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.
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.
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.