Annuities may be the most obvious choice for providing lifetime income to participants in defined contribution plans (principally, 401(k) and 403(b) plans). If annuities are offered as a plan investment or distribution option, the fiduciaries responsible for selecting the annuity provider must satisfy the fiduciary provisions of ERISA. This means that the responsible fiduciaries must undertake the selection process under the prudent process requirements of ERISA.

In 2008, in response to a requirement in the Pension Protection Act, the DOL issued a regulation designed to establish “a safe harbor for satisfying the fiduciary duties under the prudent man rule of ERISA in selecting an annuity provider and annuity contract for benefit distributions from an individual account plan.”1

In understanding the scope of this safe harbor, it is important to appreciate its limitations:

  • First, it does not establish the only means by which fiduciaries may satisfy their fiduciary obligations in selecting an annuity provider. Rather, it sets out an optional means of satisfying this obligation.2
  • Second, it does not establish a “standard of care” or even minimum standards but rather provides a guide to fiduciary “best practices” in selecting an annuity provider. This is true because the regulation indicates that fiduciaries may satisfy their obligations other than by following the regulation. Since “safe harbors” ordinarily are viewed as creating a higher standard than what the law requires, the regulation exceeds the “baseline” of what ERISA imposes on fiduciaries in meeting their obligations under the prudent man rule.
  • Third, the regulation does not provide a “bright line” test that can be followed to meet the safe harbor. Instead, it outlines a process, a series of steps for fiduciaries to follow that are essentially those required for any fiduciary decision.

To avail themselves of the “safe harbor,” fiduciaries need to take the following five steps3:

  1. Engage in an objective, thorough and analytical search for the purpose of identifying and selecting providers from which to purchase annuities.
  2. Appropriately consider information to assess the ability of the annuity provider to make all future payments under the annuity contract.
  3. Appropriately consider the cost (including fees and commissions) of the annuity contract in relation to the benefits and administrative services to be provided under the contract.
  4. Appropriately conclude that, at the time of the selection, the annuity provider is financially able to make all future payments under the annuity contract and the cost of the annuity contract is reasonable in relation to the benefits and services to be provided under the contract.
  5. If necessary, consult with an appropriate expert or experts in connection with their consideration and conclusions.

While these guidelines are helpful, they are devoid of details. With one exception, the regulation does not indicate what information to consider (step 2) or how to evaluate whether that information shows that the provider will be able to make all future payments. The exception, found in the preamble to the regulation, is that fiduciaries are told to look at negative information in rating agency reports. The absence of a clearer roadmap makes it especially difficult for the fiduciaries of small and mid-sized plans to engage in this analysis, which could have a deterrent effect on offering annuities in the large majority of plans.

Earlier this year, Fred Reish, Bruce Ashton and Joe Faucher wrote a white paper on the fiduciary issues related to the selection of annuity providers. In the paper, they provided a checklist of information that we believe a plan fiduciary should consider in order to satisfy the requirement to “appropriately consider information to assess the ability of the annuity provider to make all future payments under the annuity contract.” To review the White Paper, go to http:// Lifetime-Income-in-Defined-Contribution-Plans.4