Compliance

Guaranteed Investment Contracts Called Out In Principal Lawsuit

Participants in plans that purchased guaranteed investment contracts from the Principal say the arrangement has led to prohibited transactions under ERISA.

By John Manganaro editors@plansponsor.com | May 17, 2017

Principal Life Insurance Company and Principal Financial Group are both named in a newly certified class action Employee Retirement Income Security Act (ERISA) lawsuit, filed in the U.S. District Court for the Southern District of Iowa.

At the heart of the complaint are guaranteed investment contracts (GICs), a type of group annuity contract sold to retirement plans. According to the complaint, Principal operates the Principal Fixed Income Guaranteed Option, also known as the Principal Fixed Income Option. Retirement plans in which the certified class are participants and beneficiaries invest in the Fixed Income Option pursuant to a GIC that governs the relationship between the plans and Principal.

Plaintiffs suggest the contract is inappropriately structured and has enabled Principal to “exercise its discretionary authority to retain unreasonably large and/or excessive profits rather than crediting the participants and beneficiaries of the plans with appropriate returns.”

The complaint suggests participants in plans that invested in the Fixed Income Option are “credited at an interest rate which Principal can set and change in its sole discretion. The rate is applied to all participants in all plans that invest in the Fixed Income Option.” The contract itself does not specify the rate, “nor does it promise that the rate will not go below a certain level. Nor does it promise that the rate will remain in effect throughout the life of the contract.”

“Throughout the relevant time period, Principal invested the assets it received pursuant to the contract as it chose, and retained for itself the difference between the investment earnings of those assets and the interest it chose to credit to the plans, otherwise known as the spread,” plaintiffs argue. “As stated in a Principal Annual Meeting 10K Report, ‘assets invested in GICs and funding agreements generate a spread between the investment income earned by us and the amount credited to the customer.’ Even while its earnings on the money paid by the plans were in the hundreds of millions of dollars, Principal reduced the amount credited to the Plans and their participants.”

Plaintiffs say Principal also “retained the spread in addition to an already high disclosed fee for providing administrative and/or recordkeeping services to plans. In other words, the contract allowed Principal to set its own compensation as a service provider to the plans, and to collect unreasonable and/or excessive fees from participants.”

Given this situation, ERISA breaches are alleged along the lines that “the contract is a plan asset of the plans holding it. Because Principal exercised discretionary authority over the administration of the contract, including setting the credited rate, it owed fiduciary duties to plan participants with respect to the contract.” Thus, according to plaintiffs, Principal breached its fiduciary duties “by unilaterally setting its own compensation and by charging unreasonable and excessive fees incident to administering the contract.”

As a result of Principal’s actions, plaintiffs argue the plans’ assets were “diminished,” and they seek “damages and equitable relief on behalf of the class.”

NEXT: Digging into the complaint

The text of the lawsuit goes into considerable detail regarding the GIC entered into between the plans and Principal: “Principal offers plans that invest in the Fixed Income Option a so-called Guaranteed Interest Rate defined as the rate, which when credited and compounded daily, will produce the effective annual interest rate we announce to you for the Guaranteed Interest Fund to which the Applicable Schedule relates.” According to plaintiffs, the contract “does not specify the Guaranteed Interest Rate or set forth a methodology for determining the rate, or set a floor below which the Guaranteed Interest Rate cannot go.”

The contract also provides for a “Composite Crediting Rate,” which is declared for each deposit period, or the period of time within which deposits to a guaranteed interest fund can be made, itself set forth in a schedule to the contract. Plaintiffs observe the Composite Crediting Rate is calculated using a methodology set forth in the contract, which is based on the aggregate value and expected value of Guaranteed Interest Funds. “Expected values are determined by Principal based on net cash flows accumulated with interest at the Guaranteed Interest Rate,” they explain. “The contract does not set a floor below which the Composite Crediting Rate cannot go.”

The main argument that emerges from these details is that, under such a contract, “Principal appears to have discretionary authority to change the Guaranteed Interest Rate at any time,” thereby triggering fiduciary duties.

The complaint continues: “The contract provides for a delay of 12 months or payment of a surrender charge if a plan withdraws its interest in the Fixed Income Option. There are also limitations on participants’ abilities to transfer funds to competing investments in their Plans. Specifically, participants are subject to an ‘Equity Wash,’ meaning they must first transfer funds to a noncompeting investment option for a stated period of time. Essentially all fixed-income and cash equivalent investments are defined as competing investment options, so if they no longer wish to invest in the Fixed Income Option, participants are forced to switch to a higher-risk investment first.”

Plaintiffs say this leaves participants in the plans “highly vulnerable to Principal’s decision to change the credited rate.” They further claim Principal, through this arrangement, has permitted and engaged in ERSIA prohibited transactions.

“Meanwhile, Principal reduced the credited rate to plans continuously and precipitously between 2008 and 2014,” participants allege. “In June 2008 the net crediting rate (crediting rate less fees for administrative and recordkeeping services) was 3.95%; by June 2010 it had dropped to 2.55%, and by June 2013 it had dropped to 1.35%. Thus, while Principal’s net investment income from its general account declined by about 10.5% from 2010 to 2013, Principal unreasonably reduced the net crediting rate and plan participant earnings by about 47% over the same period.”

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