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Passage of the SECURE Act brought long-awaited regulatory relief for champions of guaranteed income products in defined contribution plans.
A provision of the bill—the Fiduciary Safe Harbor for Selection of Lifetime Income Provider—amends an existing safe harbor plan sponsors could tap if they wanted to add an annuity to an investment menu.
In order to satisfy the old safe harbor, plan fiduciaries were required to "appropriately" conclude at the time of selecting an annuity that the insurance company "is financially able to make all future payments under the annuity contract," according to a 2012 field assistance bulletin issued by the Labor Department.
That requirement—forecasting the long-term solvency of an insurance company—was regarded as onerous by many plan sponsors, according to industry surveys, and explains, in part, the slack adoption of annuities in 401(k) plans. According to the Plan Sponsor Council of America, less than 10 percent of employers offer an annuity in their 401(k) plan.
Using state insurance commissioners
With the new safe harbor passed in the SECURE Act, employers will be able to rely on state insurance commissioners, which establish liquidity requirements for insurance companies designed to facilitate long-term solvency.
Fiduciaries can satisfy a requirement to periodically review a selected insurance company by receiving annual representations from the insurer that they are in compliance with state regulations.
If an employer satisfies the new safe harbor, they cannot be held liable after a participant begins receiving payments from annuities. Nor will employers be liable for investment losses within annuity contracts.
And perhaps most importantly, an employer cannot be held liable for an insurance company's inability to meet its long-term obligations under annuity contracts.
Bob Melia, executive director of the Institutional Retirement Income Council, whose members include insurance companies and asset managers, told BenefitsPRO in earlier coverage that the new safe harbor will not necessarily make annuities omnipresent in 401(k)s, and that opinions differ on how much it will spark annuity adoption.
"Employers will only adopt—and should only adopt—retirement income solutions if it makes their plan a better human resource tool. Unless, or until plan sponsors are thinking like that, I don't think you will see widespread adoption," said Melia.
Is the safe harbor open to abuse?
While the SECURE Act has vast bipartisan support, critics of annuities have said the safe harbor will expose retirement savers to unnecessarily expensive and opaque investment products. Chris Jones, chief investment officer for Edelman Financial Engines, has concerns over language in the safe harbor, and said some are positioning it as a "green light" to offer annuities in retirement plans.
"The notion that plan sponsors might see this a as a blank check to put these types of products in plans is problematic," said Jones. "Some are positioning this as a 'safe harbor' for annuities in retirement plans. I don't think it's as big of an issue for large plan sponsors, but I do worry about smaller employers that don't have inside ERISA counsel. My concern is sponsors will be misled."
Jones is leery of annuities being part of a qualified default option.
Unlike target-date funds, annuities often come with surrender charges. And participants may be exposed to "lapsation," where they end up pre-paying for longevity insurance they may not use if the choose not to annuitize at retirement.
"That's a big source of revenue for insurance companies," added Jones. "Annuities can be an important building block for retirement. But there is a lot of abuse in selling these products. Our concern is the safe harbor will provide an opportunity for inappropriate products to make their way into 401(k) plans."
No safe harbor for picking an annuity
Jim Szostek, vice president of taxes and retirement security at the American Council of Life Insurers, says Jones' concerns are unfounded, and that using regulators to determine an insurance company's future viability is the right policy approach.
"This is an annuity provider selection safe harbor," said Szostek, with emphasis on provider. "It is not a safe harbor for picking an annuity."
Szostek notes that language in the provision states that selecting an annuity is still subject to a fiduciary standard. The cost of an annuity, including fees and commissions, will still have to be reasonable under ERISA's standard, according to the safe harbor.
While fiduciaries are not obligated to select the cheapest products, they will be required to undertake a cost benefit analysis when putting annuities in 401(k) plans. What fiduciary sponsors will not be required to do is independently assess the long-term solvency of an insurance company.
"This is about helping to pick a provider," said Szostek. "We think relying on state insurance regulators is the right approach."
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Nick Thornton
Nick Thornton is a financial writer covering retirement and health care issues for BenefitsPRO and ALM Media. He greatly enjoys learning from the vast minds in the legal, academic, advisory and money management communities when covering the retirement space. He's also written on international marketing trends, financial institution risk management, defense and energy issues, the restaurant industry in New York City, surfing, cigars, rum, travel, and fishing. When not writing, he's pushing into some land or water.