Our (Chris Tobe, CFA,CAIA & James Watkins Esq) summary of our testimony from July 24 on QDIAs in 401ks to the ERISA Advisory Council was released. Of the many witnesses I believe Jim and I urged the most caution and emphasized the need for transparency. You can read the full reports at https://www.dol.gov/sites/dolgov/files/EBSA/about-ebsa/about-us/erisa-advisory-council/2024-qdia.pdf https://www.psca.org/news/psca-news/2025/5/full-qdia-report-released-by-erisa-advisory-council/

Our portion is below –

 Investment Fiduciaries James Watkins and Chris Tobe 

James Watkins is an attorney with Invest Sense LLC. His current practice provides forensic fiduciary audits for plans and other trustees. Chris Tobe is the Chief Investment Officer for the Hackett Robertson Tobe Group. He works as a consultant to retirement plans and serves as a litigation consultant.

Mr. Watkins stated there are three cases that he refers to as the “responsibility trinity,” that defines the area of fiduciary responsibility right now: 1. Tibble v. Edison – recognized the Restatement of Trusts (Restatement) as a legitimate resource in resolving fiduciary issues and ruled that a plan sponsor has an ongoing fiduciary duty to monitor plan investment options for prudence 2. Hughes v. Northwestern – ruled that a plan sponsor has a fiduciary duty to ensure that each investment option within a plan is prudent and to remove any that are not 3. Brotherston v. Putnam – ruled that comparable index funds can be used for benchmarking purposes, citing Section 100 b(1) of the Restatement, that index funds are proper comparators Mr. Watkins stressed that he is a big proponent of cost benefit analysis and believes the math is not that hard to do, especially as it is being used to determine whether an investment is in the best interest of a participant. Mr. Watkins stated that the industry does not support his focus on cost benefit analysis given studies that show the majority of actively managed funds are not cost efficient.

   Regarding annuities within a QDIA, Mr. Watkins noted that he most often is asked by the plan sponsor considering an in-plan annuity solution whether a participant can get out of it, and if so, how. Mr. Watkins’s understanding is the only way a participant can get out of an annuity without harsh tax penalties is to do a 1035 exchange (a tax-free exchange of an existing annuity contract, life insurance policy, or endowment for another of like kind). Mr. Watkins stated that he is aware of a lot of annuity providers trying to embed annuities into target date funds within qualified plans. He suggested that this raises the question about the 50 feasibility of a 1035 exchange in a qualified plan, and whether it is the only way you can make this move or can a participant make an exchange from a like product to another like product.

  Mr. Watkins thinks that enhanced disclosures should be provided to participants with the appropriate information to ensure that they understand the annuity product, which should include the conditions for them to “break even” and how that would work if they were to surrender the annuity contract. Mr. Watkins stated that, if annuities are embedded in QDIAs, there needs to be much more meaningful, clear, and simple disclosures provided to enable the participant to make an informed decision and comply with IRC section 404(c). Mr. Watkins concluded by stating he does not believe annuities should be offered in a plan nor specifically in a QDIA. If ERISA does not require that a plan offer guaranteed income products or annuities, he does not see a reason to do so. His biggest concern is that once a participant is in an annuity, they lose control and are locked in. Mr. Watkins was asked if he has seen any ERISA 3(38) fiduciaries (those who have the authority to buy and sell assets, make strategic decisions, and otherwise handle all aspects of account investing) implementing annuity solutions in collective investment trusts or in unregistered products. He indicated that many plan sponsors are encountering products embedded in collective investment trusts and a lot of proprietary products. He believes that collective investment trusts are not transparent enough and participants do not understand or have access to information, as they would in a mutual fund that posts information in a newspaper or Morningstar. He stated that collective investment trusts typically do not publicly publish their performance results or their fees.

  Mr. Tobe began his testimony by stating that target date funds hold 50% of all 401(k) assets and thinks they deserve more fiduciary oversight by regulatory agencies. Historically, TDFs have been primarily offered in mutual funds registered with the Securities and Exchange Commission (“SEC”), but the trend is that more target date assets are flowing into weakly regulated state collective investment trusts. The SEC does not allow investments in annuities, crypto currency, and private equity, for example, in mutual funds. By contrast, state-governed collective investment trusts do permit these types of investments, and do not offer the same level of disclosures and transparency as mutual funds. They also have lower capital requirements as well. 51 Mr. Tobe suggested the Council should examine federally-regulated investment vehicles being used as they are more transparent. He believes that collective investment trusts should become federally-regulated rather than being regulated at a state level. He noted that there are some collective investment trusts that are superior to mutual funds because they are “clones of a mutual fund” but have lower fees.

    In his opinion, the collective investment trusts being offered by insurance companies are deploying illiquid investments (annuities, private equity). He stated that this is just a way to get highpriced annuities into the mainstream target date fund solutions. He raised concerns that there are no requirements for the insurance companies to disclose interest spreads, and that there is no transparency into the revenue that the insurance companies are earning. Mr. Tobe believes that QDIAs should be held to the highest standard, that all investments should be held to the highest federal standards, such as compliance with Global Investment Performance Standards, and that the Department should be pushing for more transparency for collective investment trusts. Mr. Tobe testified that he would not recommend annuities, private equity or crypto currency in any DC plan or embedded in a QDIA as those investments are too expensive and risky right now. When asked how participants should protect themselves from market volatility, Mr. Tobe suggested that a participant should move into the lowest risk target date fund; annuities bear embedded risks that are not readily transparent to the holder. He believes that annuities could be downgraded and that insurance companies have high default risk that translates to high risk for that component of a participants’ investment. He stated that the risks for partial annuitization are the same until there is more transparency and information on annuities.

Mr. Watkins stated that a lot of the concerns could be addressed if the insurance companies could guarantee that annuities could provide a commensurate return, but historically that has been very expensive.

  Some Council members noted this was inconsistent with their professional experience and 52 suggested it should be researched further. Members of Council also questioned the witnesses’ opinions regarding the insurance companies default risks, noting that historical failure of insurance companies has been very low and less than 0.03%.

When asked where they would want to see changes that would provide them with comfort with the annuity products, Mr. Tobe suggested federal regulations that oversee the insurance agencies, coordinated in partnership with the Department for ERISA-based assets. When asked what level of fees and risk would satisfy the witnesses that a product is worthwhile, Mr. Watkins responded that the issuer would need to provide a cost benefit analysis that shows the return and guarantee. Mr. Tobe also offered a detailed example of how to diversify over 4 to 5 insurance companies to minimize the default risk and use synthetic stable value-like solutions for annuities to keep the fees low.   

   When asked if defined contribution plans should only use mutual funds due to their greater transparency, Mr. Tobe replied no and that he would rather see greater transparency requirements for collective investment trusts.