Compliance

Guaranteed Investment Contracts Called Out In Principal Lawsuit

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