When the Government Accountability Office recently reported that plan sponsors’ liability concerns were the primary deterrent to offering annuities in 401(k) plans, the agency charged with serving as Congress’ watchdog wasn’t exactly breaking new ground.
For more than a decade, regulatory initiatives of various forms have aimed to broaden availability of annuities in 401(k) plans.
Virtually all of those initiatives have intended to address sponsors’ long-standing liability risk in using annuities as a decumulation strategy for plan participants.
In 2005, the Employee Retierment Income Security Act Advisory Committee recommended the U.S. Department of Labor address plan sponsors’ fiduciary responsibilities in selecting insurance companies as a way to encourage wider adoption of in-plan annuities.
The Pension Protection Act of 2006 went further, requiring the Labor Department to promulgate new regulations addressing the issue.
In 2008, a month before President Obama was elected, the Labor Department released an annuity selection safe harbor under outgoing Labor Secretary Elaine Chao and outgoing Assistant Secretary Bradford Campbell, who headed the Employee Benefits Security Administration.
But sponsors would prove to be uninspired by the safe harbor.
The extent of forthcoming 401(k) class-action litigation, which was picking up momentum as the 2008 safe harbor was issued and has clearly raised sponsors’ sensitivity to fiduciary liability, may not have been predictable to Bush administration regulators when they crafted the regulation.
In order to qualify for liability protection under the safe harbor, sponsors must make a prudent assessment of an annuity issuer’s ability to satisfy its future obligations to 401(k) participants.
The GAO’s recent report found that stakeholders broadly view that requirement as vague, and ultimately unhelpful.
“The safe harbor requires plan sponsors to consider ‘sufficient’ information to ‘appropriately’ reach a conclusion about the annuity provider’s future solvency without defining the terms ‘sufficient’ and ‘appropriate’,” the GAO’s report says.
Absent more specific criteria, sponsors won’t feel they can use the safe harbor for protection, concluded the GAO. The report implies that in-plan annuity options will remain a novelty as 76 million baby boomers migrate to retirement, many facing the uncertainty of longevity risk without defined benefit pension guarantees and inadequate savings.
Bush's Labor Department had low expectations
The GAO titled its report with a conclusion — "DOL Could Take Steps to Improve Retirement Income Options for Plan Participants."
As the report notes, when the Bush administration’s Labor Department issued the proposal to the safe harbor, it estimated the regulation would do little to whet sponsors’ appetites for annuities. Regulators expected the safe harbor would only increase participants’ take up of in-plan annuities by 1 percent.
That prediction has proven prescient. In 2011, Aon Hewitt found 10 percent of sponsors offered an annuity option in-plan. In 2015 that number dropped to 7 percent.
According to the most recent data from the Plan Sponsor Council of America, about 9 percent of plans in 2014 offered in-plan lifetime income solutions (the first year the group broke out that data in its annual report).
By those measures, the needle hasn’t moved much, if at all. In the GAO report, 39 of the 54 sponsors it surveyed did not offer an annuity — 26 of those that don’t said liability concerns influenced their decision.
“Assessing the future financial health of an insurer can be a difficult task for a plan sponsor,” the GAO said in reference to the limitations of the safe harbor, which, ironically, was released as the Federal Reserve was authorizing billions in bailout money to AIG and other financial institutions deemed too-big-to-fail.
“Many plan sponsors responding to our survey indicated they would be more likely to offer an annuity if the benefits of the safe harbor were more readily available,” GAO wrote in its report.
DOL punts on amending safe harbor
The GAO report recommended seven steps the Labor Department could take to increase plan participants’ access to annuities and other lifetime income generating strategies.
First on the list was a recommendation to amend the existing annuity selection safe harbor to give sponsors clearer criteria for assessing an insurer’s long-term solvency.
In response to those recommendations, Phyllis Borzi, assistant secretary of Labor and head of the Employment Benefits Security Administration, noted that the Labor Department has been open to exploring ways to increase access to lifetime income products, but said helping “plan sponsors minimize their legal risks” by amending the selection safe harbor would erode the Employee Retirement Income Security Act's consumer protections.
“We are concerned that your suggestion carries the risk of degrading the oversight required of a fiduciary responsible for protecting the rights and interests of plan participants and beneficiaries,” wrote Borzi.
Borzi did not rule out amending the annuity selection safe harbor — the issue had been placed on the agency’s regulatory agenda. But she did say the agency has moved the project to “long term action” status because of other higher priority projects (she did not name implementation of the fiduciary rule).
Sri Reddy, senior vice president at Prudential Financial, which distributes its variable annuities through its own recordkeeping platform and seven others, does not see the report as a total loss, despite the Labor Department's resistance to the GAO’s recommendations.
“The fact that GAO was willing to invest what they did is really useful to moving this important issue forward,” said Reddy in an interview. “Clearly both agencies have competing perspectives — it’s not our place to opine on either agency’s point of view.”
'Ambiguity' in the safe harbor
Notwithstanding the safe harbor’s limitations, Reddy is bullish on the place of annuities in 401(k) plans. Overall adoption numbers may be skewed by the fact that 20 percent of sponsors still offer defined benefit plans in conjunction with 401(k) plans — those participants would not necessarily benefit from an annuity within their defined contribution savings plan.
And larger sponsors, who Reddy said are often using Prudential annuities through other record keepers, are showing more interest in annuities, but they tend to take longer to implement new solutions. “Smaller plans can make those decisions more effectively and nimbly,” he said.
Prudential was interviewed for GAO’s report.
So was retirement investment account plan advisory specialist CapTrust. Jennifer Dunbar, a consultant at the Raleigh, North Carolina-based company, says CapTrust’s fiduciary approach values annuities and other strategies that get retiring participants adequate drawdown strategies.
Sponsors are often reluctant to consider in-plan annuities because of “ambiguity” in the safe harbor, but according to Dunbar, the barriers go way beyond whatever disagreement may exist between the Labor Department and the GAO on the safe harbor.
“We find the biggest obstacles are associated with complexity of the current product set and participants’ ability to make sound decisions around this complexity,” she said.
Most options available to sponsors require significant resources to understand and evaluate, said Dunbar. CapTrust will and does recommend in-plan annuities as a 3(21) fiduciary. Often a plan’s record keeper will only offer its own proprietary annuities. In that case, CapTrust leads a comparative review with annuities on other platforms to determine a product’s appropriateness. Overall, that process can be time-consuming for sponsors, she said.
While a clearer safe harbor would be welcomed, ultimately, simpler products from issuers, and enhanced technology from record keepers to allow for portability of annuities when participants change jobs, will be needed to spur adoption.
Absent the willingness of regulators and industry to innovate, Dunbar said she doesn’t expect any material pick-up in use.
All or nothing on annuitizing savings
Treasury officials told the GAO that many plans lack the ability to partially annuitize savings.
That leaves participants with an all-or-nothing choice that may not amount to sound investment strategy.
The prospect of turning over every dollar in a 401(k) account puts many participants off, moving them to opt for a lump-sum distribution at retirement, an option that presents its own risk for savers.
Some retirement experts have advocated for incorporating annuities in target-date funds as a way to partially annuitize savings.
About two years ago, asset manager AllianceBernstein began offering its Lifetime Income Strategy Solution, a target-date fund with an annuity option available to participants as they approach retirement.
Participants can allocate a portion of their savings to the annuity, beginning no earlier than age 50. The target-date fund is for the large plan market, requiring a minimum $500 million investment in target-date assets.
“We’re seeing more interest, but only a select few sponsors have been serious in taking the next step,” said Richard Davies, a senior director and head of global defined contribution at AllianceBernstein. The company was also interviewed by GAO, he said.
“We agree with the GAO’s observation that the great majority of plan sponsors, given the litigious environment facing the DC world today, are reluctant to move ahead without more specific process guidance from the DOL. The industry needs some sort of regulatory catalyst before we can expect to see broad adoption,” said Davies.
Selecting an insurance provider — and assessing its long-term ability to pay claims — is very different from selecting an asset manager. Most larger sponsors are comfortable with the latter; few have experience on the insurance side, said Davies.
Davies said AllianceBernstein has an internal fiduciary oversight committee that vets the annuity products layered into the target-date funds. It also uses an outside ratings agency to assess the long-term solvency of its insurance partners.
But that doesn’t absolve sponsors of their fiduciary requirements. In her response to the GAO, the Labor Department's Borzi suggested 3(38) plan advisors could step in to provide assistance to sponsors in selecting annuities. That would preserve the consumer protections she says will be lost in amending the safe harbor.
But fiduciary consultancies aren’t willing to fully provide that service, said Davies. Some are willing to help sponsors collect research but are stopping short of recommending providers. Other defined contribution plan consultants have been prohibited by their internal counsel from recommending providers.
Davies said AllianceBernstein's Lifetime Income Strategy target date fund has never been part of a plan consultant’s formal search.
“The interest we are seeing is coming from innovative plan sponsors, not from plan advisors,” said Davies.
“They may still use a consultant as a sounding board, but the question they ask is ‘Tell me why I shouldn’t do this’ rather than ‘Should I do this.’ For those sponsors, the existing DOL guidance is adequate — but they are few in number,” said Davies.