Annuity companies have been innovative in addressing marketplace concerns in the sale of guaranteed income annuities to individuals outside of 401(k) and 403(b) plans. The recession has spurred even more interest in these products, with insurers telling us they are seeing an increased interest in both annuitization and in other guaranteed insurance products. A number of these annuity products for the "non-pension" markets are beginning to show up in some defined contribution plans, though awkwardly so. Those product designs don’t typically fit well with ERISA’s rules, and are often administered on computer platforms which don’t support ERISA compliance.
The nut that is proving the hardest to crack is finding a way make these products available to 401(k) participants in a simple, compliant and seamless way, either as a form of distribution or as a way for participants to otherwise protect their investments within the plan-and many vendors have designed products attempting to meet these criteria.
Plan Sponsor co-hosted a webinar a few weeks ago with MetLife, in which the use of annuities as distributions from defined contributions were discussed. Kent Mason, an old friend and a fine lawyer with Davis and Harman, commented that he believed that one of the key reasons annuities and other longevity products were not being used by DC plans is because of the way the RMD rules apply to them. Though I hold Kent’s opinions in the highest regard, I have to disagree with him on this point. I think instead the fiduciaries’ concerns lie with the fear of locking up funds for a lifetime with a single company. I would go with the view of another longtime friend, Dan Herr of Lincoln Financial Group. Dan’s experience tells him that the key obstacle to the purchase of annuities for individuals is something he calls the "4 I’s": Irrevocability, Inflexibility, Inaccessibility and Invisibility.
In applying Dan’s theory to the 401(k) marketplace, it seems to me that addressing those "4 I’s" would also serve to address the concerns of fiduciaries, to which I would add a fifth "I": Immobility (or, to be more precise, portability).
Lets take a look at each one of those "I’s" separately, from a fiduciary’s view. In this Part 1, I’ll discuss Irrevocability. The other "I’s" will be covered in blogs soon to come.
The traditional annuity, one in which a set price is paid for a set amount of lifetime income, is typically irrevocable. I call this "your grandpa’s annuity." Once a participant commits a substantial payment to the insurance company, it is gone for good. This gives both fiduciaries and participants a great deal of heart burn. It locks a participant up for a lifetime, raising some very difficult fiduciary concerns about the predictability of an insurers’ solvency. It is not a new concern, as Individuals live with that same fear when they buy any life or annuity product-a concern about what I call the "30 year risk" (my apologies to the actuaries).
It sees to me that the first element in an adequate fiduciary review is to get at least a layman’s grasp on the nature of insurance and insurance regulation. Pooling risks with others is an uncomfortable concept that is foreign to a fiduciary with a defined contribution mindset. The pooling of risk and the undertaking of this "30 year risk" are critical societal functions, but they pose significant risks to a state’s citizens whose policyholders are unable to address individually. Because of this, states have uniformly stepped in to protect their citizenry by regulating insurance in ways of no other industry:
- Reserves are required for the risks taken (one of the big AIG failures was that large levels of risk were taken on without any reserving by a non-insurance subsidiary which was not governed by an insurance regulatory authority);
- The manner in which the reserves are invested are heavily regulated for investment risk and type;
- Insurance companies are regularly and comprehensively examined by state insurance authorities and must do substantial regular reporting on their assets and the nature of them.
- Insurance companies are required to participate in their state guarantee associations to protect the policyholders of all companies within the state. (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. The best solution for the future is the proposal for a sort of FDIC program for plan annuities, as described by the David John, Bill Gale of the Retirement Security Project and Mark Iwry, Ass’t Treasury Sec’y.
- Review of marketing material of all insurance products is required.
I would think that an adequate fiduciary review would have the fiduciaries acknowledging that the task they undertake is different from the mere investment of account balances; the standard against which they will be judged has necessarily a stronger insolvency risk; and that they have addressed that risk adequately-in part-by understanding and relying upon the state’s regulatory role in managing the risk.
Fiduciaries can then further manage the risks by looking closely to the terms of the annuities being purchased. They can look for products that offer terms which address their concerns. For example, they can look well-priced "outs" in the form of cash surrender options; for products which are funded in part with separate accounts which are protected from the insurer’s creditors; or for funds and guarantees which are partially re-insured by an unrelated insurance company-thus spreading the risk.
This should then be balanced and integrated into looking at how the other 4 "I’s" are addressed- a topic of soon to be published blogs.
NOTE: I have moved offices (though still with Evan and Monica), moving back downtown (yes, Fort Wayne has a very nice downtown!). I needed to change telephone numbers in the process.
My new contact information is: