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403(b) plans and lifetime income programs suffer a similar malady: both sorts of arrangements operate in a sort of “exception” environment, where they rely upon atypical application of the standardized qualified plan rules in order to effectively work. This means that these programs are not typically amenable to broad and sweeping policy statements of the sort which are often issued by senior government leaders. This leadership challenge, by the way, is not limited to gov’t policy leaders. I have been privy to a number of glaring business examples over the years where corporate leaders have also become enamored by a concept, which then fails miserably where the “details” of implementing such grand ideas have to meet reality.

So it seems to be with Executive Order 14330, which seeks to “Democratize” ERISA retirement plan investments, by making it simpler for participant directed defined contribution plans to offer things like private equity interests to plan participants as DIAs.

To say that this particular government efforts is causing some consternation amongst ERISA plan fiduciaries is probably an understatement as-among other concerns- it raises the concern for the lack of something as simple as appropriate benchmarking against with to measure such decisions. This then, of course, gives rise to fears of class action lawsuits and related costs of fiduciary insurance.

For the 403(b) fiduciary, however, the “exception” environment in which they operate serves to alleviate some of the consternation facing other DC fiduciaries. This is because that, without a statutory change, 403(b) investments are still limited to annuity contracts and custodial accounts holding mutual fund investments. None of these will support the typical private equity investment.

Even should the proposed 403(b) CIT legislation ever pass, it would likely still be insufficient to support private equity investments from being held by most 403(b) plans. This is because the proposed CIT modifications still require that the PE investment be held as part of an 81-100 collective trust. The legal structure of the collective trust is anathema to the manner in which the PE investment is typically structured and operates, which rely on the condition and decisions of each individual plan. Even should somehow someone contrive a “solution” to this challenge, it would necessarily rely upon a contorted process.

As I noted in my last blog, details of the way in which regulations apply are critically important, even in the application of broader policy. To this end, it is these details which can help ease the anxiety of the 403(b) fiduciary.

A side note: this article was written without any use of AI, though I’ve little doubt that this information will soon end up in an AI program near you without, of course, any attribution…

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As part of the DOL’s efforts under Executive Order 14192, titled Unleashing Prosperity Through Deregulation (90 FR 9065, Feb. 6, 2025), the Department undertook to withdraw two seemingly innocuous annuity regulations which, by any cursory review, appeared to have outlived their usefulness. I would suspect that most of us didn’t give those withdrawals a second glance.

Innocuous, however, those actions were not. The two regulations not only laid out some serious technical groundwork for the current DC lifetime income programs but-as the affected stakeholders pointed out to the DOL-they are actually still in use. Fortunately, this caught the attention of a number of my old colleagues in the industry, who were able to make the point to the DOL that withdrawal of these regs could actually be disastrous, and lead to some pretty serious ramifications. This then led to the DOL’s withdrawal of those withdrawals.

There are valuable lessons about DC lifetime income programs we can all draw from the DOL’s miscalculations about the continuing efficacy of annuity regulations. I think each reinstated regs is worth a quick look, as each of them provide what I think are different, and meaningful, lessons on the lifetime income’s “Learning Curve” I discussed in my January blog:

The long tail of annuities. My “favorite” of the reinstated regs is 29 CFR 2550.401c-1, the “Harris Trust” Reg. It is actually my favorite because it is the issue which first got me seriously involved in the activities of the American Council of Life Insurers, where I eventually chaired its Pension Committee. In one of those cases now seemingly long forgotten, the Supreme Court ruled in John Hancock Mutual Life Insurance Co. v. Harris Trust & Savings Bank, 510 U.S. 86 (1993) that, under certain circumstances, the assets of an insurance company’s general account which back certain annuity guarantees can actually be treated as an ERISA plan’s “plan assets.” Technically the issue involved the definition of what constituted a “guaranteed benefit policy.” That SCOTUS decision was so disruptive to the annuity industry that Congress directed the DOL to write a reg which would “grandfather” any annuity contract issued on or before December 31, 1998, which met certain conditions in order to prevent insurance company assets from being subject to ERISA’s fiduciary rules.

The “Harris Trust” reg was the result of these efforts. DOL sought to withdraw this reg, stating that because “the regulation is limited to Transition Policies issued on or before December 31, 1998, it is not likely that any Transition Policies remain in effect.” Given that annuities can be inter-generational, it’s a serious misjudgment to assume that annuities merely 37 years old would not still be in effect. This long tail of annuities is one of the reasons why state insurance law imposes such substantial reserving requirements. Preventing its withdrawal was critical for the insurance industry. By the way, it is really the “Harris Trust” efforts which led to insurers generally removing their discretion in the calculation of any “Market Value Adjustment” under annuities sold to DC plans.

Details matter. The Department also sought to withdraw the existing “annuity safe harbor” regulations under 29 CFR 2550.404a-4. It’s reasoning for doing so was that the “annuity safe harbor” under the Secure Act’s ERISA 404(e) obviated the need for the existing reg as “an unnecessary and inefficient alternative [to 404(e)] and may inadvertently be a trap for the unwary;” that the new 404(e) “provides a more streamlined, less costly safe harbor than the (existing) regulation, but with the same level of safe harbor relief;” that “removing the regulatory safe harbor also eliminates situations in which a plan fiduciary might waste time and resources in analyzing and comparing the pros and cons of the two safe harbors to determine which safe harbor is best;” and that “the continued existence of the current safe harbor could mislead interested parties into believing that no other safe harbor exists or that there are benefits to using the regulatory safe harbor rather than the statutory safe harbor.”

Putting aside whether or not that assessment is accurate or just some new sort of bureaucratic babble, the DOL withdrawal effort overlooked a key detail: the existing safe harbor applies to both the selection of the insurer as well as the selection of the actual annuity product. The new 404(e) annuity safe harbor, in contrast, only applies to the selection of the insurer, not the annuity product. This sensibly lead to the withdrawal of the withdrawal.

We are making progress along that learning curve.

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If any company in the United States wants to sell you a guarantee that- in return for a premium- they will make monthly payments to you for as long as you are alive, that company simply needs a license from a state to do so.

This really-not-so-simple requirement actually has massive implications. Licensure is a critical cog in a system which has provided financial and retirement security for millions of Americans for generations, and for good reason. Achieving and maintaining this status is anything but simple, of course.

Approaching two hundred years or so in the making have been those state law-based regulatory requirements which are imposed on companies before they are licensed to make what would otherwise seem to be an outrageous guarantee of monthly payments for the rest of your life. These rules governing the amount, investment, secure handling, reporting and auditing of assets backing those guarantees issued by licensed insurers have resulted in a robust regulatory scheme governing the capital which backs these guarantees.

The system is far from perfect, for sure. Even now, the states are struggling with the manner in which to appropriately deal with offshore private capital of insurers, and the impact of this growing practice on the credibility of these guarantees; and there are serious public policy concerns about whether the state guarantee association structures (which effectively “insure the insurers”) is adequate. In addition to the regulatory imperfections, there likely are few among us who haven’t had horrible experiences in dealing with insurance companies. Then, abusive sales practices have always haunted the industry; the industry has not been particularly adept at transparency; and any ERISA standards by which to assess, compare and monitor the appropriateness of the particular terms of any these guarantees which are purchased by retirement plans are but in the developmental stages.

But we need look no further back than the MEWA debacles of recent decades to see what happens when privately issued “benefit promises” are not protected by this regulatory scheme. Think about those unscrupulous promoters who used ERISA to avoid the financial reserves requirements otherwise imposed by states on health insurers as a condition of maintaining their license to issue critical insurance guarantees. When circumstances turned against those promoters who had promised an “unreserved for” benefit (as the actuaries will tell you that circumstances inevitably will), hundreds of thousands of participants in these plans were left devastated after paying for “health insurance” which ultimately was not there when they needed it the most.

For all of its deficiencies, this regulatory scheme still well governs the reserving, secure handling, and investment of the $5.7 trillion in the general account assets of US life insurers (as of the end 2024, according to the ACLI 2024 Life Insurers Fact Book) which (among other things) backs up the lifetime income promises utilized by defined contribution plans.

There are serious implications for the retirement plan industry related to this state of affairs. The raw power and impact of $5.7 trillion in accumulated assets and their proper management cannot be ignored by the industry, especially given the likelihood that, ultimately, millions of ERISA plan participants may well be relying upon this massive pool for their retirement security. Successfully regulated capital is critical to retirement security in the U.S., and is a matter to which the non-insurance industry’s serious attention cannot long be avoided.

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Executive’s Life’s 1991 collapse made a mockery of the insurance company rating system. Just months prior to its demise, S&P had given that insurer its highest rating (AAA, “Extremely strong capacity to meet financial commitments”) and Moody’s was awarding it one of their highest ratings at a1. An excellent review of this debacle was published by the GAO in 1992, for those interested in that sort of background. Effectively, though Executive Life had established sufficient insurance reserves to qualify for those high ratings, the ratings companies (and, for that matter, the state insurance commissions) failed to give sufficient weight to the fact that those reserves were made up of junk bonds of, shall we say, dubious value.

There have been at least three notable downstream (though much delayed) effects resulting from this failure which should be of interest to the retirement community. The first was Dodd Frank’s 2010 virtual banning of the use of any financial ratings in the federal regulatory system, including their use in establishing fiduciary standards under ERISA. The second was the eventual establishment in 2011 by the NAIC-after, embarrassingly, some two decades of consideration-of the Risk Based Capital (RBC) standards governing the investments of life insurance companies, a standard which arguably could have prevented Executive Life’s collapse. The third was the establishment of the insurance company ERISA safe harbor for fiduciaries under the Secure Act, upon which fiduciaries can now rely in the absence of any adequate rating system.

In spite of the resultant lack of value of insurer ratings to the ERISA fiduciary, there still remains a sort of residual impact on fiduciaries arising from the fact that higher ratings are still being pursued by insurers. This impact occurs because one of the key elements attendant to any rating from a rating agency is their assessment of the level of insurance reserves established by the insurer. State laws requires an insurer to establish sufficient “regulated capital” (my term, in reference to those investments of life insurance companies subject to the RBC rules, the value of which now exceeds $9 trillion in the U.S.) to back up that seemingly audacious promise to fund benefit payments decades hence. Though the state laws may establish minimums, insurers may establish greater reserves in order to obtain higher ratings.

The end result of this condition is a subtle but important one for the fiduciary “industry.” It calls for an effort (aside from the assessment of the design of any DC lifetime income program) to understand whether the cost of any high rating of an insurer is worth the impact on the “return” on the policy purchased by the plan. It’s not cheap to maintain the highest ratings offered by the ratings agency, as it requires paying for the maintenance of higher reserves. This can create downward pressure on an insurer’s choice of crediting rates to be offered under annuity polices purchased by plans. The question is then joined: what is the value to the fiduciary in accepting a potentially lower crediting rate in return for choosing an insurer with a higher claims paying rating? Put more directly, is there a value difference in utilizing a company with higher rating, and where-and how- do you draw the line?

Engaging in this sort of highly technical assessment effort will not be for the faint of heart, as there are also other of these sorts of issues lurking in the background which will demand unique quantitative analysis. I would think that the quants performing these services would also be interested in becoming familiar with things like the details of the Risk Based Capital standards, and the current industry and regulators’ efforts at addressing risks related to the growing offshore schemes.

This then suggest to me that there is likely to be a sort of bifurcation in the professional fiduciary market. There will be those who will be able to perform the valuable task of assessing any particular DC lifetime income program for plans or their fiduciaries, identifying any program’s relative advantages and disadvantages. But then there will need to be a limited segment of the industry which has developed the capability to perform the sort of quant analysis suggested above. Though only being part of any overall assessment of any lifetime income program, I would think the questions it addresses eventually becomes an important piece of any ultimate review.

Note: the image included in this blog is from my favorite Dr. Sues book, Bartholomew and The Oobleck. Its a drawing of the magicians coming up from the dungeon, an image I often think of when called upon to do weird technical stuff, like called for in this blog…

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I had to chuckle a bit when I first read Nevin Adam’s excellent (of course) recap of the latest DC class action lawsuit, this one involving JP Morgan Chase Bank’s DC plan’s selection of stable value funds. He noted the complaint alleges that “throughout the Class Period, identical or substantially identical stable value funds with higher crediting rates, and hence lower spreads, were available to the Plan, but were not selected by Defendants.” In trying to make this point, the pleadings offered something called a “comparator chart,” attempting to compare annuity contract based stable value funds.

Image my surprise-and that chuckle- when I saw that about a third of the “funds” listed in that chart included annuity contracts on which I worked for nearly two decades. Having now captured my interest, the merits of the lawsuit aside, that chart and the related allegations reminded of an important lesson when dealing with any annuity: do your homework first or, as my mentor Roger Siske would regularly advise, know what you don’t know.

This advice holds for the fiduciary activity we are seeing in the DC lifetime income market. There are substantial, and critical, efforts in play which will serve to assess the annuity pieces of income programs. As I’m sure those working on these evaluation models have found, assessing annuities is a dynamic process. It involves putting any contract under any particular plan or arrangement in “context.” The designs, terms, crediting rates and the like shift over time and circumstance, and may well apply differently depending on the arrangement.

There’s a couple of examples to make this point. First is the retail fixed index annuity (FIA). This type of contract may well serve the individual “wealth” market, but is mostly inappropriate for use in a retirement plan. However, where an FIA is designed for retirement plans, it offers some of the most efficient vehicles for a plan’s delivery of lifetime income guarantees. So, relying upon details of the retail FIA when assessing a plan-designed FIA is, in my judgement, not “doing the homework.”

Then there’s the notion of an exploring an insurer’s “spread,” an inquiry often made by fiduciary advisors. An insurer’s setting of crediting rates or “bonus” levels (often found in a GLWB) at any particular time can often be dependent on some unusual time-dependent factors. This may include the insurer’s own risk capacity at the time of the setting of the rate (yes, capacity is a real “thing”); the market’s interest rate environment; an insurer’s own “reserving requirements;” or their particular interest (or disinterest) in expanding in certain portions of the market. Translating “spread” (even if you can somehow calculate it uniformly or precisely) is, quite frankly, meaningless for a fiduciary. It tells a fiduciary little about the guarantees being offered. It would be an example, again in my judgement, of not knowing what you don’t know.

It is encouraging to see the work being done in lifetime income assessments, and pleadings like we are seeing in the JP Morgan class action are a reminder of the importance of spending the time and effort to get it right.

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The ongoing Pension Risk Transfer (PRT) litigation poignantly demonstrates the growing importance of the SECURE Act’s “Annuity Safe Harbor” provision to the continuing efforts to design and develop responsive DC Lifetime Income programs.

The PRT plaintiffs claim fiduciary violations of the DOL’s “safest available annuity” (or “SAU”) requirements under DOL Reg 29 CFR 2550.404a–4 by certain DB plan sponsors in their selection of annuity carriers to fund the wind-down of their DB plans. Among other things, that reg required plan fiduciaries to actually “conclude” whether an annuity provider is financially able to make all future payments under the annuity contract.

Those SAU regs actually have a bit of a checkered history, however, when it comes to DC plans. The DOL first applied that rule to DC plans in 2002, which somewhat chilled the development of lifetime income programs for the DC market. Fears arose because it looked very much like there could only be a single insurer which could issue annuities to retirement plans, and that acceptability would be solely reliant on an insurer’s ratings. In any event, the demand that fiduciaries make some sort of prescient determination as to an insurer’s future solvency impaired much of the interest in further developing these programs. It also began a decade’s long legislative effort to “solve” for that problem, eventually resulting in the passage of SECURE’s Annuity Safe Harbor.

At the same time that SAU was being applied to DC plans, a revolution of sorts was occurring in the retail annuity markets. A number of insurers were engaged in efforts to develop sophisticated products which provided more meaningful lifetime income benefits which address the insured’s needs. So-called “living benefits,” like the GLWB, and new types of annuities, like the fixed indexed annuity- each addressing the flaws in both straight life and variable annuities- were becoming available outside of retirement plans. With notable exception, these products were not generally being developed for use with retirement plans.

The potential fiduciary exposure for which SECURE’s Annuity Safe Harbor solved is really about the nature of an insurer’s practices in creating these new types of guarantees. I encourage you to take a look at a blog I posted a few years back called the “Mathematics of the GLWB.” That piece touched on some of the “infrastructure” details which an insurer must employ to be able to provide the sorts of guarantees now being offered in virtually all new DC Lifetime Income programs. For example, the more flexible of these programs must use sophisticated investment hedging programs in order to adequately manage the risks involved with the provision of these specialized guarantees. The unanswered question, prior to SECURE, was what it would take for a fiduciary to make an assessment of such insurers which would meet the SAU standard. Indeed, it was these sorts of concerns which led, in part, to the QLAC requirement using a simple, straight life annuity.

The Annuity Safe Harbor removed this uncertainty, and encouraged a number of insurers to become further active in developing flexible products for the retirement plan market. Effectively, the safe harbor entitles fiduciaries to rely upon the well-developed state regulatory schemes governing insurer solvency. Regardless of what one may otherwise think of state insurance regulators (take a look, for example, at the DOL’s disdain of state insurance authority in the fiduciary rule), there are well developed and generally standardized financial standards which need to be maintained by insurers which seek to issue financial guarantees which can span a generation. While states have been regulating this (generally) well for over a hundred years, there currently is no federal regulator which can effectively govern the financial operation of insurance companies.

It was simply foolhardy to impose that SAU obligation on fiduciaries of private retirement plan fiduciaries, who are not in the business of taking accountability for the operation of a complex and highly regulated financial services company.

Now, it will be challenging, at best, to bring a successful “safest available annuity” claim against those DC fiduciaries in selecting insurers under their DC Lifetime Income programs. This safe harbor does not, of course, provide any protection against the imprudent selection of any given product issued by an insurer, nor does it address the continuing opaqueness issues surrounding many annuity contracts. However, The PRT litigation is showing the enduring value of even the limited protection of the safe harbor.

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The efforts to get some sort of handle on how to review, assess and implement DC lifetime income programs is very reminiscent, to me, of my experiences following the system-wide impacts following the fundamental changes introduced by the 2007 403(b) regulations from the IRS-along with the rippling effect they had on the application of DOL and SEC regulatory rules. It wasn’t that the 403(b) rules were complex (though we often heard that complaint), it was truly a matter of fitting an unfamiliar scheme into an otherwise well-established market. Traditional 401(k) providers of all sorts plunged into 403(b) opportunities which were opened by those regulatory changes, finding that success was dependent on becoming familiar with quite a cache of logistical minutiae.

So, it is now that those policymakers, developers and promoter of DC lifetime income programs (many of us who have been actually working at this for quite a while) continue to hear the refrain that these programs, and the attendant insurance arrangements upon which many of them rely, are “complicated.” Having had to recently parse through some horribly complex fiduciary advisory material assessing the prudence of target date funds in defined contribution plans, I’m not so sure that insurance has cornered the market on “complexity.”

“Complexity” here seems to be more about the disconcerting demands required when unfamiliar “de-cumulation” programs are introduced into a market founded on accumulation. It’s all about the learning curve on how to use the rules with which we are all familiar to an unfamiliar set of facts.

For example, most of us can easily discuss the application of settlor versus fiduciary functions, but not where to draw the line for decumulation programs; the annuity contract is simply a contract which has been approved by regulators, the rub being limited terms which can be negotiated; identifying how the differing elements of the limited types of annuity types affect a de-cumulation program is not a particularly heavy lift; ERISA’s familiar prudence standards still apply, but in ways with which we are only now becoming familiar; and the plan document requirements are really quite simple and straightforward and can fit into most pre-approved programs, as long as you know what boxes to check in the adoption agreement. As I said, it is all about the learning curve.

Industry growing pains do abound, however, but they are similar to those which accompanied the transition from 401(k) private pooled trust accounts and balance forward accounting to the current, mutual fund/CIT based daily valuation programs. For example, we do not yet have an industry clearinghouse, like the NSCC for mutual funds, through which to coordinate and facilitate the transfer of insurance interests; and individual “middleware” services have been sprouting up to accommodate these transfers until the industry-wide infrastructure becomes more sophisticated. This is where most of the “complexity” really lies. The advisor and fiduciary need not be familiar with these underpinnings- they simply need assurances that the system works, and a knowledge of what limitations may be imposed at the end of the day.

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Professional research and advisory firms have developed an impressive array of benchmarking tools over the years, which soundly provide guidance to plan fiduciaries on the selection and monitoring of pooled investment funds. Often using a rigorous combination qualitative and quantitative measures, fiduciaries rely heavily upon these tools to (among other things) demonstrate their compliance with fiduciary standards. The really good ones effectively integrate judgement with the use of number. This includes, for example, inclusion in their benchmarking practices a measure of qualitative assessment such as changes in management and the managers’ adherence to their own published investment goals in establishing their “scorecards.” Central to the use of most of these arrangements is the benchmarking of fees and their impact on the total performance of those funds.

There are substantial efforts underway in many parts of the industry to develop similar sorts of benchmarking tools for assessing, comparing and monitoring the growing variety of lifetime income programs for defined contribution plans. A very real challenge these developers face arises from the fundamental difference in the nature of the investments involved: existing equity based assessment tools translate poorly into critiquing programs where decumulation risks are the critical factor. Even the language used to produce these new tools is demanding a new mind set.

I attribute Matt Gray, an actuary with Allianz Life, with suggesting a new and viable route to addressing this challenge. He outlined it in the Retirement Income Consortium’s July 18 Webinar on “How to Analyze Fees Associated with Retirement Income Solutions.” I invite you to take a look at the last few slides of that presentation, as Matt succinctly lays out the case that effective benchmarking of lifetime income programs is all about “outcomes,” not fees.

Just looking at fees doesn’t tell you a lot with regard to these programs, where annuity products are a key element of the design. This is not to understate the importance of knowing where the “stated” (or “explicit”) fees lie, and who is getting compensated. However, their role in the benchmarking process is much different than it is for scoring equity investment products. The actual “costs” related to covering the variety of lifetime risks within an annuity are imbedded into the products themselves, and cannot be meaningfully compared in the same manner as we have always approached “fees.” What you really are looking at in order to conduct a comprehensive review of any product’s relative reasonableness are the “outcomes” which are being provided (which CAN be quantified) for the premiums being paid.

I would suggest that the benchmark developer’s next step, once building out the “outcomes analysis,” is then to develop and weave into these outcomes a new set of relevant qualitative tools.

Relevancy is important in the qualitative analysis. I take note that at least a few elements of the “conventional wisdom” being proposed by a number of professionals really don’t seem to pass muster. A prime example is an often misstated notion that the type of annuity used in a program does not really matter, and that each type simply provides an actuarial restatement of the same priced risk. This is not true, as each type of type of annuity provides much different “efficiencies.” A variable annuity is, structurally (because of the way insurance rules apply to them), one of the most efficient platforms under which to accumulate wealth in a plan (see, for example my blog on this point); where the fixed indexed annuity (again, because of the way in which insurance rules apply to them) appears to be very efficient at providing certain income benefits.

Another example is the use of the “spread” an insurer realizes on its general account investments in any given year, a question now often being asked by a number of advisers. Though collecting this factoid may be an interesting exercise, it has little relevance (for a number of reasons, including state reporting protocols) to a fiduciary’s quantitative or qualitative assessment of a lifetime income program.

I also wonder if an outcomes based approach may not actually help address the concerns many have expressed as to whether or not insurance products should be used in these programs, or whether even these programs should be offered in a DC plan. I suspect it will.

It also well makes my point from my previous blog that we all need to become accustomed to a whole new use of technical language.

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The growing acceptance of the idea that defined contribution plans need to provide participant access to a “DB-Like” retirement income benefit is only really possible now because of the foundational work over the past two decades by key policy thought leaders like Mark Iwry, David John, and a handful of others.

Further success of this critical policy initiative will be dependent, methinks, on a number of pieces next falling in place. Chief among these is the achieving a coherent understanding by a wide swath of fiduciaries, advisers and participants of what the notion that DC Lifetime Income programs as a part of a plan participant’s investment palate entails.

Just this idea that DC plan participants are now being more broadly offered the opportunity to choose to devote a portion of their account balances toward guaranteeing lifetime income is a sea change in employer sponsored retirement programs. This opportunity was rarely available even under some of the most “flexible” retirement programs offered in the past.

Having this valuable new and unfamiliar element available as part of a DC plan means developing support mechanisms of all sorts to actually deliver their value. Really grasping this requires understanding a new “language” (and concepts) with which we all must now become accustomed if these programs are to work. The ideas are not really complicated, but very unfamiliar to the most of us.

A classic example can be found in the investment arena. These lifetime income programs are typically part of an investment menu which utilize annuity contracts somewhere in the “offering.” Annuities are needed because many of these programs are often “risk” based, where the insurer-not the plan or the government-assume the financial risk that are inherent in providing these guarantees. Most of the well-known metrics usually used in selecting between competing equity fund investments have limited usefulness when making decision with regard to selecting these new annuity based programs (even though some of those programs have important equity elements).

One of the concepts which best demonstrates this demand arises under something called the “guaranteed lifetime withdrawal benefit,” or GLWB. A GLWB is one of a small handful of annuity features which we call “living benefits,” which is simply a class of payouts which give participants a measure of flexibility in managing their lifetime income streams. The GLWB is a core feature of many of the new programs currently available in the market.

Basic to the GLWB is something called the “benefit base,” under which the insurance company enhances the participant’s eventual retirement payout the longer the participant actually participates in the GLWB. The idea of “time” increasing an annuity benefit is a basic insurance practice, but has never played a role in the traditional DC investment vocabulary-and can almost sound a bit nefarious. It isn’t. It reflects the idea that the longer a participant holds (and doesn’t surrender) the accumulated benefit under a GLWB program, the lesser the risk the insurer bears in its actuarial calculation of the eventual lifetime guarantees it will provide. This, then, enables the insurer to guarantee the payment of an enhanced benefit over time.

With DC lifetime income programs now garnering wider acceptance, at least conceptually, their increased use and ultimate success will demand quite a shift in the “conventional wisdom” surrounding plan investments.

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Generating over 19,000 written comments, the DOL’s proposed fiduciary rule changes clearly hit a “vein.” Though the proposed changes are complex and multi-tiered, there are two of them which are particularly garnering most of the attention.

The first is the proposal to compel the application of a version of the retirement plan fiduciary rules to the retail sale of non-registered individual annuity contracts, at the point of sale, to an individual’s IRA. As substantial, expensive and potentially disruptive a change that this will introduce, these rules are still generally compatible with those which sales organizations must apply at the point of sale where “registered” investment products are sold by registered representatives.

This differs dramatically from the second of these proposed changes, that is, the proposed regulation of an annuity product’s compensation design. Abusive sales practices have been the bane of federal and state regulators, and most financial service companies, for as long as investment products have been developed and sold. However, regulating investment sales practices-whether it be by the SEC, FINRA, state regulation or even the DOL-have mostly been imposed at the point of sale.

In a departure from this regulatory norm, the DOL now seems to be attempting to regulate the design of the product the insurer builds-not just its sale. This is truly uncharted territory, especially as it is likely to widely impact the retail sale of annuities.

Like the design of any investment product, whether it be a mutual fund, annuity contracts or CIT, compensation design is an integral part of their development. These businesses produce investment products which are designed, priced and managed by very serious investment professionals (and, in the case of insurers, actuaries) which seek to profit off of their expertise. A key element of investment design is the manner in which marketing and sales compensation are actually built into the product features.

This regulatory practice may well give rise to a few issues for which to be on the watch should these rules be finalized as proposed.

Workability

DOL proposes to require that the insurer avoid certain, specific types of incentive based compensation (such as, of all things, award trips) that it builds into its products. The fundamental mandate is that any compensation design must not prioritize the financial interests of the insurer over that of the purchaser.

This seems to be a very odd requirement to impose on insurance companies-or any business, for that matter. These companies are judged by the market (and their investors or-in the case of a mutual insurer-its policyholders) by, among other things, their profitability. It seems like there may be all sorts of legal and behavioral issues which spring from such a counterintuitive demand in the regs. Among other things, it imposes this “obligation” in a competitive business environment where sales are a critical factor in the organization’s success (and survival), and where each other insurer has competing products and compensation schemes. As a result, I’m not quite sure any business has the capability of meeting this standard-especially considering that an insurer must maintain its financial viability over the policyholder’s lifetime in order to guarantee lifetime benefits. This legitimately raises the question of the rule’s workability- and whether this regulatory design can be effective at preventing abusive sales practices at the point of sale.

Note that this element is also a bit of an outlier, by its own terms: the DOL (rightfully) exempts investment companies (mutual funds) from this product compensation design requirement (and the requirement that it establish and monitor “best interest” practices), which it now seeks to impose on insurance companies.

Disjointed enforcement authority

DOL enters this uncharted territory being hobbled by ERISA’s Reorganization Plan #4. This rule gives the DOL the responsibility to promulgate conflicted advice rules under IRAs, but gives it no authority to enforce those rules. The ultimate result is that the DOL, SEC nor FINRA have the authority under federal law to enforce the imposition of this compensation design regulation as it applies to non-registered annuity contracts by non b-ds to IRAs. Though Treasury appears to have some authority regarding these sales, it seems to only have the ability to tax this behavior, not to otherwise regulate sales behavior.

That responsibility falls to the states. The states then only have the authority to enforce their own annuity design rules, not the DOL’s. This means that successful implementation of the proposed rules necessitates the coordination between some federal entity (which needs to build insurance expertise) and the states.

Dealing with enforcement practices related to the implementation of this rule is likely to be a challenge.

Conflation of IRA and retirement plan issues

In addition to the workability and enforcement issues being raised by these elements of the proposed rules, I do want to share an observation regarding the “mashing” together of IRA and retirement plan compensation rules. The announcement of the new fiduciary scheme by the White House was accompanied by a scathing (and to my mind) unfounded indictment of fixed indexed annuities-the design of which, by the way, are well suited for retirement plans. These comments actually demonstrated a much broader point: there seems to be limited awareness of the vast difference in the product design, pricing and sales practices related to annuities (including fixed indexed annuities) sold to retirement plans and of those sold to IRAs.

Think about it: the “suitability” required of the sale of annuities to IRAs under state law looks at each individual’s personal circumstances, with a correlating need to match the annuity’s terms with the individual’s needs. This takes time and expertise of a different sort than where an annuity is purchased under a retirement plan, the purchase of which is required to be “prudent” for the plan.

The ultimate goal of averting abusive sales practices may not be well-served by conflating the regulation of the processes involved in a retirement plan purchase of an annuity with those necessary for an individual purchasing an annuity for an IRA. Uniformity has its value, of course, but there is likely to be substantial value for tailored solutions in such a diverse marketplace.

Continue Reading The Fiduciary Rule’s Foray Into Uncharted Territory