The question of what the appropriate fiduciary standard should be in assessing the insurer insolvency risk when purchasing annuities by defined contribution plans continues to be a tough one.
It is also one of the critical issues to be resolved if the efforts to encourage lifetime income from these plans is to be successful. The recent Lifetime Income Hearings hosted jointly by the IRS and DOL made it clear that resolving this issue, together with portability, participant education and transparency, all need to be effectively addressed over time if there is to be widespread acceptance of DC annuitization.
I testified at those hearings, being privileged to be on the same panel as the distinguished and entertaining Professor Shlomo Bernatzi and Ben Yahr. One of the two issues of which I spoke was the insurer solvency fiduciary issue.
A number of witnesses at the hearing testified to what I hear regularly from financial advisors as well: plan fiduciaries don't want to be sued 15 years from now if an insurance company which issued annuity products chosen for the plan's distribution annuities became insolvent. One of the sources for this problem is with the language that the DOL has used in its fiduciary safe harbor, which requires the fiduciary to
'"appropriately conclude(s) that, at the time of the selection, the annuity provider is financially able to make all future payments under the annuity contract...."
It is understandable that commentators and advisors who look at the above standard will take pause: If you're a fiduciary, this is pretty daunting stuff. Without a crystal ball, how in the world can you conclude that an insurance company will be here 15 or 20 years hence? The standard is generally being read as effectively prohibiting a fiduciary from choosing an insurance carrier, because there is no fiduciary which can foretell the future.
I suggest that no fiduciary standard can require a conclusive prediction of the future, and that it is probably even a misapplication of the safe harbor to read it that way. The ERISA standard is not prescience, but prudence:
"with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like characterr and with like aims."
"Wizardry," is not specifically required.
But the pooling of longevity risk (such as found in annuities) and mortality risk (such as found in life insurance) are important societal functions. No individual can-or should- solely bear the risk arising from the insolvency of the entity pooling those risks. The States have all recognized this, and the critical need of risk pooling, and have long sought to address, manage and regulate this risk. In each of the states is a substantial and integrated regulatory scheme which governs insurance company investments, reserving, contracts and sales practices. And at the tail end of it all is the guarantee associations, ultimately based on the ability to assess healthy insurers for the insolvency risk.
These state based systems can be flawed in some fundamental ways but, for now it is our "circumstances then prevailing." Assessments based upon a biennial review, and guarantees based on assessments at the time of failure, can cause heartburn. But It is all we have. The baby may be ugly, but the baby's ours, as they say.
Rating agencies, as flawed as they may be, may also help. They provide a good measure of current financial health. These measures provide a much more current assessments than provided by the state's system's biennial review. But the rating agencies own no crystal bell, either. After all, Executive Life had a very high rating when it collapsed. And do not forget the potential issue of rating agency bias.
So what should a fiduciary do?
Annuities have been being purchased by plans for a very long time. Are these, and every fiduciary choosing annuities at risk? Not necessarily so.
There are a number of different things a fiduciary can do. As an example, I suggest that the following acts by a fiduciary could demonstrate prudence which would provide protection:
- Become familiar with their and their participants rights under state insurance solvency rules, should the chosen carrier become insolvent.
- Commit, perhaps by way of the plan's Investment Policy Statement, to represent and assert participant claims upon insurer insolvency.
- Review insurer ratings, and choose only those companies on currently sound financial footings (note, this would not require taking only those with the highest rating; many of the ratings below the highest represent soundness); and
- When reviewing the terms of the annuity, flush things out to see if there is reason to question an insurer's solvency. So, for example, if an annuity is extraordinarily inexpensive or paying too high of a crediting rate on its accounts, the fiduciary needs to look further. If its too good to be true (such as in the Executive Life offerings) there is a duty to explore.
There are a several other acts which could demonstrate prudence, this is only one set which may work.
So what should the DOL do?
It needs to separate "future state" from "circumstances now prevailing." Given the flawed system we have, a new, more robust, uniform and transparent system of guarantees need to be established. But while such a system is being debated, it needs to expressly recognize that fiduciaries should be able to rely upon what we now have. I know DOL staff recognizes there is no crystal ball, and that it would be silly to think that the safe harbor requires such. But the language of the safe harbor is causing great discomfort, and a slight modification to recognize that "no prescience is required" would go a long way.
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