Trustees of pension plans cannot take a break. Their responsibilities and personal risks continue to increase. Pressure is mounting on all fronts: regulatory, litigation, demand from participants.
The recent Supreme Court decision in Hughes v. Northwestern will no doubt embolden plaintiff’s attorneys. Inflation has reached rates not seen in 40 years, potentially undermining investment policy statements and product lines. Recent regulatory activity from the Department of Labor includes: a U-turn in its stance on ESG, an aggressive cybersecurity initiative, and a stern warning about cryptocurrencies. And, now, plan participants are calling for lifetime income options in 401(k) plans that push plan trustees into the new world of annuity contracts.
Plan trustees have always had to keep pace with innovations in the evolution of investment products and asset classes. At first, they focused their attention on traditional equity and fixed income strategies, either in index or active mandates. However, as investment offerings became more sophisticated, over time trustees developed the necessary expertise in alternative asset classes such as real estate, private equity, venture capital and hedge funds. Think about it, that’s a huge body of expertise to take in.
Historically, and due to regulations and industry practices, annuity contracts have been widely sold outside the confines of company pension plans. Generally, plan participants would receive plan distributions, in whole or in part, and purchase annuity contracts. Given these models, trustees never had to develop expertise in annuity contracts. All of this is changing.
With the proliferation of target date funds, many of the larger investment managers are incorporating annuity life income options into their products. State Street Global Advisors, Vanguard, BlackRock, TIAA and Fidelity have all introduced elements of lifetime income products to their retirement investment lines. There is a huge financial incentive to keep assets “within the plan”. These new products are forcing plan trustees to consider products that weren’t on their radar screen. Plan trustees have little experience or knowledge in the technical and mysterious world of annuity contracts.
While insurance companies have made efforts over the years to introduce variable annuity products into the retirement plan ecosystem, mutual fund companies have achieved large-scale hegemony among qualified plans. The introduction of annuity products in term funds is a major initiative for the insurance industry. Driven by demand from plan members, target date funds are the largest AND fastest growing plan option. Incorporating lifetime income products into term funds will give insurance companies a long-sought beachhead in the retirement industry. And it will provide them with direct access to what is now well over a $3 trillion market.
Incorporating life annuity features into term funds will require plan trustees to adopt a whole new level of expertise; as if they didn’t have enough on their plate!
Most investment products (including alternative asset classes) are offered to pension plans as a form of investment security, some listed, some not. Well-established analytical tools and principles have been developed over decades so that trustees can assess the performance and suitability of each of these investment products.
However, annuity contracts are not investment securities. Rather, they are individually negotiated contracts between an insurance company and the annuitant. Although annuities generally fall into particular generic categories (deferred, immediate, and lifetime guaranteed withdrawal), the amount of variation between contracts can be staggering. While securities (and the companies that issue, offer, or underwrite the instruments) are governed by federal securities laws and regulated by the Securities and Exchange Commission, insurance companies and the contracts they enter into are state-governed – 50 different regulators and regulators. straight. Again, the variety can be staggering. This is the world into which trustees of pension plans are forced.
To be specific, when a plan trustee selects a target date fund that includes a lifetime income option, the trustee will essentially select and approve the annuity contract underlying the lifetime income feature. Although the plan trustee may think he is off the hook because the fund sponsor has chosen the annuity provider, the annuity is an essential part of the target date fund. Therefore, just as the plan fiduciary must be a careful expert in glide path analysis (another important feature of a target date fund), the plan fiduciary will also need to be a careful expert in choosing of the pension. It’s quite a large order. Pension plan trustees have been warned.
Annuity contracts may be the last straw in the fragile fiduciary infrastructure employed by plan sponsors under ERISA. When ERISA was adopted in 1974, the investment landscape was much simpler than it is today. In fact, the selection of index funds in the early 1980s seems downright primitive compared to the vast array of investment products currently available to pension plans. Most plan trustees take their responsibilities seriously and want to do the best job possible. As the financial arena has become more complex and sophisticated, the burden placed on them may have become too heavy.
Unfortunately, if this assumption turns out to be true, the losses will be significant. And let’s remember that nothing less than American retirement savings is at stake.
mitch ashamed is Founder & Manager at Trustee Harrison.