Compliance June 20, 2024

DOL Pushes Back on Fiduciary Rule Challenge

The regulator filed a brief in federal court supporting the final rule.

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The Department of Labor answered one of two open lawsuits in the federal courts challenging the Retirement Security Rule on June 14. The regulator’s first response in court argued that the new rule is compliant with existing case law and is substantially different from a 2016 regulation that was vacated by the U.S. 5th Circuit Court of Appeals.

The Retirement Security Rule, finalized in April, expands the definition of fiduciary such that a financial professional who holds themselves out as acting in their client’s best interest and providing advice that can be relied on is a fiduciary under the Employee Retirement Income Security Act. This remains the case even if the advice is applied on a one-time basis, as is often the case with retirement plan rollover recommendations, plan menu design and annuity sales.

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The first lawsuit, led by the Federation of Americans for Consumer Choice, an insurance industry group, was brought before the U.S. District Court for the Eastern District of Texas on May 2 and is the lawsuit that the DOL filed a responsive brief in. The other suit, filed in the Northern District of Texas by the American Council of Life Insurers and other insurance trade groups is also open and was filed May 24.

The FACC complaint, which was filed alongside other independent insurance agents, argued that the current rule is much like the vacated version, covers the same professionals and the same transactions and on substance is all but the same as the 2016 fiduciary rule.

The DOL answered in its brief that “the Retirement Security Rule is far more modest in scope than the 2016 Rule vacated by the Fifth Circuit, and lacks the features that led to that rule’s vacatur.” The regulators argued, among other points, that:

  1. The new rule focuses on the relationship between the adviser and the investor and how the adviser presents themselves, rather than “every financial professional in every transaction will be deemed a fiduciary.”
  2. There are no contractual requirements in the new rule, and therefore no new private right of action created by exposing advisers to contract violation liability under state law.
  3. There are no limits on mandatory arbitration.

Further, the DOL argued that it is not limited to the original five-point test, first promulgated in 1975 and the predecessor the Retirement Security Rule and can continue to make rules consistent with ERISA. The regulator also noted that the text of ERISA does not say that professionals offering one-time advice cannot be fiduciaries.

In its complaint, the FACC had also argued that the rule would be damaging to annuity markets, which are currently booming due in part to higher interest rates.

In its response, the DOL wrote that: The plaintiffs’ “arguments are largely grounded in policy concerns about the insurance industry that cannot override the clear text of the statute passed by Congress. Contrary to Plaintiffs’ wishful thinking, ERISA does not inherently exclude investment advice about plan assets when insurance agents are involved. Instead, ERISA adopted a fiduciary standard focused on function.”

The brief expressed the concern, in defense of the rule, that in the absence of its implementation: “Insurance agents providing professionalized investment advice are free to hold themselves out as acting in their clients’ best interest while prioritizing lucrative commissions from sales of annuities and rollover recommendations that may involve a retiree’s life savings—so long as they are not on a monthly retainer nor providing recurring investment advice.”

The DOL pointed out that one plaintiff, ProVision Brokerage LLC, states on their website that it “is driven by making a difference in the financial health of people’s lives,” and “[t]he needs/goals/wants of those we serve are the only thing that matters; period.”

The brief then notes that “insurance professionals selling annuities can make these sorts of representations to retirement investors, but then make annuity recommendations regarding ERISA plan assets with no accountability to actually act in their clients’ best interest as ERISA requires.”

The lawsuit was brought by the FACC and independent insurance agents James Holloway, James Johnson, TX Titan Group LLC, ProVision Brokerage and Eric Couch versus the DOL and Julie Su in her role as acting secretary of labor.

Data and Research June 20, 2024

Annuities Embedded in TDFs: The Way Forward?

Vanguard research suggests that hybrid annuity target-date funds can potentially benefit for less engaged participants, but effectively implementing the solution will likely pose challenges.  

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Hybrid annuity target-date funds have begun to pick up steam as an investment option in defined contribution plans, but recent Vanguard research suggests that these products still face hurdles around implementation, participant behavior and suitability.  

Brian Miller, senior investment specialist and head of target-date product management at Vanguard, says embedding an annuity into a target-date fund that participants default into can be a strategy to address the retirement income needs of investors who are less engaged or lack the desire or ability to construct their own asset allocations. 

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However, Miller says “it remains to be seen” whether embedding annuities into TDFs will become more of a trend going forward.  

“I think you’re certainly seeing some plans that are more willing to adopt this type of strategy, in particular, insurance companies [or] those that previously had a defined benefit plan might be a little bit more used to this type of payment plan,” Miller says. “Those companies have typically been a little bit more at the forefront of adopting this type of strategy.” 

Speakers at this month’s PLANSPONSOR National Conference argued that TDFs with an annuity sleeve that kicks in when a person is further in their career will become standard as a qualified default investment alternative. The speakers were split, however, on whether this will function as an opt-in or opt-out situation.  

Meanwhile, according to research from the Defined Contribution Institutional Investment Association, only 39% of recordkeepers currently offer an annuity with a guaranteed lifetime withdrawal benefit.  A GLWB is the most frequently offered in-plan guaranteed option, especially among recordkeepers who only offer one annuity option. In addition, DCIIA found that there is no clear trend in annuity offerings based on organizational size. 

But for the majority of plans today, Miller says the focus is on selecting the best investments for accumulation, keeping costs low and offering programs and benefits that are straightforward. According to Vanguard’s paper, most hybrid annuity TDFs have three components: 

  • A multi-asset allocation to support asset growth 
  • An income funding strategy for the guaranteed income product purchase  
  • An annuity for guaranteed income 

The investment value of hybrid annuity TDFs, according to Vanguard, is that they remove market risk and longevity risk by providing income from the annuity, but this benefit comes at a cost of reduced accumulated wealth from the annuity purchase.  

“Whether it’s a hybrid annuity target fund or a standard target fund, during the accumulation phase, it’s going to look pretty similar,” Miller says.  

With hybrid annuity TDFs though, Miller says it will start to allocate more toward bonds, which would eventually be used to purchase an annuity. When someone decides to purchase the annuity, they will receive guaranteed income in exchange for some of the potential growth they might have gained with a portfolio that invested more in equities.  

“In essence, you’re taking less risk, or getting that guaranteed income and addressing that longevity risk,” Miller says. “But your ability to grow that asset pool is obviously diminished a little bit because you’re taking that, let’s call it 30%, portion out, and moving that over to the annuity, versus leaving it in the market.” 

Vanguard also recommends that plan sponsors consider many factors when evaluating hybrid annuity TDFs. For example, an annuity component may not be optimal for everyone, and the appropriate type of annuity, timing and amount of the annuity are likely to differ significantly across participants. Vanguard suggests that plan sponsors should include a few personalization options for more engaged participants that can be tailored to their individual needs.  

Portability is also a concern, as participants are unable to transfer annuity benefits as easily as funds. As a result, Vanguard suggests that plan sponsors explore partnerships with annuity providers to enhance portability or introduce portable annuity options.  

When it comes to the cost of these investment vehicles, Vanguard recommended that plan sponsors offer transparent information on costs and charges and reinforce it with the value of the solution, as well as provide financial planning support.  

Miller adds that one of the major hurdles to offering this solution is educating participants about it. While the word “annuity” tends to hold a negative connotation for a lot of people, the idea of guaranteed income is very attractive to employees.  

“I think for plan sponsors, an absolutely big consideration is, what is the educational hurdle?” Miller says. “Do they have the ability to partner with their asset manager [or] recordkeeper to provide that educational material in a very straightforward way to those participants?” 

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