy" is what I recall Jimmy Stewart saying.  Plan participants have always had this kind of advocate in the EBSA, but those efforts look to clearly become more focused.

Annuities to be addressed

At long last, both the DOL and the IRS will be taking a look at the technical rules related to the offering of annuities in 40(k) plans. The DOL announced that they will be soon be publishing an RFI on annuity issues, while the IRS  announced that they will be considering auto-annuitization. This will be both challenging and fun, particularly as it comes to making annuities sensibly transparent, able to be effectively compared, and in designing programs that make sense for those with modest accumulations. 

And for those of you still looking for Part 2 of my fiduciary analysis of annuities, its on the boards and will be out shortly.

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Retirement plan vendors throughout the industry are engaging in efforts to prepare for the new disclosure requirements for the 2009 Form 5500 schedules, particularly the disclosures related to direct and indirect compensation under Schedule C and the substantial requirements for Schedule A.

I had the pleasure of a couple of informative conversations this week which were very enlightening. First, Tom Horton of Barrett and McNagney (and one of the very best retirement plan lawyers I know) and I were talking about some about the effects the new Schedule C will have on the plan administrator's obligations (I know, I know, we need to get a life!). We spoke of how the Schedule C will be providing data for the fiduciaries to which they never had access in the past related to 12(b)-1 fees, sub-transfer fees and other sorts of revenue sharing.  What do they do with it? Well, it seems that that they would be ill advised to ignore it. Failing to undertake a review of the data once they receive it may well result in a fiduciary failure. But there is yet another twist. The plan administrators may well need to be on the lookout for the data. If they don't receive it, they are under the obligation to report that failure. Failing to report that failure can trigger non-filing penalties for the Form 5500.

If that wasn't depressing enough, Janice Wegesin, author of the Form 5500 Preparer's Manual  and I had a conversation about how the Form 5500 Schedule A applies to individual ERISA 403(b) contracts. The data demands are really pretty incredible. The best example is the requirement under the Schedule to report consolidated information on transfers between the insurance company general account investments and variable investments under those individual contracts. I know of several employers with thousands of such contacts. I'm not sure I want to be anywhere near those 5500's. But like the Schedule C, there is a reporting requirement under Schedule A which requires the plan administrator to report vendors who do not provide that data to the plan. So it means that plan sponsors will need to be looking for this ugly data.

Its going to be an interesting reporting season, I'm afraid.

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The DOL released to Field Assistance Bulletin 2009-2 on July 20th, which provides much needed Title 1 reporting relief for 403(b) plans. 

So, first of all, our hats off to Ass't Sec'y Borzi, for what looks to be one of her first public acts, and to the Good Bob Doyle, for showing true leadership in assisting a critical sector of our society which has been unduly burdened at a time their scarce resources are most needed elsewhere.   

Here's what the relief does:

 The 2009 Plan Year for 403(b) Plans has been recognized as a "Transitional Year."  This means that if an annuity contract or custodial account  to EITHER a former employee or current employee:

1. was issued before January 1, 2009;
2. had all contributions, or rights to contributions,  to it cease prior to 1/1/09;
3. has all of the rights enforceable against the insurer without involvement by the employer; and
4. holds only fully vested amounts,

assets in that contract will be excludible from the 2009 Form 5500 and 5500-SF.  Even better, those former employees owning those contracts will not need to be counted as participants toward that 100 participant threshold for large plans. (As an aside, there is a technical question about current employees: though they may be excludable by virtue of a pre-2009 contract, they may then be includable because of operation of the universal coverage rule, even if not owning a post 2008 contract).

Pretty incredible. Simple, clear and adminsterable.  Just for kicks, you may want to try to re-read Rev. Proc. 2007-71 again, just to appreciate how valuable the DOL's guidance really is.

It is not Nirvana by any stretch of the imagination. First of all it is all only transitional, but granted when it is needed the most and in a very timely fashion. We now have time to discuss the nature of permanent relief. Secondly, it is only for reporting purposes, not other Title 1 purposes such as spousal consent and others.

Next, though is a practical problem.  The third requirement mandates that all rights are enforceable without involvement of the employer. In the current environment, with vendors demanding employers' approval of all distributions from all contracts- even of those deselected vendors with no contributions after 12/31/2008 which employers have otherwise excluded from their plans- employer approval may make those contracts ineligible for exclusion from the 5500 and participant counts.

This is a bit sad, as often employers will sign these vendor imposed forms as a matter of convenience just as a way to help employees who need the money- lending truth to the axiom that no good deed will go unpunished.

Who knows. Perhaps Andy Zuckerman's fine staff (and they truly are a good bunch) is penning tax relief right now which would mirror that granted by the DOL......

I have updated this with a further blog with the following:

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Some of the dust is settling, in an odd sort of way, on the IRS issues related to 403(b) plans. For sure, there are many unresolved and contentious issues that remain open or poorly addressed (such as terminations and dealing with historical contracts) which will continue to to cause vendors, employers and employees all shared amounts of anguish.  There is enough of a framework in place however, to now get down to the nitty gritty of running 403(b) plans.

So what are we finding as we get down to this nitty gritty of things? Most striking is the unique ways in which ERISA's fiduciary rules will need to be used in their application to ERISA 403(b) plans.  It is not that the rules were never there in the past, it is just that the new rules have forced the industry and employers to more closely define their relationships and the duties for which vendors and employers will each be responsible. This process of defining roles has caused us all to look more closely at how the rules apply, in ways we have never done in the past.

All 403(b) practitioners are painfully aware of the controversies surrounding the threshold question of whether any particular plan is governed by ERISA Title 1. Once you get past that point and attempt to, for example, draft a proper investment policy, you will see that we will not be able to apply many of the ERISA rules in the same manner in which we are used to applying them in the 401(k) context. This is particularly true where individual annuity contracts or individual custodial contracts are involved. We are all likely to find some challenging surprises as we work through the details.

Let me give you an example. Individually owned variable annuity contracts are a "staple" in the 403(b) industry. They continue to be regularly offered in 403(b) plans, even with the advent of "401(k)-like" group custodial arrangements.  These variable annuity contracts offer investment accounts, called "separate accounts" or sub accounts which are treated by security laws as a type of mutual fund.  Annuity contracts (for technical tax reasons) cannot offer publicly available mutual funds in their separate accounts, so these funds are often designed as "clones" to those publicly available mutual funds offered to 401(k) plans.

These separate accounts often offer large numbers of different investment sub-accounts managed by a wide variety of managers with varying styles.  The management of these investment accounts are all monitored and benchmarked by the annuity companies.  Occasionally, the annuity company will find it necessary to completely replace a fund (a "fund substitution") because of either performance or investment style considerations.

The fund substitution process is a lengthy one,  governed by the Investment Company Act of 1940, requiring notice and proxies going to the individual participant in a 403(b) plan-not, typically, the plan sponsor.

What are the ERISA implications of a fund substitution under individual annuities for the 403(b) plan fiduciary? It is clear that the choice of an annuity carrier for an ERISA 403(b) plan is a fiduciary act, which also carries with it the ongoing obligation to periodically review the appropriateness of that choice.  In a 401(k) plan, changing the investment fund made available to the participant is a fiduciary choice. Likewise, some duty will also apply to changing the investment choice by way of a substitution of an investment fund in an ERISA  403(b) annuity. 

So the question becomes what is the fiduciary obligation of a 403(b) plan sponsor who has no right to vote on such a substitution, or otherwise have any authority with regard to the contract? I think its pretty clear that the plan fiduciary has an obligation to review the fund substitution, and make an independent determination as to whether the new fund is  appropriate for its plan. The review is going to be quite different than the typical 401(k) review as the fiduciary really will have no control over whether or not the substitution will occur.

If the fund substitution is appropriate, the fiduciary need to take no further action other than to document its review. If the substitution is not appropriate, some very real fiduciary issues arise.  It seems that the fiduciary would need to approach the carrier and ask that their employees be blocked from being able to make new deposits to the inappropriate fund. If the annuity company does not have that ability, there may be a fiduciary obligation to cease making contributions to that entire contract. With regard to the existing funds which will be substituted, where the fiduciary has no authority over the contract, little can be done. But it seems that the fiduciary is unlikely to be found in breach where it has no authority, but may have some sort of duty to inform participants of its finding.  

This problem is by no means limited to annuity contracts. If an ERISA 403(b) plan funded with individual custodial accounts permits the participant to invest in any of that mutual fund family's funds, the availability of all of those funds would be subject to fiduciary review, as well as any material changes made to the management of any of those funds.

This is all so different than the process to which we have become accustomed in the 401(a) world. What does all this mean? It means that 403(b) plan sponsors of plans funded with individual contracts  will need to pay close attention to matters to which they have likely paid little attention in the past, and monitor changes in their annuity contract and custodial account offerings over which they have little control.

In a broader context,  it really seems to me that a whole new line of ERISA will develop, much as it had to when 401(k) plans became popular, and how it will need to further develop as annuitization grows. The circumstances of 403(b) administration will demand unique approaches to the law.

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One of the natural byproducts of doing a lot of 403(b) work is a necessary familiarity with many of the security law rules which apply to retirement  plans. This familiarity is recently becoming handy on the 401(a) side of our business as well, with the SEC showing an increasing interest in all retirement plans. The DOL, FINRA and the SEC have a growing "commonality of interests" in things like disclosure and advice.

It is striking, though, how separate the securities compliance world is from the ERISA compliance world-though it is a "separation" which will eventually die a natural death. Security practitioners and ERISA practitioners will be getting to know each other well, and probably sooner than later.

So this is my contribution to that effort. The link below brings you an article which describes ERISA compliance for the security law compliance officer. To many of you, this will be very basic, and pretty boring stuff. The securities folks, however, have expressed amazement of some of the basic things I have written about, things which we take for granted.

My article is entitled "SEC's and DOL's Cross Agency Waltz: The ERISA Connection to Disclosure, Advice, Compensation and Conflict of Interest ", in the May-June 2009 Issue of the Practical Compliance & Risk Management For the Securities Industry."  It really is impressive how closely correlated these rules of the various "compliance" industries really are.

POST NOTE:

I've been told by a number of readers that the above link is not working well, coming up "garbage." If so, try this link for another PDF version , or write me at rtoth@gillercalhoun.com and I'll get you a copy.

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