On Dec. 20, 2019, President Trump signed the Setting Every Community Up for Retirement Enhancement (Secure) Act into law. This bipartisan legislation, which had been in the works for several years, seeks to further promote access to retirement income within the 401(k) market.
An important aspect of this act is a “safe harbor” provision for the selection and use of annuity products underwritten by insurance companies. (This provision was added to the Employee Retirement Income Security Act (ERISA) of 1974 in Section 404(e) and is called “Safe Harbor for Annuity Selection.”)
This safe harbor was considered essential given that many plan sponsors have been reluctant to use in-plan annuities due to possible liability issues should an insurer, selected to underwrite an in-plan income annuity, later become insolvent.
While it was hoped that this safe harbor would provide an impetus for more defined contribution plans to begin introducing in-plan annuity options, this has yet to occur. Certainly, the onset of the global pandemic in early 2020 acted as a brake on new initiatives, but a long-ingrained reluctance on the part of plan sponsors to introduce retirement income solutions is likely the larger factor.
That, however, may be changing. A recent survey from TIAA shows that nearly nine in 10 plan sponsors who do not offer in-plan guaranteed lifetime income annuities are at least somewhat interested in offering them, and that three in four plan sponsors are extremely or very interested in a target date fund that allocates a portion to lifetime income.
Given the growing interest in the integration of annuities into defined contribution (DC) plans, we thought it timely to provide guidance around how plan fiduciaries might best choose from among the growing number of investment options that embed in-plan annuities.
To this end, it is our suggestion that plan fiduciaries, after making the business decision to include an annuity option in a DC plan, adopt something along the lines of the following two-step approach to selecting the most appropriate program:
1. Establish a Compliant Insurer Selection Process, as clearly defined by the safe harbor in the Secure Act legislation;
2. Once a list of acceptable carriers is determined, establish a Compliant Product Selection Process to select the best program offered by one (or more) of those insurers.
At first blush, the Secure Act safe harbor for insurer selection appears fairly straightforward, providing immunity from legal action if a plan sponsor selects an annuity carrier with the following attributes outlined in Section 204(2):
1. It is licensed to offer guaranteed retirement income contracts
2. At the time of selection and for each of the preceding seven years, it:
3. Undergoes a financial examination by its domiciliary state at least every five years.
But such a reading would misconstrue the intent of the safe harbor, which is captured in Section 204. This clause states up front that a fiduciary must “engage in an objective, thorough, and analytical search for the purpose of identifying insurers from which to purchase such contracts.”
In short, the act is asking fiduciaries to act in a prudent manner to identify a suite of insurers that can best meet the obligation of providing long-tail income annuities. Only after identifying this subset of insurers can the easier tests outlined above be applied.
A consensus is building among experts in the DC industry that the safe harbor language implies that a plan fiduciary must have a prudent process by which to address this two-part test. The need for the process will not be new to plan sponsors who have long been advised by counsel and pension actuaries that this approach, together with thorough documentation, is the best protection against lawsuits around investment selection, plan fees, etc.
ALIRT Research, in its work with annuity-based programs targeting the DC market, has developed a service that meets the standard of an “objective, thorough, and analytical” vetting of insurance companies, both as regards their ability to offer annuity products to the retirement market as well as their relative financial condition over time.
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The latter is achieved through ALIRT’s proprietary two-page insurer analyses, updated quarterly, and including a score card that provides a financial “reading” based on 45 financial inputs.
This service allows fiduciaries a defensible manner in which to not only select an initial peer group of insurers, but also to track and document their relative financial well-being on a quarterly basis through customized reports. In short, this encapsulates the “process-oriented” approach that an increasing number of DC consultants are advocating.
Once a suite of appropriately vetted carriers is isolated, it is time to focus on product/program selection. As mentioned, over the last several years an increasing number of investment offerings have come to market that include the use of annuities for lifetime income. We note that these offerings are continuously updated in a product grid available on the website of the Institutional Retirement Income Council.
(IRIC is a product and provider agnostic, membership-based organization formed to facilitate the culture shift of defined contribution plans from supplemental savings plans to programs that provide retirement security through institutional income strategies.)
While there is no specific safe harbor for the selection of such offerings, the Secure Act legislation does suggest that a cost-benefit analysis be undertaken at the time of product selection. In addition, previous safe harbor language from 2008 (2550.404a-4) provided guidance around the selection of both insurers and the contracts they offer. Legal experts believe that this previous guidance will continue to have a bearing on current practices.
While an agreed-upon industry standard for what constitutes an appropriate product evaluative process for fiduciary advisors is still forming, our analysis of the expert guidance from IRIC suggests that such a process include the following steps, which form a decision tree of sorts:
Step 1: Determine whether an in-plan or out-of-plan annuity better meet the sponsors’ needs;
Step 2: If in-plan, determine whether auto or affirmative election is a better approach for this plan
Step 3: Based on the outcomes of steps 1-2, evaluate which solutions involving annuities are best to offer.
Fiduciary Insurance Services (FIS) employs the above process by first having the plan sponsor provide answers to a number of checklists developed by IRIC. These checklists address issues such as whether or not the plan sponsor:
For the products/programs that remain in contention after preference checks, FIS then evaluates guaranteed monthly income, potential monthly income, and account balance at preset age when running each of the available product solutions through Monte Carlo simulations.
Again, the focus here is upon a repeatable process using expert sources that can be thoroughly documented.
With today’s market offering ever fewer safe investment returns that can outplace inflation, the pooling protections available through insurance products should prove increasingly valuable to a retirement portfolio. Furthermore, securing protections through a trusted source that can access favorable institutional pricing, such as an employer, may become even more valuable to the next generation of retirees.
Given this, both employees and employers are beginning to acknowledge the importance of offering annuity products in their defined contribution plans. Thankfully, the Secure Act now offers additional protections enabling employers and their fiduciary advisors to connect employees with efficient annuity solutions. Insurers, in turn, have responded by rolling out a growing number of programs.
It is now incumbent upon industry consultants to provide the advice, tools and services that enable plan fiduciaries to quantitatively evaluate both the insurance carriers offering these products and the products themselves. FIS and ALIRT, for their part, are working together to provide just such guidance, and hope that the process outlined above can serve as a template for plan advisers in making sound retirement income choices.
David Paul is principal of ALIRT Insurance Research, where he co-directs the company’s research staff, manages internal IT initiatives and product development, pens a number of the firm’s insurance industry research pieces, and oversees business development. He has worked as an insurance industry research analyst since 1993.
Michelle Richter is principal and founder of Fiduciary Insurance Services LLC, New York, a consulting firm and registered investment adviser. In addition to this role, she has been named the executive director of the Institutional Retirement Income Council (as of Oct. 1).
