The Treasury's issuance of proposed regulations introducing the "Qualified Longevity Annuity Contract" is a substantial step in the efforts to better provide plan participants the ability to use their defined contribution balances to plan for retirement security. One of the QLAC's most useful effects is that it gives us a "base," a laboratory of sorts, which permits us to look closely at the legal and practical issues in "real time" which are related to using DC plans to help fill in the gaps left by the demise of defined benefit plans.
One of the fundamental issues the proposed regulation raises is one which is beyond Treasury's control: what is the fiduciary's exposure to the potential future insolvency of an insurer when choosing a QLAC provider? Absent a federal insurance system like the FDIC or the PBGC which ultimately guarantees this risk-which is likely to be a number of years off, if even possible-does this means that it will never be prudent for a fiduciary to purchase a QLAC, or any annuity, under which a single insurance company insures the risk?
Many of us have been seeking legislative and regulatory solutions to this for a number of years, to little avail. Having thought about this much, and having blogged on it on the issue on more than one occasion, I have come to the conclusion that it is unfair to expect the DOL (and likely well beyond its mandate) to develop much more of a standard beyond what it has already published. If you read its "annuity safe harbor" standard closely, you will see that it is comprehensive and describes the fiduciary standard well. But there still exists a queasiness about how to apply it.
I believe that the issue, however, is not as intractable as it seems, and the answer does not lie in further regulation. It lies in becoming more comfortable with the idea of risk and the commercial pooling of interests. Fiduciaries should be able to comfortably assess an insurer without either becoming insurance experts or- at least on the narrow issue of insolvency- having to rely on an expert's prognostication as to whether an insurer will be around decades from now.
The real issue, as made starkly clear by the SCOTUS in the oral arguments on heath care reform, is that there appears to be a serious lack of understanding in the legal, judicial and investing communities of the nature of risk and of the commercial pooling of interest. This lack of understanding seems to be underpinned by a reluctance to accept that we, collectively as a society, share certain risks that can only be managed at a more global level.
There are a few key (but not so obvious) concepts, that have existed for centuries that the law (and financial advisors) should recognize, and upon which fiduciaries should be able to rely:
- Risk is a natural part of life.
- Our individual risks often are inter-related. Thus people can, and have, well managed these risks by pooling interests with those who have similar risks.
- Managing this pooling is complicated and requires specialized knowledge which has been successfully accomplished commercially (which also provides a level of financial accountability which structurally may be missing in government based programs).
- Financial "scale" is necessary to make risk pooling commercially work.
- Such "scale" and complexity makes it impossible for any single policyholder to protect itself against fraud and mismanagement of the pool.
- Collectively acting through government provides the regulatory scale necessary to protect citizenry from insurance (pooling) mismanagement and fraud, and the regulation of pooling is significant. Making sure commercial insurance is able to fulfill the pool's promise is an appropriate government function for protecting the well being of its citizenry.
In the end, the risk of insurer insolvency is a societal risk for which no fiduciary should be held accountable, as long as they are familiar the regulatory structure which is in place and uses it in making their decisions.
Regrettably, I believe much of the misunderstanding about pooled risk is reflected in deeply rooted political beliefs which was epitomized by the "Ownership Society" concept promoted by the Bush II administration. Though no one can deny the need for accountability, one should neither deny that longevity risk can really only be managed by acting in accordance with our common, and thus pooled, interests.
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