Liability of Annuity Agents rests on Fiduciary Status

Summary of ERISA Fiduciary Standards and Prohibited Transactions

The issue of whether or not you, as an agent, are considered a fiduciary for a qualified plan determines your liability. Under ERISA, fiduciaries are personally liable for breaches of their responsibilities. However, parties in interest (including service providers) are not personally liable and are not held to the same strict standards as fiduciaries.

Defining Fiduciary

ERISA provides three alternative definitions for a fiduciary. The term "fiduciary" includes (1) people with discretionary authority or control over the management of the qualified plan or the disposition of its assets, (2) those who render investment advice for a fee or other compensation, and (3) those who have discretionary authority or responsibility in the administration of the plan.

Classification as a fiduciary is not limited to individuals. It can also apply to plan administration companies, including insurance companies.

The basic question for an insurance company and its agents is "At what point do the services provided in the course of the sales process cross the line from those of a 'party-in-interest' (i.e. a seller of insurance) to those of a fiduciary (i.e., one whose actions must be in the best interest of the plan participants)?" This issue applies to any professional who provides advice to an ERISA plan, including accountants, lawyers and consultants.

ERISA prohibits a fiduciary from: (1) dealing with plan assets in the fiduciary's own interest or for the fiduciary's own account; (2) acting in any transaction involving the plan on behalf of a party whose interests are adverse to the interest of the plan or its participants and beneficiaries; or (3) receiving any consideration for the fiduciary's own personal account from any person dealing with the plan in connection with any transaction involving plan assets.

ERISA and the Internal Revenue Code prohibit certain types of transactions between a qualified plan and parties-in-interest to the plan. Engaging in a prohibited transaction will subject the disqualified person to onerous tax penalties as well as personal liability for any losses to the plan.

A "prohibited transaction" occurs under ERISA if a plan fiduciary causes a qualified plan to engage in a transaction that the fiduciary knows or should know constitutes a direct or indirect:

Under ERISA, parties-in-interest include fiduciaries and service providers as well as their relations and organizations owned at least 50% by them.

PTE 84-24: Insurance Agents as Fiduciaries

As a general rule, life insurance agents are afforded a certain degree of protection for sales to qualified plans. In the past, the DOL (jointly with the IRS) issued Prohibited Transaction Exemption (PTE) 77-9 which was later superseded by PTE 84-24. PTE 84-24 addresses the transactions normally conducted by insurance agents or brokers, pension consultants, insurance companies, investment companies and investment company principal underwriters who might (because of the transactions) be considered fiduciaries by their activities relating to the plan.

The exemptions found in the prior PTEs relieve the individuals listed above from fiduciary responsibility if certain conditions are satisfied.

An exemption is granted for a transaction that involves, among others:

First, an exemption from the prohibited transaction restrictions and tax penalties is granted in these situations if the transaction is carried out "in the normal course of business." Second, the transaction must be on terms at least as favorable to the plan as those with an outside party would be. Third, the combined total of all "fees, commissions, and other consideration" received by the insurance agent or broker or pension consultant must be reasonable. An excise tax can be imposed equal to the amount in excess of that which is reasonable compensation.

To qualify for the exemption, the agent must:

The fiduciary to the plan must be given this information prior to the transaction. Written approval and acknowledgment is retained for a period of six years following the time of the transaction. A new disclosure must be given (and new fiduciary authorization received) each time a materially new kind of product is sold or when more than three years have passed since the previous disclosure.

To the extent this exemption procedure is not followed, the insurance agent, pension consultant or broker becomes a fiduciary. As such, he or she might be held accountable for losses to the plan.

Reich v. Lancaster

A recent court case illustrates the problems that crop up when insurance agents run afoul of the rules associated with ERISA in the qualified and welfare benefit plan marketplace. If you want an example of how not to conduct business, here it is.

A federal appellate court decision, Reich v. Lancaster 55 F.3d 1034 (5th Cir. 1995), affirmed a lower court determination that an insurance agent who sold whole life insurance policies to a union welfare fund was a fiduciary, violated his fiduciary duties by selling whole life insurance policies instead of term policies and received unreasonable compensation for those sales.

The facts in this case as outlined by a Texas District Court were as follows. An insurance agent (Agent) was the owner and chairman of Company A, which in turn owned all the stock in Company B. Three of the Agent's sons were also involved in these Companies as employees, officers and directors. In 1983, a Plumbers Union (Union) and a Local Health and Welfare Fund (Fund) contacted the Agent through its trustees about providing insurance to the Fund. Company B was hired as a consultant, replacing another consulting firm for the Fund. Company A was hired as claims administrator replacing another administrator. The Agent proposed, and the trustees of the Fund agreed, to purchase $10,000 of whole life insurance for each participant from an insurance company (Insurance Company X). Company A was the regional manager for Insurance Company X with an obligation to attempt to meet production goals of approximately $500,000 in first-year life insurance premiums.In 1984, the Agent proposed and the trust for the Fund approved, the purchase of an additional $10,000 of whole life insurance for each participant from Insurance Company X. In 1985, Insurance Company X canceled its agency contract and its regional manager contract with the Agent and Company A. Later in 1985, the Fund canceled the life insurance policies with Insurance Company X and purchased from Insurance Company Y individual universal life policies for each Fund member with a death benefit of $25,000. As a result of the transactions, by the end of 1985, approximately 2½ years after the Agent became the Fund's consultant, the Fund had spent nearly $1,000,000 in premiums on the purchase of life insurance. The Agent and his companies had received over $550,000 in commissions. The commission structure from Insurance Company X was an 85 percent commission for the first year premium, 55 percent for the second year and 10 percent for the third year.The Labor Department brought suit against the Agent, his companies, his sons and other individuals, alleging numerous ERISA violations. The district court held for the Labor Department on almost all issues. The appellate court affirmed on essentially all aspects and issued an extensive opinion.

Three main issues came out of this case, of which every insurance agent should be aware:

1. Insurance Agent as Fiduciary

The first issue in this case centered on the question, "At what point do the services provided cross the line from those of a party-in-interest (i.e. a seller of insurance) to those of a fiduciary (i.e., one whose actions must be in the best interests of the plan participants)?"

The Agent was held to be a fiduciary because he exercised discretionary authority and control over assets in the Fund. He did not have explicit authority or control but merely influenced the decisions of the trustees who, the Court found, were unsophisticated in these types of investment matters. The Court determined that the Agent had taken control of the situation and that the trustees were simply rubber-stamping anything the Agent proposed. As part of its reasoning, the Court noted that the trustees agreed to spend $1,000,000 in premiums on life insurance when the Fund had only $750,000 in assets. The Court also found that at the time he made the proposals, the Agent did not:

Company A, which served as claims administrator, was also a fiduciary. The Agent and Company A were considered "one and the same" with sufficient discretion and control to fall within the definition of fiduciary.

2. High Commission Versus Low Commission Insurance

As part of this issue, the lower court ruled (and the appellate court agreed) that the Agent and Company A violated ERISA when they caused the Fund to purchase whole life insurance from Insurance Company X and universal life insurance from Insurance Company Y. The Agent argued that (1) whole life insurance was an appropriate investment; (2) group term life insurance did not meet the needs of the trust; and (3) any losses in the Fund were not caused by the insurance product but were the result of the trustees allowing policies to lapse.

The Court rejected all these arguments and maintained that all of the actions leading to the loss were actions caused by the Agent and Company A and that the purchase of whole life insurance was undertaken primarily as a means of increasing commission income and was not undertaken because it was a suitable investment for the plan or because group term insurance was not available.

3. Unreasonable Compensation

The last holding was that the income received by the Agent and Company A was unreasonable compensation. Not only did they receive the commission income from the sales of the life insurance policies, but the Agent also collected (in some cases) checks from the Fund in excess of the premium amounts and kept the difference as compensation. In supporting its assertion that the compensation was unreasonable, the Court noted that the commission income was greater than the income that had been received by the previous Fund consultant and that the parties had received more than the actual premium payment without full disclosure of those facts.

Reich v. Lancaster concerns overreaching conduct that may create difficulties for legitimate sales practices by insurance agents. ERISA's intent was never to deny the sales of insurance products inside qualified and welfare benefit arrangements. However, self-dealing has always been a major concern under ERISA. The holdings in the case have the potential for establishing particularly difficult precedents and standards for life insurance sales. Insurance agents should be especially sensitive to these issues when dealing with ERISA pension or welfare benefit plans.

References

Prohibited Transaction Exemption 95-60; Application No. D-09662, Release Date: July 12, 1995, Doc 60 F.R. 35925-35932

Prohibited Transaction Exemption 84-24; 49 Fed. Reg. 13208 (Apr. 3, 1984)

Final Class Exemption Issued For Transactions Involving Insurance Company Accounts, Pension & Benefits Week, Page 3, Research Institute of America, 90 Fifth Avenue, New York, NY 10011, Vol. 1, No. 30, July 24, 12995

AALU Bulletin No. 95-64, Washington Report, AALU, 1922 F Street, N.W., Washington, D.C. 20006, July 19, 1995

AALU Bulletin No. 95-58, Washington Report, AALU, 1922 F Street, N.W., Washington, D.C. 20006, June 29, 1995

Labor Department Grants Exemption To Insurance Companies On Plan Assets, BNA Pension & Benefits Reporter, The Bureau of National Affairs, Inc., 1231 25th Street, N.W., Washington D.C. 20037-1197, Vol. 22, 1651, July 17, 1995

John Hancock v. Harris Trust and Savings Bank 114 S. Ct. 517, 126 L. Ed. 2d 524 (1993)
Reich v. Lancaster, 55 F. 3d 1034 (5th Cir. 1995) 

Source: Pension & Benefits Week (Jun. 1997)