A number of friends, and other commentators, had suggested to me that I was perhaps “overstating” the position I had discussed on my last blog regarding the delivery of 404a-5 notices to non-electing participants in an elective deferral plan. It was a very kind way of saying that I was wrong. After looking at the
The “Tussey Twist” to the DOL’s Disclosure Rules
The DOL has long treated the revenues sharing programs (such as 12b-1 and sub-transfer agent fees) related to investment funds in the same manner as the SEC: as an integral part of the funds’ operating expenses. This choice, however, has the side effect of the actual amount of the revenue sharing not ever having to
Annuity Termination Charges under 408b-2: What is “Without Penalty?”
Pension funds and insurance companies share a little discussed attribute, one which I have mentioned from time to time on this blog: they are both great drivers of capital formation. One of the unique aspects of capital formation through these entities is the function of time: it takes time, to quote the bankers from the movie Mary Poppins in the infamous "Fidleity Fiduciary Bank" scene, to “build railways through Africa” (or even California, for that matter). Pension funds and insurance general accounts are of a nature uniquely suited to such investment, the commitment to which often may span decades.
Annuity contracts purchased by 401(k) plans, and other retirement plans, often offer the ability for the plan or the participant to invest in these insurer’s “general accounts” as an investment fund. They are now often marketed as “stable value funds” which, in return for time, provide guarantees of principal, some measure of guaranteed returns, and enhanced crediting rates. Though they are called "stable value funds," they are really nothing like the stable value mutual funds. They are backed (in part) by real "things" like investments in bridges, roads, equipment, factories, apartments and shopping malls.
Many of these general account investments offered under annuity contracts, however, have the hated “contingent deferred sales charges” (otherwise known as surrender charges), or “market value adjustments (MVA) ” to the stable fund investments, should these contracts be terminated or substantial amounts withdrawn before a stated time. Surrender charges are generally related to sales costs, but the MVA, as unpopular as they may be, are often necessary because of the long term capital investments backing the guarantees which may be provided. Many products today, by the way, are offered without surrender charges or MVAs, but also generally offer reduced crediting rates in return.
Which really brings us to an obscure problem the DOL has struggled with in the past under ERISA’s plan asset rules (in attempting to define a “transition guaranteed benefit policy”), and now is an issue which may well come to the forefront because of the termination rules under Reg. 1.408b-2(c)(3). 1.408b-2(c)(3) states that a contract will not be considered reasonable if it does not permit termination “on reasonably short notice under the circumstances“ of the contract by the plan without penalty to the plan. Fortunately, the DOL noted that this should not be read to prevent long term contracts, nor contracts which “reasonably compensates the service provider” for their loss upon early termination of the contract. This exception will not apply if that recoupment is “in excess of actual loss or if it fails to require mitigation of damages.”
So the question becomes what does “without penalty” mean, under 408b-2, when you are terminating an annuity contract. As noted, the DOL had addressed this issue in the past in an odd, and very specialized, regulation under ERISA 401(c)(1) – which may now have renewed meaning under 408b-2. Under 2550.401c–1, the DOL outlined what it meant to terminate an annuity contract "without penalty" for purposes of that reg. It established a standard to be applied to both the surrender charge and the MVA: ”the term penalty does not include a market value adjustment (as defined in paragraph (h)(7) of this section) or the recovery of costs actually incurred which would have been recovered by the insurer but for the termination or discontinuance of the policy, including any unliquidated acquisition expenses, to the extent not previously recovered by the insurer."
This seems consistent with the language used in 408b-2.
The challenge for regulators, insurers and the responsible plan fiduciary will be figuring out when annuity contract termination charges cross this line. Though annuities designed for the retirement market typically are designed to meet these rules, there may be some questions related to retail annuities placed into plans.
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