Embedded annuities return to the table

The Trump administration has revived discussion of a retirement plan strategy that has bedeviled defined contribution executives for years — embedding annuities in DC plans.

Most DC plan executives resist incorporating annuities or other lifetime income options into their plans, fearing they will be held accountable as fiduciaries if insurance providers fail to meet their obligations or go bankrupt.

"Despite the benefits that annuities can provide, they are not widely offered in defined contribution plans," said a Treasury Department report issued Oct. 27 on multiple financial, legal and regulatory issues, including retirement income. The fear of being sued under the Employee Retirement Income Security Act is "the principal deterrent to offering an in-plan annuity option."

To address this concern, ​the Treasury and Labor departments should "develop proposals on how to establish or certify one or more expert, independent fiduciary entities to assess the long-term financial strength of annuity providers," the report said.

These assessments "could be in the form of ratings or other specific metrics," the report said. They "could assist ERISA-governed plan sponsors in complying with their fiduciary duty obligations in selecting annuity providers for plans and enable fiduciaries to rely on such assessments as a safe harbor."

Although DC industry members said a new rule would be helpful, it wouldn't automatically lead to plans or participants embracing in-plan annuities. The current rule, enacted in 2008, hasn't encouraged many sponsors to offer this option.

"Based on input from others, my assessment is that for many — perhaps most — plan sponsors, adding this additional insight concerning insurer financial strength will not change the equation from a net 'con' to a net 'pro' with regard to in-plan annuities vs. other in-plan income solutions," said John M. Towarnicky, executive director of the Plan Sponsor Council of America, Chicago.

Noting insurance-rating agencies already exist, Mr. Towarnicky said: "A company's financial strength at the time of an annuity purchase is no guarantee of financial stability." He recommended the DOL create "enabling guidance" that would describe "what steps sponsors have to take to have an income payout strategy."

This approach was cited by the Government Accountability Office in a 2016 report on how the DOL could improve retirement income options. The DOL should "clarify" the annuity safe harbor "by providing sufficiently detailed criteria" to comply with the rule "relating to assessing a provider's long-term solvency," that report said.

Mr. Towarnicky said the most recent PSCA survey found only 5% of sponsors had a retirement income guarantee within their plans. Another 12% said they were considering adding a lifetime income product. The report, published in December 2016, contained 614 responses.

Fiduciary exposure, cost, operational issues, the lack of portability and risk exposure were primary reasons cited by members for eschewing in-plan lifetime income products, he said.

In-plan annuities "are a nice-to-have rather than a must-have," said Lori Lucas, the Chicago-based executive vice president and defined contribution practice leader for Callan LLC. "There are so many must-haves that the nice-to-haves get pushed down the to-do list."

The biggest impediment is the DC executives' belief that in-plan annuities aren't necessary or aren't a priority, said a January 2017 Callan report based on a survey of 165 clients and non-clients. Other reasons were fiduciary concerns, the belief that in-plan annuities would cost too much for the plan and participants, the fear that participants wouldn't want or need in-plan annuities, and insurance risk.

The report said 3.8% of respondents offered an in-plan retirement income product, such as annuities, and 1.9% offered longevity insurance last year.

"Any improvement in the safe harbor would be well-received," said Ms. Lucas, emphasizing a new regulation is only part of the answer. "You need motivated plan sponsors. You need to incentivize them to encourage adding retirement income solutions" to their plans.

The DOL asked for public comments on lifetime income solutions in 2010 to update its 2008 safe harbor rule. Some sponsors that offer in-plan retirement income products view this rule as providing sufficient protection, but most disagree.

"Many employers and their professional advisers are not comfortable relying on the (2008) safe harbor," the Treasury Department report said. Terms describing fiduciary duties "are not defined," and the rule requires sponsors to "reach conclusions about the solvency of an annuity provider years or decades into the future."

ERISA attorney Bradford Campbell conceded the 2008 regulation didn't work as hoped.

"Most people viewed it as a recitation of prudence — not an objective checklist," said Mr. Campbell, Washington-based counsel for Drinker, Biddle & Reath LLP and a former assistant secretary of labor for the Employee Benefits Security Administration during the George W. Bush administration.

Mr. Campbell said the DOL, rather than the Treasury, would be the best agency to develop a new safe harbor rule to "protect participants, cut off frivolous lawsuits and encourage more innovative products."

However, he wondered how fast the Labor Department could act because "so few political decision-makers in the Trump administration have been put in place." Most notably, Mr. Campbell's old job has been vacant since Phyllis Borzi left in January at the end of the Obama administration.

Last month, President Donald Trump nominated Preston Rutledge — who has been tax and benefits counsel for the Senate Finance Committee since 2011 — as his EBSA chief. The Senate Health, Education Labor & Pensions Committee will hold a hearing on the nomination Nov. 15.

The Labor Department announced in 2014 that it was working on safe harbor rules, according to the Treasury Department report, but "the DOL has not issued any proposals to replace or amend the safe harbor." Mike Trupo, a Labor Department spokesman, declined to comment. Ms. Borzi could not be reached for comment.

"I don't know why there was no traction on this," said Robert Austin, the Charlotte, N.C.-based director of research for Alight Solutions, referring to the absence of a broader safe harbor.

He speculated the DOL devoted so much time on developing the fiduciary rule and other matters such as fee transparency that time ran out on the Obama administration before the department could propose rules. Other experts interviewed by P&I shared that view.

In recent years, regulators have acted to ease participant and sponsor concerns about in-plan annuities.​

For example, the IRS said in October 2014 that target-date funds containing deferred annuities won't violate rules against DC plans discriminating in favor of higher paid employees, as long as other IRS guidelines are followed.

The DOL said this ruling meant such target-date funds could serve as a qualified default investment alternative. And in 2015, DOL issued formal guidance on sponsors' fiduciary responsibilities in monitoring an annuity provider's financial health.​

Still, the annuity safe harbor "remains the No. 1 area cited for concern among sponsors," said J. Mark Iwry, a non-resident senior fellow at the Brookings Institution, Washington.

The Treasury Department recommendation "is what we were espousing for several years," said Mr. Iwry, the former Treasury Department deputy assistant secretary for retirement and health policy during the Obama administration. "I'm delighted to see it."

From 2010 to 2017, "we pressed hard to make lifetime income in plans part of the system," he said. "We wanted to take down barriers and modify rules to accommodate annuities"​ in retirement plans. Mr. Iwry has mixed opinions about responses to the absence of an expanded safe harbor. "For many sponsors, the concern is genuine," Mr. Iwry said. "For some other sponsors, it's more in the nature of an excuse not to provide annuities in their plans by going to the trouble and rolling up their sleeves" to offer such an option.

Another big issue discouraging sponsors from acting is "they don't see their employees clamoring for annuities," he added. "So many experts in the field recognize the value of lifetime income, and they know participants will appreciate it once it's made available to them."