[Federal Register Volume 60, Number 43 (Monday, March 6, 1995)]
[Rules and Regulations]
[Pages 12328-12330]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-5321]
[[Page 12327]]
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Part V
Department of Labor
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Pension and Welfare Benefits Administration
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29 CFR Part 2509
Interpretive Bulletins Relating to the Employee Retirement Income
Security Act of 1974; Final Rule
Federal Register / Vol. 60, No. 43 / Monday, March 6, 1995 / Rules
and Regulations
[[Page 12328]]
DEPARTMENT OF LABOR
Pension and Welfare Benefits Administration
29 CFR Part 2509
[Interpretive Bulletin No. 95-1]
Interpretive Bulletins Relating to the Employee Retirement Income
Security Act of 1974
AGENCY: PWBA, Department of Labor.
ACTION: Interpretive Bulletin.
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SUMMARY: This document announces the Department of Labor's (the
Department's) view of the legal standard imposed by section 404(a)(1)
(A) and (B) of part 4 of title I of the Employee Retirement Income
Security Act of 1974 (ERISA) on a plan fiduciary's selection of an
annuity provider when purchasing annuities for the purpose of
distributing benefits under an employee pension benefit plan. Under
this standard, plan fiduciaries choosing to purchase annuities have a
duty to select the safest available annuity provider, unless under the
circumstances it would be in the interests of participants and
beneficiaries to do otherwise. The document also provides guidance to
plan fiduciaries regarding circumstances when it may be in the interest
of the participants and beneficiaries to purchase other than the safest
available annuity.
EFFECTIVE DATE: The standard announced in this bulletin is effective
January 1, 1975.
FOR FURTHER INFORMATION CONTACT:
William W. Taylor, Plan Benefits Security Division, Office of the
Solicitor, U.S. Department of Labor, Rm N-4611, 200 Constitution Ave.,
NW., Washington, DC 20210, (telephone (202) 219-9141) or Mark Connor,
Office of Regulations and Interpretations, Pension and Welfare Benefits
Administration, U.S. Department of Labor, Rm N-5669, 200 Constitution
Avenue NW., Washington, DC 20210, (telephone (202) 219-8671). These are
not toll-free numbers.
SUPPLEMENTARY INFORMATION: In order to provide a concise and ready
reference to its interpretations of ERISA, the Department of Labor
publishes its Interpretive Bulletins in the Rules and Regulations
section of the Federal Register.
Published in this issue of the Federal Register is ERISA
Interpretive Bulletin 95-1, which describes the application of the
fiduciary standards set forth in section 404(a)(1) (A) and (B) of
ERISA, 29 U.S.C. 1104(a)(1) (A) and (B), in selecting an insurer to
provide pension benefit distribution annuities to plan participants and
beneficiaries. The Department is publishing this Interpretive Bulletin
because it believes there is a need for further guidance regarding the
selection of such annuity providers by plan fiduciaries.
(Sec. 505, Pub. L. 93-406, 88 Stat. 894 (29 U.S.C. 1135))
Background
Annuities are issued by insurers in a variety of forms designed to
suit different purposes. This interpretive bulletin addresses only
annuities that are purchased by pension plans with the intention to
transfer liability for benefits promised under the plan to the annuity
provider (i.e., the insurance company).\1\ Annuities designed to serve
this purpose are sometimes referred to herein as benefit distribution
annuities. Regulations issued by the Department explicitly recognize a
transfer of liability from the plan when such an annuity is purchased
from an insurance company licensed to do business in a State. 29 CFR
2510.3-3(d)(2)(ii).\2\ Pension plans purchase benefit distribution
annuity contracts in a variety of circumstances. Such annuities may be
purchased for participants and beneficiaries in connection with the
termination of a plan, or in the case of an ongoing plan, annuities
might be purchased for participants who are retiring or separating from
service with accrued vested benefits.
\1\In particular, the interpretive bulletin does not address
fiduciary responsibilities in connection with the purchase of
annuities for investment purposes. See infra note 5.
\2\This regulation defines the term ``participant covered under
the plan'' for certain purposes under title I of ERISA. The
Department notes that the regulation was issued primarily to define
the class of participants entitled to receive copies of certain plan
documents without charge and without request under ERISA sections
101(a) and 104(b)(1), 29 U.S.C. 1021(a) and 1024(b)(1). 40 FR 24649
(June 9, 1975), 40 FR 34528 (Aug. 15, 1975). A premise of the
regulation was that, by using the term ``participant covered under
the plan,'' Congress had provided a ground for distinguishing
between the class of all participants within the meaning of ERISA
Sec. 3(7) and participants entitled to receive copies of plan
documents without charge and without request. 40 FR 24649 (June 9,
1975). Thus, the regulation is not intended to define the term
``participant'' or ``beneficiary'' for all purposes under ERISA,
and, in particular, is not intended to define these terms for
purposes of standing to bring a civil action under ERISA section
502(a), 29 U.S.C. 1132(a).
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The selection of an annuity provider under these circumstances is a
fiduciary decision governed by part 4 of title I of ERISA.
Specifically, pursuant to ERISA section 404(a)(1), 29 U.S.C.
1104(a)(1), fiduciaries must discharge their duties with respect to the
plan solely in the interest of the participants and beneficiaries.
Section 404(a)(1)(A), 29 U.S.C. 1104(a)(1)(A), states that the
fiduciary must act for the exclusive purpose of providing benefits to
participants and beneficiaries and defraying reasonable plan
administration expenses. In addition, section 404(a)(1)(B) requires a
fiduciary to act with the care, skill, prudence and diligence under the
prevailing circumstances that a prudent person acting in a like
capacity would use.\3\
\3\On March 13, 1986, the Department released an information
letter addressed to John N. Erlenborn, who was then the Chairman of
the Advisory Council on Employee Welfare and Plans. In the letter,
the Department stated in pertinent part:
Consistent with the functional analysis of fiduciary activity,
the choice of an insurer would appear to involve the type of
discretionary authority over the disposition of plan assets covered
in section 3(21)(A) [of ERISA]. . . . Therefore, it appears that the
fiduciary provisions of ERISA, including the prudence requirement of
section 404(a)(1)(B), will apply to the choice of an insurer to
issue annuities upon plan termination.
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Several developments over the past few years have resulted in
questions being raised about the security of the pension benefits
promised to participants and beneficiaries under benefit distribution
annuity contracts purchased on their behalf. In particular, concerns
have been expressed about the ability of certain insurance carriers to
satisfy their annuity liabilities because their investment portfolios
contain or contained substantial amounts of high-risk, high-yield debt
securities (also known as ``junk bonds'') or troubled real-estate
loans, or a combination of both. The basis for such concerns is best
exemplified by the well-publicized developments involving the Executive
Life Insurance Companies of California and New York. State regulators
in both California and New York were forced to take control of the
operations of the Executive Life Companies, whose poor financial
condition is principally attributable to substantial investments in
high risk bonds. In response to such developments, the Department has
acted in the following areas to enforce ERISA's fiduciary standards and
determine whether additional regulatory action is warranted.
Litigation
Subsequent to the failure of Executive Life, the Department's
enforcement activities have centered on, among other things, the
process by which plan fiduciaries selected annuity providers.
The Department has filed lawsuits against numerous companies whose
plans purchased annuities because the plan fiduciaries who, acting in
their fiduciary capacities, failed to follow adequate procedures
designed to select [[Page 12329]] the safety available insurance
carrier when choosing an annuity provider. Cases have been brought
against several companies which purchased annuities from Executive Life
including Pacific Lumber Co., Magnetek, Inc., Smith International,
Inc., Geosource, Inc., American National Can Company, AFG Industries,
Inc., and Raymark Industries, Inc. as well as against the Strouse Adler
Company which purchased annuities from Presidential Life Insurance
Company. It is the Department's position that these fiduciaries
breached their fiduciary responsibilities under ERISA in connection
with their selection of annuity providers.\4\ Consent orders settling
the Secretary's claims have been entered in certain of these cases.
\4\The Pension Annuitant's Protection Act of 1994, Pub. L. No.
103-401, 108 Stat. 4172 (1994) amended section 502(a) of ERISA to
clarify the standing of pension annuitants to bring actions for
fiduciary breaches that occurred. In addition, the Act specifies
that a court may order appropriate relief to assure the annuitant's
receipt of the amounts provided or to be provided by the annuity,
plus reasonable prejudgment interest. The amendments made by the Act
apply to any legal proceeding pending, or brought, on or after May
31, 1993.
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Regulatory Action
In addition to its enforcement activities, the Department and the
Pension Benefit Guaranty Corporation (PBGC) sought to determine if, in
addition to and independent of ERISA's fiduciary standards, minimum
standards for annuity providers would be appropriate and necessary in
order to ensure a reasonable likelihood that participants or
beneficiaries on whose behalf annuities are purchased will receive
their promised pension benefits. It was anticipated that such
modification might be effected by amending the minimum standards which
already exist under the regulation at 29 CFR 2510.3-3(d)(2)(ii). On
June 21, 1991, both the Department and the PBGC published advanced
notices of proposed rulemaking (ANPRMs) in the Federal Register (56 FR
28638 and 56 FR 28642 respectively) soliciting information and comments
from the public as to whether regulatory action relating to the
purchase of annuity contracts was necessary and if so, what form such
action should take.
After receiving over thirty letters in response, the Department
reviewed the comments and, after extensive deliberation, the Department
has determined that no regulatory action should be taken at this time
to amend the minimum standards under the regulation at 29 CFR 2510.3-
3(d)(2)(ii). More generally, the Department has decided not to
promulgate any regulation limiting the circumstances under which the
purchase of an annuity will be considered a full distribution of
benefits for a participant or beneficiary such that the plan's and the
employer's obligations to pay benefits have been served.
The following interpretive bulletin concerns solely the fiduciary
standard and is published in addition to and independent of the
regulatory minimum standard at 29 CFR 2510.3-3(d)(2)(ii).
The Interpretive Bulletin
The interpretive bulletin explains that, when choosing an annuity
provider for purposes of a benefit distribution, whether for purposes
of separation or retirement of a participant or upon termination of a
plan, compliance with ERISA's fiduciary rules requires, at a minimum,
that plan fiduciaries conduct an objective, thorough and analytical
search for the purpose of identifying and selecting providers from
which to purchase annuities. In conducting such a search, a fiduciary
must evaluate a potential annuity provider's claims-paying ability and
creditworthiness because the participants and beneficiaries whose
entitlement to benefits will be transferred to the annuity provider
have a paramount interest in the ability of the provider to make those
payments. As a result, the interpretive bulletin states that a plan
fiduciary choosing an annuity provider for the purpose of making a
benefit distribution must take steps calculated to obtain the safest
annuity available, unless under the circumstances, it would be in the
interests of the plan participants and beneficiaries to do
otherwise.\5\ The Department recognizes that, in many circumstances
likely to arise under existing law, the interest of the plan
participants and beneficiaries may require the selecting fiduciary to
consider the cost of the annuity (to the extent that the cost is borne
by the participants and beneficiaries) in addition to the annuity
provider's claims-paying ability.\6\ Cost consideration may not,
however, justify purchase of an unsafe annuity.
\5\This standard does not apply to the purchase of annuities for
plan investment purposes. As with any other ordinary investment
decision, ERISA's fiduciary duty of prudence requires that the risk
attendant to such products, in the context of the plan's investment
portfolio, and its funding, liquidity and diversification needs,
must be weighed against the promised return. Thus, fiduciaries may
select such investments that involve greater risks, but that also
provide an expected investment return that is commensurate with that
greater risk. In this regard, the Department notes that in an
investment contract with an annuity option, the standard described
herein, while not applicable to the decision to invest in the
investment product, nonetheless applies to the fiduciary's decision
to exercise the annuity option.
\6\Under IRC Sec. 4980, an excise tax of up to 50 percent may be
imposed on the amount of any employer reversion from a qualified
plan unless the employer establishes and maintains a qualified
replacement plan to which assets are transferred, or provides
certain benefit increases for participants.
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The Interpretive bulletin also explains that an annuity provider's
claims-paying ability and creditworthiness should be evaluated on the
basis of a number of factors. Although ratings provided by insurance
rating services may be a useful factor in evaluating a potential
annuity provider, reliance solely on such ratings would not be
sufficient to meet the requirement of a thorough and analytical search
for an appropriate annuity provider.
List of Subjects in 29 CFR Part 2509
Employee benefit plans, Pensions.
For the reasons set forth in the preamble, Part 2509 of Title 29 of
the Code of Federal Regulations is amended as follows:
PART 2509--INTERPRETIVE BULLETINS RELATING TO THE EMPLOYEE
RETIREMENT INCOME SECURITY ACT OF 1974
1. The authority citation for Part 2509 continues to read as
follows:
Authority: 29 U.S.C. 1135. Section 2509.75-1 is also issued
under 29 U.S.C. 1114. Sections 2509.75-10 and 2509.75-2 are also
issued under 29 U.S.C. 1052, 1053, 1054. Secretary of Labor's Order
No. 1-87 (52 FR 13139).
2. Part 2509 is amended by adding a new Sec. 2509.95-1 to read as
follows:
Sec. 2509.95-1 Interpretive Bulletin relating to the fiduciary
standard under ERISA when selecting an annuity provider.
(a) Scope. This Interpretive Bulletin provides guidance concerning
certain fiduciary standards under part 4 of title I of the Employee
Retirement Income Security Act of 1974 (ERISA), 29 U.S.C. 1104-1114,
applicable to the selection of annuity providers for the purpose of
pension plan benefit distributions where the plan intends to transfer
liability for benefits to the annuity provider.
(b) In General. Generally, when a pension plan purchases an annuity
from an insurer as a distribution of benefits, it is intended that the
plan's liability for such benefits is transferred to the annuity
provider. The Department's regulation defining the term ``participant
covered under the plan'' for certain purposes under title I of ERISA
recognizes that such a transfer occurs [[Page 12330]] when the annuity
is issued by an insurance company licensed to do business in a State.
29 CFR 2510.3-3(d)(2)(ii). Although the regulation does not define the
term ``participant'' or ``beneficiary'' for purposes of standing to
bring an action under ERISA Sec. 502(a), 29 U.S.C. 1132(a), it makes
clear that the purpose of a benefit distribution annuity is to transfer
the plan's liability with respect to the individual's benefits to the
annuity provider.
Pursuant to ERISA section 404(a)(1), 29 U.S.C. 1104(a)(1),
fiduciaries must discharge their duties with respect to the plan solely
in the interest of the participants and beneficiaries. Section
404(a)(1)(A), 29 U.S.C. 1104(a)(1)(A), states that the fiduciary must
act for the exclusive purpose of providing benefits to the participants
and beneficiaries and defraying reasonable plan administration
expenses. In addition, section 404(a)(1)(B), 29 U.S.C. 1104(a)(1)(B),
requires a fiduciary to act with the care, skill, prudence and
diligence under the prevailing circumstances that a prudent person
acting in a like capacity and familiar with such matters would use.
(c) Selection of Annuity Providers. The selection of an annuity
provider for purposes of a pension benefit distribution, whether upon
separation or retirement of a participant or upon the termination of a
plan, is a fiduciary decision governed by the provisions of part 4 of
title I of ERISA. In discharging their obligations under section
404(a)(1), 29 U.S.C. 1104(a)(1), to act solely in the interest of
participants and beneficiaries and for the exclusive purpose of
providing benefits to the participants and beneficiaries as well as
defraying reasonable expenses of administering the plan, fiduciaries
choosing an annuity provider for the purpose of making a benefit
distribution must take steps calculated to obtain the safest annuity
available, unless under the circumstances it would be in the interests
of participants and beneficiaries to do otherwise. In addition, the
fiduciary obligation of prudence, described at section 404(a)(1)(B), 29
U.S.C. 1104(a)(1)(B), requires, at a minimum, that plan fiduciaries
conduct an objective, thorough and analytical search for the purpose of
identifying and selecting providers from which to purchase annuities.
In conducting such a search, a fiduciary must evaluate a number of
factors relating to a potential annuity provider's claims paying
ability and creditworthiness. Reliance solely on ratings provided by
insurance rating services would not be sufficient to meet this
requirement. In this regard, the types of factors a fiduciary should
consider would include, among other things:
(1) the quality and diversification of the annuity provider's
investment portfolio;
(2) the size of the insurer relative to the proposed contract;
(3) the level of the insurer's capital and surplus;
(4) the lines of business of the annuity provider and other
indications of an insurer's exposure to liability;
(5) the structure of the annuity contract and guarantees supporting
the annuities, such as the use of separate accounts;
(6) the availability of additional protection through state
guaranty associations and the extent of their guarantees. Unless they
possess the necessary expertise to evaluate such factors, fiduciaries
would need to obtain the advice of a qualified, independent expert. A
fiduciary may conclude, after conducting an appropriate search, that
more than one annuity provider is able to offer the safest annuity
available.
(d) Costs and Other Considerations. The Department recognizes that
there are situations where it may be in the interest of the
participants and beneficiaries to purchase other than the safest
available annuity. Such situations may occur where the safest available
annuity is only marginally safer, but disproportionately more expensive
than competing annuities, and the participants and beneficiaries are
likely to bear a significant portion of that increased cost. For
example, where the participants in a terminating pension plan are
likely to receive, in the form of increased benefits, a substantial
share of the cost savings that would result from choosing a competing
annuity, it may be in the interest of the participants to choose the
competing annuity. It may also be in the interest of the participants
and beneficiaries to choose a competing annuity of the annuity provider
offering the safest available annuity is unable to demonstrate the
ability to administer the payment of benefits to the participants and
beneficiaries. The Department notes, however, that increased cost or
other considerations could never justify putting the benefits of
annuitized participants and beneficiaries at risk by purchasing an
unsafe annuity.
In contrast to the above, a fiduciary's decision to purchase more
risky, lower-priced annuities in order to ensure or maximize a
reversion of excess assets that will be paid solely to the employer-
sponsor in connection with the termination of an over-funded pension
plan would violate the fiduciary's duties under ERISA to act solely in
the interest of the plan participants and beneficiaries. In such
circumstances, the interests of those participants and beneficiaries
who will receive annuities lies in receiving the safest annuity
available and other participants and beneficiaries have no
countervailing interests. The fiduciary in such circumstances must make
diligent efforts to assure that the safest available annuity is
purchased.
Similarly, a fiduciary may not purchase a riskier annuity solely
because there are insufficient assets in a defined benefit plan to
purchase a safer annuity. The fiduciary may have to condition the
purchase of annuities on additional employer contributions sufficient
to purchase the safest available annuity.
(e) Conflicts of Interest. Special care should be taken in
reversion situations where fiduciaries selecting the annuity provider
have an interest in the sponsoring employer which might affect their
judgment and therefore create the potential for a violation of ERISA
Sec. 406(b)(1). As a practical matter, many fiduciaries have this
conflict of interest and therefore will need to obtain and follow
independent expert advice calculated to identify those insurers with
the highest claims-paying ability willing to write the business.
Signed at Washington, DC, this 28th day of February 1995.
Olena Berg,
Assistant Secretary for Pension and Welfare Benefits, U.S. Department
of Labor.
[FR Doc. 95-5321 Filed 3-3-95; 8:45 am]
BILLING CODE 4510-29-M