With the rise of defined benefit (DB) pension plan annuity purchases over the last five years, plan fiduciaries need to understand their obligations and where things can potentially go wrong. Pension plan annuity purchases continue to be a popular de-risking strategy for plan sponsors. Moreover, many plan sponsors are making progress regarding their frozen pension plans and terminating them altogether—culminating in an annuity purchase.

Fiduciaries are required to act in the best interest of plan participants. Selecting an insurer to provide all future benefits for participants is typically the last fiduciary decision made with respect to those in a qualified pension plan. So what is involved?

DOL 95-1

In 1995, the Department of Labor (DOL) published Interpretive Bulletin (IB) 95-1, which “provides guidance concerning certain fiduciary standards … applicable to the selection of an annuity provider for the purpose of benefit distributions from a defined benefit plan … when the plan intends to transfer liability for benefits to an annuity provider.” Plan fiduciaries must act in the best interest of plan participants in selecting the insurer that can supply the “safest annuity available.” DOL 95-1 also requires that plan fiduciaries “conduct an objective, thorough and analytical search, for the purpose of identifying and selecting providers from which to purchase annuities.”

Specifically, DOL 95-1 lists six criteria that must be analyzed:

• The quality and diversification of the annuity provider’s investment portfolio;
• The size of the insurer relative to the proposed contract;
• The level of the insurer’s capital and surplus;
• The lines of business of the annuity provider and other indications of an insurer’s exposure to liability;
• The structure of the annuity contract and guarantees supporting the annuities, such as the use of separate accounts; and
• The availability of additional protection through state guaranty associations and the extent of their guaranties.

These criteria are just the minimum standard. Further items such as the provider’s risk management and administrative capabilities should be reviewed.

DOL 95-1 goes on to state, “Unless they possess the necessary expertise to evaluate such factors, fiduciaries would need to obtain the advice of a qualified, independent expert. A fiduciary may conclude, after conducting an appropriate search, that more than one annuity provider is able to offer the safest annuity available.”

Qualified, Independent Experts

When hiring a “qualified, independent expert,” plan fiduciaries need to understand what that service provider will supply, as not all such providers approach pension plan annuity purchases in the same way. Sponsors should evaluate how candidates measure up in the following areas:

Fiduciary status. First and foremost, sponsors need to ask whether the service provider is taking on fiduciary responsibility. If he is not, or is unwilling to accept that role in writing, that may be a non-starter. If he will accept fiduciary responsibility for the advice he gives, plan sponsors need to dig a little deeper. Specifically, they need to learn what type of insurance, bond or financial backing is behind his fiduciary claim. Even service providers with considerable experience may not have the balance sheet, or liability insurance, backing their fiduciary status; plan sponsors should at least have an understanding of those two backstops.

Documentation. Plan sponsors also need to understand the deliverable the service provider will supply. Will it be a one-page list of the insurers that meet the DOL 95-1 criteria or something that details out the specifics? A good report will include robust documentation of the underlying analysis. There is considerable variety in what service providers deliver in this space, and plan sponsors need to be comfortable that the documentation they receive will stand the test of time.

The bid process. Plan sponsors will also want to understand how their service provider approaches the bid process. This is a gray area, and different firms view the fiduciary responsibility differently. For example, some firms consider the actual annuity placement to be a settlor function and therefore the service provider running the placement is exempt of any fiduciary responsibility. On the other hand, some firms consider the bid process to also be a fiduciary responsibility because the end result is advice on the disposition of assets from a qualified plan.

What Plan Sponsors Need To Do

Making the critical decision of placing pension benefits with an insurer carries substantial fiduciary weight. In making this decision, plan sponsors and their fiduciary committees need to ensure that they:

• Hire qualified, independent experts with a meaningful understanding of their fiduciary role;
• Obtain robust documentation of the process by which the independent expert qualified insurers as offering the “safest available annuity” that will stand the test of time; and,
• Understand how their service provider views—or doesn’t view—its fiduciary responsibility with respect to the actual bid process for selecting an insurer.

Following a prudent process with participants’ best interests at heart will give plan sponsors meaningful comfort that they have fulfilled their fiduciary responsibilities in this last and final fiduciary decision for their pension plan participants.

Michael Clark is a managing director and consulting actuary in River and Mercantile’s Denver office, and is the 2019-2020 President of the Conference of Consulting Actuaries.