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What you seldom see in any of the literature related to the DC Lifetime Income programs is any useful information about the method of distributing the guarantees. This isn’t just one of these nerdy things that “engineers” (see my post on “Engineers, Analysts and Operators” where I suggest there are distinct roles in the DC lifetime income world….. ) have to deal with, but is one which should be part of any prudent assessment by a fiduciary. Comparing how this stuff works can have a meaningful impact on any choices being made between programs.

There is actually a very identifiable list of the way in which lifetime income payments can be made under the auspices of a DC plan. So here’s my take on the variety of ways in which these things work: 

  1. Post-distribution annuity purchase. This applies to programs where the sponsor, or a vendor, arranges for participants to purchase well priced retail annuities with their plan distributions. Cash is distributed from the plan, the amounts fully taxed, and an annuity purchased by the individual after the distribution from the plan. A portion of subsequent distributions from the annuity are actually treated as a non-taxable return of principal.  This link can provide a useful description of the annuity exclusion ratio   used in tax calculations.
  2. In-kind distribution of a non-QPDA/Non-IRA contract. This applies where the plan, itself, purchases the well-priced retail  annuity, which does NOT have a rider which makes it either a “Qualified Plan Distribution Annuity” (QPDA) or an IRA (see below). The participant is taxed fully on the fair market value of the annuity, and distributions are treated in the same manner as under #1. 
  3. In-kind annuity rollover to a 408(a) IRA custodial account. This applies to programs where the plan has purchased the annuity, whether it be under the distribution method of a CIT or through an in-plan annuity purchase program. This would not likely not apply to a QLAC.  The plan can choose to permit a non-taxable in-kind rollover of that annuity to an Individual Retirement Account under Code Section 408(a), where the annuity is treated simply as an investment of the custodial account. This matters because the RMD and taxation rules will not apply at the annuity level; they will apply at the IRA level.
  4. In-kind annuity rollover as a 408(b) IRA annuity. This also applies to programs where the plan has purchased the annuity, whether it be under the distribution method of a CIT or through an in-plan annuity purchase program. This would likely also not apply to a QLAC. The plan can choose to permit a non-taxable in-kind rollover of that annuity as an Individual Retirement Annuity under Code Section 408(b), where the annuity itself is the IRA. Where this differs from #3 is that the RMD and taxation rules will apply at the annuity level.
  5. In-kind distribution of a QPDA. This also applies to programs where the plan has purchased the annuity, whether it be under the distribution method of a CIT or through an in-plan annuity purchase program. This likely applies to the QLAC. Instead of permitting a rollover in #3 or #4, the plan can choose to require, instead, that the distribution of the annuity be made as a non-taxable in-kind distribution of a Qualified Plan Distributed Annuity (“QPDA,” or, as Code Section 401(a)(38) references, the “Distribution” annuity). That QPDA is treated as a plan for distribution purpose, including calculation of the RMD, taxation purposes, as well as amounts being able to be rolled over to another QPDA, plan or IRA.
  6.  Systematic plan withdrawals. This applies to plan designs where insurance guarantees have been accumulated and held by the plan in a contract which is treated as a plan investment, rather than as a plan benefit. The annuity payments, even if made directly from the insurer to the plan participant and the participant is the annuitant under the contract, is simply treated in the same manner as any other periodic withdrawal from the plan. There is no separate RMD for the annuity itself; those rules will apply at the participant account level.
  7. Plan “form of benefit ” annuity. This applies to circumstances where, by operation of the plan’s terms, an annuity payout benefit is made available as a distribution option and is elected by the plan participant. This is the “traditional” method of payout of lifetime income from a DC plan, and is likely paid from an annuity purchased by the DC plan to cover its obligations under the plan’s terms.  The Code’s “payment as an annuity” rules will likely apply, and issues regarding taxation and inability to rollover those payments should be addressed and disclosed. It does get a bit complicated when something like a GLWB and systematic withdrawals are made. 

Any inquiry of types of distribution should not stop here. They should also include an assessment of how and when the spousal consent rules will apply in any chosen method of distribution (and who will do it!) and, intriguingly, the availability of Roth treatment on the distributions from an annuity. 

These sorts of issues are seldom addressed, but prudence does require they be given the appropriate attention.

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The idea of Lifetime Income programs under defined contribution plans has become well accepted in the retirement plan community. There are numerous studies which show their value, from a retirement policy standpoint, and the attractiveness of those sorts of programs to both plan sponsors and plan participants. Also widely discussed, however, is the fact that there is minimal uptake of these programs by plan sponsors, even where there is a growing variety of well-designed options available from which fiduciaries and sponsors to choose. It seems as if, as Matthew Eickman (the Managing Partner at the Fiduciary Law Center) observed, that we are now into a “how do you make it available” phase of development.

This is not necessarily about garnering plan sponsor interest; every indicator is that the interest is there. In reality, it’s more about product delivery: how do you get widespread integration into the DC ecosystem?

What is needed to make it work, from my own long experience, is basic business acumen. It simply has to be “worth it” to the businesses invested in that “ecosystem” to commit the financial resources necessary to build the expertise to develop, market, implement and support changes to the ecosystem to make DC Lifetime Income readily available to plans. This has to happen regardless of what sort of DC LI program one may want to build and promote, whether it be tontines, annuities, CIT target date programs, systematic withdrawals, in-plan based programs, or IRA based purchase programs.

We are in a market well-conditioned, after Schlichter and Deere, to focus extraordinary efforts on reducing the costs of investments to plans. But what happen if those costs, mostly related supporting collective investments found in mutual funds, CITs and insurance separate accounts, are simply not sufficient to support the infrastructure necessary to make a very different-but-valuable financial function work?

After all, for example, the actuarial related costs to guaranteeing income are very real, even if not in an actual insurance program, as are the costs related to trying to fit these guarantees into a system premised on the daily valuation of equity related investments. This business sector is also well aware of the necessary expenses inherent in establishing and supporting lifetime income programs-including education and marketing, which are too often conflated with abusive sales practices.

Yet we see little in the market explaining to affected fiduciaries the necessity, or the value, of paying for such efforts. This lack of explanation and discussion is, very unfortunately, resulting in a number of opaque practices often being utilized, which never will be seen under 408(b)(2) or 404a-5 disclosures.

A plan’s paying these costs can be both prudent and reasonable, either directly or as built into the products themselves, and can well meet the DOL’s proposed prudence safe harbor requirement-if adequately explained and disclosed. Yet, without this forthright sort of discussion and disclosure, I see little chance there will really be a coherent way to fully and rationally compare these programs to each other.

If a business undertakes to provide guarantees, or access through DC plans to them, it would be well worth reconsidering any efforts which may infer that this uniquely positioned benefit is somehow being provided without cost, or with costs which are comparable to making equity investments available.

Math equations and formula written in chalk on messy chalkboard

Tacit in the language of the DOL’s proposed prudence safe harbor requirement that a fiduciary “read and critically review” the investment documents supporting a broad range of often commonplace DC investments is, I would think, the implication that the documents provided to the fiduciary should, indeed, be “readable.”

There are really two different types of challenges facing the fiduciary related to readability of investment documents which purveyors of DC plan investments really do need to address, even without a plan’s use of alternative investments.

The first challenge is that the fiduciary will now need to actually read and understand the impact of the investments’ terms, especially in instances where those terms are complex and highly conditioned. The second is for the fiduciary to try to accurately translate those terms to participants in a manner required by 404a-5, which requires the plan administrator’s participant investment disclosures be “written in a manner calculated to be understood by the average plan participant.” 29CFR 2550.404a-5(e)(5).

Those who create these investment documents are really doing a disservice to plan fiduciaries when they ignore these needs, and, instead, focus on whatever function of the investment they are trying to market to the plan.

Putting it into perspective, “readability” has long been a concern of regulators where individual investors have been involved. For example, there are the efforts of the SEC to require plain English attributes in individual shareholder documents, which fortunately also show up in the documents passed along to plan participants upon their request, under 404-a-5. These are relatively simple for a fiduciary to review and explain.

Then there are the long-standing efforts of the National Association of Insurance Commissioners and the state insurance commissioners to likewise impose readability standards on the sale of retail insurance contracts sold to individuals. Where individual contracts originally designed for the retail market (think, for example, the individual FIA with a GLWB-but more on that in another blog) have been redesigned for their use with DC plans, these are also relatively straight forward for a fiduciary to understand and explain to plan participants.

Where there seems to be a growing problem is where plans use financial instruments to which few, if any, readability standards have ever applied. Chief among these instruments are (i) those related to those 81-100 trusts (think CIT) which collectively purchase these other investments with “readable documents” (such as mutual funds), and make them available to plans under participation agreements which often have their own terms and conditions not imposed by the investments they purchase; and (ii) group annuity contracts which, depending the nature of the investments or guarantees being offered, can impose all sorts of unreadable terms and conditions. Adding to the problem are CITs which purchase group annuity contracts. The resulting imposition of terms and conditions can become almost “geometric” and unmanageable.

Complicating it all even further is that there seems to have been in the past a sort of “unwritten” regulatory assumption that as long as an independent fiduciary was involved, and as long as the plan was covered by ERISA’s fiduciary standards, that a plan could be treated as a sort of sophisticated investor to which certain protections really need not apply. After all, the “few” highly trained quants, attorneys, advisers and accountants can be called upon to make it all work and protect plan participants. Under these sorts of conditions, any sort of “readability” of investment documents is really non-sensical.

Reality, however, needs to come into play. With over $10 trillion dollars in 401(k) assets, alone; with the DOL’s proposed prudent investor rule putting investment advisors at the center of any prudent activity; and with those advisors being required to read and critically review investment documents; something now needs to give. A limited “sophisticated investor” approach will simply fail.

The proposed DOL prudence safe harbor reg, oddly, appears to be opening the door to address this. Once the proposed reg becomes final, it will be incumbent upon the program developers and marketers to do something. They will need to put fiduciaries into a much better spot than they now find themselves. Providing “readable” detailed documents will help them in fulfilling that twofold challenge of being able to understand the terms and conditions of the investment, and to accurately translate them to a participant disclosure.

Businessman Happy to See His Water Bucket is Full While Business

The DOL’s proposed prudence safe harbor regulations have pretty much made it “table stakes” for some responsible person somewhere to read and understand any annuity contracts on behalf of the plan which are provided as part of any DC lifetime income program. This means, of course, you have to first know where those annuities are to be found, and what part they play in any such program. This isn’t always as easy as you may think.

This is because of the way some of these programs are actually marketed. There are at least two different ways to accumulate income guarantees in a DC plan which are generally marketed. The first is to accumulate those income rights in insurance contracts which are purchased by the plan, itself. These are generally referred to as “In Plan” annuities. The “In-Plan” annuity program, which has really been around for quite a while, includes the “traditional” purchase program, where a DC plan actually buys and holds an annuity contract (such as the “stable value” group annuity contracts, or even the typical 403(b) annuity contract). There are a number of sophisticated DC Lifetime Income Programs which also utilize In Plan annuities, such as the in-plan managed account.

A second way they are marketed are through programs which seem to avoid the need for the plan itself to purchase an annuity to accumulate guarantees, and are sold as “alternatives” to the In Plan annuity program. Annuities are purchased and held by a Collective Investment Trust as part of a target date or other sort of CIT managed fund. This theoretically avoids the plan having to get involved in the technical and logistical details which have to be addressed when an In-Plan annuity is utilized.

Simple enough, you may say. But it truly is not. When you peel through the layers of any DC lifetime income program (even those which simply provide for a cost effective purchase of an annuity at the time of retirement), you’ll find that they ALL actually have to utilize In Plan annuities of some sort if income guarantees are to be distributed. This will always involve the plan, itself, directing the purchase of an annuity-to be owned by the plan-before it is actually distributed.

Why does this matter to anyone? Because it still involves the separate purchase of an annuity contract directed by the plan which involves the same sort of processes involved in an In Plan program. An annuity contract is still purchased, in accordance with insurance rules; the form of which still needs to be read and assessed; it needs to be properly accounted for in the plan’s financials; all of the In Plan annuity rules related to 5500 reporting need to be properly recorded; participant investment disclosures attended to; and compliance 408b2 will still be necessary.

In short, don’t miss these details in providing a prudent assessment of these sorts of “phantom” annuities which you may find underlying a program not marketed as having In Plan annuities. It is awfully easy to miss.

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This topic has never been one that has much concerned either analysts or operators of programs which involve the purchase by a DC plan of an annuity contract. This one has always been in the purview of the engineer-those insurance legal and compliance folks who have well established procedures to deal with each state’s insurance laws.

However, when you look at it closely, especially in relation to the selection of any of these innovative DC lifetime income programs, you can see its relevance to the analyst, as least requiring they know something about it.

The issue: what is the state of issue of any annuity contract purchased under any of these programs, and how does choice impact the plan participants and the fiduciaries?

I think you start with a fundamental insurance rule that applies to ALL DC Lifetime income selected by any non-governmental plan sponsor: at some point, regardless of the design of the lifetime income program, the plan itself must be the purchaser of an annuity contract.

This is just not in the case of the “In Plan Annuity,” where the participant can direct the purchase of an annuity accumulations as an investment option of part of a plan’s internal managed account, or to be directly held by the plan and allocated to a participant’s account. It also includes those instances where the insurance guarantees are being accumulated under a CIT structure, and under those “purchase programs” where a participant can elect the purchase of an annuity contract at the time of separation from service.

In each of these instances, the plan itself must eventually, at some point in the process, be the actual purchaser of the annuity contract in order for the distribution of those rights to properly occur. For example, where a participant elects to take a distribution of the lifetime income guarantees accumulated under the typical CIT arrangement, the plan itself must actually purchase (or direct a purchase on its behalf) an insurance contract with those guarantees before they are distributed. This is also the case in those “purchase” programs, where the participant is given the ability to select from a menu of negotiated annuities offered by the plan at separation from service. The plan still must first purchase (or direct the purchase on its or the participant’s behalf) that annuity contract before then distributing it to the planned participant. In all of these instances, the plan participant is NOT the purchaser, the plan is. Looking at my recent blog on distributing annuity contracts may be helpful to understand this point.

In insurance lingo, this means that an insurance application typically must be completed, and a contract delivered (note, the process may be a bit different on the issuance of a certificate under a group annuity contract). There are actually three purchaser options: the “plan” (as a legal entity); the trustee of plan, typically a different entity, especially if part of a lifetime income program; or even the employer (which is permitted by the Code and ERISA to own an annuity contract on behalf of the plan). Often, each of these entities can be domiciled in different states.

And therein lies the rub. There are a bunch of nitty little insurance details related to that choice of purchaser but the REAL question which demands some attention by the purchaser relates to the “domicile” of the purchaser. Any insurance person will tell you that domicile is important, and you want to, if at all possible, avoid the contracts’ issuance being in particular states (indeed, a number of policies are not even filed in certain states because of the various state regulations and approval processes). Each annuity contract “form” is subject to the the insurance rules of the state in which the contract is sold. The question then becomes whether or not there is anything meaningful in there which affects anyone but the issuing insurer.

There are probably two separate answers to that question. The first is the most obvious one, but not one often discussed. Each state requires insurance companies required to participate in their state’s guarantee associations to protect the policyholders of all companies within the state in the case of the insurer’s insolvency. (See the NOLHGA site for further information). This is an imperfect system, and insurance companies are severally restricted by law from discussing this guarantee with their policyholders. However, an analyst, or fiduciary should, in any event be aware of what the rules limitations and restrictions apply to the purchasing plan in that state-which will then impact any participant’s rights, as the distributed contract will be considered as being subject to the laws of the state in which it was purchased.

The second answer is that the analyst should be having that conversation with the folks who are offering the product or program, for information on the impact of being purchased in one state rather than another, if that option is available. In many instances there is little meaningful difference, but it is a data point to be known.

Attention to these sorts of details will serve to protect fiduciaries in their selection of lifetime income programs.

I appreciate your reading my blogs, and hope you would consider “subscribing” to them, for free, in the column on the right side of this page. If you do so, each post will be delivered directly to your email address the day after it is posted, and you’ll never miss beat!

Thanks!

Bob

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One of the key fiduciary roles in the assessment of any DC lifetime income program process necessarily involves whether, and how, the plan or the vendor accommodates any required spousal consent rules related to the payout of annuities.

The vast majority of the defined contribution plans comply with ERISA and the Code’s spousal consent rules by simply requiring spousal consent to the participants change in any beneficiary to someone other than the spouse. This simplicity does not change when a plan chooses to offer either an accumulation of lifetime income guarantees as an investment option under the plan (as opposed to the lifetime income benefit being provided as a stated benefit under the plans terms), or a program which offers the participant the ability to choose an annuity at the time of separation from service.

Where the circumstances may change, however, is when the plan actually takes the steps to either pay out the accumulated benefit in the form of an annuity contract, or offers to purchase and distribute an annuity contract at the time participants separate from service. This is where the fiduciary needs to be “in the know” as to whether, when and how any spousal rights apply to payment of that benefit. This involves being informed as to how and when a participant may elect during any “applicable election period” to waive a Qualified Joint and Survivor Annuity (QJSA); how the rights to revoke any such election during the applicable election period is actually implemented; as well as the operation of the right to elect something called the qualified optional survivor annuity (“QOSA”) during such period.

This involves a number of inquiries. One is whether these rules actually apply to the distribution. There is a difference whether the annuity contract is treated as a distribution annuity (see my prior blog, where I discuss those differences) or whether it is simply an in-kind rollover to an IRA. Another inquiry is to whether or not the plan itself must be involved in the execution of those rights, which may occur when immediate annuities are purchased and distributed at the time of separation from service. This inquiry will also include an assessment of the manner and timing in which any “right to revoke” an election impacts the election periods demanded by the law. Yet another inquiry is where the line is drawn between what the plan must do and what the insurer must do.

Particularly instructive, here, is Revenue Ruling 2012-3, which provides some pretty bright lines as to whether the plan itself or the insurance company-treated, for these purposes, as the plan administrator of the QPDA- is the responsible party.

This is where a prior post of mine regarding the “Engineers, Operators and Analysts” of Lifetime Income really comes into play. The plan sponsor or its advisor (the “analyst” in my category of things) need not be familiar with the intricacies of the application of these rules in all circumstances. THAT is under the purview of the “engineer” or the “operator” of these programs. What the analyst needs to know, however, is how the choices those “engineers” made in the program being reviewed impacts its fiduciary assessment of the program, including its judgment of the ability of the responsible party to actually pull it off.

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Often overlooked in a fiduciary analysis of any DC Lifetime Income Program are the impacts arising from the method in which any accumulated lifetime income guarantee is being distributed from any particular program. There are substantial differences between any of the available methods, and the impact of each of them on any participant. They really should be fully understood by the fiduciaries involved in the selection and maintenance any lifetime income program, especially if one is attempting to comply with the DOL’s proposed prudence safe harbor.

DC plans are probably the most efficient vehicle around under which to “accumulate” interests in guaranteed lifetime income. Whether it be through the periodic purchase of annuitization rights, and their effectively “averaging” of annuity purchase rates; accumulation of longevity bonuses under a GLWB; the increases in the guaranteed base; or any number of other features, there are very real and economically sound reasons to accumulate income rights through DC plans.

Distributing those rights accumulated in a DC plan is quite another matter. DC plans are, by their inherent limitations, lousy at making lifetime income payouts. This is mostly because of the same malady DB plans suffer: any plan sponsored by any employer can, and will (I would also argue, must) undergo transitions over a participant’s lifetime which is going to impact either access to or protection of accumulated guarantees-which, as we continue to see, can be a problem. For example, plan sponsors DO go out of business, and their plans terminated; plans regularly merge and change, often altering the fundamental nature of the plans themselves; employees, of course, leave employers, and need to find a way to effectively “port” those accumulated guarantees (who, after all, actually trusts their former employer with something as critical as this?)

The Holy Grail of Lifetime Income Programs is, to my mind, providing participants the ability to consolidate and protect hose accumulated guarantees someplace away from the actual DC plan itself. And protection of those guarantees is fundamental to any program’s design.

With all this in mind, there are a handful of ways to distribute accumulated guarantees from DC plans which fiduciaries need to keep in mind. (Note that some variants of these distribution methods also are being effectively used in some programs which focus on the cost-efficient and competitive purchase of the annuities using accumulated account balances instead focusing on distributing accumulated guarantees).

The following is a pretty accurate summary of the ways to distribute these guarantees:

  1. Annuity purchase at time of distribution. Purchasing a new annuity at the time of distribution is, surprisingly, a common method in CIT based Lifetime Income Programs, annuities which are then distributed under 2, 3, or 4, below. CITs are valuable tools in the lifetime income world, but many of the current designs unnecessarily don’t well accommodate their inherent limitations. CIT’s, themselves, can’t issue individual annuity contracts or accumulate a participant’s individual guarantees to such rights. This means that the plan (or the CIT’s vendor) must separately record the accumulation of income rights under the CIT arrangement. Then, at the time the guarantees are to be distributed (through liquidation of the related target date fund, separation of service by the participant, or termination of the plan, for example) the plan is then given the right to purchase an individual annuity contract on behalf of the participant. This newly purchased annuity reflects, as much as possible, the bookkeeping entries related to those accumulated rights, at as much as a similar cost as possible under the circumstances. These annuities can then be distributed under the plan using methods 2, 3 or 4, below. Any fiduciary needs to become familiar with any limitations, expenses and risks occurring throughout this sort of process leading up to the distribution.
  2. In-kind rollover of the annuity to, or as, an IRA. To the extent the plan’s design either accumulates income rights attached to an in-plan annuity (which can even happen when tied to a CIT), or purchases an annuity under the program under #1, above, that annuity (with its related income rights) can be rolled over as an IRA annuity under 408(b), or rolled over to an IRA custodial account under 408(a), both as non-taxable transactions. There are a number of technical differences between the two methods with which the fiduciary should become familiar.
  3. QPDA. That annuity sitting in the plan can, instead, be distributed by the plan as a Qualified Plan Distributed Annuity (see, for example, 1.401(a)(31) or, in the case of 401(a)(38), a qualified plan “distribution annuity”). Also a non-taxable event, the distribution of a QPDA has dramatically and fundamentally different treatments than the annuity rollovers in #2. The QPDA is not actually a rollover, it is technically a sort of plan to plan transfer: the contract is treated under the Code as an ongoing plan, and the insurer is treated as the plan administrator (whatever that means!). 403(b), 401(a) DB plans and insurers have been utilizing this approach for generations, and is a useful tool for 401(a) DC plans as well.
  4. Non QPDA in kind distribution. The plan’s design can instead, simply make a taxable distribution of the annuity itself with the accumulated guarantees; the participant would be taxed on the present value of that annuity, (a very interesting effort in and of itself); and the participant is now the proud owner of an annuity subject to the same annuity rules as apply to any purchaser of a retail annuity.

These distributions each can either be an individual annuity or an individual certificate from a group annuity; and in each of these scenarios, the annuity is considered as being distributed by the plan as it is no longer a plan asset. If properly constructed, none of these annuity distribution programs actually require terms which are not already a part of most pre-approved adoption agreements and plan documents. And, yes, it’s actually a pretty good design, for several reasons, for a plan to actually own individual annuities under which the participant is named as the annuitant.

It is these sorts of close details which will fall on the fiduciary’s plate, to be part of its assessment as to the prudence of the decision to select any particular lifetime income program for any particular plan sponsor.

It is our familiarity with these sorts of granular issues which led us to kick of our Lifetime Income Practice at the Fiduciary Law Center (see our fun vids on our thoughts on this at the lifetime income website). As an fyi, my email there is rtoth@fiduciary.net.
Bob

Businessman Happy to See His Water Bucket is Full While Business

We have all been well attuned over the decades since mutual funds became available to be daily traded under DC plans to a very particular view of an investment funds’ cost. ERISA’s participant investment disclosure rules have successfully established what I best described as a certain “language,” which permits any participant or fiduciary to assess whether the cost of any mutual fund investment is competitive and reasonable. These costs are strikingly explicit, well defined and even required under the SEC’s prospectus disclosure rules. This data then enables the fiduciary advisors’ “qualitative” exercise of judgement in their provision of advice.

These well-established data points are all now turned topsy-turvy when fiduciaries attempt to apply some version of them to assessing the annuity investments in a DC plan. After all, these annuity products are widely offered in tandem with mutual fund investments in target date funds and as elements of managed accounts.

There then becomes a two-fold challenge: first, how do you assess the prudence of the purchase of the annuity coverage, and, secondly, how do you then cobble that assessment together with the independent assessment of the mutual fund investments to which they are tied? There is then the added complication of the “fixed account” portion of these arrangements, often funded by an insurance general account, which has its own standards against which it must be benchmarked.

Though annuities can, and often do, provide access to equity exposure through either their separate accounts in variable annuities or indices in fixed indexed annuities which CAN be easily benchmarked, assessing the prudence of an insurance guarantee of lifetime income is quite a different matter. This is in large part because of the nature of the purchase: the fiduciary isn’t simply choosing an objectively benchmarked investment; it is paying the insurance company for its financial exposure to actuarial risk; investing in and maintaining the infrastructure necessary to support that risk over generations; and its costs in establishing the expertise necessary to providing those sorts of services. These types of intergenerational costs are not given to the sort of fee disclosure to which we have all become accustomed.

Mutual funds or CITs are incomparable, as they don’t need to build what it takes to guarantee payments over a lifetime. A very simple example is the annuity contract itself: in order to be able to be sold to a plan in any state, the terms of the contract have to (1) accommodate that particular state’s legally required terms, and (2) it has to be submitted independently to each state for its own approval. There is no such demand of a CIT.

There is recognition of this state of affairs. For example, the DOL’s Model Participant Disclosure form actually started to lay the foundation for what needs to be done. “Table 4-Annuity Options” under the 404a-5 regs recognizes this state of affairs by looking at “Objectives/Goals,” Pricing Factors,” and “Restrictions Fees.” It is this from which we should all be building.

One of the biggest obstacles is that he defined contribution market is still generally unfamiliar with-and reticent to use- the terminology and concepts related to these annuities. Much of the confusion and reluctance seems, however, to relate to the lack of familiarity of fiduciaries and participants with annuity terms, and not necessarily due to any inherent complexity in their use.

I expect that, just like the defined contribution market becoming comfortable over time with the terms and concepts of mutual fund investments and their operation, the market will eventually achieve a similar level of familiarity with annuity terminology. The manner in which to properly benchmark those products will then become routine. It does involve, oddly enough, acceptance and use of something other than the traditional view of “costs” which have dominated the equity market-a quantitative assessment which may otherwise be considered “opaque” in the equity world. But it also entails the insurance industry accepting more transparency in explaining to fiduciaries what it does.

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AI’s limitations became pretty apparent after yet another delightful and “robust,” shall we say, conversation with an old friend, an economist, about intriguing ideas on how to universally effectuate, accumulate and port lifetime income guarantees derived from employment. That conversation got granular, as it often does, with voices raising over details of certain innovative infrastructure tweaks, in progress with some clients, which may serve to make these ideas more usable and welcoming to employers and employees.

AI’s value is no doubt apparent through these sorts of conversations, as it really is a very useful tool we use in sorting out all manner of chaff. Yet my small corner of the world entails a unique weaving together of seemingly unrelated details between what conventional wisdom considers completely different structures to make the sorts of policy initiatives under discussion actually work. This is where AI has a more limitied value.

The need for these conversations isn’t going away, either, because of the value of the policy initiatives underlying them. As noted in Brookings Retirement Security Project’s important 2019 paper by David John, William Gale and Mark Iwry“ From Saving to Spending: A proposal to convert retirement account balances into automatic and flexible income” summarized that

In our view, as discussed above, the right goal should be for retirement savings plans to offer automatic mechanisms that would make it easy for participants to convert saving balances into income. Properly structured and regulated, automatic retirement income structures could help new retirees in much the same way that automatic enrollment and escalation help savers.”

Getting to this “properly structured and regulated” system of converting savings to income does require a bit of Zigging Down the Zag (Dr. Seuss), especially when we are trying to do it in a system designed to simply accumulate savings. It is a challenge faced in asset accumulation systems worldwide, and has had its fits and starts here. We in the U.S. , however, actually have an advantage of an extensive “kit” in the DC system from which to work. Deconstructing things like CITs, target date funds and annuities and reconfiguring them-within regulatory bonds, of course- to try to effectively pull off the policy initiatives is a fascinating (and workable) task, which will serve us well going forward.

These sorts of efforts are well beyond the ken of existing AI systems. And in the future? Perhaps, but it may require integration with the ability to sit down in a pub and draw on a napkin with us…. (see the beer napkin annuity).

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“No Duh!”was my favorite response by a colleague to the DOL’s alt asset proposed regulation, which is replete with references to the need of the fiduciary adviser to “read and critically review” the core documents of any of a plan’s investments. That proposed reg does grant plan sponsors some grace, only requiring that they (who retain the investment adviser) “read and critically review” the assessment of that fiduciary adviser, without imposing on them the obligation to also read those underlying investment documents. Sponsors can rely upon their 3(21) and 3(38) advisers to fulfill that obligation.

This is just not an “alt asset” investment requirement: it looks to have been wrapped up as part of a general prudence expectation for non-alt investments, as well, such as annuity contracts and mutual funds (or at least some their procedures). I strongly suspect that this now explicit prudence requirement that fiduciaries read and critically review documents will NOT be changed in the process of finalizing this regulation. This function is, as one may say, as American as apple pie. I think that it is a general assumption that fiduciary advisers actually do “read and critically review” these base documents (thus the appropriateness of the “no Duh” comment) as part of any fiduciary review, or their firms’ technical staffs actually accomplish this feat. Yet I also strongly suspect that this procedure has been generally more strongly honored in its breach. Having written many annuity contracts, CIT documents and other investment documents over time-while having had to read and assess far too many of them in the process- I also will assure you (as if you didn’t already know!) that these documents are not written to be read-or even understood by the faint of heart.

This really goes to the core of the matter, I think. With ERISA having no readability standards, the advisers seeking to take advantage of the benefits granted (see, for example, Matthew Eickman’s excellent write up on these opportunities) to them by the safe harbor (or now just to be prudent) are likely to find themselves having to translate some of these very ugly documents into a sort of plain English that is decipherable by their plan sponsor clients. It looks as if a successful “translation” may become a part of the advisers’s own fiduciary obligation.

Plan English has been a goal eluding federal and state regulators in the retail market for a very long time. The SEC, in its A Plain English Handbook, actually has some meaningful suggestions about what this standard could look like:

We’ll start by dispelling a common misconception about plain English writing. It does not mean deleting complex information to make the document easier to understand. For investors to make informed decisions, disclosure documents must impart complex information. Using plain English assures the orderly and clear presentation of complex information so that investors have the best possible chance of understanding it.

Plain English means analyzing and deciding what information investors need to make informed decisions, before words, sentences, or paragraphs are considered. A plain English document uses words economically and at a level the audience can understand. Its sentence structure is tight. Its tone is welcoming and direct. Its design is visually appealing. A plain English document is easy to read and looks like it’s meant to be read.

Applying this in the context of DC Lifetime Income Programs, I have always strongly felt that their successful implementation really does require a knowledgeable advisor. Its not that such matters are particularly complex, they are just in an area in which the typical plan sponsor has little familiarity. With these newly explicit prudence requirements, advisers probably now need to dive in where they probably have not in the past.