Annuities: The straw that breaks the back of retirement plan fiduciaries

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Retirement plan fiduciaries can’t catch a break. Their responsibilities and personal risks keep increasing. The pressure builds, on all fronts: regulatory, litigation, participant demand.  

The recent Supreme Court decision in Hughes v. Northwestern will undoubtedly embolden plaintiff’s lawyers. Inflation has clocked in at rates not seen in 40 years, potentially undermining investment policy statements and product line-ups. Recent regulatory activity at the Department of Labor includes: a flip-flop in its position on ESG, an aggressive initiative concerning cybersecurity, and a stern warning regarding cryptocurrencies. And, now plan participants are clamoring for lifetime income options within 401(k) plans which are pushing plan fiduciaries into the brave new world of annuity contracts. 

Plan fiduciaries have always had to keep pace with innovations in the evolution of investment products and asset classes. At first, they focused their attention on traditional equity and fixed income strategies, either in indexed or active mandates. However, as investment offerings grew more sophisticated, over time, fiduciaries developed the necessary expertise in alternative asset classes such as real estate, private equity, venture capital, and hedge funds. Think about it, this is an enormous body of expertise to assimilate.

Historically, and as a matter of regulation and industry practices, annuity contracts have largely been sold outside of the confines of corporate sponsored retirement plans. Typically, plan participants would take plan distributions, in whole or in part, and purchase annuity contracts. Given these patterns, fiduciaries never had to develop expertise in annuity contracts.   That is all changing.

With the proliferation of target-date funds, many of the largest investment managers are incorporating annuity-based life income options into their products. State Street Global Advisors, Vanguard, BlackRock, TIAA and Fidelity have all introduced elements of life income products into their retirement investment line-ups. There is a huge financial incentive to keep assets “within the plan.” These new products are forcing plan fiduciaries to consider products that have not been on their radar screen. Plan fiduciaries have little experience or knowledge in the technical and arcane world of annuity contracts.

While insurance companies have made efforts over the years to introduce variable annuity products into the retirement plan ecosystem, the mutual fund companies have achieved large scale hegemony among qualified plans. Introduction of annuity products into target-date funds is a huge initiative for the insurance industry. Propelled by plan participant demand, target-date funds are the largest AND fastest growing plan option. Incorporation of life income products into target-date funds will give insurance companies a long sought-after beachhead in the retirement plan industry. And it will provide them with direct access to what is now well over a $3 trillion market.

The integration of life annuity features into target-date funds will require plan fiduciaries to adopt a whole new level of expertise; as if they didn’t have enough on their plate!

Most investment products (including alternative asset classes) are offered to retirement plans as some form of investment security, some publicly traded, others not. Well established analytic tools and principles have developed over the decades in order for fiduciaries to assess the performance and appropriateness of each of these investment products.

Annuity contracts, however, are not investment securities. Instead, they are individually negotiated contracts entered into between an insurance company and the annuity-holder.  While annuities typically fall into particular generic categories (deferred, immediate, and guaranteed lifetime withdrawal), the amount of variation among contracts can be staggering.  Whereas securities (and the firms issuing, offering or underwriting the instruments) are governed by the federal securities laws and regulated by the Securities and Exchange Commission, insurance companies and the contracts they enter into are governed by the States – 50 different regulators and bodies of law. Once again, the variety can be staggering. This is the world that retirement plan fiduciaries are being forced into.

To be specific, when a plan fiduciary selects a target-date fund that includes a lifetime income option, the fiduciary will essentially be selecting and approving the annuity contract underlying the life income feature. While the plan fiduciary might think that they are off the hook because the fund sponsor has selected the annuity provider, the annuity is an essential component of the target-date fund. Therefore, just as the plan fiduciary must be a prudent expert with respect to the analysis of the glide path (another material feature of a target-date fund), the fiduciary will also need to be a prudent expert in the selection of the annuity. That is a pretty tall order. Retirement plan fiduciaries are on notice.

Annuity contracts may be the straw that breaks the back of the fragile fiduciary infrastructure employed by plan sponsors under ERISA. When ERISA was passed in 1974, the investment landscape was vastly simpler than it is today. In fact, the selection of index funds in the early 1980’s seems downright primitive compared to the vast array of investment products currently offered to retirement plans. Most plan fiduciaries take their responsibilities seriously and want to do the best job possible. As the financial arena has grown more complex and sophisticated, the burden that has been placed upon them may have become too great.

Unfortunately, if this hypothesis turns out to be true, the losses will be significant. And, let’s remember that nothing less than America’s retirement savings is at stake.

Mitch Shames is Founder & Managing Director at Harrison Fiduciary.