Compliance July 13, 2015

DOL Clarifies Annuity Selection Safe Harbor Regulation

In a Field Assistance Bulletin, the DOL answers questions it has received about the fiduciary selection safe harbor regulation for DC plans.
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A regulation issued by the Department of Labor (DOL) in 2008 regarding the selection of annuity providers under defined contribution (DC) plans (safe harbor rule) provides plan fiduciaries with safe harbor conditions for the selection and monitoring of annuity providers and annuity contracts for benefit distributions.

However, in Field Assistance Bulletin 2015-02, the DOL says a recurring comment about the safe harbor rule is that employers remain unclear about the scope of their fiduciary obligations with respect to annuity selection under defined contribution plans. In particular, questions continue to be raised about how to reconcile the “time of selection” standard in the safe harbor rule—which embodies the general principle that the prudence of a fiduciary decision is evaluated under the Employee Retirement Income Security Act (ERISA) based on the information available at the time the decision was made—with ERISA’s duty to monitor and review certain fiduciary decisions.

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According to the bulletin, “the time of selection” means:

  • the time that the annuity provider and contract are selected for distribution of benefits to a specific participant or beneficiary; or
  • the time that the annuity provider is selected to provide annuities as a distribution option for participants or beneficiaries to choose at future dates.

The DOL notes that the safe harbor rule provides that when an annuity provider is selected to offer annuities that participants may later choose as a distribution option, the fiduciary must periodically review the continuing appropriateness of the conclusion that the annuity provider is financially able to make all future payments under the annuity contract, as well as the reasonableness of the cost of the contract in relation to the benefits and services to be provided. The fiduciary is not, however, required to review the appropriateness of its conclusions with respect to an annuity contract purchased for any specific participant or beneficiary. A fiduciary's selection and monitoring of an annuity provider is judged based on the information available at the time of the selection, and at each periodic review, and not in light of subsequent events.

According to the bulletin, the frequency of periodic reviews to comply with the safe harbor rule depends on the facts and circumstances. For example, if a "red flag" about the provider or contract comes to the fiduciary's attention between reviews (e.g., a major insurance rating service downgrades the financial health rating of the provider or several annuitants submit complaints about a pattern of untimely payments under the contract), the fiduciary would need to examine the information to determine whether an immediate review is necessary.

The guidance in the bulletin is limited to the selection and monitoring of annuity providers for benefit distributions from DC plans. But the DOL notes that it and the Department of the Treasury are engaged in a joint initiative to encourage the prudent consideration, offering, and use of lifetime income alternatives, including annuities, in retirement plans. The DOL is considering guidance about fiduciary selection and monitoring of annuity providers and contracts that are offered as investment options under DC plans as part of its project.

Investing July 13, 2015

Active Management Important to Investors

Professional U.S. investors say protecting capital in down markets is one of the most important considerations when selecting an active manager.
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Sixty-three percent of professional U.S. investors foresee an increase in market volatility in the next 12 months, according to the MFS Active Management Sentiment survey.

Seventy percent say protecting capital in down markets is one of the most important considerations when selecting an active manager, and 63% say actively managed strategies work best in a falling market. Evidence bears this out, MFS Investment Management says; over the past 25 years, the top quartile of active managers have achieved an average of 7.6% in excess returns in bear markets.

Despite significant flows to passive strategies since the financial crisis of 2008, only 38% of professional investors are highly confident in passive management.

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When selecting an active manager, 83% of investors in the U.S. say risk management is the most important trait, followed by active security selection (67%). Asked about their concerns regarding active managers, 68% of respondents said being too focused on short-term investment returns of the past 12 months or less. In the U.S., 82% of investors said they are willing to pay more for outperformance over five years, and 68% are willing to pay more for managers who can outperform over 10 years.

Sixty percent of U.S. professional investors said that actively managed strategies will continue to play a significant role in their portfolios in the future, and U.S. investors have allocated 77% of their portfolio assets to active investment strategies.

“At some point, we will see additional volatility, and that creates opportunity for active managers to identify risks and generate alpha,” says Joe Flaherty, chief investment risk officer for MFS Investment Management. “Downside risk management is part of the value proposition that active managers can deliver through research and security selection. Many active global managers have significantly outperformed in falling markets. A passive strategy, by definition, takes full market risk. In recent years, strategies that straddle the line between active and passive have become increasingly popular with investors.”

CoreData conducted the study for MFS Investment Management, based on a survey 1,038 financial advisers, institutional investors and professional buyers around the globe, including 575 in the United States.

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