Compliance December 19, 2018

Future Regulation Holds the Key for Lifetime Income Options in DC Plans

The safe harbor provision in the Retirement Enhancement and Savings Act would safeguard plan sponsors from liability issues stemming from any losses from the insurer’s ability to meet financial obligations.
Reported by
Art by Kyle Smart
Art by Kyle Smart
Art by Kyle Smart

As 2018 comes to a close, the retirement industry offers lists of what plan sponsors and providers may expect as the new year rolls in. One, as the industry saw early in March, includes the bipartisan-supported, comprehensive yet widespread bill involving potential retirement reforms—otherwise known as the Retirement Enhancement and Savings Act (RESA).

While the bill contains many provisions regarding retirement plans, one aspect—the safe harbor provision—would add a fiduciary safe harbor to plan sponsors for the selection of lifetime income providers in retirement plans. Michael Kreps, principal at Groom Law Group, says the proposed provision answers concerns from employers about an insurance company’s inability to pay an annuity, while requiring plan sponsors to review considerations prior to offering the lifetime income options, in order to avoid fiduciary liability.

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“What they were concerned about was what they had to do with the insurer’s ability to pay,” he says. “They were worried that if they put annuities in a plan and then the insurer wouldn’t be able to pay many years later, the plan sponsor could be liable.”

According to Kreps, plan sponsors fear that if they offered in-plan annuities, but the insurer was not be able to complete the financial obligation, or pay for the annuity, they could be held liable for the outstanding annuity, and possibly sued by plan participants. While several pieces of guidance have been issued to avoid possibly unsafe annuity purchases, including a 2008 Department of Labor (DOL) safe harbor provision and a 2015 Field Assistance Bulletin (FAB), the 2018 proposed regulation is the only one that would safeguard plan sponsors from liability issues stemming from any losses from the insurer’s ability to meet financial obligations.

Major differences among these regulations include how plan sponsors can effectively vet financially stable insurance companies. The 2008 DOL provision required plan sponsors to conduct objective, thorough and analytical searches for select providers, consider engaging with experts to evaluate providers, and “appropriately conclude” that the insurer would be able to fulfill all future payments. This requires an extensive and at times meticulous process for plan sponsors—who may have little experience—to carry out successfully.

“The current guidance requires employers to conduct an exhaustive financial appraisal of annuity providers,” says Roberta Rafaloff, vice president of Institutional Income Annuities at MetLife. “An appraisal that most companies have neither the resources nor the expertise to perform.”

While the 2015 FAB recognized a majority of the 2008 DOL considerations—aside from an instruction requiring plan sponsors to understand the reasonableness of fees—the safe harbor provision of RESA differentiates itself by including protection for plan sponsors acting as liable fiduciaries.

Additionally, whereas RESA mandates plan sponsors to obtain several indications of an insurer’s financial good standing, including a report indicating the insurer is not under supervision by the state and has not been for the past seven years, the previous FAB stated that plan sponsors were “only responsible for relying on information about the insurer available at the time of the selection of the annuity.”

“With respect to the insurer’s ability to pay, [the safe harbor provision of RESA] also lays out a few things that plan sponsors need to consider,” adds Kreps. “This includes a written report from the insurer stating that the insurer is licensed to issue the contract and received audited financial statements in accordance with state law.”

Another feature of the provision measures a provider’s credit worthiness, to see whether the entity has completed financial obligations in the past, Kreps says.

Next: The future of safe harbors

An Employee Benefit Research Institute (EBRI) report found almost half (48%) of workers are either very or somewhat interested in annuities. However, a MetLife survey showed less than 10% of employers currently offer these solutions to their participants. Rafaloff credits this lack of enthusiasm to current DOL guidance, which limits protection for employers. 

“[It] creates barriers for businesses looking to offer retirement income options to their employees. Plan sponsors are looking for common sense guidance,” she says.

Employers believe the DOL should offer safe harbor provisions in order to expand lifetime income options to their plan participants. Rafaloff adds how in the MetLife study, 92% of DC plan sponsors agreed on the importance for the DOL to provide a workable safe harbor for annuity carrier selection criteria.

Moving forward, should RESA be applied in 2019 or in the future, the retirement industry can expect an uptick in annuity purchases, says Rafaloff.

“The legislation will help enhance employer-sponsored retirement plans by removing regulatory obstacles and expanding access to lifetime income solutions,” she says. “We believe the safe harbor provision in RESA will significantly advance the adoption and availability of annuities within DC plans.”

Administration December 17, 2018

DB Plan Glide Paths Should Be Dynamic

When a glide path is established, it needs to be revisited at least once a year to ensure that the goals for the pension plan are achievable.
Reported by
Art by Mark Wang
Art by Mark Wang
Art by Mark Wang

Defined benefit (DB) plan sponsors need to revisit the glide path of their plan at least once a year to ensure that as its funding status improves or deteriorates, the plan’s exposure to both risk (equities) and hedges (fixed income) are commensurate to where it is on the funding status spectrum, experts say. Generally speaking, as a pension plan’s funding status improves, it will decrease its risk exposure and increase its hedging positions.

“The volatility in the marketplace has definitely pushed clients to take a closer look at their pension plans’ asset allocation, with many plans choosing to implement de-risking strategies,” says Ken Stapleton, senior institutional investment consultant at MassMutual in Enfield, Connecticut.

MassMutual focuses on middle market pension plans, those with $100 million in assets, Stapleton says. Whereas larger pension plans employ complex investment options, MassMutual serves its middle market plans  with a “fully integrated investment and actuarial approach to guide sponsors along a de-risking path for their plan using investments and asset allocation strategies that make sense for their size and needs,” he says. “We boil it down to a focus on funded status volatility and the three largest factors in that calculation: 1) asset allocation, 2) liability movement and 3) company contributions. That initial stake in the ground allows MassMutual to present a number of asset allocations to achieve the investment return needs of the plan.

“We view equities as our return-seeking assets and fixed income as our liability-hedging assets, where the shift towards fixed income comes as funded status improves,” Stapleton continues. “Equities will range across asset classes and include diversifiers such as REITS [real estate investment trusts] and alternatives, while fixed income will often target the duration of the liability.”

Al Pierce, managing director at SEI Institutional in Oaks, Pennsylvania, agrees that as a pension plan’s funding status improves, its asset allocation should be de-risked. Like MassMutual, SEI approaches each client from the perspective of how much they want to contribute to the plan, how much volatility they can tolerate and the date when they would like the plan to be fully funded, he says.

For instance, if a pension plan sponsor does not want to contribute any money but has a high tolerance for volatility, it could have a glide path that does not do any de-risking until it gets very close to its end target date, Pierce says. Or, if a pension plan sponsor has a $20 million deficit and is contributing $5 million a year to the plan, its plan’s glide path could very well reduce its exposure to risk, he says.

An important point to remember in all of this is, when a glide path is established, it needs to be revisited at least once a year to ensure that the goals for the pension plan are achievable, Pierce says. Those conversations could result in the pension plan sponsor increasing its contributions or changing its asset allocation.

Brett Cornwell, vice president, client portfolio manager, fixed income, at Voya Financial, agrees that as a pension plan’s funding status improves, it is important to “reduce the volatility and narrow the range of outcomes so that the sponsor has better visibility into what the plan has the potential to return and what it will need to contribute.

“You are trying to make sure that as gains occur, you lock them in,” Cornwell continues. “This year has been a great indication of why it is so important to lock those gains in by moving into liability hedging assets. It is less about trying to predict the interest rate environment and more about focusing on the funding status. We definitely think managing a corporate pension plan is more than managing a long duration portfolio. You need to pivot and truly understand how the liabilities behave. Ultimately, you have to manage the portfolio in a risk-appropriate way so that the plan can meet benefit commitments.”

Cornwell says that the earliest iterations of liability-driven investing (LDI), “or LDI 1.0, was about extending the duration of the assets. As we move into LDI 2.0 and 3.0, it becomes a more complex game.”

Thomas Cassara, managing director at River and Mercantile in New York, has developed a glide path that embraces all of the concepts addressed above, but that also uses equity put and call options. “These tools can be added to a portfolio to manage equity risk in a cost effective and customized way.”

Cassara explains: “For a plan sponsor holding equities, it is possible to sell off potential upside that it does not expect to need, using call options, and to buy protection against market falls using put options, forming a ‘collar’ on equity returns. Using put and call options in this way can allow a plan sponsor to hold more growth assets for longer while still reducing risk.”

Cassara says that reaction to this approach from River and Mercantile’s pension plan clients has been favorable. “They appreciate having that extra layer of risk diversification and that our approach to each pension plan is custom fit,” he says.

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