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.
A Compliant Insurer Selection Process
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:
- Operates under a certificate of authority from its domiciliary state
- Has filed audited statutory financial statements
- Maintains reserves which satisfy statutory requirements
- Was/Is not under an order of supervision, rehabilitation, or liquidation
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.
