Stars aligning for use of annuities in 401(k) plans

In recent years, policymakers have increasingly paid attention to annuities as one way to help investors solve the retirement puzzle. A recently released government report reviews the current barriers to annuities on the 401(k) plan menu and suggests that the Department of Labor could do more to make these oftentimes controversial lifetime income products available to plan participants.

The report by the Government Accountability Office, which is the nonpartisan, auditing arm of Congress, was requested by Senator Elizabeth Warren (D-Mass.) and Rep. Bobby Scott (D-Virginia), the ranking member of the House committee that oversees pension regulation. It was completed in August and released publicly on Sept. 8.

The thrust of the report is that only a quarter of all defined-contribution plans offer some form of annuity option for workers and that more plan sponsors would probably offer them except for concerns over fiduciary liability.

In 2008, the DOL did offer some guidance on the prudent selection of annuity options for a plan. Under a safe harbor, the Department said plan sponsors should, among other things, “appropriately consider information sufficient to assess the ability of the annuity provider to make all future payments under the annuity contract,” and “appropriately conclude that, at the time of the selection, the annuity provider is financially able to make all future payments.”

According to the GAO report, which surveyed 54 plan sponsors and most of the major record keepers, the guidance wasn’t helpful, largely because terms like “sufficient” and “appropriately” weren’t the kind of clear criteria that they needed. The report also noted that when the DOL proposed the safe harbor, the Department estimated that the share of participants offered annuities by plan sponsors would only increase by 1 percentage point.

One plan sponsor told the GAO: “There is not a single bit of upside to me as a plan sponsor in offering an option that participants don’t want, particularly when it is a complex offering with lots of room for 20/20 hindsight by plaintiff’s counsel.”

The GAO concludes its report by offering two primary recommendations. First, that the Department encourage plan sponsors to offer annuities by more clearly defining the steps a plan sponsor should take when assessing an annuity provider’s long-term solvency. Second, that the DOL also offer a new safe harbor for annuity options, just as it does with the commonly used sec. 404(c) safe harbor for securities options.

Given the Department’s traditional support of a robust fiduciary standard rooted in trust law, it’s not surprising that the agency pushed back when asked to comment on the GAO’s recommendations. In its response, Assistant Secretary Phyllis Borzi said, “Rather than strengthening consumer protections … we are concerned that your suggestion carries the risk of degrading the oversight required of a fiduciary” by shifting too much of the responsibility for annuity selection to participants. She pointed to recent developments in response to the conflict-of-interest rule in which some service providers are willing to take on responsibilities as a 3(38) fiduciary, which could better preserve ERISA’s prudence and loyalty duties when making annuity selection decisions.

Annuities have always been a tough sell for workers faced with a choice of putting all of their eggs in one basket — purchasing an annuity — when taking a lump-sum payment offers a diversity of investment options. Although many products offer riders to help beneficiaries in the event of an untimely death of the policy holder, an annuity is still generally viewed as a “take it or leave it” choice. Consequently, few participants take advantage of annuities even when they are available, offering plan sponsors little incentive to take on potentially greater liability by offering them.

Regulators would clearly like to see this resistance turned around. Recently the Treasury Department adopted new rules that permit partial annuitization in pension plans. The GAO report also commended the DOL for clarifying that target-date funds can include an embedded deferred annuity, even if less than 1% of plans currently offer this option.

As the stars continue to align — more regulatory clarity, better products and heightened interest by participants — we foresee future opportunities for annuities to become more prevalent in plans.

Blaine F. Aikin is executive chairman of fi360 Inc.