DOL FAB provides guidance on DC annuity fiduciary obligations

August 17, 2015

On July 13, 2015, the Department of Labor released Field Assistance Bulletin 2015-02, providing guidance concerning "the nature and scope of fiduciary responsibilities to act prudently in making, monitoring and reviewing annuity selections under a defined contribution plan." In this article we review the FAB.

DC annuities – fiduciary issues

While the Administration (and policymakers generally) would like to encourage DC plan sponsors to include annuities as a distribution option, many sponsors have resisted doing so. A major sponsor concern is fiduciary risk. Unlike a distribution of cash (e.g., in a lump sum), an annuity is, in effect, an investment. Payment under the annuity will take place in the future (sometimes, a very long time in the future) and will depend on the ongoing solvency of the annuity carrier. Selection of the annuity carrier will generally be a fiduciary act by a plan fiduciary. And if the carrier at some time in the future becomes insolvent, and is unable to pay promised benefits, the participant may – perhaps a very long time after the actual distribution of the annuity – sue the fiduciary, claiming that the carrier was imprudently selected.

In 2008, DOL published a regulation providing a ‘safe harbor’ for certain DC annuity purchases. Plan fiduciaries have, however, generally not considered that safe harbor very ‘safe’, largely because it requires the fiduciary to:

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.

A critical question for plan fiduciaries has been, how long does the obligation to prudently select the annuity provider last? How far in the future can a terminated participant who took an annuity distribution come back and sue a fiduciary based on a claim that the annuity carrier was imprudently selected?

FAB 2015-02 addresses that issue.

FAB 2015-02

FAB 2015-02 states that, where an annuity is provided as a distribution option in a DC plan, the plan fiduciary has an obligation, as of the time of selection, to prudently select an annuity carrier that meets the safe harbor regulation's requirements (including the requirement that it conclude that "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 addition, the plan fiduciary has an ongoing duty to ‘periodically review’ that conclusion. The Supreme Court recently held, in the Tibble case, that this duty to prudently monitor ‘exists separate and apart’ from the duty to prudently select. The FAB cites that holding.

Clarifying the scope of these duties, the FAB states:

The fiduciary's selection and monitoring of an annuity provider is judged based on the information available at the time of the selection, and at each periodic review, and not in light of subsequent events.

The periodic review requirement in the Safe Harbor Rule does not mean that a fiduciary must review the prudence of retaining an annuity provider each time a participant or beneficiary elects an annuity from the provider as a distribution option. The frequency of periodic reviews to comply with the Safe Harbor Rule depends on the facts and circumstances. For example, if a ‘red flag’ about the provider or contract comes to the fiduciary’s attention between reviews (e.g., a major insurance rating service downgrades the financial health rating of the provider or several annuitants submit complaints about a pattern of untimely payments under the contract), the fiduciary would need to examine the information to determine whether an immediate review is necessary, or, depending on the facts and circumstances, the fiduciary may need to conduct an immediate review.

Examples provided in the FAB indicate that the duty to periodically review the selection of an annuity carrier lasts as long as the plan continues to offer participants the option to purchase an annuity from that carrier. However, once the carrier is ‘de-selected’ – and either a substitute carrier is chosen or the plan discontinues offering annuities – the duty to monitor the old carrier generally ends.

When are plan fiduciaries off the hook?

With regard to DC annuities, a critical question for fiduciaries is: how far into the future may a participant bring a lawsuit claiming that the annuity carrier was imprudently selected or monitored?

ERISA generally provides for a six-year statute of limitations for a claim based on a fiduciary breach. With regard to the application of this statute of limitations to fiduciary claims based on the imprudent selection/monitoring of an annuity carrier, the FAB states:

Absent fraud or concealment, these provisions [ERISA's statute of limitations] mean that a plaintiff must base his or her claims on actions or omissions that occurred within the six years preceding the lawsuit. Thus, for example, if the plaintiff bases his or her claim on the imprudent selection of an annuity contract to distribute benefits to a specific participant, the claim would have to be brought within six years of the date on which plan assets were expended to purchase the contract.

From this language and the analysis provided in the FAB, it seems clear that, generally, plan fiduciaries are ‘off the hook’ six years after the plan has ‘de-selected’ the annuity carrier. Also, if the participant's claim is based on the imprudent selection of an annuity contract, plan fiduciaries are also generally off the hook six years after the date the annuity was purchased. It's not entirely clear whether, in DOL's view, a participant could sue more than six years after the purchase of the annuity but less than six years after the ‘de-selection’ of the annuity carrier, based on a claim that the fiduciary failed to prudently monitor the annuity carrier.

We note that the FAB describes DOL's position on these issues. It is not a regulation, and the extent to which it will be given the force of law will depend in part on the extent to which the courts accept (or defer to) DOL's position.

Conclusion

DOL seems to want to reassure plan fiduciaries that the use of annuities in a DC plan does not present prohibitive risks. That was a primary reason for the publication of the 2008 safe harbor regulation. In FAB 2015-02, DOL stated that:

Confusion or lack of clarity regarding the nature and scope of fiduciary responsibilities to act prudently in making, monitoring and reviewing annuity selections under a defined contribution plan could lead plan sponsors or their advisors in some instances to overestimate or otherwise misunderstand the duration or extent of those fiduciary responsibilities. This, in turn, could create or reinforce disincentives for plan sponsors to offer their employees an annuity as a lifetime income distribution.

Thus far, many plan sponsors have, however, been reluctant to add an annuity feature to their plan, in part (in some cases, in large part) because of the fiduciary risks. It's unclear how much better sponsors will feel after the release of this FAB. The FAB does make clear that, six years after de-selecting an annuity provider, plan fiduciaries will generally have no fiduciary exposure. Whether that provides enough comfort to persuade more plan sponsors to include an annuity option in their DC plans remains to be seen.

We have been writing a series of articles on the related issue of the ERISA duty to monitor. Our latest is The duty to monitor -- 401(k) plan investments.

October Three Consulting, LLC is a full service actuarial, consulting and technology firm that is a leading force behind the reemergence of defined benefit plans across the country. A primary focus of the consultants at October Three is the design and administration of comprehensive retirement benefits to employees that minimize the financial risks and volatility concerns employers face.

Through effective plan design strategies October Three believes successful financial outcomes are achievable for employers and employees alike. A critical element of those strategies is the ReDB® plan design. The ReDefined Benefit Plan® represents an entirely new, design-based approach to retirement and to the management of both the employer’s and the employee’s financial risk, focusing on maximizing financial efficiency and employee value.

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