Possible Rough Waters Ahead for the SECURE Act Safe Harbor

By: Mitch Shames

Litigation storm clouds threaten the safe harbor in the Secure Act regarding the selection of annuity providers for retirement income benefits. The recently filed law suits against AT&T and Lockheed Martin set out detailed arguments challenging annuity provider selection in the context of a pension de-risking transaction. A central argument to the broader claim for relief is that the price of an annuity contract bears a material relationship to the credit quality of the issuers. This position could one day overwhelm the legislative safe harbor in the Secure Act. Fiduciaries are well advised to understand the undercurrents at play in the selection of annuity providers.

The safe harbor reflected in the Secure Act was designed to address the deeply held concern that plan fiduciaries would hesitate, if not refuse, to adopt retirement income solutions if they were potentially on the fiduciary hook for making decisions about the credit quality and financial condition of annuity providers. 

Effectively, the safe harbor, requires that annuity issuers provide annual disclosures and certifications as to the issuers financial condition. Plan fiduciaries will be able to rely upon these certifications in order to meet their obligations in determining that an issuer is financially capable of satisfying its obligations under an annuity contract. Presumably,  in the event that an annuity provider misses any scheduled payments due to financial hardship or bankruptcy, the plan sponsor likely would be protected against any claims of breach of fiduciary duty which question the financial health of the issuer.

The Safe Harbor offers real protection for plan fiduciaries.

However, while the Safe Harbor addresses the credit quality of the issuer, it doesn’t cover other factors that fiduciaries will need to review and approve related to retirement income products, namely the terms and price of any annuity contracts. Fiduciaries must determine that the price and terms of an annuity contract are reasonable. 

Given the arguments set forth in the AT&T and Lockheed Martin cases that there are correlations between price and credit quality, it would appear that any analysis of price will have to take into account the credit quality of the issuer. At a minimum, a fiduciary would have to determine that the price paid for a particular annuity reflects the solvency risk of the issuer. Otherwise, how else does one analyze the price of an annuity?

In the context of de-risking transactions, and after the bankruptcy of Executive Life in 1991, the Department of Labor has been quite clear regarding the correlation of annuity pricing with credit quality of the issuer when it released  Interpretative Bulletin 95-1. The IB sets out a process by which independent fiduciaries must analyze various factors related to the price and credit quality of an issuer BEFORE selecting “the best available annuity” on behalf of a plan.

In the AT&T case, the plaintiff’s complaint follows the logic of IB 95-1, arguing that the fiduciaries selected less expensive annuity contracts issued by riskier insurance companies; “AT&T’s securities filings reveal that it paid Athene an unusually low percentage of the value of the pension benefits being transferred.” Paragraph 97, AT&T, Plaintiff’s brief.   In other words, plaintiff’s counsel is very quick to assert that there is a correlation between credit quality of the issuer and the price of the annuity contract, and fiduciaries MUST weigh the balance between price and credit quality. 

Back to the Secure Act. As explained above, the Secure Act requires that fiduciaries analyze the price of the annuity contract. Whether one turns to IB 95-1 or the arguments of the plaintiff’s in the AT&T and Lockheed Martin cases, it appears that any analysis of the pricing of an annuity contract would need to factor in the credit quality of the issuer. Not all insurance are companies are the same. 

To be fair, IB 95-1 requires that a fiduciary select that “safest available annuity”. This high standard does not apply to annuity purchases related to retirement income products.  Nonetheless, the IB and the current litigation assume that there is a correlation between annuity prices and credit quality. For a fiduciary simply to ignore this potential correlation seems unduly risky.

One thing that is fairly certain, if we look out 10 years and a well funded retirement solution annuity goes bankrupt, I can imagine that the plaintiff’s lawyers will turn back to this fundamental principle that price and credit quality are correlated. At that point, a defendant who has relied exclusively on the safe harbor and has analyzed price with no consideration of credit quality will be forced to argue that there is no correlation between price and credit quality. I suspect that is not a great argument to make.

And, let’s not overlook the obvious, once a plan is in litigation, the battle is already lost.  The goal, years in advance, is to insulate the plan, and the fiduciaries from potential litigation liabilities. Litigation is expensive and time consuming.

I’m not at all suggesting that the Safe Harbor is worthless. No, it is very important protection.

However, best practices, and a deep understanding of these products, the regulatory positions, and litigation, strongly suggest that any fiduciary reviewing retirement plans solutions should include some type of review or analysis of the credit quality of the issuer.  The analysis certainly can start with the data provided by the issuer in compliance with the safe harbor.  Turning to the standards of IB 95-1, an analysis also might include some or all of the following:

  • 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 availability of additional protection through state guaranty associations and the extent of their guarantees;
  • Agency ratings; and
  • Analysis by, and consultation with, independent consultants.

Serving as a fiduciary is essentially a belts-and-suspenders process. Prudence demands a standard of care that goes above a minimum level of analysis. Furthermore, prudence also requires a creative understanding of potential new theories of liability; connecting the dots in ways that might not be obvious. In order to avoid litigation, and if required mount an effective defense, any fiduciary hired to assist in the review and selection of retirement income products should have a sophisticated understanding of the relationship between pricing and credit quality and should followed procedures reflecting this correlation. Blind reliance on the safe harbor should be avoided.

Once the squalls of litigation descend upon the safe harbor of the credit quality of the issuer, it’s too late to engage in a deep dive on credit quality of an issuer in default.

If you are interested please reach out to us. We love to brainstorm around these issues and we’d be happy to connect with you!



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