In earlier newsletters, we discussed two of the key issues for selecting an insurance company to provide guaranteed income for retirees under 401(k) and other defined contribution plans. We explained that the process is not inherently different from - or more difficult than - other fiduciary decisions (for example, selecting investment products or providers). We pointed out that the DOL safe harbor regulation is helpful, but does not give specific guidance on what information should be reviewed. We described some of the information a plan committee or other fiduciary should consider, noting that a plan committee does not need to predict the future, but instead just needs to make an informed, prudent decision.

In this article, our focus is again on the fiduciary process of selecting an insurance company.

But first, why should a plan consider offering a lifetime income guarantee? By "lifetime income guarantee," we mean an annuity (or other product provided by an insurance company) that guarantees a stream of payments for the life of a retired participant, and possibly his or her spouse. The reason to offer a guarantee is to eliminate, or at least reduce, the risk that a retiree will outlive the money in his or her plan account or rollover IRA. Elements of this risk include the possibility of living longer than expected, market downturns at the "wrong" time, the impact of withdrawing retirement funds too quickly and the erosion of critical decision-making capacity as the retiree ages. A guarantee of payment for life addresses those risks.

How should a committee select an insurance company? ERISA requires fiduciaries to engage in a prudent process, which entails gathering and assessing relevant information and making a rational decision based on that information. But what if the committee just selects a well-regarded insurance company that has a long history of providing annuity benefits to thousands of annuitants? In one case, then Appeals Court Judge Antonin Scalia (now Supreme Court Justice Scalia) said that "[e]ven if a trustee failed to conduct an investigation before making a decision, he is insulated from liability if a hypothetical prudent fiduciary would have made the same decision anyway."1 In other words, if other fiduciaries would have chosen that insurance company after engaging in a prudent process, the committee making the same choice - but without conducting an investigation - would not be exposed to liability.

We are not advocating that fiduciaries avoid engaging in a prudent process. However, it may help a committee feel comfortable with its decision if it knows that many others have chosen that insurance company to provide guaranteed retirement income.

With that in mind, what information should a committee consider? Among other factors, some key issues for evaluating insurance companies include the following:

  • Whether the company is regulated by all, or almost all, of the states. The degree of scrutiny by state regulators varies from state to state, but many state agencies conduct thorough, detailed and rigorous investigations; fiduciaries can take comfort in their findings of soundness.
  • The company's commitment to the annuity or guaranteed income business assessed by the number of guaranteed income contracts and total assets in guarantees.
  • The quality and consistency of the company's ratings across all of the major rating agencies.
  • The consistency of the ratings over an extended period (generally, at least one economic cycle). The long-term financial stability of an insurance company - expressed by uniformly high ratings over extended periods of time - is particularly important for selecting a provider that will pay benefits many years in the future.

For further information regarding the issues discussed in this article, see the White Paper we published in May 2012 (co-authored with Joe Faucher) titled "Lifetime Income in Defined Contribution Plans: A Fiduciary Approach" at www.drinkerbiddle.com/resources/publications/2012/Lifetime-Income-in-Defined-Contribution-Plans?Section=Publications.

Footnote

1 Roth v. Sawyer-Cleator, 16 F.3d 915, 919 (8th Cir. 1994); Herman v. Mercantile Bank, N.A. 143 F.3d 419, 420 (8th Cir. 1998). See also, Bussian v. RJR Nabisco, Inc., 223 F.3d 286, 300 (5th Cir. 2000): "ERISA's obligations are nonetheless satisfied if the provider selected would have been chosen had the fiduciary conducted a proper investigation." Note, however, that while the "hypothetical prudent fiduciary" standard may protect a fiduciary that engaged in an imprudent search from being liable for damages, it may not prevent an injunction against the fiduciary from acting on behalf of the plan in the future. See, Brock v. Robbins, 830 F.2d 640, 646-647 (7th Cir. 1987).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.