In July 2008, Bob Kistler, Nick Curabba and I put together what may have been the first published effort at compiling the fundamental rules which govern the distribution of lifetime income from defined contribution plans.

Quite a bit has happened since then. There’s been two new GAO studies on lifetime income; a joint DOL and Treasury Request for Information Regarding Lifetime Income Options (the “RFI”) and the related hearings; the issuance by the IRS of two contradictory revenue rulings on key lifetime income issues, and a clarification on those issues by a subsequent Revenue Ruling; a Revenue Ruling on DC transfers to purchase benefits under a DB plan; two new sets of proposed IRS regulations, including the Qualified Lifetime Annuity Contract regs; The ERISA Advisory Council issued a report on the “spend-down” of retirement assets; and the DOL’s Advanced Proposed Rule Making on lifetime income disclosure.

A number of new lifetime income products have been introduced into the market by both insurers and mutual fund companies to build upon all of this interest.

On the liability side, NOLHGA (the National Organization of Life and Health Insurance Guaranty Associations) issued a report on the “Life and Health Insurance Guaranty System, and the Financial Crisis of 2008–2009” which helps explain how state guaranty associations cone into play in protecting lifetime income; and there have been several key court decisions addressing fiduciary status under group annuity contracts.

A more complete and up to date description of how lifetime income can work in a DC plan is in order. Evan Giller (newly Of Counsel with Boutwell and Faye) and I put together the attached piece entitled “Regulatory and Fiduciary Framework for Providing Lifetime Income from Defined Contribution Plans.“ It is originally appearing in the New York University Review of Employee Benefits and Executive Compensation – 2013, published by LexisNexis Matthew Bender, Copyright 2013 New York University. In the paper, we’ve drawn upon our long experience with retirement plan annuities, mixing it well with all of these new developments.

One of the paper’s key features is that it lays out a framework by which fiduciaries may be able to make fiduciary determinations on products and insurers without requiring further guidance from the DOL; relying instead on traditional concepts.

We found that each of the sections in this paper could have easily been significantly expanded, now that we have a broader experience in the workings of this idea.

Please let us know what you think!

If you are wringing your hands trying to figure out how you report those 403(b) “policy loans” on the Form 5500 Schedule H, understand that you are not alone-and that there is no easy answer to your dilemma. This problem arises from a continuing flaw in the Form 5500, which the DOL never fixed after requiring 403(b) plans to fully report financials for plan years 2009.

A “policy loan” is an instrument unique in the retirement market to the 403(b) plans. With just a few exceptions, it is the manner in which loans are made by vendors under 403(b) annuity contracts. They are fundamentally based on policy loans from insurance contracts issued in the non-retiremnt market.

Here’s the source of the problem: Typically, for the “plan loan” (of the sort under a 401(k) plan and the 403(b) plan with Custodial Accounts (ether group or individual)) the funds for a loan are actually removed from the participant’s account, and investments are liquidated. What is left in the plan is an account receivable backed by the promissory note, and there are no investments in the plan to report. This matches up well with Line 1(c)8, which requires that the outstanding value of the be included as part of the plan’s financial statement as an asset.

But the 403(b) annuity “policy loan” is much different. The cash from the loan is obtained from the insurer’s general account, and no investment funds are ever liquidated from the participant’s annuity contract. An amount equal to the value of the outstanding value of the loan are transferred to a “restricted” investment held within one of the annuity contract’s investment funds, or in a separate account specially designed to pay a special rate of interest on that investment. The participant has no access to those funds, and the funds are released over time as the loan (with interest) is repaid to the insurer.

The asset statement from the insurer then shows that there is an investment still in the contract, as an asset equal to the value of the outstanding loan. It is earning interest which is reportable on the 5500, and is reportable as an asset of the plan as part of the value of Line 1(c)10 or 1(c)14 of Schedule H. If you then also report the outstanding value of the loan on Line 1(c)8, as you seemingly are required to do, you have double counted the value of the asset, and have an unbalanced financial statement.

Auditors hate this, and they try to address it in a number of creative ways. The problem is that it can’t be ignored: the loan balances, and in particular the defaulted loans, still need to be reported. I find it useful to be reported on the auditor’s report, either as a footnote or separate paragraph. But don’t ignore the issue.

This is not so much a problem for Schedule I filers, for small plans, because the participant loans are reportable on line 3 just as a description of assets in the plan, where it does not need to balance back to Line 2.

 

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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.

With October 15 closing in and large numbers of Form 5500s being finalized also comes the wrapping up of all the loose ends necessary for audits to be completed.

There is some disturbing stuff in that potpourri of issues crossing our desks. Most striking is that even now, some six years after the publication of IRS and DOL guidance related to the "new world" of 403(b) regulations, there continues to be a basic misunderstanding of some of the fundamental remaining differences between 403(b) and 401(k) plans-even from otherwise reputable auditing firms.

One set of those involves the reporting rules related to the correction and reporting on the 5500 of one of the most common errors in any elective deferral plan, the late deposit of those deferrals into the plan. We were asked to by an IQPA to provide evidence that the Form 5330 was filed on a 403(b) plan with late deferrals, and that a VFCP has been filed. 

As you may imagine, I actually took some pleasure in answering this question. But the answer could serve as a reminder for many:

  • Though late deferrals to an ERISA 403(b) plan do need to be reported under the Compliance portion of  the Form 5500 Schedule H or Schedule I, Form 5330 cannot be filed-in spite of the silence in the Form 5500 instructions. This is because the Tax Code’s prohibited transaction rules, Section 4975, do not apply to 403(b) plans-even if it is an ERISA 403(b) plan. Form 5330 is only for plans to which 4975 applies.  Tell your auditor NOT to file the Form 5330, and that no 5330 penalty tax is due.
  • Late ERISA 403(b) deposits are, however, violations of ERISA’s prohibited transaction rules under ERISA Section 406.  This means that the DOL’s Voluntary Fiduciary Compliance Program (VFCP)  does apply to these deposits. But your analysis shouldn’t stop there. Note that, unlike the mandatory rule under Code Section 4975, the ERISA 5% penalty on the earnings on these late deposits under ERISA 502(i) is an administrative penalty that may be assessed by the DOL.  The statute only requires that you fix the late deposit (by paying the interest), not that you report it other than on the Form 5500 or pay a penalty. In small cases- lets say, for example, where the maximum penalty imposed is little more than a few dollars-it is well worth considering not filing under VFCP.  An auditor will have a hard time dinging a plan for a sawbuck or two.

  • And about those "late" deposits.  Some insurance companies are notorious about the time in which they take to actually allocate their 403(b) deposits to individual contracts. I’ve seen one vendor claim that it has seven days to do it. The problem this causes on audit is that many auditors pick up the posting date of the contribution to the participant’s contract, and claim that the late posting represents a late deposit, and a prohibited transaction.  This is not the rule. The DOL has recognized this issue of there being time between the deposit and the date it is allocated. It provided and an important example in its preamble to its “deposit” rules under 2510.30-102 that

    “Where, for example, an employer mails a check to the plan, the Department is of the view that the employer has segregated participant contributions from plan assets on the day the check is mailed to the plan, provided that the check clears the bank.”

Remind your auditor that the test is the date that the money is irrevocably sent from the employer’s account (such as by check or wire), NOT the date the vendor allocates the deposit to the contract.

Just as my frustration with Independent Qualified Public Accountants was peaking, our oldest son, Ryan (who is in the business, working for the Newport Group in North Carolina) dropped us a note reminding us that when you Google the term IQPA, the lead result is the "International Quarter Pony Association."  Levity does help put things into perspective…..  

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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.   

 

 

 

 

 

A  little noticed class action law suit first filed against TIAA-CREF in 2009 is finally coming home to roost for many fiduciaries of 403(b) plans-without many affected plans even having a clue that they have become members of that class action. The case is Bauer-Ramazani, et al. v. Teachers Insurance and Annuity Association of America-College Retirement and Equities Fund (TIAA-CREF), et al., Case No. 1:09-CV-190, pending in federal court in Brattleboro, Vermont.

The lawsuit challenges the manner in which TIAA manages what is commonly known as the "gain-loss" processes related to the untimely fulfillment  of participant investment instructions in the "separate account" under TIAA’s ERISA  variable annuity contracts. 

This is a critical issue in the operation of these 403(b) plans.  It is also the sort of claim one might expect to be brought by fiduciaries of the affected 403(b) plans, (the ones with the legal responsibility for managing these plans) and that the named members of the class would be other affected plans. But neither is the case here. In a legal absurdity, the "named plaintiffs," (that is, those who brought the suit and who are legally charged with representing the interests of the affected plans in the class) are not the affected plans or plan fiduciaries, but two plan participants in a small 403(b) plan in Vermont.  And the court documents seem to be geared instead  to individual participants in the affected plans, not the fiduciaries of those plans.

This was all made possible by the US Supreme Court landmark decision in LaRue, which established that participants could maintain certain fiduciary lawsuits as long as they were representing the plan as a whole, and not as a claim for their own benefits.

Now the United States District Court in Vermont has approved that class, which means the class action is now  proceeding to litigation on the merits of the claims. The definition of the class includes "all persons, including all ‘persons’ as defined by 29 U.S.C. § 1002(9), who at any time during the Class Period requested a transfer or distribution of TIAA-CREF mutual fund or money market accounts covered by ERISA whose accounts were not transferred or distributed within seven days of the date the account was valued and were denied the investment gains.”

Because of the operation of ERISA, "persons" in this context also means "plans," as a participant’s rights under a plan are derivative of the plan’s rights. So every 403(b) ERISA Plan which holds a TIAA contract during the class period (which is August 17, 2003 to May 9, 20013) is a member of the class.

This is where it really does get complicated. In spite of LaRue, fiduciaries of these plans likely still have an obligation to monitor this lawsuit, which includes making those decisions related to the plan’s involvement in the lawsuit: the representation of their interests in the lawsuit; the management of the lawsuit;  the adequacy of the class representatives; and any settlement which may be achieved.  There will be inevitable problems here, should the participants of a plan in the class disagree with their plan’s fiduciaries on the conduct of the litigation, or on settlement offers.

This is serious stuff. So, you would think,  that all of TIAA’s plans would receive notice of this important lawsuit, or that at least the notices were to be geared for them. For example, the right to opt out of the lawsuit has just passed on August 15, and you would think that fiduciaries would need to know that information.

Well, think again. Though the Federal Rules of Civil Procedure require members of a class  to be given the "best notice that is practicable under the circumstances, including individual notice to all members who can be identified through reasonable effort," (the "cy pres" notice) it does not appear that the form of notice approved by the court accommodated notice to the affected plans. Many plans and their related fiduciaries are yet unaware  of this lawsuit. The cynic would say that the counsel for neither the Plaintiffs or Defense viewed it in their interests to raise with the Court the thought that plans and fiduciaries would be class members, and to design notices which would reach those class members.  So the Court approved a form of notice which did not include a method by which plans could be readily notified, being seemingly designed instead to reach  individual participants.

This is important, with the period for opting out of the class-a fiduciary choice-passing.  Fiduciaries will now be bound by whatever is found by the Court and, if a number of the arguments presented by either party to date is any indicator, getting a sound decision by the Court may be mere serendipity.

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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.   

  

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Many of you know, or know of, Shlomo Benartzi, the Behavioral Economist from UCLA who studies retirement behavior. I had the pleasure of testifying with him in the DOL/Treasury Lifetime Income hearings.

Professor Benartzi wrote an intriguing article in P&I, discussing the need for innovation in the retirement marketplace, and advocating the establishment of an incubator to identify and test promising new ideas which promote retirement security. In particular, Shlomo noted the growing acknowledgement of the problem of leakage from defined contribution plans.

In an almost stealth–like way, innovation is creeping into the marketplace and creating ways to address critical retirement issues, even without an incubator. Though these programs can do little to address what I view as the basic retirement inadequacy issue-that is, employers are generally moving away from the traditional notion of building adequate retirement programs into their employment models-they are making progress toward making the best of what we’ve got.

Examples of some of these programs with which our firm has been actively involved are worth discussing. We take the Ted Giesel (a/k/a Dr. Suess) approach to these sorts of things. Giesel was fond of saying that he had the habit of, “looking through the wrong end of a telescope,” and that has made all the difference. For us, it is in looking at the close details of the rules with a fresh eye which is making all of the difference.

It’s worth noting that these efforts all depend heavily (and in surprisingly detailed ways) on technology. None of these programs would have been possible without the technological advancements over the past decade:

Aggregation Models. This is the “after-effect” of the DOL advisory opinion on Multiple Employer Plans. Working with vendors like TAG and Transamerica, we are implementing an effective way to achieve scale in fiduciary and investment services which effectively mimics the benefits of a MEP without their risks. This, in turn, provides employers with opportunities they may not otherwise have in plan design and investments, particularly with the growing complication of the fiduciary rules.

 

DC PLan Loan insurance. Some of my good friends, and people I hold in very high regard, do publicly chastise (dare I say “pooh-pooh”? Its got to be in a Dr. Sues book somewhere!) the notion of DC plan loan insurance. But it is an interesting and valuable innovation which (when properly designed, priced and disclosed) protects plan participants from plan-related losses due to circumstances beyond their control. It also provides one marketplace solution to the DC leakage problem Prof. Benartzi addresses in his article. Custodia’s (the company whose product with which we are involved) current model is based on existing rules, and there is proposed legislation to make it more easily fit within plans. This is one of those innovations that should be given a chance to stand or fall in the marketplace.

 

DC Lifetime Annuity Patents. The US Patent and Trademark Office has issued 3 patents in the past 3 months related to providing lifetime income from defined contributions plans (LFG’s, US 8,429,052 B2; Pru’s US 8,438,046 B2; and Genworth’s US 8,433,634 B1). I am the “inventor” on one of them, LFG’s, which provides a way to seamlessly annuitize from a NAV platform. The three patents all take a different approach to lifetime income, which actually makes a couple of important points. First, on the impact and value of good regulation. The proposed QLAC regulation on annuities and Rev Rul 2012-3 both laid the base to permit these patents to work. Without those pronouncements, these three programs really could not be effectively implemented. Secondly, don’t fear these process patents. They show that there are a large number of ways to skin this cat, and that those investing in their own “skinning” methods should be able to protect them.

 
This is really just the tip of the iceberg; there are a number of other things stirring as well. By “looking through the wrong end of the telescope,” I think you’ll find that the current rules can support a great deal of innovation which can promote retirement security. We just have to look…..

Multiple Employer Plans continue to be an issue for not only PEOs, but for a number of organizations which have successfully used the MEP method in the past to provide “scale” which is otherwise unavailable in the smaller end of the 401(k) marketplace. But for the “bad actors” as in the Hutcheson matter, this scale can effectively provide smaller employers with a high level of fiduciary coverage, well priced investments, a wide variety of non-proprietary investment funds and a greater level of professional service they really could not get elsewhere.

The DOL Advisory Opinion 2012-04 has caused us to take a closer look at how to otherwise achieve this scale. Scale in investments and services, we find, is still possible without using MEP, and in ways which tend to have a lower risk profile for both the MEP sponsor and participating employers.

The attached whitepaper,sponsored by TAG Resources, the applicant for Advisory Opinion 2012-04, “Fixing the MEP: Using an Aggregation Program to Manage the “ASO” Risk in the PEO Multiple Employer Plan” discusses this alternative to a MEP. It does so in the context of addressing the “ASO” problem in a PEO. PEOs, regardless of their position with regard to the application of 2012-04 to their own lines of business, have a problem if they offer their MEPS on an a la carte basis, which is referred to as the ASO (“Administrative Services Only”) business.

This paper has application well beyond the ASO issue. It provides some thoughts with regard to the manner in which service providers may be able to effectively provide scale to the smaller case marketplace.
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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.

A number of years ago, I was in-house ERISA counsel for Kellogg Company (yes, the home of Tony the Tiger). The company’s CEO was in charge of the food manufacturer’s trade group at the time, and he sent me to DC to review and help “fix” the retirement plan for its employees. This was a time prior to even the IRS’s Administrative Policy on Self Correction (“APRSC”-I am showing my age). As I explained to the group’s Executive Committee the issues and the list of horribles which could result, the V.P. for Taxes of Kellogg stopped me in the middle of my presentation and blurted out: “Toth, this s**t’s hard!”

And so it is now, with the new “state of the 403(b) world.”  Through fits and starts, and in efforts often delayed, the IRS now has mostly in place a set of comprehensive rules for dealing with 403(b) plans following the unfortunate issuance of the unnecessarily complex regulations in 2007.   In reviewing the recently issued package of 403(b) efforts, including the new EPCRS; the ”pre-approved” plan rules under Rev Proc 2013-22; and the new sample plan language, I think back to that vulgar, but accurate, comment made to me many years ago:

This stuff’s hard.

When considering these new plan document rules and the new EPCRS together, there is a massive volume of sometimes difficult detail in the guidance.  Much of it is thoughtful, some of it controversial and, I would suggest, some of it innovative. For example, it ventures into the world of effectively requiring pre-approved plans while staying within its regulatory bounds (as we’ll be discussing in future blogs).  And for those of us wonks, sadly, it’s all very interesting as well.

The most striking aspect of this effort, however, is what seems to be a newly institutionalized view that 403(b) plans are, in fact, much different than 401(a) plans, and often demands much different treatment. Here is language from the Rev Proc:

“The program described in this revenue procedure is similar in many respects {comment: note NOT the “same”} to the Service’s pre-approved plan program for plans qualified under § 401(a), which is described in Rev. Proc. 2011-49, 2011-44 I.R.B. 608. For example, two categories of pre-approved plans — prototype plans and volume submitter plans, which are described in section 5 and section 7 of this revenue procedure, respectively — are available under both programs…..Although the program described in this revenue procedure is similar in many respects to the program described in Rev. Proc. 2011-49, there are differences between the two programs, beyond those that result from the differences in the Code requirements under § 401(a) and § 403(b).”

This is so different from the early days of this regulatory effort, where Reader, Bortz and Architect would all insist that there were few (nor should there be any) fundamental differences between 403(b) and 401(a) plans, a bias that is still reflected in the 2007 regs.

Now, instead, we may be finding ourselves in a much better position of working through the details on how to apply the rules differently (and where) in an environment that is now willing to recognize this reality. Hopefully, we seem to be at the beginnings of the implementation of a regulatory scheme that adequately deals with that  403(b) uniqueness.

This is relatively uncharted territory for all of us.  Lou Campagna said it well when he commented on how the DOL also went into unfamiliar grounds with the new 408(b)(2) regs. He noted that sometimes they just aren’t going to get it always right, but the effort is well worth it.

That’s going to be the case here, as it really is breaking into new ground. The IRS now has established a coordinated structure by which we can reasonably attempt to develop compliance. We are not going to like some of the IRS’s choices; and there still is quite a bit of institutional learning about 403(b) plans that still needs to be had. But we now see some sanity in dealing with this calamity. I think we’re going to find, in spite of some of the bumps we all see in this right now, that this was nicely done.

12b-1 fees and other revenue sharing arrangements have really become the guts and glue of the retirement plan business. The marketplace has come to rely upon these critical arrangements to subsidize plan administration, investment advice and a whole range of services enjoyed by plans and participants. The fees are now subject to prior disclosure rules under 408b-2 and (very limited) reporting under schedule C. They have become such a fixture in marketplace that there seems to be a growing sense that these fees belong to  the plans whose assets generate them, and that fiduciaries are somehow entitled to them.

Except that this isn’t quite so. There is actually another competing set of fiduciary rules which need to be considered when dealing with revenue sharing, and 12b-1 fees in particular.

Remember the true nature of 12b-1 fees: they are paid from mutual funds to distributors under their selling agreements with an investment company to promote the mutual fund.  Payments are made from a mutual fund’s assets under that fund’s 12b-1 program, authorized by the SEC’s Rule 12b-1 to the  Investment Company Act of 1940,  in order to  promote that mutual fund and to  defray the related distribution costs.   It must be approved initially by the investment company’s board of directors as a whole, and separately by the investment company’s “independent” directors. If the 12b-1 plan is adopted after the sale of fund shares to the general public, it also must be approved initially by a vote of at least a majority of the mutual fund’s voting securities.  

The mutual fund’s Board members are under the fiduciary obligation to the fund shareholders to make sure that those 12b-1 fees are being used for the benefit of promoting and distributing the fund’s shares. I invite you to read the preamble to the 2010 proposed changes to the 12b-1 fees which outlines this obligation in detail. It also contains some great statistics on the use of these fees.

So how is it, then, that a fund’s self-serving distribution payment designed solely to promote the best interest of the mutual fund become subject to the ERISA rule that compensation generated by the plan be paid in the interest of the plan?

Its important to parse out just how this works.  

Starting with the basics, it is the fund distributor who is contractually entitled to the 12b-1 payment, not the plan, and for very specific distribution purposes. The mutual fund’s Board has already had to make a fiduciary determination that the fee is reasonable, in the best interest of the mutual fund shareholders, and that its payment complies with Rule 12b-1.  

Separately, the ERISA plan’s fiduciary can only permit the purchase a mutual fund which has a 12b-1 program if the amount of the 12b-1 fee is reasonable from the plan’s point of view, regardless of whether the mutual fund feels its reasonable.  Going into this determination of reasonableness, however, would be things like how the particular 12b-1 charge stacks up against other competing funds that the plan may be able to purchase and whether, or to what extent, the mutual fund’s distributor (who really does now control the use of the 12b-1 fee to which it is entitled under its selling agreement with the mutual fund) will be used to offset service or other costs incurred by the plan.

It is so easy to presume that the 12b-1 fees belong to the plan, especially because of their pervasive nature in the marketplace. But don’t make this mistake. In the end, a plan’s ability to benefit from 12b-1 fees is only a derivative one.  A plan has no inherent right to a 12b-1 fee generated by the assets it purchases. The right to those fees belong solely to distributor, one who is paid under a selling agreement for promoting the interests of the mutual fund-not the plan.  The plan ‘s fiduciaries obligation is to make sure that the fee is reasonable, that the total amount a distributor receives off of the plan (including 12b-1 fees) is reasonable and, if the distributor commits to sharing the fee, that the commitment is properly honored.  

By the way, It is also important to understand that there can be an element of sales commission built into that fee, payment of which is also  acceptable under ERISA as long as certain conditions are met- a point I have noted in the past.  

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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.   

Winter Storm Nemo’s approach to the East Coast this weekend, threatening snows of epic proportions, should come as little surprise to at least one group of employee benefit professionals: the Annual Joint Meeting of the Great Lakes Area TE/GE Council, Gulf Coast Area TE/GE Council, Mid-Atlantic Pension Liaison Group, Northeast Pension Liaison Group, Pacific Coast Area TE/GE Council, which is in Baltimore Thursday and Friday.

3 of the last 4 years, the same has happened. Those who end up staying in the Inner Harbor Hotels tend to be locked up with little to do but wait it out. Those of us, such as Conni and I and other Great Lakes types, who choose the fine accommodations at Fells Point, tend instead to enjoy ourselves through these delays. Unfortunately for us this year, because of the flu, we have been unable to attend the Meeting, and we send our greetings to our many friends there.

Now to the techie stuff:

I know of no common investment used by retirement plans that is less well defined than the term “stable value fund.” Investment companies, insurance companies, financial advisors, and others all seem to define them a bit differently. They can be found in mutual funds, collective trusts and in group annuity contracts. They can also be “synthetic” in nature, with investment managers cobbling together “stable value funds” within a plan consisting of a number of different investment funds otherwise available under the plan.

To my mind, the annuity contract’s guaranteed fund, or fixed account, has always bee the quintessential stable value fund, as it has guaranteed principal and its returns are generally based upon the performance of an insurance company’s general account. The vast majority of assets within an insurer’s general account are those also found within other so-called “stable value funds”-with the difference being that that insurance accounts were actually guaranteed

Advisors never really took well to the guaranteed account as a stable value fund, often because they often had (though with decreasing frequency now) market value adjustments or withdrawal restrictions imposed under certain market conditions. And then there was the matter that the assets in a general account are subject to the general creditors of the insurance company.

This last point becomes important should an insurer become insolvent. Though it doesn’t happen often, and state bankruptcy law and guaranty associations have done a very good job over time in protecting general account products from an insurers insolvency, it creates a terrible marketing problem for insurers: how do you explain this risk in a competitive bidding situation, where a competing type of stable value fund doesn’t bear that risk? The “mere” fact of a guarantee of interest and principal, I guess, doesn’t cut it (does my cynicism show? As you can tell, I am a fan of these products, if well designed).

The solution to this marketing problem? How do you provide the valuable guarantees while avoiding having to explain that embarrassing problem of insolvency risk? Well, lets put guaranteed account investments in an insurance separate account. (An insurance separate account is what you typically see as the “investment funds” in a 401(k) plan which has a group annuity contract. The assets are generally custodied outside of an insurance company’s general account, and under a separately established investment policy). You see, the assets of a separate account are not subject to the claims of an insurer’s creditors under most state laws (with, of course, certain exceptions).

Without going into too much gory detail, this really could be a bit of sleight of hand if designed wrong. There are many separate accounts which really are invested like stable value funds from collective trusts, for example. But if it has guarantees of principal or interest-the “guaranteed separate account”-the risk just moves down a level, and the investor in the guaranteed separate account is still subject to an insurer’s insolvency risk. So, instead of the insurer standing up for the value of the guarantees, and how well the insolvency risk is managed and priced into the product, the risk is instead hidden and not discussed.

Well, the National Association of Insurance Commissioners is taking a look at this practice, and coming down strongly on the side of making these types of separate accounts subject to the general creditors of the insurer. I guess this means that now insurers will finally need to actively promote the true value of their guarantees, and market the good nature of the commercial pooling of interests-hmm, then again, maybe not……

For those nerdy enough to want to read it, the proceeding of the NAIC can be found here.

 Sales compensation on financial products sold to employer plans has always been a critical piece of making the private retirement system work, particularly in the small to mid-size marketplace. As policymakers attempt to adopt different policies to increase the “penetration” of plans in this important segment of the marketplace, no such effort will really be successful unless professionals are paid for the work it takes to get plans to those employers.  It is the financial service companies which pay sales commission on their products which really makes these policy initiatives work. 

Yet, there seems to have been a certain “ick” factor with the DOL’s approach to sales compensation. This is surely based in part on the sales abuses we have all seen; and the DOL really does see the ugly underbelly of sales on a regular basis. But this still does not diminish the importance of commissions to the successful implementation of retirement policy.
 
Perhaps it’s this “ick” factor which is leading to the growing ambivalence about the way the DOL approaches sales commissions.
 
Compensation paid on the sale of a financial product to a retirement plan, whether it be an insurance commission from the deposit to an annuity or from the payment of a 12b-1 fee related to the purchase of a mutual fund, is paid under a contract between the distributor and the financial service company. This compensation is paid in order to promote the company’s best interest, and there is the concept of “active and effective” by which agents and reps are judged.  They are paid to promote the company’s interests, not the plan’s.
 
Under ERISA 406(b)(2), this is the classic adversity of interest.  Which is really the reason why prohibited transaction rule 84-24 (originally 77-9) is necessary: it permits a fiduciary to authorize the payment of a commission to an adverse party as long as a few conditions are met.
 
The regs under 408(b) 2 (the drafting of which I am an unabashed fan), however, never really addresses this sort of inherent conflict. Instead, a strong argument can be made that the reg appears to cast sales commissions as service compensation, and serves to complicate this matter. Consistent with other recent DOL activity, it casts the payment of an asset or deposit based sales commissions as the payment of indirect compensation from the plan.  Yet, this compensation is paid under a contract between the sales rep and the financial service company (not the plan and the rep) where the rep is duty bound to protect the interests of the company paying the comp, not in the interests of the plan.  
 
So, though this disclosure may make the comp reasonable comp under 408(b)(2) (that is, if you view sales as a service), it still does not relieve the 406(b)(2) adversity problem.  To make any sense of this, it looks like you still need to comply with PTE 84-24 in addition to the 408(b) 2 disclosures. 
 
408(b) 2 did have a clarifying effect, by the way, on PTE 84-24. For years, there had been ongoing discussions on whether or not the recipient of a commission is really the receipt of compensation from the plan, and whether an agent or rep was really party-in-interest to a plan which would be covered by the prohibited transaction rules. By casting commissions as indirect compensation, this question is effectively closed.
 
I know this discussion sounds a bit tortured, and even a bit non-sensical. But it has real meaning; especially when we are talking about whether, and under what conditions, certain compensation related to a plan is permitted to be paid.  I’m afraid that, as we integrate the PT rules into the growing body of fiduciary regulation, we will be stumbling into this sort of things more often.
 
  
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