Upping the Ante for Fiduciaries
In March, 1995, DOL issued interpretive bulletin 95-1 charging that the selection of an insurance company to provide distribution annuities is a fiduciary act, and that plan fiduciaries have a duty in most cases to select the safest available annuity provider. In addition, the fiduciary obligation of prudence requires, at a minimum, that plan fiduciaries conduct an objective, thorough and analytical search for the purpose of selecting the safest provider. DOL makes clear that reliance solely on ratings from insurance rating services would not be sufficient to meet this requirement. The search must evaluate a number of factors relating to the provider's claim paying ability and creditworthiness, including the quality and diversification of the provider's investment portfolio, the size of the provider relative to the proposed contract, the level of the provider's capital and surplus, lines of business and other indications of the provider's exposure to liability, terms of the contract, such as guarantees, use of separate accounts, and possible outside protection such as state guaranty associations.
Unless they possess the necessary expertise to evaluate such factors, DOL expects fiduciaries to hire qualified, independent experts to advise them.
DOL's action was prompted, in part, by the well publicized failure of Executive Life Insurance, and the recognition that numerous insurers were heavily invested in junk bonds or troubled real estate. The possibility of widespread insurance company failures raised concerns for the security of pension benefits under benefit distribution annuity contracts. This was especially troubling, because PBGC protection was lost once the employers shifted the pension burden to an insurer by purchasing annuities. (DOL and PBGC are still considering whether more regulation may be needed in this area).
Interesting points about the bulletin:
1. It only applies to "benefit distribution annuities", not to annuity contracts purchased as plan investments. Investments, of course, are subject to ERISA's duty of prudence, but fiduciaries may chose to select an investment contract with a greater risk if it promises a greater investment return.
2. The bulletin was made effective retroactive to January 1, 1975. If your plan has any still-active benefit distribution annuities, you should consider whether you process for selecting the annuity provider would have measured up to the standard of an "objective, thorough and analytical search for the safest possible provider. If you are not comfortable with the answer, consider reevaluating the safety of the provider based on data available today and, if necessary, consider if any steps can be taken now to strengthen the security of those contracts.
3. The bulletin allows that there may be situations when it is in the interests of the participants to purchase other than the safest available annuity, such as when a contract with marginally increased safety is disproportionately more expensive, and participants are likely to bear the increased cost, or when the insurer deemed safest is unable to demonstrate an ability to administer the payment of benefits. However, DOL notes that cost considerations never justify buying an unsafe annuity, and a fiduciary can not justify the purchase of a riskier annuity solely because the plan doesn't have enough assets to purchase a safer contract.
4. By requiring fiduciaries to select the safest available contract, DOL has, in effect, made trustees and other fiduciaries personally liable for the insurers' later failure to pay benefits. Since you, as a trustee, are guaranteeing the insurance company, you should consider whether your fiduciary liability coverage limits are adequate. (Hint: theyr'e not.)
