WASHINGTON -- Life insurers are breathing easier now that the Department of Labor has issued a rule guiding the management of pension assets in their central investment pools.
The rule comes more than six years after the Supreme Court decided some pension fund assets that life insurance companies manage in their general accounts are subject to the Employee Retirement Income Security Act. Alarmed at that decision, the life insurance industry succeeded in persuading lawmakers in 1996 to enact legislation under which insurers that met certain requirements would not have to worry about pension assets in their central investment pools being regulated by ERISA. But that law applies only to policies issued before Dec. 31, 1998.
The Labor Department's initial proposal for implementing the 1996 change was viewed by the life insurance industry as onerous and going far beyond the dictates of the law. But the final rule, issued Jan. 5, is a "vast improvement over the proposed regulation, and more workable for us," said Ann Combs, chief counsel of pensions at the American Council of Life Insurers, the Washington-based trade association.
Jon Breyfogle, a partner at The Groom Law Group, a Washington law firm with life insurance industry clients, agrees. "By and large, virtually all the changes the department made were favorable and in response to concerns expressed by insurers," he noted.
For starters, the rule spells out that traditional, fixed-rate guaranteed investment contracts, such as the kind offered as investment options in many 401(k) plans, are exempt from federal pension law. Guaranteed benefit contracts are by law exempt from ERISA, but the DOL had not earlier defined which contracts were exempt.
"The Department of Labor made great strides forward in these rules. They excluded, as a guaranteed policy, a fixed-rate GIC, which is a welcome statement that had previously not been made," said A. Richard "Brick" Susko, a partner in the New York law firm of Cleary, Gottleib, Steen & Hamilton.
While that provision is certainly helpful, the life insurance industry notes that not all GICs will be exempt. "A lot of GICs have bells and whistles," Ms. Combs said.
Proposed changes OK'd
Still, the Labor Department did give the life insurance industry a lot of the changes it had requested in the proposed rule. For example, the rule requires insurance companies to notify policy-holders before they make any major changes in their contracts, and give contract-holders the opportunity to bail out of the contract if they wish. The initial proposal had required life insurance companies to tell policy-holders about all changes, not just "material" ones.
The new rule also does not require insurance companies to give policy-holders proprietary financial information, such as profit margins and pricing data, as the proposed rule had required.
Moreover, the rule gives insurance companies the opportunity to fix any inadvertent failures in compliance within 60 days without becoming subject to ERISA.
That provision will be especially comforting to third parties dealing with insurance companies because "they do not inadvertently become subject to ERISA," Mr. Susko said.
Risking it all
Insurance companies that do not comply with the rule, however, could risk having all pension fund assets in their central investment pool subject to ERISA.
That, in turn, could make some of the insurance companies' transactions illegal under federal pension law, and disrupt their investment strategies by letting pension fund clients sue them to undo certain financial transactions.
"That is probably the most problematic provision," Ms. Combs said. The life insurance industry had requested that instances of non-compliance result only in the affected policy being treated as subject to ERISA.
The insurance industry also got only part of what it wanted in the manner in which it must let clients wriggle out of contracts. Policy-holders who wish to bail out must be given the option of taking all of their money at once at market value. If, however, that would result in a loss (for example in a down market) policy-holders may pull out their money at book value over a 10-year period, at one percentage point lower than they would have earned under their contract.
The Labor Department's earlier proposal would have required insurance companies to make the payouts over five years. Insurers argued that would have forced them to drastically alter their investment strategies and possibly result in lower investment returns for all of their clients.
Because life insurance companies typically invest the assets in their central investment pools for the long term, that concession was appreciated, Ms. Combs said.
But the regulator did not yield on another point the insurance industry had wanted. Contract-holders, not the life insurers, will be able to pick the payout method.
Because of the uncertainty that creates, insurance companies might still have to change their investment policies for the assets backing the group annuity contracts, possibly shortening the duration of their investments to handle making lump-sum payouts, Mr. Breyfogle said.
That's because the rule requires insurers to give all of their clients the choice of picking their payout method in case of a termination, not just new contract-holders.
Finally, the insurance industry is thrilled that the rule gives up to 18 months, for most provisions to take effect.