“Do not put all your eggs in the same basket,” or diversification, is one of the most important investment principles. Many annuities used in retirement plans such as fixed, index, and lifetime annuities in 401k type plans, have single-entity credit and liquidity risk. Many plans avoid annuities, but for those who do the risk could be mitigated by downgrade clauses or purchasing credit default swaps.
Harry Markowitz’s landmark 1952 paper, “Portfolio Selection,” established the foundation of modern portfolio theory: portfolio risk depends on how investments move together, as well as the risks of individual holdings. Combining investments with imperfectly correlated returns can reduce portfolio risk. Merely accumulating more securities offers less protection when they share the same underlying vulnerabilities. traders.berkeley.edu
ERISA §404(a)(1)(C) requires fiduciaries to diversify plan investments to minimize the risk of large losses, unless circumstances make foregoing diversification clearly prudent.
For fixed income investors, that principle has a practical application: spread exposure across independent issuers so that one company’s financial trouble cannot devastate the portfolio.
An annuity issued by a single insurer can concentrate participants’ retirement savings in one company’s ability to honor its promises. Executive Life’s failure and AIG’s need for an extraordinary federal rescue demonstrate why an insurance guarantee cannot substitute for evaluating credit and liquidity risk. Insurer distress could expose participants to payment delays, withdrawal restrictions, and/or losses. Plan fiduciaries who fail to prudently evaluate and monitor that concentration, assess exit rights, and document the justification for accepting the risk can increase their exposure to ERISA liability for resulting losses.
A downgrade clause would give a retirement plan a practical way to reduce single-insurer risk when the insurer’s financial strength deteriorates. For example, a plan could require an insurer to meet a specified AA financial-strength rating at purchase, with an enforceable right to withdraw the full contract value—including accrued interest—if its rating falls to A. The plan could then transfer the proceeds to another insurer meeting its AA standard, following appropriate due diligence. The principle is straightforward: participants should not become captive creditors of a weakening insurer because leaving would trigger a financial penalty. Downgrade clauses are not regularly offered in annuities because they are lest profitable to the insurer. The difference in costs or yield so annuities with and without downgrade clauses could be used as a way to measure risk related damages.
Credit default swaps offer another potential way to reduce an annuity’s single-insurer credit risk. A $100 million Lincoln fixed-annuity allocation illustrates why single-insurer risk should receive a dollar valuation. Applying the historical 97.8-basis-point Lincoln CDS spread reported for September 2025 produces an annual credit-protection cost equivalent of $978,000—approximately $4.89 million over five years before adjustments. That figure is a starting point for valuing the exposure participants bear. A damages estimate would refine it for the actual annuity issuer and contract, subtract the residual risk of the prudent alternative, and credit any additional compensation participants received. The absence of an insurer failure does not make the exposure economically worthless; it means the analysis must value the contractual risk rather than simply count unpaid benefits.
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