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January 2013
Dear Reader: The Drinker Biddle Retirement Income Team brings together seasoned lawyers with diverse talents in multiple practice areas, including employee benefits, investment management, securities, insurance, income taxation and government relations, to provide one source to which financial services companies and plan sponsors can look for help in resolving complex legal issues that impact the design and sales of retirement income products and their selection for use in defined contribution plans. This is our second newsletter, which addresses legal issues faced by retirement industry service providers insurance companies, mutual funds, banks and trust companies, investment advisers, broker-dealers, thirdparty administrators and record-keepers as well as by plan sponsors and fiduciaries. Our newsletters aim to provide timely A Most Influential Individual and valuable information regarding recent or expected regulatory On January 3, 2013 RIABiz named Fred developments and industry trends.
Reish one of the 10 most influential individuals in the 401(k) business: Fred Reish is one of the most authoritative and knowledgeable leaders about any aspect of retirement plans. Congratulations, Fred!
For additional information about the Retirement Income Team and legal, regulatory and other issues affecting retirement income products and services, please visit our website at http://www. drinkerbiddle.com/services/practices/investmentmanagement/retirement-income-team. To sign up for other Retirement Income Team publications and updates please send an email communication to DrinkerBiddle.Investment.Management@dbr.com. John Blouch Chair, Retirement Income Team John.Blouch@dbr.com (202) 230-5420
In This Issue
Page
2 ERISA Considerations in the Sale of Individual Annuity Contracts to Plans 3 Insurance Companies Take Steps to Reduce Their Risks Under Guarantees in Outstanding Variable Contracts 5 Applying the Qualified Joint and Survivor Annuity Requirements to GMWBs 6 Proposed IRS Guidance Would Facilitate Partial Annuity Distributions from Pension Plans, but Raises Concerns for Some Plan Sponsors 7 Projections of Retirement Income 9 Around the Firm
The Retirement Income Team can be most effective by focusing on the issues, developments and trends that impact you. Please let me or any other member of the team know if there is a matter relating to retirement income products or services that is of particular interest to you or if you have any comment or question regarding the information in our newsletters or on our website.
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of the 408(b)(2) regulation. That is, it is the issuance of a product and not the provision of a covered service. However, there are other issues for insurance companies. For example, most annuity contracts designed for the individual market contain provisions that are permissible under the insurance laws but create fiduciary issues for insurance companies when the contracts are held in ERISA retirement plans. That is because of the convergence of two fundamental ERISA concepts. First, an asset held within an ERISA plan is a plan asset and, thus, is subject to ERISAs fiduciary and prohibited transaction rules. Second, the exercise of discretionary control over a plan asset may give rise to a fiduciary status, e.g., for the insurance company. (Unfortunately, that can occur even if the insurance company had not focused on the fact that the contract was owned by an ERISA plan.) From an ERISA perspective, discretionary control can result from the ability of an insurance company to affect the terms of the individual annuity contract. That could include, for example, a provision that permits the insurance company to amend the terms of the annuity contract unilaterally. (Note that there is guidance that permits limited amendment rights if certain procedures are followed.) If an insurance company has broad discretion to amend an annuity contract or a particular provision of an annuity contract (that is, affect the value of a plan asset), the insurance company may become a fiduciary for that purpose. (Note that ERISA requires that a fiduciary exercise its discretion in the best interest of the plan participants.) Furthermore, if an insurance company exercises its discretionary amendment rights, or any other discretionary rights under the contract, for its own interest, there is a risk that the insurance company could have engaged in a prohibited transaction as well as a fiduciary breach. That could result in the insurance company being required to restore any losses or other amounts involved to the plan, together with interest and penalties. What should insurance companies and brokers do with this information? I am not suggesting that the sale of individual annuity contracts to ERISA plans should be avoided, but instead that contracts should be designed, and the sales process undertaken, with ERISA in mind. Fred Reish is a partner in the firms Employee Benefits & Executive Compensation Practice Group, Chair of the Financial Services ERISA Team and a member of the Retirement Income Team. His practice focuses on fiduciary issues, prohibited transactions, tax-qualification and retirement income. He represents plans, employers and fiduciaries before the governing agencies (e.g., the IRS and the DOL); consults
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Insurance Companies Take Steps to Reduce Their Risks Under Guarantees in Outstanding Variable Contracts
By Bruce W. Dunne (202) 230-5425 Bruce.Dunne@dbr.com
The 2008-2009 financial crisis, ongoing market volatility and persistently low interest rates have significantly increased the risks and costs to insurance companies of the lifetime income guarantee provisions in their variable annuity contracts. Insurance companies have responded in a number of ways. Some have exited the variable annuity market altogether. Others have redesigned the products they offer by reducing guarantee rates, increasing fees, limiting available investment options and/or tightening asset allocation programs. A few have taken steps recently to reduce their risks under outstanding contracts by: refusing to accept additional purchase payments from existing contract holders;1 offering incentive payments to terminate lifetime income riders or exchange into new contracts with less generous benefits;2 or offering to buy-out contracts in exchange for an enhanced surrender value.3
Suitability
Sales of variable annuity contracts are subject to Financial Industry Regulatory Authority (FINRA) Rule 2111, the general suitability rule, and FINRA Rule 2330, which applies specifically to sales and exchanges of variable annuities. Rule 2330 requires that a selling broker-dealer have a reasonable basis to believe that the customer has been informed of, and would benefit from, the various contract features, and that the particular contract as a whole (including any riders) is suitable for the particular customer. In the case of a contract exchange, the suitability determination must also take into account whether the customer would incur surrender charges, be subject to a new surrender period or increased fees or charges or lose existing benefits, and whether the customer would benefit from product enhancements and improvements in the new contract. The SEC staff has stated that offers to exchange existing contracts for newer contracts offering less generous benefits, as well as offering incentive payments for the surrender of a contract or the termination of guaranteed benefit riders, raise suitability questions. Susan Nash, the Associate Director of the Division, has pointed
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Disclosure
Before pursuing one of the strategies, a company should consider the potential impact of the presence or absence in its current prospectus of disclosures regarding the risk that it might, under future market or other conditions, cease accepting purchase payments or offer contract holders incentives to surrender certain benefits. Recent specific disclosures in 1933 Act filings regarding the strategies have included: why an offer to terminate a guaranteed benefit rider is being made (e.g., high market volatility, declines in the equity markets and the low interest rate environments make continuing to provide the [guarantee] costly to us); the manner in which an incentive amount will be calculated (including examples); how a contract holder should evaluate an offer and the factors to be considered (including circumstances under which the offer should not be accepted); and how an offer may benefit both the insurer and the contract holder (e.g., the insurer would benefit financially because it would no longer incur the cost of maintaining expensive reserves for the guarantees, and the contract holder would benefit by receiving an increase in the surrender value of the contract and by reduced fees under the contract).
Conclusion
An insurer that wishes to take steps to reduce the risks of the lifetime income guarantees under its outstanding variable annuity contracts should consider whether its proposed course of action is permissible under the terms of the contracts, the impact of disclosures in its existing prospectuses, the new disclosures that will be required and the suitability and other compliance issues that may arise under the federal securities laws. In addition, if the insurer has sold the contract to retirement plans, it should also consider the ERISA issues addressed in the accompanying article by Fred Reish. Bruce Dunne is of counsel to the firms Investment Management Practice Group and a member of the Retirement Income Team. He focuses his practice on the registration, reporting, exemptive and other provisions of the federal securities laws, with emphasis on their application to investment companies, including retail and variable insurance products mutual funds, insurance company separate accounts and private investment funds, and to investment advisers.
See Prudential Annuities Life Assurance Corporation Variable Account B, Prospectus Supplement dated Aug. 23, 2012 (Restrictions on Additional Purchase Payments) (File No. 333-152411). 2 See Separate Account VA B of TransAmerica Life Insurance Company, Post-Effective Amendment No. 41 (filed Feb. 24, 2012) (File No. 33-56908). 3 See Hartford Life Insurance Company Separate Account Three, Prospectus Supplement dated Dec. 28, 2012, (Enhanced Surrender Value Offer for Eligible Contracts with the Lifetime Income Builder II Rider (filed Nov. 1. 2012) (File No. 333-119414). 4 Norm Champ, Director, Division of Investment Management, SEC, Remarks to the ALI-CLE Conference on Life Insurance Products (Nov. 1, 2012). The Director also indicated SEC staff concern whether particular actions, such as refusing additional purchase payments, are permitted under the terms of the applicable contract. 5 See note 1 above. 6 See notes 2 and 3 above. 7 Susan Nash, Associate Director, Division of Investment Management, SEC, Remarks to the IRI 2012 Government and Regulatory Affairs Conference (Jun. 26, 2012). 8 See note 4 above.
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Exchange Offers
An offer to exchange a registered variable annuity contract for another such contract issued by the same or an affiliated insurance company is subject to Section 11 of the 1940 Act. Under Section 11, which
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and if he dies before the funds run out, there is no residue left for his beneficiaries. Of course, if he outlives his life expectancy, he continues to be paid. In contrast, in the case of a GMWB, when a participant purchases a GMWB guarantee, he pays a smaller premium, retains control over the funds in his account and, when he retires, withdraws his own funds from his account. There are restrictions on how the funds must be invested and how much the retiree may withdraw each year. If the retiree dies before the funds run out, the balance goes to his beneficiaries, and the insurance company pays nothing. In this sense, the GMWB guarantee is more akin to disability insurance. That is, under disability insurance, payments are made by the insurance company only upon the happening of the covered event which is also the case under the GMWB guarantee. So how does this impact the QJSA analysis? To the extent the IRS has looked at the issue, it has done so in private letter rulings (PLRs). PLRs may be relied on only by the individual taxpayer to whom they are issued and do not constitute legally binding precedent for other taxpayers. That said, PLRs often reflect the thinking of the IRS on key issues but cannot be considered authoritative guidance. In the case of GMWBs, the IRS has said in one PLR that the annuity starting date is the date when a participant begins to take systematic withdrawals. If those withdrawals begin while the participants benefit remains in the plan, then according to the IRS position in this PLR the participant must take distributions under the joint and survivor requirements of the GMWB feature unless his spouse consents to a different form of distribution. Consider, for example, a GMWB that permits distributions at 5 percent of the benefit base on a life only basis and 4.5 percent on a joint and survivor basis. If the IRS position in this PLR were to be applied, the practical impact would appear to be that the participant must take distributions at 4.5 percent absent spousal consent. This requirement would only apply to the affected participant and not to the entire plan. Suppose, however, that the participant rolls his entire account balance, including the GMWB guarantee, to an IRA before beginning systematic withdrawals. The IRS position suggests that the QJSA rules do not apply to IRAs. Thus, in the case of a rollover, there is no annuity starting date so there is no requirement for the spouse to consent to the lump sum distribution to the IRA. And thereafter, the retiree is able to withdraw funds without requiring spousal consent.
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Proposed IRS Guidance Would Facilitate Partial Annuity Distributions from Pension Plans, but Raises Concerns for Some Plan Sponsors
By Joshua J. Waldbeser (312) 569-1317 Joshua.Waldbeser@dbr.com
When employees covered under a defined benefit pension plan retire, they may be faced with an unenviable choice if the plan allows participants to elect either a lump sum
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Disclaimer Required by IRS Rules of Practice: Any discussion of tax matters contained herein is not intended or written to be used, and cannot be used, for the purpose of avoiding any penalties that may be imposed under Federal tax laws.