DOL Bulletin Clarifies Annuity Provider Selection Responsibilities

Interpretive Bulletin No. 95-1, issued on March 6, 1995 by the Department of Labor (DOL), outlines the DOL's perspective on the standards to govern [under the Employee Retirement Income Security Act (ERISA)] a plan fiduciary's selection of an insurance carrier when purchasing annuities for the purpose of distributing benefits under an employee pension benefit plan. The standards provided in the Bulletin are retroactive to January 1, 1975, the general date in which most of the provisions of ERISA became effective.

Background

One way a qualified pension or profit-sharing plan extinguishes its liability to a plan participant is by purchasing a "qualified distributed annuity" contract. Purchasing the annuity from an insurance carrier rather than paying proceeds directly out of plan assets has generally been the favored approach for most qualified plans due to the increased ease of operating the plan. Regulations issued by the DOL explicitly recognize a transfer of liability from the qualified plan when such an annuity is purchased from an insurance company licensed to do business in the given state. Qualified distributed annuity contracts mirror the provisions of the qualified plan as to the normal form of benefit payable (i.e., Life Only, Life and Ten-Year Certain, or Qualified Joint and Survivor Annuity, etc.) as well as provide the actual amount accrued under the plan and payable under the annuity. Such annuities may be immediate or deferred.

Generally, distributed annuity contracts may be purchased for participants and beneficiaries in connection with the termination of a plan, or in the case of an ongoing plan, annuities might be purchased for participants who are retiring or separating from service with vested accrued benefits payable at some date in the future (the annuity starting date).

The DOL maintains that the purchase of annuities to satisfy a plan's liability to participants is a fiduciary decision. As such, ERISA requires a fiduciary to act with the care, skill, prudence and diligence under the prevailing circumstances that a prudent person acting in a like capacity would use. In addition, the fiduciary must act for the exclusive purpose of providing benefits to participants and beneficiaries and defraying reasonable plan administration expenses as well as discharge their duties with respect to the plan solely in the interest of the participants and beneficiaries.

Standard of Review

Bulletin No. 95-1 states that a plan fiduciary choosing an annuity provider for the purposes of making a benefit distribution must take steps to obtain the safest annuity available, unless under the circumstances, it would be in interests of plan participants and beneficiaries to do otherwise. The plan fiduciary should conduct an objective and thorough analytical review designed to select the "safest available" annuity provider. Of particular note as of the current date, Courts have not defined by ruling the "safest available" standard other than through several lawsuits brought by the DOL against a number of employers who purchased Executive Life annuities after terminating their over-funded pension plans.

Relying solely on ratings provided by insurance rating services would appear to not be sufficient to meet the standard. In searching for an annuity provider, fiduciaries must evaluate a number of factors including:

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 lines of business of the annuity provider 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 those guarantees
7. the strength of any parent or affiliated company of the annuity provider

Costs and Other Considerations

Situations may develop in which it is in the best interest of the participants and beneficiaries to purchase an annuity that is not necessarily the safest available annuity. Such costs and considerations that might influence the purchase of a competing annuity that is not necessarily the safest available are outlined below.

1. the safest available annuity is only marginally safer, but disproportionately more expensive than competing annuities.
2. The participants and beneficiaries are likely to bear a significant portion of increased costs when the marginally safer annuity is purchased rather than the competing annuity.
3. The annuity provider offering the safest available annuity is unable to demonstrate the ability to administer the payment of benefits to participants and beneficiaries.

According to the Bulletin, a fiduciary's decision to purchase more risky, lower-priced annuities to ensure a reversion of excess assets that will be paid solely to the employer-sponsor in connection with the termination of an over-funded pension plan, would violate the fiduciary duties under ERISA to act solely in the interest of the plan participants and beneficiaries.

A fiduciary may not purchase a riskier annuity solely because there are insufficient assets in a defined benefit plan to purchase a safer annuity. In this situation, the fiduciary may have to condition the purchase of annuities on additional employer contributions sufficient to purchase the safest available annuity.

Special care should be taken in reversion situations where fiduciaries selecting the annuity provider have an interest in the sponsoring employer (i.e., where the trustee is the plan administrator and the employer). This relationship may be considered a conflict of interest, which might affect their judgment and therefore create the potential for violation of the ERISA prohibited transaction rules.

References

Pensions & Investments, Crain Communications, Inc., 740 Rush St., Chicago, IL 60611-2590, March 6, 1995BNA Pension & Benefits Reporter, The Bureau of National Affairs Inc., 1231 25th Street, N.W., Washington, D.C. 20037, Vol. 22, No. 10, March 6, 1995.

Labor Department Interpretive Bulletin No. 95-1 on Plan Selection of Annuity Provider, 60 FR 12328, March 6, 1995.

The Mercer Report, William M. Mercer, Inc. 1166 Avenue of the Americas, New York, NY 10036, Number 46, March 20, 1995.