What the SECURE Act Means for Annuities in Retirement Plans
Here's how retirement plans can best choose from among the growing number of investment options that embed in-plan annuities.
On December 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.”) The safe harbor was considered essential, given that many plan sponsors have been reluctant to use in-plan annuities due to possible liability issues should the insurer selected to underwrite an in-plan income annuity later become insolvent.
While it was hoped that the safe harbor provision 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 may be changing. A recent survey from TIAA shows that nearly 9 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 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. After making the business decision to include an annuity option in a defined-contribution plan, plan sponsors should adopt something along the lines of the following two-step approach to selecting the most appropriate program:
- Establish a compliant insurer selection process, as clearly defined by the safe harbor provision in the SECURE Act;
- Then, establish a compliant product selection process to select the best program after selecting the shortlist of acceptable carriers.
Compliant Insurer Selection Process
At first blush, the SECURE Act’s safe harbor provision for insurer selection appears fairly straightforward. It provides immunity from legal action, as long as the plan sponsor selects an annuity carrier with the following attributes (as outlined in Section 204(2)):
1. The carrier is licensed to offer guaranteed retirement income contracts.
2. At the time of selection, and for each of the preceding seven years, the carrier has:
- Operated under a certificate of authority from its domiciliary state;
- Filed audited statutory financial statements;
- Maintained reserves that satisfy statutory requirements; and
- Not been under an order of supervision, rehabilitation, or liquidation.
3. The carrier undergoes a financial examination by its domiciliary state at least every five years.
Such a simplistic reading would misconstrue the intent of the safe harbor provision, 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 other words, 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 plan sponsor apply the easier tests outlined above.
Consensus is building among experts in the defined-contribution industry that the safe harbor language implies that a plan fiduciary must have a prudent process for addressing this two-part test. The need for such a 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 defined-contribution market, has developed a service that meets the standard of an “objective, thorough, and analytical” vetting of insurance companies, regarding both their ability to offer annuity products to the retirement market and their relative financial condition over time. The latter is achieved through ALIRT’s proprietary two-page insurer analysis, updated quarterly, which includes a scorecard providing a financial “reading” based on 45 financial inputs.
This service allows fiduciaries a defensible approach to both selecting an initial peer group of insurers, and tracking and documenting their relative financial well-being on a quarterly basis through customized reports. In short, this encapsulates the “process-oriented” approach that an increasing number of defined-contribution consultants are advocating.
Establishing a Compliant Product Selection Process
Once a plan sponsor has isolated a group of appropriately vetted carriers, it is ready to focus on product/program selection. Over the past several years, an increasing number of investment offerings have come to market that include the use of annuities for lifetime income. These offerings are continuously updated in a product grid available on the website of the Institutional Retirement Income Council. (IRIC is a product- and provider-agnostic membership-based organization formed to facilitate the culture shift of defined-contribution plans from supplemental savings plans to programs that provide retirement security through institutional income strategies.)
Although there is no specific safe harbor for the selection of such offerings, the SECURE Act legislation does suggest that a cost-benefit analysis should be undertaken at the time of product selection. In addition, previous safe harbor language from 2008 (2550.404a-4) provided guidance around the selection of both insurers and the contracts they offer. Legal experts believe this previous guidance should have a bearing on current practices.
While an agreed-upon industry standard for what constitutes an appropriate product-evaluation process is still forming for plan sponsors, our analysis of the expert guidance from IRIC suggests that such a process should include the following steps, which form a decision tree of sorts:
Step 1: Determine whether an in-plan or out-of-plan annuity better meet the sponsor’s needs.
Step 2: If in-plan, determine whether auto or affirmative election is a better approach for this plan.
Step 3: Based on the outcomes of steps 1 and 2, evaluate which solutions involving annuities are best to offer.
Fiduciary Insurance Services (FIS) employs the above process by first having the plan sponsor provide answers to a number of questions in checklists developed by IRIC. These checklists address issues such as whether the plan sponsor:
- Prefers to retain responsibility for participants in its plan following their retirement;
- Is a fast-follower or will consider an offering only once the majority of its competitors have done so;
- Is willing to consider changing recordkeepers; and
- Has previously offered a defined-benefit plan, such that its employee base is familiar with and desires a guaranteed-income benefit.
Based on the answers to these questions, FIS will help plan sponsors evaluate the available programs on the IRIC product grid to determine whether any of the products should remain in contention. For the products that are still on a plan sponsor’s shortlist after these preference checks, FIS will run each product through Monte Carlo simulations designed to determine guaranteed monthly income, potential monthly income, and account balance at a preset age.
Again, the focus is on developing a repeatable and thoroughly documented process that uses expert sources.
With today’s market offering ever fewer safe investment returns that can outplace inflation, the pooling protections available through insurance products should prove increasingly valuable to a retirement portfolio. Securing protections through a trusted source that can access favorable institutional pricing, such as an employer, may become even more valuable to the next generation of retirees.
Thus, both employees and employers are beginning to acknowledge the importance of offering annuity products in their defined-contribution plans. The protections in the SECURE Act may enable some employers to connect employees with efficient annuity solutions. Insurers, in turn, have responded by rolling out a growing number of programs.
David Paul is principal of ALIRT Insurance Research, where he co-directs the company’s research staff, manages internal IT initiatives and product development, pens a number of the firm’s insurance industry research pieces, and oversees business development. He has worked as an insurance industry research analyst since 1993.
Michelle Richter is principal and founder of Fiduciary Insurance Services LLC, New York, a consulting firm and registered investment adviser. In addition to this role, she has been named the executive director of the Institutional Retirement Income Council (as of Oct. 1).
From: ThinkAdvisor