ERISA Concerns for Annuity Contracts in DC Plans

In recent years, there has been an increase in the sale of individual annuity contracts to participants in defined contribution (DC) plans, and most of these sales are of individual variable annuity contracts with guaranteed minimum withdrawal benefits (GMWBs), according to Fred Reish, partner and chairman of the financial services ERISA team at Drinker Biddle & Reath.  Plan sponsors who offer annuities must be aware of the possible issues related to the sales process and terms of the annuity contract, Reish told PLANSPONSOR.

The preamble to the Department of Labor’s (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, Reish explained. To make things more complicated, insurance agents and brokers have typically 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.

However, the DOL has not clearly stated whether an insurance agent or broker must satisfy both disclosure requirements, but Reish said the consensus from ERISA attorneys seems to be that it’s safer to satisfy the conditions of both requirements. If both must be satisfied, Reish said he is 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.

Plan sponsors should also be aware of the discretion an insurance company has over the contract. 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, Reish said.

In an individual variable annuity contract, insurance companies can change their fees from year to year at their discretion. However, if the seller is a fiduciary, this is prohibited transaction, Reish explained. This could result in the insurance company being required to restore any losses or other “amounts involved” to the plan, together with interest and penalties.

Reish said he is not suggesting that the sale of individual annuity contracts to ERISA plans should be avoided, but instead contracts should be designed—and the sales process undertaken—with ERISA in mind.

Reish suggests annuity products should be specifically designed for retirement plans, and the discretion of the insurance company should be limited. ERISA attorneys can add provisions into the contracts to limit the insurance company’s discretion, he said.

“When you stand next to trouble, sometimes you get into trouble,” Reish cautions plan sponsors. When offering annuity products, plan sponsors should be aware of three main points:  

•  If there are annuity contracts in the retirement plans, are they from highly rated insurance companies?
•  Is the annuity product specifically designed for retirement plans?
•  Is the annuity reasonably priced? “You can’t have excessively expensive products inside ERISA plans,” he added.

Plan sponsors should work with knowledgeable advisers—who have insurance expertise—to determine the sponsors’ best defense against running into annuity problems, he concluded.