When Buying Distribution Annuities DOL Dictates Fiduciaries Select the Safest Available Annuity Contract

Employees are frequently provided annuity contracts to pay pension benefits when they leave their jobs or when a plan is terminated. The DOL has issued an interpretive bulletin providing the legal standards for a plan fiduciary's selection process when buying annuities for the purpose of distributing benefits under a pension plan. The bulletin is intended to better assure the protection of plan participants whose benefits are annuitized. The standards are effective retroactively to Jan. 1, 1975. (DOL News Release 95-72, 3/1/95; DOL Interpretive Bulletin 95-1, 3/6/95, Federal Register p. 12328)

According to the DOL, the selection of an annuity provider for the purpose of making a benefit distribution, whether on a participant's separation or retirement, or on plan termination, is a fiduciary decision. To meet the requirement that fiduciaries must act for the exclusive purpose of providing benefits to participants and beneficiaries and defraying reasonable plan administration expenses, fiduciaries choosing an annuity provider must take steps calculated to obtain the safest annuity available.

Only when it would be in the interests of participants and beneficiaries to do otherwise would a fiduciary be justified in buying other than the safest annuity contract.

To meet the fiduciary obligation of prudence, fiduciaries must, at a minimum, conduct an objective, thorough, and analytical search for the purpose of identifying and selecting providers from which to buy annuities. In conducting the search, a fiduciary must evaluate a number of factors relating to a potential annuity provider's claims-paying ability and creditworthiness. Reliance solely on ratings provided by insurance rating services is not sufficient to meet this requirement.

The types of factors that should be considered include, among others:

1. the quality and diversification of the annuity provider's investment portfolio
2. the size of the insurer relative to the proposed contract
3. the level of the insurer's capital and surplus
4. the annuity provider's lines of business and other indications of an insurer's exposure to liability
5. the structure of the annuity contract, and guarantees supporting the annuities, such as the use of separate accounts
6. the availability of additional protection through state guaranty associations and the extent of their guarantees

Unless they possess the necessary expertise to evaluate these factors, fiduciaries have to obtain the advice of a qualified, independent expert.

A fiduciary might conclude, after conducting an appropriate search, that more than one annuity provider is able to offer the safest annuity available.

In some circumstances, it may be in participants' and beneficiaries' interest to buy other than the safest available annuity. This may occur when the safest available annuity is only marginally safer, but disproportionately more expensive than competing annuities, and the participants and beneficiaries are likely to bear a significant portion of that increased cost.

Or it may be in participants' and beneficiaries' interest not to buy the safest available annuity if the provider of this annuity is unable to demonstrate the ability to administer the payment of benefits to the participants and beneficiaries.

However, increased cost or other considerations could never justify putting the benefits of annuitized participants and beneficiaries at risk by buying an unsafe annuity. Also, a fiduciary's decision to buy riskier, lower-priced annuities to ensure or maximize a reversion of excess assets that will be paid solely to the employer in connection with the termination of an over-funded pension plan would violate the fiduciary's duties. Similarly, a fiduciary may not buy a riskier annuity solely because there are insufficient assets in a defined benefit plan to buy a safer annuity. The fiduciary may have to condition the purchase of annuities on additional employer contributions sufficient to buy the safest available annuity.