In recent years — perhaps because of the volatility of stock markets or the aging of the baby boomers — we have seen increased activity in the sale of individual annuity contracts to participants in defined contribution plans. More specifically, most of the sales are of individual variable annuity contracts with guaranteed minimum withdrawal benefit riders (GMWBs).
While the desire of participants to obtain insurance company guarantees is understandable, there are a number of issues related to both the sales process and the terms of the contracts when viewed from an ERISA perspective. In this article, I discuss only two of them.
First, the preamble to the DOL’s 408(b)(2) regulation indicates that the regulation’s disclosure requirements apply to insurance brokers and the sale of insurance contracts to ERISA-governed retirement plans. To complicate matters, insurance agents and brokers have historically relied on Prohibited Transaction Class Exemption 84-24 (and its disclosure requirements) to avoid prohibited transactions in the sale of insurance contracts to retirement plans. Unfortunately, the DOL has not clearly indicated whether an insurance agent or broker must satisfy both disclosure requirements. If both must be satisfied, we are concerned that there may be a significant number of inadvertent violations (and resulting prohibited transactions) in the sale of individual annuity contracts to retirement plans. (In conversations with other ERISA attorneys, there appears to be a consensus that the “safe” position is to satisfy the conditions of both requirements.)
From the perspective of an insurance company, it seems clear that the issuance of an annuity contract to an ERISA retirement plan does not fall within the scope of the 408(b)(2) regulation. That is, it is the issuance of a product and not the provision of a covered service. However, there are other issues for insurance companies.
For example, most annuity contracts designed for the individual market contain provisions that are permissible under the insurance laws but create fiduciary issues for insurance companies when the contracts are held in ERISA retirement plans. That is because of the convergence of two fundamental ERISA concepts. First, an asset held within an ERISA plan is a “plan asset” and, thus, is subject to ERISA’s fiduciary and prohibited transaction rules. Second, the exercise of discretionary control over a plan asset may give rise to a fiduciary status, e.g., for the insurance company. (Unfortunately, that can occur even if the insurance company had not focused on the fact that the contract was owned by an ERISA plan.) From an ERISA perspective, discretionary control can result from the ability of an insurance company to affect the terms of the individual annuity contract. That could include, for example, a provision that permits the insurance company to amend the terms of the annuity contract unilaterally. (Note that there is guidance that permits limited amendment rights if certain procedures are followed.) If an insurance company has broad discretion to amend an annuity contract or a particular provision of an annuity contract (that is, affect the value of a plan asset), the insurance company may become a fiduciary for that purpose. (Note that ERISA requires that a fiduciary exercise its discretion in the best interest of the plan participants.) Furthermore, if an insurance company exercises its discretionary amendment rights, or any other discretionary rights under the contract, for its own interest, there is a risk that the insurance company could have engaged in a prohibited transaction as well as a fiduciary breach. That could result in the insurance company being required to restore any losses or other “amounts involved” to the plan, together with interest and penalties.
What should insurance companies and brokers do with this information? I am not suggesting that the sale of individual annuity contracts to ERISA plans should be avoided, but instead that contracts should be designed, and the sales process undertaken, with ERISA in mind.