The October 2025 Bank for International Settlements (BIS) report, ‘The Transformation of the Life Insurance Industry: Systemic Risks and Policy Challenges,’ provides authoritative evidence that strengthens the arguments made in my recent article on Commonsense401kProject regarding offshore private credit causing increased risk in retirement products backed by Insurance Company General Accounts. The findings demonstrate how structural changes in the life insurance and private equity sectors reinforce ERISA prohibited-transaction concerns. [BIS (2025), pp. 1–3] [Tobe, Commonsense401kProject (2025)]
1. BIS Findings with ERISA Implications
The BIS report documents how life insurers, increasingly owned or partnered with private equity, are reshaping their balance sheets with higher allocations to opaque private credit and structured securities. Key findings include:
Private equity acquisitions of insurers have created conflicts of interest, with affiliated managers steering assets into their own private credit deals.
Offshore reinsurance has surged, with U.S. insurers ceding over $2 trillion of reserves by 2023, 40% to Bermuda and Cayman affiliates subject to lighter regulation.
U.S. insurers now allocate roughly 30% of general account assets to corporate debt and 18% to structured securities, many rated internally or opaquely.
Liquidity stresses are rising from surrender spikes and collateral calls on derivatives, forcing insurers into procyclical asset sales.
The Eurovita case shows how a private-equity-owned insurer collapsed in 2023, requiring a ‘surrender holiday’ and taxpayer-backed resolution. [BIS (2025), Box B, p. 15; Reuters (2023)]
3. Why This Reinforces Prohibited Transaction Risks
The BIS findings strengthen three ERISA prohibited transaction arguments:
Party-in-Interest Conflicts – Affiliated transactions between private equity sponsors, insurers, and offshore reinsurers constitute prohibited self-dealing.
Prudence and Reasonableness – Fiduciaries cannot verify valuations or spreads when private ratings and opaque fee structures dominate.
Offshore Arbitrage – By ceding assets to offshore affiliates, fiduciaries place plan money into regulatory regimes with weaker solvency and disclosure standards.
4. Systemic Risk as Fiduciary Breach
The BIS study shows insurers’ systemic risk contribution (measured by SRISK and ΔCoVaR) has risen relative to banks, particularly in North America. As insurers adopt riskier private credit portfolios, ERISA fiduciaries exposing plan participants to these structures cannot argue they are prudent or diversifiable. The systemic nature of the risk means it is embedded in the financial system, not isolated to one plan or product. [BIS (2025), pp. 18–22]
5. Policy and Litigation Implications
This evidence has three main uses:
Litigation: BIS provides an independent, global authority confirming that PE-linked insurer structures create conflicts, opacity, and systemic risks, supporting claims under ERISA §406.
Policy: BIS recommendations—standardized reporting, capital charges, macroprudential oversight—map directly onto ERISA fiduciary requirements for prudence and exclusive benefit.
Advocacy: Regulators and courts should treat offshore PE-insurer structures as per se prohibited transactions unless they disclose spreads, risks, and conflicts transparently.
Conclusion
The BIS report validates and deepens the concerns outlined in our earlier article. Offshore private equity and private credit structures of life insurers are not just opaque—they are riddled with self-dealing, systemic risk, and regulatory arbitrage. These are exactly the types of arrangements that ERISA’s prohibited transaction rules were designed to prevent. For fiduciaries, the message is clear: reliance on these products is not only imprudent but may be per se unlawful.
UPDATE November 6 2025: Insurers use small ratings agencies to get favorable ratings on Private Credit. The SEC is investigating Egan-Jones for this Practice. Egan Jones has only 20 analysts rating over 5000 different issues. https://www.bloomberg.com/news/articles/2025-11-06/egan-jones-probed-by-sec-over-its-credit-ratings-practices Bloomberg Analysis of NAIC shows that capital charges for AA- rated issues is half of what an A rating is so the incentive in $billions is to inflate ratings.
Private equity has long been marketed to U.S. retirement plans as a source of diversification and “illiquidity premium.” But for ERISA fiduciaries, private equity contracts are not simply another asset class; they are contracts structured to evade transparency, domiciled in offshore havens, and riddled with conflicts. Unlike mutual funds or collective investment trusts (CITs) subject to SEC or OCC oversight, private equity partnerships are bespoke, one-sided agreements with managers and affiliates who extract hidden fees and indemnify themselves against liability.
II. ERISA’s Fiduciary and Prohibited Transaction Framework
ERISA imposes the highest fiduciary standard in U.S. law. Fiduciaries must act solely in participants’ interests, with the prudence of an expert, and for the exclusive benefit of plan participants (29 U.S.C. §1104(a)(1)). The statute also flatly prohibits certain transactions: deals with “parties in interest” (29 U.S.C. §1106(a)) and self-dealing by fiduciaries (29 U.S.C. §1106(b)). Once triggered, they are per se violations unless the fiduciary demonstrates an exemption under §408, and under Cunningham v. Cornell Univ. the burden rests with fiduciaries.
III. Offshore Domiciles and Regulatory Arbitrage
Most private equity funds are domiciled offshore — Cayman Islands, Luxembourg, or Jersey — or structured in Delaware partnerships. These domiciles provide tax and secrecy advantages to managers while obscuring risks and fees from investors. Trustees at Kentucky TRS admitted they could not even disclose which offshore jurisdictions were used for their private equity allocations, illustrating how these structures undermine fiduciary transparency.
IV. The “25% ERISA Exemption” and Its Abuse
Under the DOL’s plan asset regulation, if less than 25% of a fund’s investors are ERISA plans, the fund is exempt from ERISA’s fiduciary standards. This loophole allows private equity managers to deliberately structure investor pools to avoid ERISA oversight, commingling ERISA assets in vehicles designed to evade fiduciary duties. Fiduciaries allocating into these structures are still liable for knowingly participating in prohibited transactions.
V. Hidden Fees, Four Sets of Books, and Conflicts
Private equity funds extract multiple layers of fees: management fees, carried interest, monitoring and transaction fees, and financing spreads on affiliated debt. Managers often maintain multiple sets of records for tax, investors, and regulators. Independent research by Phalippou and others shows that all-in costs exceed 600 basis points annually. This far surpasses index fund costs of 3–10 basis points and violates ERISA’s requirement that expenses be reasonable.
VI. Friends and Family Side Letters
Side letters grant favored investors preferential disclosure, liquidity, or fee terms. ERISA plans are rarely among the favored class. Instead, insiders profit at the expense of plan participants. Offering documents often warn that these selective disclosure practices may violate applicable law. Under ERISA, they are transfers of plan value to other investors without adequate consideration — a prohibited transaction.
VII. Illiquidity and Monitoring Failures
Private equity contracts bind fiduciaries for 7–12 years with little or no exit rights. Valuations are controlled by the GP, preventing fiduciaries from independently monitoring prudence as required by Tibble v. Edison. Secondary sales are restricted and discounted, leaving fiduciaries unable to act if investments become imprudent.
VIII. Why Private Equity is a Prohibited Transaction
Bringing the evidence together: 1. GPs and affiliates are parties in interest, receiving compensation directly and indirectly. 2. Waivers of fiduciary duty and indemnification clauses create textbook self-dealing. 3. Side letters transfer value away from ERISA investors. 4. Offshore domiciles and 25% exemptions are deliberate attempts to evade oversight. 5. Illiquidity and opaque accounting make prudence and monitoring impossible.
Therefore, private equity contracts are per se prohibited transactions unless an exemption applies, and fiduciaries bear the burden of proof. No credible exemption exists.
IX. Policy Implications
Allowing private equity in 401(k)s undermines participant protections, normalizes opaque insider-driven contracts, and invites other high-risk vehicles like crypto and offshore private credit. Courts should recognize that PE in ERISA plans is incompatible with fiduciary duties and prohibited transaction rules.
Appendix Update – Financial Times (Dec. 10, 2025): Retailization of Private Equity Deepens Fiduciary Risk
A new Financial Times analysis, co-authored by Ludovic Phalippou and William Magnuson, documents a significant industry push to extend private equity access to everyday investors, including 401(k) and other retail retirement savers — and explains why this “retailization” of private funds heightens legal and fiduciary risks rather than mitigating them. Financial Times
1. Private Equity Designed for Sophisticated Investors, Not Retail Plans
Historically, private equity funds operated under a light regulatory regime because they were assumed to be accessible only to sophisticated institutional investors with the capacity to evaluate complex fee structures, valuation conventions, illiquidity, and bespoke governance arrangements. In contrast, everyday retirement savers — including 401(k) participants — lack these institutional safeguards and repeat-player advantages. LinkedIn
2. Rising Legal Vulnerabilities When Exposed to Retail Savers
The FT article highlights specific vulnerabilities that are now exposed when private equity products are marketed to non-institutional investors:
Opaque Performance Measures: Common private-equity metrics such as internal rate of return (IRR) can be misleading, particularly when used without context on timing, reinvestment returns, or hurdle structures.
Hidden and Complex Fee Structures: Catch-up clauses, waterfall provisions, and other bespoke compensation mechanics are often poorly understood even by institutional LPs, and are likely to be poorly understood by retirement plan fiduciaries and participants.
Valuation and Liquidity Risks: The infrequent and GP-controlled nature of valuations in private equity obscures true risk and may misstate returns relative to liquidity needs of retirement plans.
Suitability and Disclosure Gaps: Retail investors expect public company-style disclosures and safeguards that private equity by design does not provide. Their lack prompts higher litigation risk when practices are perceived as misleading or unfair. Financial Times
Because retail investors do not fear being cut off from future funds — unlike institutional LPs — the FT commentary underscores that courts, not regulators, may become the primary venue for enforcing accountability in cases of misrepresentation, unfair practices, and lack of transparency. The piece suggests that “tobacco-style” legal challenges could emerge as investors challenge private equity’s opaque practices once retail capital is involved. LinkedIn
3. Implications for ERISA Fiduciaries and Prohibited Transaction Analysis
This Financial Times critique strengthens the view that private equity’s intrinsic structural and disclosure characteristics make it incompatible with the ERISA fiduciary and prohibited-transaction framework:
ERISA’s prudence standard requires fiduciaries to act with the care of a “prudent man” in light of the information available. When basic valuation, fee, and liquidity information is non-standardized and opaque, the prudence standard cannot be meaningfully satisfied.
ERISA’s disclosure requirements and prohibited-transaction rules are premised on transparency and arm’s-length conflict discipline — conditions that private equity’s documented marketing and structuring practices actively undermine when extended to retail retirement assets.
The heightened legal risk of misrepresentation claims — foreshadowed in the FT coverage — underscores that reliance on traditional private equity justification (e.g., institutional sophistication, negotiated side letters, bespoke GP terms) does not extend to 401(k) fiduciaries, whose participants are not repeat sophisticated actors.
The FT commentary thus reinforces that private equity, particularly as it is evolving to include retail investor access (e.g., through 401(k) platforms or retailized vehicles), presents novel and acute ERISA compliance challenges and potential prohibited transaction risks not addressed by current industry guardrails. Financial Times
Appendix: Private Equity Contracts and Prohibited Transactions
Excerpt: “Other sections of limited partnership agreements waive the general partner’s fiduciary duty. One common means of doing that is to provide that the general partner may consider interests other than that of the investors in his fund, including his own interest. Pension funds should never indemnify vendors against criminal liability. Officers and directors who approved such an indemnification would breach their fiduciary duty to the fund. Indeed, pension funds should not indemnify vendors for the vendors’ own negligence.”
Cited examples: Blackstone V, Blackstone VI, Oak Hill III (all held by KRS). Kentucky Retirement Systems (KRS) held Blackstone and Oak Hill contracts where indemnification clauses explicitly covered “criminal” conduct, while other sections allowed the GP to consider its own interests ahead of investors
ERISA impact: This constitutes a transfer of value from plan participants to insiders — a clear §406(a)(1)(D) violation (transfer of plan assets for less than adequate consideration).
Exhibit 2: Offshore Domiciles & 20% Plan Asset Exemption
Excerpt: “Most private equity and private credit funds used by U.S. pension and 401(k) plans are organized in offshore domiciles like the Cayman Islands, Luxembourg, or Jersey. The purpose is tax avoidance and regulatory arbitrage—not participant protection. These structures often shield disclosure of true expenses and valuation practices, and favor affiliates through preferential terms hidden in side letters.”
“KY TRS counsel Beau Barnes replied that members and taxpayers do not have a right to know what offshore tax haven TRS has put his money. The only source of domicile information is within confidential documentation.”
ERISA impact: If a fund claims exemption under the 20% rule, then ERISA fiduciaries cannot rely on statutory protections inside the contract. That makes any allocation itself a prohibited transaction, as plan assets are knowingly commingled into structures designed to evade ERISA
Exhibit 3: Friends and Family Side Letters
Source: Tobe AltsCrypPE11mar25.docx book chapter in upcoming book 401k invesments
Excerpt: “Private equity fund offering documents often disclose that investors agree to permit managers to withhold complete and timely disclosure of material information. The fund may have agreed to permit the investment manager to retain absolute discretion to provide certain mystery investors with greater information. As a result, the fund you invest in is at risk that other unknown investors are profiting at its expense. Offering documents warn these nondisclosure policies may violate applicable laws.”
Excerpt: “Private equity and private credit contracts typically lock fiduciaries into long-term, illiquid structures (7–12 years for PE). ERISA requires fiduciaries to monitor and, if necessary, remove imprudent investments. But in these vehicles, no liquidity exists to exit a deteriorating manager. Secondary sales are limited, heavily discounted, and often require GP consent.”
ERISA impact: Lock-in periods and GP-controlled valuations make ongoing prudence impossible.
Excerpt: “Private equity and private credit funds generate fees in layers: management fees, carried interest, transaction, monitoring, and advisory fees paid to affiliates, and financing spreads embedded in affiliated lending. Managers often keep multiple sets of records—one for investors, one for regulators, one for tax, and one for themselves. This opacity mirrors the hidden spread profits problem with annuities.”
ERISA impact: Hidden fee extraction is a prohibited transaction: plan assets are transferred to parties in interest for less than adequate consideration (§406(a)(1)(D)).
Add-On Section: The Trillion-Dollar Carry—Private Equity’s Hidden Fee Machine
Ludovic Phalippou’s latest research (April 2025) quantifies, for the first time, the aggregate “carried-interest” compensation earned by private-equity fund managers—and the findings expose just how massive and opaque this income stream has become. Using fund-level cash-flow data and fee terms from over 12,000 funds representing $8 trillion in deployed capital, Phalippou estimates that aggregate carried interest now exceeds $1 trillion, absorbing roughly 18 percent of all investor profitsLudoNov25.
1. Concentrated and Conflicted
Over 70 percent of all carry flows to U.S.-based managers, and more than half accrues to leveraged-buyout funds, not venture-capital vehicles. Venture capital accounts for less than 10 percent of total carry, undermining the industry’s long-standing political claim that favorable tax treatment is needed to “encourage innovation.” If carry were taxed as ordinary income rather than capital gains, Phalippou estimates that the United States would have collected roughly $250 billion in additional tax revenue over the study periodLudoNov25. In ERISA terms, this represents a massive transfer of plan-asset profits to the general partners (GPs) of private-equity partnerships—exactly the sort of self-dealing compensation Congress sought to prevent through the prohibited-transaction rules.
2. Effective Fees Far Above the Advertised “2 and 20”
Phalippou’s investor-level analysis of 15,900 limited partners (LPs) reveals that a subset of LPs—particularly asset managers and captive insurers—pay effective carry rates exceeding 25 percent of profits, and occasionally above 40 percent. By contrast, endowments and public pensions experience somewhat lower incidence because their portfolios are more diversified and include more funds-of-funds. This means ERISA-plan investors committing to private-equity funds may, in practice, be paying double-digit “spread” compensation above the stated contractual rate—precisely the hidden remuneration that should trigger a §406(a)(1)(C) and (D) prohibited-transaction analysis.
3. Fiduciary Implications for ERISA Plans
The study’s trillion-dollar total underscores that carried interest is not a side bonus—it is a dominant source of profit for private-equity general partners, effectively functioning as a performance-based revenue-sharing scheme. When ERISA plan assets are invested in such funds, the GP becomes a party-in-interest receiving variable compensation from plan assets, violating the core prohibition on self-dealing unless a specific exemption (e.g., PTE 84-14 or PTE 77-4) can be affirmatively proven to apply. Nothing in the LPA structure or disclosure regime ensures that such exemptions are satisfied. In fact, Phalippou’s finding that carry payments track “scale and incidence” rather than actual alpha performance supports the argument that these fees constitute unearned, conflicted compensation.
4. Policy and Enforcement Takeaways
Phalippou’s trillion-dollar estimate transforms the policy debate:
The “carried-interest loophole” is not a minor tax quirk but the largest single unreported compensation pool in global finance.
Because public and ERISA-regulated pensions are among the dominant limited partners, a substantial fraction of that trillion dollars was extracted from retirement trust assets.
The data provide a quantitative foundation for DOL and SEC enforcement: if even a small portion of these payments derive from plan-asset funds without a valid exemption, the entire structure constitutes a systemic prohibited-transaction breach
Appendix 2: Why Even AI Cannot Cure Private Equity’s Structural Problems — Reinforcing the Prohibited-Transaction Thesis
A. Setting the Stage: AI Hype vs. Private Market Reality
Recent commentary by Ludovic Phalippou highlights a growing trend among allocators: the belief that artificial intelligence (AI) and machine-learning (ML) tools can overcome private markets’ opacity and complexity — making them more “manageable,” transparent, or at least assessable. Top1000funds.com+1
Yet according to Phalippou, and echoed by multiple practitioners and academic studies, the core structural problems of private equity remain — and in many respects, AI may even make them worse. Top1000funds.com+2Interactive Brokers+2
B. Key Limitations of AI in Private Equity — Implications for ERISA Fiduciaries
PE Structural Problem
Why AI Fails to Resolve It (per Phalippou & other experts)
Implication for ERISA Plans / Fiduciary Duty
Opacity & strategically framed disclosures (fund documents, LP agreements, side letters, fee structures, recycled fees, exemptions, special clauses)
AI tools often rely on summarizing large text volumes — but in private-market funds, the “meat” is hidden in footnotes, exceptions, complex clauses, and custom contractual terms. What matters (e.g., how “net invested basis” is calculated, how portfolio-company fees are “rebated,” how recycling clauses are triggered) is typically buried in dense legal prose that AI summarizers may gloss over or misinterpret. Top1000funds.com+2Interactive Brokers+2
Using AI-based due-diligence or screening tools gives a false sense of transparency. Fiduciaries relying on AI summaries may miss critical risks, conflicts, or hidden fees. The result: imprudent allocations based on inadequate information — exactly what ERISA’s prudence standard is meant to prevent.
Non-standardized, inconsistent metrics across funds (e.g., different treatments of carry, recycled fees, expense allocations, valuation conventions)
AI algorithms — especially those trained on public markets or “standard” data sets — struggle when each fund uses its own bespoke conventions. The heterogeneity makes apples-to-apples comparisons deceptive or impossible. As Phalippou notes, inconsistent disclosures mean that even “basic elements” such as multiples of money can vary materially across funds. Top1000funds.com+2Top1000funds.com+2
Artificial standardization through AI can mask the true variability and risks across funds. Fiduciaries may be misled into believing they have comparable investments when hidden structural differences make actual risk/return profiles wildly divergent. That undermines the “reasonable and prudent person” analysis required under ERISA.
Long feedback loops and illiquidity — private-equity funds often lock up capital for 7–10+ years; valuations are infrequent, stale, and controlled by GPs
AI thrives on high-frequency data, rapid feedback loops, and standardized metrics. By contrast, private markets deliver delayed, sparse, fragmented, and strategically curated data — the very environment AI is ill-suited for, according to Phalippou. Top1000funds.com+2Interactive Brokers+2
The illusion that AI can “make PE manageable” undercuts the reality of undiversifiable illiquidity and stale, opaque valuations. Fiduciaries cannot rely on AI-generated “model valuations” or “screening outputs” as a substitute for real transparency and periodic, reliable valuation and oversight.
Potential for manipulation, “gaming,” and hidden disclosures — GPs aware of AI screening may adapt their documents to obscure downside, over-emphasize favorable metrics, or bury adverse info in footnotes or hidden clauses
Phalippou warns that as asset owners adopt AI tools, GPs will adapt — inserting more obfuscation in footnotes, complex side-letter terms, and ambiguous language designed to mislead summarization tools. Top1000funds.com+1
This dynamic magnifies the conflict-of-interest risk: AI-powered “transparency” becomes a veneer. Because AI can be fooled, fiduciaries may unwittingly accept flawed assumptions or understates risks — a recipe for imprudence and potential self-dealing under ERISA.
C. Why This Matters: AI Doesn’t Substitute for ERISA Protections — It Reinforces Their Necessity
The described AI-driven efforts to “quantify” or “standardize” private equity obscure how deeply non-standard and bespoke PE funds are. That heterogeneity is exactly why ERISA’s fiduciary and prohibited-transaction framework — requiring transparency, independent valuation, disclosure of conflicts, and prudent monitoring — is critically important. AI doesn’t eliminate the need; it makes poor compliance more plausible.
The use of AI may give fiduciaries — and plan sponsors — a false sense of security, especially if they believe AI screening suffices for due diligence. But given the structural limitations and possibility of AI being “gamed,” that confidence would be misplaced.
In fact, the presence of “AI due diligence” as a selling point or justification for including PE in pension plans may represent a new layer of misrepresentation — akin to “tech-enabled opacity.” If a PE fund pitches itself to a pension with “AI-optimized reporting / analytics,” that may signal not transparency, but an effort to automate obfuscation.
Thus, far from mitigating the risks of PE as a plan asset, the rise of AI-enhanced private-market investing amplifies the prudential and fiduciary risks — buttressing the argument that PE contracts should be treated as per-se prohibited transactions under ERISA (or at least subjected to the strictest scrutiny).
D. Addendum to Original Appendix Exhibits: AI & “Model Risk” as Additional Evidence of Conflicted Compensation and Lack of Prudence
You may insert an additional exhibit — something like:
Exhibit 6: AI-Enabled Private-Equity as New Mode of Obscured Risk Compensation
Summary of Phalippou’s remarks at the 2025 Fiduciary Investors Symposium (footnote-buried clauses, non-standard metrics, risk of GP adaptation to AI screening). Top1000funds.com+1
Reference to academic evidence on AI/LLM bias, confirmation bias, and model risks when applied to complex, non-standard financial contracts. arXiv+1
Correlation to hidden-fees & carried interest issues already documented: AI does not substitute for oversight, but may facilitate deeper concealment.
Conclusion (for the Appendix)
The latest scholarship and industry commentary — especially from Phalippou — confirms an uncomfortable truth: AI does not resolve private equity’s underlying conflict, opacity, and risk structure. If anything, by enabling a new veneer of “data-driven sophistication,” it may exacerbate the very problems that make PE incompatible with ERISA’s fiduciary and prohibited-transaction framework.
Accordingly, the proliferation of AI-driven investment tools and “AI-optimized” PE funds should strengthen — not weaken — the case that PE allocations in retirement plans like 401(k)s, defined-benefit pensions, or other ERISA-regulated vehicles are fundamentally incompatible with the statutory duty of prudence and prohibited-transaction rules.
The Epstein story is far more than the sexual-abuse scandal that captures headlines. Beneath the surface lies a massive web of financial flows, offshore structures, institutional clients, and retirement-system exposure. What is being hidden when Epstein’s files remain sealed is less about individual misconduct and far more about the architecture of global finance.
The Jeffrey Epstein saga is often framed as a grotesque sex scandal, full of private islands, mansions, and alleged kompromat tapes. But the fixation on lurid details misses the bigger story.
What is really being protected when Epstein’s files are blocked or sealed? Not only the reputations of billionaire predators, but the offshore financial system that underpins modern Wall Street power.
The Vatican’s Warning – Trumps Enablement
The Vatican under Pope Francis, and now Pope Leo, has condemned this system. In its 2018 declaration, the Church warned:
“The offshore system constitutes an opportunity for illegal financial operations and grave disordered conduct… Such practices tend to enrich only a few while harming the common good.”
Trump’s administration, in contrast, functioned as the political shield for the very practices the Church identified as immoral.
Donald Trump did not just tolerate this system — his administration strengthened it.
Eugene Scalia, Trump’s Secretary of Labor (and son of Justice Antonin Scalia), oversaw policies weakening fiduciary standards for retirement plans, paving the way for offshore annuities and private equity in 401(k)s.
Jay Clayton, Trump’s SEC Chair (and a longtime Wall Street lawyer whose clients included Apollo and Goldman Sachs), blocked stronger disclosure rules for private equity and hedge funds.
Steven Mnuchin, Trump’s Treasury Secretary, was a hedge fund and private equity insider who steered tax policy to favor offshore holdings.
Mick Mulvaney, acting White House Chief of Staff and a deregulation zealot, openly pushed to gut consumer and financial oversight.
Randal Quarles, Trump’s Fed appointee (and a former Carlyle Group partner), eased restrictions on private equity and alternative asset managers.
Together, they created an environment where the offshore system flourished — and where products tied to offshore reinsurers and private equity funds could be funneled into retirement accounts.
Banking Connections
Epstein’s banking ties matter for two reasons: (1) they show banks that should have been the first line of defense against money-flows tied to abuse and trafficking may have instead served as plumbing for concealment; (2) they link Epstein’s operations to major institutional finance—thus extending the risk beyond his personal network into the banking sector, and thereby into the broader financial system.
New lawsuits against Bank of America and BNY Mellon allege that both banks knowingly facilitated Jeffrey Epstein’s enterprise by opening and maintaining accounts, processing hundreds of millions of dollars, and delaying suspicious-activity reporting—echoing the patterns that already cost JPMorgan and Deutsche Bank big settlements. These cases widen the frame: Epstein’s power flowed through systemically important banks, not merely boutique private platforms.
House Judiciary Democrats (Ranking Member Jamie Raskin) have already flagged the new BNY case to press for disclosures on how Epstein moved money through those institutions.
Apollo, Leon Black, and Offshore Power
The clearest example is Leon Black, co-founder of Apollo Global Management.
Black admitted to paying Epstein $158 million after Epstein’s 2008 conviction.
Apollo routes billions through Cayman Islands and Luxembourg private equity funds.
Apollo exerts extreme influence over the largest U.S. public pension fund, California Public Employees’ Retirement System (CalPERS). Apollo’s long shadow still falls across CalPERS. The fund’s pay-to-play past—Buenrostro’s prison term and Villalobos’ suicide in the wake of an SEC action in 2010 that centered on Apollo-related fees—defined a generation of governance failures, yet allocations endured even as Apollo paid SEC penalties for fee/expense abuses.
.
The Offshore System: The Hidden Infrastructure
The more I examined the record, the clearer it became that offshore finance is the plumbing behind the Epstein phenomenon.
These vehicles allow fee-generation, tax minimization, regulatory arbitrage, and concealment of beneficial ownership or activity.
His banking links suggest that major institutions processed these flows despite red flags.
His private-equity connections mean that major institutional investors (like pensions) potentially invested or had exposure to firms that paid Epstein, used offshore structures, and may have funneled public-money into opaque entities.
This convergence — offshore secrecy + bank facilitation + institutional pension-fund investment — is the larger story. The sealed records of Epstein may hold not just sex-trafficking evidence, but ledger entries, bank wires, trust formation documents, hedge/private-equity fund flows, reinsurance contracts, and pension-fund allocations that trace the path of money from ordinary savers to the very heart of offshore finance.
The Real Scandal
Yes — the sex-trafficking revelations of Epstein are shocking. But the bigger scandal is: the offshore finance system that facilitated it, and the institutional structures that allowed money from savers and public pensions to flow into that system. These are the stakes: banks under scrutiny, private equity firms under investigation, pensions exposed, retirement savers at risk.
And the files? They’re locked away for a reason. Because once the ledger sheets, trust documents, bank filings, and fund allocators are exposed, the protective veil around the offshore system begins to unravel.
The Department of Labor’s June 2024 49-page “Report to Congress on Interpretive Bulletin 95-1” concludes that IB 95-1’s factors remain “relevant,” endorses a principles-based approach, and declines to materially strengthen fiduciary obligations for selecting PRT annuity providers. In doing so, the report ignores core ERISA prohibited-transaction risks and understates the post-transfer risk shift to retirees—risks that are amplified by offshore reinsurance, thin capital, and state-level guaranty limits that are far weaker than PBGC protection. DOL+1
What the DOL says—and why that’s not enough
The DOL affirms that IB 95-1’s existing factors (claims-paying ability, creditworthiness, etc.) still guide fiduciaries and that the guidance “should remain principles-based.” It even notes that the factors are “not exhaustive” and provide no safe harbor if a provider later defaults. Yet the report does not grapple with how today’s PRT ecosystem actually works—and how it creates party-in-interest conflicts and structural opacity incompatible with ERISA. DOL
Two omissions are fatal:
PBGC is gone after PRT. The DOL never squarely centers the reality that once benefits are off-loaded to an insurance company, participants lose PBGC insurance. That’s not theoretical; it’s PBGC’s own statement of fact. Any prudence analysis that treats an annuity the same as a PBGC-backed pension is misleading by omission. Pension Benefit Guaranty Corporation+1
State guaranty caps are a fraction of typical liabilities. Most states cap individual annuity protection around $250,000 present value (details vary). For many retirees, that is well below the exposure transferred. Treating state guaranty funds as a PBGC substitute is wrong as a matter of law and math. NAIC+2Federal Reserve Bank of Chicago+2
The risk the DOL doesn’t model: Offshore reinsurance + private-credit asset mixes
Since IB 95-1 (1995), life insurers have pivoted to asset-intensive models funded by PRT cash flows and supported by offshore reinsurers (often Bermuda). U.S. insurers shifted ~$800 billion of reserves offshore from 2019–2024 (and more than $1 trillion of offshore reinsurance liabilities by end-2024), to jurisdictions with different capital regimes and looser transparency, while allocating heavily to private credit—illiquid, mark-to-model assets whose behavior in stress is uncertain. None of that complexity is reflected in the DOL’s minimal update. Reuters+2Financial Times+2
Even foreign prudential regulators have flagged funded reinsurance risks and connected-party exposures—warning they may restrict deals if controls aren’t improved. The DOL report makes no comparable, concrete risk tests for ERISA fiduciaries selecting annuity providers engaged in those practices. Financial Times+1
Prohibited-transaction blind spot
ERISA §406 prohibits transactions that transfer plan assets to, or benefit, a party in interest—and bars self-dealing. A PRT executed with an insurer that (a) relies on affiliated/offshore reinsurers and (b) captures large undisclosed spreads from private-credit allocations raises classic §406 questions:
Conflicted economics: Affiliates capture spread profits while participants bear solvency and liquidity risk—especially post-PRT when PBGC is gone.
Opacity: Offshore cessions and private-credit marks reduce visibility into the actual asset-liability profile backing “guarantees.”
Process failure: Absent enforceable downgrade/exit rights or spread transparency, fiduciaries cannot monitor or remove an imprudent provider, which also frustrates their duties under Tibble/Hughes-style “continuing duty to monitor.”
The DOL report barely acknowledges these §406 avenues, treating PRT as a one-time prudence screen, rather than an ongoing conflict-management problem that can’t be solved by generic “factors.” DOL
“No injury” litigation head fakes don’t negate the risk
Industry commentary trumpets recent standing dismissals (no immediate injury) in PRT cases, as if that validates the structures. It doesn’t. Standing rulings say nothing about whether the PRT increased risk or violated ERISA; they only say plaintiffs sued too early. Meanwhile, at least one high-profile PRT case has survived a motion to dismiss—recognizing that allegations about substantial default risk and reduced protections are plausible. ASPPA+1
What a minimally competent DOL framework should require
If the DOL were serious about aligning IB 95-1 with today’s market, it would explicitly require fiduciaries to:
Model post-PRT risk vs PBGC: Quantify the relative default/severity risk gap between (a) PBGC-backed plan and (b) the selected annuity, including state guaranty caps and reinsurer counterparty risk. Pension Benefit Guaranty Corporation+1
Contract for downgrade/exit rights: Hardwired downgrade clauses, transfer/commutation rights, and spread transparency so fiduciaries can satisfy the continuing duty to monitor—without trapping retirees.
Address §406 directly: Treat affiliated reinsurance and undisclosed spread capture as presumptively conflicted, demanding either a clear prohibited-transaction exemption showing compliance with Impartial Conduct Standards (best interest, reasonable comp, no misstatements) or a redesign of the transaction.
Participant-level disclosure: Plain-English notice that PBGC protection ceases after PRT, and a side-by-side comparison of guarantees and limits under state guaranty funds. Pension Benefit Guaranty Corporation+1
Bottom line
By blessing a status-quo, principles-only reading of IB 95-1, the DOL has underwritten opacity at the precise moment PRT risks are surging from offshore reinsurance and private-credit exposures. Once the PBGC net is cut, participants shoulder a risk profile 10–20× higher than a PBGC-insured plan—while insurers and sponsors monetize the spread. A modern IB 95-1 must start with that reality, or it will remain a roadmap for transferring risk away from retirees’ protections and toward insurer profits. DOL+2Pension Benefit Guaranty Corporation+2
Sources
DOL, Report to Congress on Interpretive Bulletin 95-1 (June 2024) & news release. DOL+1
When it comes to offshore money games, Donald Trump has chosen the side of secrecy, speculation, and Wall Street greed — in direct opposition to the moral vision of the Catholic Church.
In 2018, the Vatican under Pope Francis issued a landmark rebuke of offshore finance. In Oeconomicae et pecuniariae quaestiones, the Holy See declared:
“The offshore system constitutes an opportunity for illegal financial operations and grave disordered conduct… that are capable of destabilizing the entire world economic system.”
The Vatican condemned tax havens, shell companies, and shadow finance, insisting that:
“Such practices tend to enrich only a few while harming the common good.”
Francis made clear that offshore secrecy was not clever capitalism, but a betrayal of human dignity. Following his death, Pope Leo has pledged to carry on this mission, reaffirming Francis’ call for transparency and stewardship over speculation and greed.
Trump’s Offshore Gift
Trump, however, has planted his flag on the opposite side. His Department of Labor’s Advisory 2025-04A delivers a multi-billion dollar gift to private equity, crypto, and insurance giants — encouraging offshore vehicles to flow directly into 401(k) retirement plans.
Where Francis and Leo denounce offshore secrecy as immoral, Trump is institutionalizing it.
Wall Street Allies in the Shadows
The real beneficiaries are Trump’s Wall Street allies:
Apollo Global Management, tied to offshore annuity giant Athene.
Blackstone, the world’s largest private equity firm, with billions routed through the Caymans and Luxembourg.
KKR, which relies heavily on offshore private credit funds.
Prudential, MetLife, TIAA, and Lincoln Financial, insurers that reinsure risky annuities through Bermuda to avoid U.S. oversight.
Crypto promoters seeking Cayman-style secrecy while flooding into retirement accounts.
These players gain the secrecy, fees, and leverage they want — while ordinary teachers, nurses, and factory workers bear the risk.
Offshore Products, Legal Landmines
As I’ve written, these offshore annuities and private equity funds are riddled with ERISA prohibited transaction risks — from undisclosed spread profits to “party in interest” conflicts.
The Vatican warned precisely against this kind of abuse:
“Money must serve, not rule. Financial speculation, driven by an aim for maximum profit, without regard for the common good, endangers the stability of the entire system.”
Trump’s DOL is not preventing such dangers — it is writing them into the rulebook.
Who Gets Hurt?
The largest 401(k) plans — about 8,000 with more than $100 million in assets — are the ones most likely to be litigated when fiduciary abuses occur. But the offshore promoters aren’t stopping there. They are targeting smaller 401(k)s, public pensions, 457s, 403(b)s, and individual annuity buyers, where litigation risk is minimal and oversight weak.
This is precisely the scenario the Vatican condemned: the powerful exploiting regulatory gaps while ordinary people carry the risk.
The Moral Divide
Pope Francis (and now Pope Leo): Offshore secrecy is immoral, destabilizing, and corrosive to the common good.
Donald Trump and his Wall Street allies: Offshore finance is a profit machine, and workers’ 401(k)s are the next feeding trough.
Trump has not just ignored the Vatican’s call for ethical finance — he has actively reversed it. If Francis stood for transparency and justice, Trump stands for opacity and greed. If Pope Leo carries on Francis’ moral warning, Trump functions as its antithesis: the Anti-Pope of offshore investing.
The rise of private equity and private credit allocations in defined contribution (DC) and defined benefit (DB) plans has been framed as innovation: diversifying returns, reducing volatility, and capturing “illiquidity premiums.” But beneath the marketing is a reality of offshore tax havens, opaque fee structures, and conflicted party-in-interest relationships. Just as offshore-leveraged annuities fail ERISA’s prudence and impartial conduct tests, so too do many private equity and private credit vehicles.
The common denominator: hidden conflicts and offshore structures designed to enrich asset managers at the expense of plan participants—precisely what ERISA’s prohibited transaction rules were designed to prevent.
Offshore Structures and Regulatory Arbitrage
Cayman, Luxembourg, and Jersey Havens
Most private equity and private credit funds used by U.S. pension and 401(k) plans are organized in offshore domiciles like the Cayman Islands, Luxembourg, or Jersey. The purpose is tax avoidance and regulatory arbitrage—not participant protection. These structures often:
Shield disclosure of true expenses and valuation practices.
Favor GP/affiliates through preferential terms hidden in side letters.
Conceal leverage through offshore blockers and SPVs.
Much like Bermuda reinsurance in annuities, these offshore domiciles create legal distance between fiduciaries and the assets that actually back participant promises.
Hollow Oversight
Unlike mutual funds (SEC-regulated) or bank-sponsored CITs (OCC/state banking oversight), private equity partnerships are lightly overseen partnerships where GPs dictate terms. Fiduciaries cannot claim meaningful monitoring when reporting is delayed, opaque, and selectively disclosed.
Hidden Fees, Spreads, and “Four Sets of Books”
Private equity and private credit funds generate fees in layers:
Management fees (typically 1.5–2% annually).
Carried interest (20%+ of profits).
Transaction, monitoring, and advisory fees paid to affiliates.
Financing spreads embedded in affiliated lending arrangements.
As you noted in “4 Sets of Books”, managers often keep multiple sets of records—one for investors, one for regulators, one for tax, and one for themselves. This opacity mirrors the “hidden spread profits” problem with annuities. Participants are charged multiples of what equivalent public-market exposure would cost, without transparency.
Fiduciary Conflicts and Parties in Interest
ERISA §406 prohibits fiduciaries from causing plans to engage in transactions with parties in interest, and from allowing transactions that transfer plan assets to such parties for less than adequate consideration. Private equity and private credit funds trigger these concerns:
Affiliated service providers: Many funds pay transaction/advisory fees to GP-owned affiliates—direct self-dealing.
Recordkeeper relationships: Some plan recordkeepers (e.g., insurers offering CITs or annuities) also sponsor private credit funds. Selecting those funds creates a party-in-interest loop, exactly the theory I advanced in my TIAA case study.
Valuation manipulation: Private credit managers often mark assets to model, creating inflated NAVs that justify higher fees—an undisclosed, prohibited transfer of wealth from participants to managers.
Illiquidity and Lack of Exit Rights
Like annuities without downgrade clauses, private equity and private credit contracts typically lock fiduciaries into long-term, illiquid structures (7–12 years for PE, 5–10 for PC). ERISA requires fiduciaries to monitor and, if necessary, remove imprudent investments. But in these vehicles:
No liquidity exists to exit a deteriorating manager.
Secondary sales are limited, heavily discounted, and often require GP consent.
IPS conflicts arise because most Investment Policy Statements require diversification and credit quality standards—yet fiduciaries cannot enforce them once capital is locked.
This mismatch between ERISA monitoring duties and fund design makes many private market vehicles structurally imprudent.
Why This is a Prohibited Transaction
Bringing the pieces together:
Offshore domiciles create opacity and reduce enforceability of participant rights.
Hidden fee streams constitute transfers of plan assets to parties in interest for less than adequate consideration.
Affiliate conflicts (e.g., GP affiliates providing services to the same fund) are textbook self-dealing.
Illiquidity makes fiduciary monitoring impossible, violating prudence.
Under ERISA, these features combine to make private equity and private credit funds presumptive prohibited transactions unless fiduciaries can demonstrate clear exemption and compliance with Impartial Conduct Standards—something managers resist by refusing full disclosure.
Conclusion
Private equity and private credit may be marketed as diversification, but in practice they replicate the same flaws that make modern annuities dangerous under ERISA: offshore loopholes, hidden spreads, weak regulation, opaque fees, and inability to monitor or exit.
The fiduciary takeaway is simple: until these conflicts are eliminated, private equity and private credit funds in ERISA plans should be treated as prohibited transactions, not prudent investments.
APPENDIX: How Mainstream Finance Scholarship (CFA Institute 2024) Supports ERISA Prohibited-Transaction Concerns for Offshore Private Equity & Private Credit
Source:Alexander Ljungqvist, “The Economics of Private Equity: A Critical Review,” CFA Institute Research Foundation (2024). PE EconomicsCFA
1. Opacity, Unverifiable Valuations, and Conflicts of Interest
Ljungqvist makes clear that PE funds are structurally opaque, with:
No public performance disclosure obligations
No market-to-market valuation
No liquidity
Heavily GP-controlled reporting
“Private equity is an opaque asset class…funds have no obligation to disclose performance to the public…LPs rarely account for opportunity cost, so publicly reported metrics overstate economic returns.” PE EconomicsCFA
This directly supports my argument that ERISA fiduciaries cannot prudently monitor these structures—especially offshore, Cayman, Bermuda, Luxembourg vehicles—because reporting is entirely at the discretion of the conflicted GP. This is classic ERISA §406(b) self-dealing risk.
2. IRR Manipulation and Misleading Performance Reporting
The CFA article openly acknowledges:
Interim IRRs are easily manipulated
Subscription facilities are used to artificially raise IRRs
LPs rely on “noisy” or “biased” performance metrics
“[IRR] is subject to manipulation…subscription lines increase reported IRRs by 1.9 percentage points on average…even ‘final’ IRRs may be misleading.” PE EconomicsCFA
This provides authoritative backing for my claim that fiduciaries using IRR or pro forma GP-supplied numbers are breaching ERISA’s duty of prudence, especially when GPs are offshore and disclosure is weaker.
3. Evidence PE Returns Do Not Equal Risk-Adjusted Alpha
Ljungqvist summarizes the academic literature showing no consensus on whether PE generates any risk-adjusted alpha after fees.
Many cited studies find zero or negative abnormal returns when adjusting for:
leverage
liquidity risk
market factor loadings
“Driessen, Lin, and Phalippou (2012) find no evidence of outperformance after adjusting for risk…Gupta and van Nieuwerburgh (2021) find negative abnormal returns.” PE EconomicsCFA
This supports my argument that ERISA fiduciaries cannot justify high-fee, conflicted offshore structures on the grounds of superior performance, because credible research shows the returns do not compensate for risk, liquidity, or opacity.
4. GP/LP Conflicts Are Structural and Severe
The CFA review highlights conflicts that align directly with ERISA §406(a) and §406(b):
a. GP has complete informational control
LPs “are passive sources of capital” and risk losing limited liability if they intervene.
b. GP timing of capital calls is discretionary
LPs effectively hold “a sequence of options” that the GP exercises for its own benefit.
c. GP controls valuation of unrealized assets
Key for ERISA prohibited-transaction theory: valuation affects GP carry, fees, and continuation funds.
d. GP can use financing techniques to distort results
Subscription lines, delayed capital calls, etc.
“LPs act as passive sources of capital…GPs exercise control over the timing of capital calls in ways that inflate IRRs…LPs bear liquidity and valuation risk but have little recourse.” PE EconomicsCFA
This strongly supports my argument that the GP is a fiduciary of plan assets and is engaging in self-dealing prohibited under ERISA §406(b)(1).
5. Evidence of Negative Externalities & Social Harm
This strengthens my argument that private equity and private credit may increase systemic risk—relevant to ERISA prudence and loyalty analyses.
CFA cites evidence that PE ownership can lead to:
Higher mortality in nursing homes
Higher costs in healthcare systems
Regulatory arbitrage in insurance companies
Increased leverage and bankruptcy risks
Conflicts that harm workers, consumers, and taxpayers
“PE-owned life insurers take greater risk…policyholders are exposed to greater losses when things go wrong.” “Higher mortality rates among Medicare patients in PE-owned nursing homes.” PE EconomicsCFA
This supports my theme that offshore PE/PC vehicles increase systemic and counterparty risk to ERISA plans.
6. Performance is Pro-Cyclical & Degrades When Capital is Plentiful
Classic fiduciary red flag:
“Cheap debt and abundant capital reduce subsequent returns…funds overpay…performance is lower for vintages with abundant leverage.” PE EconomicsCFA
This aligns with my argument that fiduciaries following PE marketing cycles (instead of countercyclical discipline) breach prudence.
7. LPs Cannot Accurately Monitor, Benchmark, or Exit
Ljungqvist emphasizes that:
There is no genuine secondary market.
Exit rights of LPs are controlled by GPs.
LPs cannot determine if reported NAVs are credible.
Under ERISA, any asset that:
Cannot be valued,
Cannot be benchmarked, and
Cannot be liquidated
is per se imprudent (DOL Advisory Opinion 2020-02, Cunningham, Tibble, etc.).
This directly reinforces my prohibited-transaction argument: if monitoring is impossible, prudence is impossible.
8. Key Point for My Offshore Argument: Jurisdiction + Opacity = Extreme Fiduciary Risk
The CFA article does not explicitly discuss offshore domiciles—but its analysis makes the implications obvious:
If private equity is already opaque, offshore structures amplify that opacity.
If valuations are already unverifiable, offshore administrators worsen the problem.
If GPs already control timing and reporting, offshore structures reduce LP recourse and regulatory visibility.
Thus, offshore domiciles exacerbate every fiduciary defect identified in the CFA review.
You can legitimately argue:
“Mainstream finance literature from the CFA Institute demonstrates that even domestically domiciled PE/PC funds operate with high levels of conflict, opacity, and valuation manipulation risk. Offshore domiciles multiply these risks and place ERISA fiduciaries in an untenable position with respect to prudence, monitoring, and prohibited-transaction rules.”
✔️ APPENDIX 2: IMF Evidence on Offshore Private Equity–Controlled Insurers, Regulatory Arbitrage, and Systemic ERISA Fiduciary Risks
Source: IMF Global Financial Stability Note 2023/001, “Private Equity and Life Insurers.” IMFPe23
1. IMF Confirms the Core of My Thesis: PE-Influenced Insurers Increase Illiquidity, Risk, and Opacity
The IMF unequivocally states:
“PE-influenced life insurers own a significantly larger share of illiquid assets than do other insurers.” (Figure 4; Section III) IMFPe23
These illiquid exposures include:
structured credit
CLOs
private RMBS/CMBS
private credit
mortgage loans
This supports my ERISA argument that fiduciaries cannot prudently monitor offshore PE/private-credit portfolios due to opacity, complexity, and lack of valuation reliability.
The IMF adds:
“Private assets are not able to be readily liquidated… forced sale… is likely to cause a discount.” (Section III) IMFPe23
For ERISA fiduciaries, this reinforces:
liquidity mismatch = imprudence
unverifiable valuation = prohibited transaction under §406(b)
inability to monitor = fiduciary breach under Tibble, Hughes, Cunningham
2. Strong Support for My Offshore Argument: Bermuda Reinsurance Is Used Explicitly for Regulatory Arbitrage
The IMF describes in explicit, damning terms how private equity uses offshore vehicles to escape U.S. or EU prudential rules:
“PE companies have established their own offshore-based reinsurers, primarily in Bermuda… limiting the ability of onshore regulators to monitor these activities.” (Reinsurance & Regulatory Arbitrage section) IMFPe23
This is exactly the mechanism you describe in my article:
U.S. life insurers reinsure liabilities offshore
Offshore reinsurer uses lighter regulatory capital rules
Assets backing annuities are replaced with much riskier PE private credit
The appearance of solvency is created via accounting arbitrage rather than real capital
This is powerful support for my thesis that:
Offshore PE reinsurers are intentionally used to evade solvency, valuation, and capital rules — which inherently violates ERISA prudence and loyalty.
3. IMF Confirms: Offshore PE Reinsurers Hold Even More Illiquid Assets Than Domestic PE-Owned Insurers
The IMF finds:
“Bermuda-based PE-influenced reinsurers… allocate about 20 percent of their investments into illiquid investments… much higher than global insurers.” (Figure 6; Section III) IMFPe23
This is critical evidence for my point that:
Offshore structures amplify all the risks of domestic PE ownership.
ERISA fiduciaries cannot possibly monitor this.
Such investment structures are inherently conflicted, opaque, and imprudent.
4. IMF Confirms Widespread Use of Highly Opaque Transactions: “Modified Coinsurance” and “Funds Withheld”
The IMF writes:
“These involve complex paper transactions… highly complex and less transparent… not transparent to the public.” (Section III) IMFPe23
These transactions:
obscure capital adequacy
obscure asset location (onshore vs offshore)
obscure solvency
obscure the true risk being transferred
This directly supports my ERISA position that fiduciaries relying on insurer representations about solvency or risk transfer are being misled — and are breaching their duty to independently verify.
5. IMF Confirms PE Uses Regulatory Loopholes to Artificially Inflate Capital
This is one of the strongest connections to my argument on improper gain and self-dealing:
“The use of the Scenario-Based Approach allows the additional spread on illiquid investments to result in upfront profits booked as capital.” (Regulatory Arbitrage section) IMFPe23
This provides authoritative evidence that these vehicles:
manufacture capital via accounting magic, not real solvency
are inherently misleading to fiduciaries
create a prohibited transaction because the insurer’s affiliate profits immediately from the risk transfer
This perfectly aligns with my argument that offshore PE insurers are extracting spread-based profits that ERISA plans cannot detect or evaluate.
Billions of dollars in U.S. Retirement plans are in fixed annuities in 401(k) and 403(b), pension risk transfer annuities in Defined Benefit pensions, and other annuity and insurance products. The modern annuity business under U.S. life insurers is far removed from the stable, conservative guarantees many plan fiduciaries assume. A growing body of evidence shows that large life/annuity companies are off-loading liability, investing in opaque private credit, and relying on offshore reinsurance domiciles with lighter regulation. These structural features raise serious concerns for retirement plans subject to Employee Retirement Income Security Act of 1974 (ERISA) fiduciary and prohibited-transaction rules. In short: unless an annuity contract is carefully designed, it may expose the plan to a prohibited transaction or breach of prudence.
This article draws on prior analysis of annuity risks — particularly my posts on downgrade clauses, hidden fees, pension-risk transfers, diversification failures, and guarantee association weaknesses — and integrates recent regulatory and industry data. The conclusion: fiduciaries must view most standard annuities as structurally incompatible with ERISA’s fiduciary protections unless key safeguards are present.
The Offshore/Reinsurance Loophole
Leverage and Jurisdictional Arbitrage
Major life insurers and annuity writers have increasingly used offshore reinsurance arrangements to improve capital efficiency and hide risk. According to a recent report by Moody’s Investors Service, U.S. life insurers shifted nearly $800 billion in reserves offshore between 2019 and 2024, primarily to Bermuda and the Cayman Islands. Reuters Another report from AM Best Company states that Bermuda accounted for over 40% of U.S. life-annuity writers’ ceded reserves in 2024. AM Best News+1
Offshore domiciles often permit looser regulatory requirements: different accounting rules, lower capital charges, and less public transparency than U.S. domestic state-based regulation. For example, one commentary notes that Bermuda allows insurers to file under GAAP rather than U.S. statutory accounting, enabling deferral of recognizing certain liabilities. Insurance News | InsuranceNewsNet+1
Reinsurance Risk and Embedded Illiquidity
When a U.S. insurer issues an annuity contract but then cedes the liability (and perhaps assets) to an affiliated or offshore reinsurer, plan participants face counterparty risk: if the reinsurer fails, the original issuer may be exposed to a recapture risk or be unable to meet obligations. Research from the Institute and Faculty of Actuaries (UK) on “reinsurance recapture risk” documents limited industry transparency and significant risks inherent in these arrangements. ResearchGate
In addition, offshore vehicles allow insurers to invest in illiquid, high-yield private assets (private credit, side-cars, private equity) which may not match the liquidity of participant-facing guarantees. A recent brief from the American Academy of Actuaries states that these “asset-intensive” reinsurance structures require strong governance — which is often lacking. Actuary.org
The Weakness of State Regulation for U.S. Insurers
Most annuity writers are regulated at the state level, under state insurance departments and guaranty associations. But there are multiple structural weaknesses:
Inconsistent standards: Each state sets its own solvency requirements, reserve methods, and guarantee-association limits.
Guarantee associations are limited: Many states cap the payout under guarantee associations at a level far below typical retirement-income exposures (often $250k). My prior post “State Guarantee Associations Behind Annuities Are a Joke” pointed this out.
Regulatory arbitrage: Insurers exploit weaker jurisdictions (via offshore reinsurance) to reduce capital without necessarily reducing risk. The Bank of England warned that offshore “funded reinsurance” transfers can be a form of regulatory arbitrage, prompting potential intervention. Financial Times
Taken together, these features mean the “guarantee” behind many annuities is only as strong as the balance sheet of an insurer backed by high-leverage offshore structures, not the simple promise to participants.
Why This Creates ERISA Fiduciary & Prohibited Transaction Risk
Fiduciary Prudence and Diversification
Under ERISA, plan fiduciaries must act prudently and diversify plan investments “so as to minimize the risk of large losses.” But an annuity contract backed by offshore-leveraged insurer structures and illiquid investments introduces concentrated and correlated risks: a market downturn could impair the entire insurer’s ability to meet guarantees. Without exit rights or downgrade protections you flagged in your prior blog (“Why ERISA Plans Require a Downgrade Clause…”), a fiduciary cannot monitor or respond to deteriorating credit/exposure.
Prohibited Transactions Under ERISA
ERISA §406 prohibits plan fiduciaries from causing the plan to engage in transactions with parties in interest on terms that are less than fair, or that result in the plan being operated for the benefit of a party in interest over participants. When an insurer (or affiliated reinsurer) is both a plan investment provider and engages in internal profit extraction via spreads, leveraged private investments, and offshore reinsurance, the following concerns arise:
Self-dealing – When an insurer transfers risk offshore and pockets spread profits rather than returning them to participants, it may be acting as a party in interest engaging in self-serving transactions.
Lack of transparency / disclosure – Plan fiduciaries cannot evaluate the terms of the annuity contract if the underwriting, assets backing the guarantee, or reinsurer credit quality are unknown or offshore-opaque.
Lack of exit/monitoring rights – Without appropriate contract terms (e.g., downgrade clause, liquidity rights) the fiduciary cannot prudently monitor or remove the investment when risk changes. Prior blog posts (“Annuities Are Prohibited Transactions via ChatGPT” and “Annuities Flunk Prohibited Transaction Exemptions – SCOTUS Will Open Floodgates”) explain how these deficiencies render many annuities ineligible for safe-harbor exemptions.
In combination, these structural flaws mean the plan is exposed to prohibited-transaction risk by investing in annuities under these conditions. The contract terms plus the insurer’s structure make the transaction with the insurer a transaction with a party in interest that is not “fair” to participants and lacks the fiduciary protections required under ERISA.
Practical Steps for Plan Fiduciaries
Require contract protections: Insist on downgrade clauses, an exit right or commutation right, transparency on backing assets, and reinsurer credit/investment disclosures.
Avoid offshore-leveraged providers: If an insurer uses offshore reinsurance in a way that shields its assets or elevates leverage, fiduciaries should treat the annuity as high risk.
Document the review process: A prudent process must show that the fiduciary evaluated the insurer’s structure, reinsurance arrangements, asset backing, regulatory domicile, and exit rights, and determined that the annuity still meets the plan’s IPS.
Benchmark alternatives: Consider whether pooled group annuity contracts with clean credit and transparent structure provide a better option; avoid “black-box” private-credit-levered annuities.
Conclusion
The convergence of offshore reinsurance, weak state regulation, insurer leverage, and lack of contract exit/monitoring rights means many modern annuities are structurally incompatible with ERISA’s dual requirements of fiduciary prudence and prohibited‐transaction avoidance. Unless a plan contract is designed specifically to account for these risks (and mitigate them via downgrade language, transparency, exit rights, plain-vanilla asset backing, strong domicile/underwriter credit), fiduciaries should treat the default assumption as: This annuity may be a prohibited transaction and a prudence breach waiting to happen.
Bottom line: Perennial industry marketing about “guarantees for life” hides the fact that many of these contracts are built on offshore arbitrage, high leverage, and opaque assets. That architecture is antithetical to retirement-plan fiduciary governance and safe plan design.
Revenue sharing remains one of the most misunderstood—and most abused—features of 401(k) and 403(b) plan administration. Far from being a benign cost-allocation mechanism, revenue sharing often functions as a prohibited transaction under ERISA, enriching service providers at the expense of participants, distorting plan disclosures, and creating unmanageable fiduciary conflicts.
What is Revenue Sharing?
Revenue sharing occurs when investment managers (mutual funds, CITs, or annuity separate accounts) pay a portion of their internal fees to recordkeepers or other plan service providers. These payments can take many forms—12b-1 fees, sub-transfer agency (sub-TA) fees, or “spread profits” inside annuities. Plan sponsors are told that revenue sharing is a way to cover recordkeeping without charging participants directly.
ERISA imposes the “exclusive benefit” and “prudence” rules on fiduciaries. The Department of Labor’s Impartial Conduct Standards (ICS) under PTE 2020-02 reinforce that fiduciaries must (1) act in the best interest of participants, (2) charge only reasonable compensation, and (3) avoid materially misleading statements.
Revenue sharing runs afoul of each:
Best Interest: Participants in revenue-sharing funds subsidize plan administration disproportionately, violating loyalty.
Reasonableness: As shown in litigation, identical recordkeeping services can cost $14–$21 per head in arms-length transactions, yet revenue-sharing arrangements routinely hide costs in excess of $50–$90
Transparency: Revenue sharing is invisible to most participants, exempt from clear reporting on Form 5500 under the flawed “eligible indirect compensation” definition
.
When a fiduciary allows plan service providers—who are “parties in interest”—to extract excess compensation via opaque arrangements, that is the very definition of a prohibited transaction under ERISA §406(a) and (b).
Litigation and Damages
Excessive recordkeeping fees have already triggered hundreds of lawsuits. Plaintiffs’ firms increasingly harvest 5500 data to benchmark per-head fees. Damages can be substantial:
In large plan cases, differences of just $20 per participant per year multiplied across tens of thousands of participants yield multi-million-dollar settlements.
the core damages theory is disgorgement of excess compensation siphoned through revenue sharing and annuity spreads.
Moreover, fiduciary liability insurers like Encore (formerly Euclid) admit that revenue sharing raises litigation risk, with some insurers denying coverage or raising rates for plans that persist in using it
.
Why It’s a Prohibited Transaction
Party in Interest Transfers: Investment managers, recordkeepers, and affiliates are all “parties in interest.” Payments between them that benefit the service provider are presumptively prohibited unless an exemption applies.
No Exemption Applies: PTE 84-24 (insurance products) and PTE 2020-02 (rollovers/advice) require compliance with ICS. Opaque spread-based revenue sharing cannot satisfy prudence, loyalty, or transparency requirements.
Structural Conflict: Revenue sharing incentivizes fiduciaries to select higher-fee funds that maximize kickbacks rather than lower-cost index funds—precisely the type of conflict ERISA forbids.
Fidelity at $30 a head delivers the same service as Fidelity at $90. There is no justification for allowing revenue sharing to disguise this simple fact. Best practice is competitive bidding every 3–5 years, not back-door subsidies from fund managers.
Fiduciary Lessons
Eliminate revenue sharing where possible; pay recordkeeping directly from plan assets or employer contributions.
Benchmark aggressively. Courts have held that plans must seek the best price, not just an “average” price.
Demand transparency. Full accounting of all revenue transfers is essential; without it, fiduciaries cannot prudently monitor compensation.
Treat revenue sharing as presumptively disloyal. Unless proven otherwise, it should be assumed to be a prohibited transaction.
Conclusion
Revenue sharing is not just bad policy; it is a structural conflict that violates ERISA’s core fiduciary principles. Fiduciaries who continue to rely on it are exposing themselves—and their participants—to excessive costs, distorted disclosures, and inevitable litigation. Courts and regulators should recognize revenue sharing for what it is: an unlawful transfer of plan assets to parties in interest.
Bottom line: Revenue sharing is a prohibited transaction in disguise, and damages from excessive administrative and recordkeeping fees must be pursued to restore participants’ retirement security.
Appendix: New Academic Evidence Confirms Revenue Sharing Distorts Menus, Raises Costs, and Creates Prohibited Transactions
I. Overview of the New Evidence
A 2024–2025 research program by Veronika Pool (Vanderbilt), Clemens Sialm (University of Texas), and Irina Stefanescu (Federal Reserve Board) provides the most comprehensive empirical proof to date that revenue sharing is structurally conflicted, distorts investment menus, raises participant costs, and is economically indistinguishable from a pay-to-play prohibited transaction. Their peer-reviewed article, Mutual Fund Revenue Sharing in 401(k) Plans, published in Management Science (2023/2024) and summarized in EurekAlert (2025), uses granular, payor-payee-level Form 5500 Schedule C data from the largest 1,000 U.S. 401(k) plans.
Your uploaded research file confirms and expands upon these findings. SialmPoolSfesRevShare
The results are stunningly consistent with the core thesis of your article: revenue sharing is not simply “indirect compensation”—it is an ERISA §406 prohibited transaction that drives imprudent menu construction, inflates fees, and rewards conflicted recordkeeper behavior.
II. Key Findings Relevant to ERISA Prohibited-Transaction Analysis
1. Revenue-sharing funds are preferentially added and protected from deletion
Across thousands of menu decisions:
Funds that pay revenue sharing are significantly more likely to be added to plan menus.
Funds that do not pay revenue sharing are significantly more likely to be deleted—even when their fees are lower and performance superior.
This preference cannot be explained by fund quality, asset class needs, performance, or plan demographics.
This matches classic quid-pro-quo structure: Recordkeepers protect and promote the funds that pay them.
Under ERISA:
This is a transfer of plan assets conditioned on steering participant assets—squarely within §406(a)(1)(D) and §406(b)(1)/(b)(2).
2. Revenue-sharing funds have higher expense ratios and worse net performance
The research documents:
Revenue-sharing funds have materially higher expense ratios, even controlling for asset class, share class, and plan characteristics.
All-in plan costs are significantly higher in revenue sharing plans (≈ 62 bps average) even though direct admin fees do not decline to offset revenue sharing.
Future performance of revenue-sharing funds is systematically worse than non-sharing funds—even after adjusting for fees.
This reverses the industry narrative that revenue sharing is “just a different way to pay for recordkeeping.”
Economically: Participants are paying more to receive less. Legally: This is a transfer of plan assets that benefits a conflicted service provider, failing ERISA’s exclusive-benefit rule.
3. Recordkeeper market power predicts the size and prevalence of revenue sharing
The data reveals:
Recordkeepers with greater market power (measured by network centrality in the 401(k) provider ecosystem) extract higher revenue-sharing basis points.
Funds are more likely to agree to revenue sharing when the recordkeeper controls a larger share of DC distribution.
Reciprocal arrangements between fund families (I add your interpretation: “If you put our fund on your platform, we will put yours on ours”) reduce revenue-sharing bps, revealing the negotiated, strategic nature of these payments.
This shows revenue sharing is not compensation for recordkeeping services; it is access payments—the economic equivalent of shelf-space fees, payola, or pay-to-play.
Under ERISA:
A service provider leveraging market power to extract payments from investment choices offered to participants triggers §406(b) self-dealing and §406(a)(1)(C) furnishing of services for more than “reasonable compensation.”
4. Menu distortion is economically large and systematic, not anecdotal
The paper demonstrates that revenue sharing affects:
Which funds are participants allowed to buy
Which funds disappear from menus
Which share classes are selected (higher-cost classes are systematically used when revenue sharing is higher)
The overall all-in cost borne by participants
This is the strongest academic validation to date of your longstanding position that the design of the plan menu is itself corrupted by revenue sharing.
This resolves a key litigation issue: Courts sometimes accept that “menu size” or “availability of low-cost funds” cures fiduciary breaches. But the empirical evidence shows menus are contaminated at the design stage, not just in their fee structure.
III. How This Evidence Strengthens the ERISA Prohibited-Transaction Argument
A. §406(b)(1) – Self-Dealing by the Recordkeeper
The empirical findings show the recordkeeper:
Receives compensation that varies based on which funds the plan uses.
Influences which funds appear on the menu.
Retains a portion of the participant-paid expense ratio as revenue.
Does not reduce direct fees to offset this revenue.
This is precisely the self-dealing structure §406(b)(1) prohibits.
B. §406(b)(3) – Kickbacks / Consideration Paid by Third Parties
The arrangement is the functional equivalent of a kickback:
A third-party fund pays the recordkeeper.
The recordkeeper responds by promoting or retaining that fund on the platform.
Courts require no evidence of intent—only a prohibited structure. The Pool–Sialm–Stefanescu evidence confirms the structure exists.
C. §406(a)(1)(C)/(D): Services for More than Reasonable Compensation & Transfer of Plan Assets
The paper establishes:
Participants in revenue-sharing plans pay systematically higher all-in costs, even after adjusting for direct admin fees.
Those costs do not correspond to superior services or performance.
This satisfies:
(C) – service provider receiving more than reasonable compensation.
(D) – transfer of plan assets for the benefit of a party in interest.
D. PTE 77-4 and PTE 84-24 Cannot Immunize Menu-Level Conflicts
Your existing article notes that even if a PTE could theoretically apply, recordkeepers cannot satisfy the “sole interest” or “best interest” conditions.
This new academic record affirms:
Recordkeepers systematically act against participants’ interests in menu construction.
Recordkeepers use market power to extract higher revenue-sharing bps.
Participants pay more while receiving inferior fund performance.
No PTE can bless a structural conflict that produces these outcomes.
IV. Implications for Litigation, Discovery, and Damages
1. Discovery Targets
This Appendix supports targeted discovery requests for:
All share-class selection files
Internal “approved list” rules
Revenue sharing negotiations between recordkeepers and fund families
Internal analyses of menu deletions
Econometric modeling of fund additions/deletions
2. Damages Models
The data validates damages models based on:
But-for low-cost share class selection
But-for non-revenue-sharing fund alternatives
Menu redesign using performance-adjusted replacements
Disgorgement of recordkeeper spread revenue
3. Burden-shifting under ERISA
Given this new empirical evidence:
Any plan that used revenue sharing should have the burden of proving prudence.
Participants need not show scienter; only the conflicted structure.
V. Conclusion: The Academic Literature Now Fully Supports the Prohibited-Transaction Framework
The Sialm–Pool–Stefanescu research program provides rigorous, peer-reviewed, empirical validation that:
Revenue sharing distorts menus.
It increases costs.
It decreases performance.
It benefits recordkeepers.
It harms participants.
And it is driven by conflicted economics, not legitimate service pricing.
In short:
Revenue sharing is not merely a problematic fee arrangement— it is a structural prohibited transaction embedded in the architecture of the 401(k) market.
Diversified synthetic-based stable value with its lower risks and lower fees has been effectively blocked from 403(b)s for decades by the insurance lobby, ie, TIAA, Prudential, Lincoln, AIG, Voya, and more. As more general account annuities come under ERISA scrutiny https://commonsense401kproject.com/2025/10/10/parties-in-interest-prohibited-transactions-disgorgement-tiaa-case-study/ for their lack of diversification, synthetic stable value is positioned to hopefully crack the 403b market.
1. Historical Barrier: 403(b) and Securities Law Interpretation
For decades, practitioners (and insurers, Wrap Providors) argued that synthetic stable value structures could not be offered inside 403(b) plans because of the way the Investment Company Act of 1940 was interpreted.
The technical issue: 403(b) accounts are either 403(b)(1) annuities or 403(b)(7) custodial accounts (mutual funds). The “synthetic wrap” model relies on bank/insurance wrap contracts + bond portfolios, often structured under §3(c)(7) (qualified purchaser exemption). Regulators were concerned that if each participant was treated as an investor, they’d need to be a “qualified purchaser” — which most teachers, nurses, and nonprofit employees are not.
Insurers were not incentivized to push for a solution, since general account fixed annuities were far more profitable than synthetic structures (they capture the spread). That aligns with your suspicion: insurers had no reason to advocate for allowing synthetics in 403(b).
2. The Invesco 2014 No-Action Letter — A Breakthrough
The Invesco Advisers letter (April 8, 2014) changed the picture:
SEC Staff Position: A 403(b) plan itself (sponsored by a university or hospital) can be treated as the qualified purchaser, not each individual participant.
Key Condition: The 403(b) sponsor must be subject to the ERISA “Prudent Man” fiduciary standard (or contractually agree to it). That makes the sponsor the decision-maker, rather than the participant.
Result: This removed the core legal barrier. The SEC staff said they would not recommend enforcement action if the 403(b) plan sponsor invested in §3(c)(7) Separate Accounts (synthetic stable value building blocks) through a generic stable value option managed by Invesco
403bNo-Action Letter_ Invesco A…
.
Precedent Cited: The SEC analogized to the H.E.B. (H.E. Butt Grocery 401(k)) no-action letter (2001), where 401(k) plans invested in §3(c)(7) funds without each participant being a qualified purchaser.
This effectively refuted the “not allowed in 403(b)” argument, but in practice, many large insurers kept marketing their general account fixed annuities because that’s where the hidden spread profits lay.
3. Current Push: Allowing CITs in 403(b) Plans
Recent legislation/regulation (still evolving) is designed to open 403(b) menus to Collective Investment Trusts (CITs), which are bank-maintained vehicles commonly used in 401(k).
Many of the best stable value options in the market — Vanguard Retirement Savings Trust (RST), Fidelity Managed Income Portfolio (MIP), and funds in the Hueler Universe — are structured as CITs.
These CIT stable value funds are largely synthetic-wrap based (bond portfolios plus insurance/bank contracts).
If the new law passes, there’s no structural reason they could not be offered in 403(b) — in fact, the Invesco 2014 letter provides an SEC blessing that synthetics can already fit into 403(b) if the fiduciary standard is met. The CIT legislation would simply provide the vehicle.
4. Likely Resistance from Insurers
Expect TIAA, AIG/VALIC, Prudential, Lincoln and other annuity providers to lobby against CIT adoption in 403(b). Why?
Their general account fixed annuities yield them 100–200+ bps in spread profits.
Synthetic CIT stable value products typically pass through as much or more yield to participants, with much lower hidden spreads and 1/10th the single entity credit risk.
Opening the 403(b) market to Vanguard/Fidelity synthetic CITs would directly threaten insurers’ dominant (and highly profitable) position.
Historically, TIAA in particular has used its academic lobbying power (Wharton, etc.) to promote annuity dominance in 403(b). The same playbook would likely be used here.
5. Conclusion — Would Synthetic Stable Value CITs Be Allowed?
Yes, legally: The Invesco no-action letter shows that synthetic stable value strategies can fit inside 403(b) if structured properly. The new legislation enabling CITs in 403(b) would explicitly open the door for Vanguard RST, Fidelity MIP, and other Hueler-tracked synthetics.
But practically: Insurers (TIAA, Lincoln, Prudential VALIC, etc.) have every incentive to resist or stall implementation, since it undermines their spread-based monopoly. Expect both lobbying and potential technical challenges (e.g., custodial account mechanics, fiduciary oversight arguments) to delay adoption.
Introduction: The Promise and the Pitfalls of Annuities
Suppose you held an AIG annuity in 2007 while it was being downgraded. Since it was illiquid, you could not sell it or get out, even at 80 cents on the dollar. You were trapped in a death spiral,l having to ride it all the way down to 0, powerless to get out at 90,80,70 as you could with a downgraded bond. A downgrade clause could allow you to exit at the current book value or even 90%. Instead, this combination of credit and liquidity risk creates a doomsday scenario that was only stopped in the case of AIG by a huge government intervention.
Annuities are attractive to retirement plans because they offer guaranteed lifetime income, insulate participants from longevity risk, and provide what many see as the “floor” beneath volatile investments with fixed rates. Indeed, in its recent LawFlash, Morgan Lewis celebrates a new DOL Advisory Opinion allowing certain managed-account lifetime income strategies (in which annuities are used) to qualify as QDIAs for defined contribution plans. Morgan Lewis
But the enthusiasm for annuities often understates the structural conflicts of interest baked into many products—and the absence of meaningful exit protections for prudent plan fiduciaries. That is why downgrade clauses (sometimes called “step-down,” “de-risking,” or “soft-exit” clauses) are essential guardrails. Without them, annuity allocations can morph into locked boxes with undisclosed spread profits and catastrophic losses for participants.
Below, I explain:
What a “downgrade clause” is (and why it’s needed)
Common annuity-friendly counterarguments (and why they fail)
Why annuities lacking downgrade clauses violate the Impartial Conduct Standards and thus cannot qualify for safe harbor exemptions
How fiduciaries (and litigants) should press for these clauses in plan contracts
What Is a Downgrade Clause — and Why It’s Critical
A downgrade clause is contractual language that enables a plan fiduciary (or, in some frameworks, participants) to move assets out of or adjust exposure to an annuity product under specified conditions, without incurring prohibitive penalties or lockups. Examples of showing a downgrade clause:
Permitting partial or full redemptions (or transfers) from the annuity segment, subject only to limited and predictable constraints
Requiring the insurer to step down crediting rates only prospectively (i.e. not clawing back past promised rates)
Forcing the insurer to accept commuted value payments if certain benchmarks (e.g., credit rating, liquidity, or interest rate changes) are triggered
Embedding automatic de-risking triggers (e.g. when spreads widen excessively, or when performance deviates materially) that allow rollback to a safer investment option
Why is this so vital?
Exit optionality is intrinsic to fiduciary prudence. Without it, fiduciaries cannot respond to a deteriorating contractual or market environment.
It constrains insurer opportunism—knowing they may face forced reallocation discourages excessive spread extraction or imprudent investment risk.
It mitigates the risk that an annuity becomes a “golden cage” locking in stale rates while underlying economics deteriorate.
In short, a downgrade clause helps transform an annuity from a one-way bet into a managed liability asset that preserves fiduciary flexibility and accountability.
Responding to Annuity-Friendly Arguments
“Downgrade clauses are unavailable; insurers won’t agree because they cut into excessive hidden spreads.”
This is a common refrain by annuity-industry lawyers. But it fails under scrutiny:
Market comparables exist. Some insurer contracts already embed exit rights or de-risking provisions (especially in separate account or institutional annuity offerings). The argument that all insurers refuse downgrade clauses is overbroad.
Contract negotiation is part of fiduciary process. Fiduciaries routinely negotiate plan and service agreements. Refusing to demand a downgrade clause is inconsistent with fiduciary duty.
Excess spread is not a free lunch. If insurers fear downgrade clauses will cut into “excess” profits, that signals the margins are already inflated. In fact, the need for a downgrade clause is strongest when spread profits are opaque and outsized.
Better for insurer certainty than litigation risk. An insurer may prefer a known downgrade formula to the uncertainty and reputational risk of litigation over hidden spread provisions.
Absence of downgrade clauses is a red flag—not a justification. If every insurer refuses, that underscores the structural conflict. Fiduciaries should regard that as a warning, not a safe harbor.
In short: the reluctance of insurers is a symptom, not a defense. It underscores the need for downgrade language, not the futility of it.
Why Annuities Without Downgrade Clauses Fail the Impartial Conduct Standards (and Cannot Rely on Exemptions)
PTE 2020-02 conditions safe harbor relief on compliance with the Impartial Conduct Standards: (1) best interest, (2) reasonable compensation, (3) best execution, and (4) no materially misleading statements. Reish, Neri, and Waldbeser rightly emphasize that failure to satisfy any of these disqualifies the practice from exemption relief.
Here’s how annuities lacking downgrade clauses systematically violate each:
Impartial Conduct Standard
Requirement
How Non-Downgrade Annuities Fail
Best Interest (Prudence & Loyalty)
Fiduciary must evaluate costs, risks, returns, and act loyally
Without downgrade rights, fiduciaries cannot prudently assess downside risk of lock-in. Discretionary crediting rates and opaque spread extraction further prevent any meaningful comparability or loyalty.
Reasonable Compensation
Fees and spread must be reasonable for services rendered
Hidden spreads devoid of market benchmarking—and lacking pressure from downgrade clauses—render reasonableness unverifiable, if not implausible.
Best Execution
Investments must be executed in a way to achieve the best net result
Opaque internal pricing and lack of exit rights prevents comparisons or competitive bidding; participants can’t “shop around” or demand better options.
No Materially Misleading Statements
Must fully disclose costs, conflicts, compensation arrangements
Withholding general account yields, internal rates of return, or spread margins—plus the very absence of downgrade protections—amounts to a material omission.
Because annuities absent downgrade clauses fail all four standards, they cannot qualify for PTE 2020-02. Investors and fiduciaries relying on such annuities remain exposed to ERISA §406 prohibited transaction risk—and accompanying excise taxes and fiduciary liability.
And even beyond PTE treatment, such annuities clash with the broader ERISA fiduciary principles as reflected in case law:
In Brotherston v. Putnam, the First Circuit emphasized the burden on fiduciaries to justify the prudence of structural investment choices—something impossible when exit options are foreclosed.
Cunningham v. Cornell confirmed liability where conflicted revenue arrangements taint fiduciary decisions, analogous to hidden spread practices.
Tibble v. Edison (and later Hughes v. Northwestern) affirm a continuing duty to monitor, which requires visibility and flexibility—neither of which downgrade-less annuities offer.
Thus, in litigation or regulation, one can and should argue that annuities without downgrade clauses are per se disqualified from safe harbor protection and are inherently subject to prohibited transaction treatment.
Practical Blueprint: How Fiduciaries Should Demand Downgrade Clauses
RFP and contract design: Include downgrade/step-down language as a mandatory negotiation point in insurer solicitations.
Tie downgrade triggers to objective metrics: e.g., when spread > 80 bps over benchmark, when insurer credit rating falls, or when actual GA returns deviate materially from pricing assumptions.
Require commutation or transferability options: At fair market or formula-based value, without surrender penalty.
Ongoing monitoring and audit rights: Demand transparency in internal yields, expenses, and delta between GA returns and credited rates.
Reserve right to “step out” administratively: Even absent a contract provision, fiduciaries must preserve documentation of why they declined an annuity lacking downgrade terms and be ready to demonstrate switching if needed.
If an insurer refuses all downgrade language, that refusal itself should be framed as evidence of structural conflict—and a basis to reject the product entirely.
Downgrade Protection and the IPS
I make the case above that any annuity without a downgrade clause is a trap—locking fiduciaries into an insurer’s opaque balance sheet while executives siphon off hidden spread profits. Let’s be blunt: without downgrade liquidity, these products are incompatible with ERISA, period.
The IPS Isn’t a Suggestion—it’s the Law of the Plan
An Investment Policy Statement (IPS) is not a fluffy consultant exercise; it is the governing playbook for fiduciaries. As I wrote in this earlier piece, the IPS codifies the process fiduciaries must follow to select, monitor, and—crucially—remove investments when they no longer meet standards of prudence.
So what happens when a plan’s IPS says “investments must meet minimum credit quality standards,” and the annuity provider’s general account gets downgraded? With no downgrade clause, the fiduciary is stuck—forced to keep participant money in a product the IPS says must be dumped. That’s not just bad optics. That’s a textbook breach of fiduciary duty.
The Stable Value World Already Gets It
Look at synthetic stable value funds like Vanguard RST or Fidelity MIPS. Their contracts include strict downgrade provisions. If a security in the portfolio gets downgraded below guidelines, it must be sold. That’s called discipline. That’s called fiduciary duty in practice.
Contrast that with insurance annuities: no downgrade clauses, no exit rights, no transparency. Just a locked box where the insurer pockets spread profits while participants are left holding the bag if credit quality deteriorates.
Liquidity in a Downgrade Isn’t Optional
Liquidity isn’t a luxury—it’s the lifeblood of fiduciary prudence. Without the ability to exit a failing investment, an IPS becomes a fig leaf. Fiduciaries can’t “monitor and remove” if the contract forbids removal. That’s why annuities without downgrade clauses don’t just flunk the Impartial Conduct Standards—they expose fiduciaries to prohibited transaction liability under ERISA §406.
Call It What It Is
When annuity industry lawyers claim downgrade clauses are “unavailable,” what they really mean is: they cut into our secret spread profits. Downgrade liquidity would force insurers to compete honestly, disclose their true economics, and give fiduciaries an actual choice. No wonder they fight it.
But ERISA doesn’t care about insurer margins. ERISA cares about participants. And until annuities come with downgrade clauses, fiduciaries should call these products what they are: fiduciary landmines hidden in an insurance contract.
Conclusion: The Downgrade Clause Is Not a Nice-to-Have — It’s an ERISA Necessity
Absent a downgrade clause, an annuity allocation is akin to handing over plan assets with no option for redemption and no clarity on internal yield. That structure invites hidden spread profiteering, foils market discipline, and violates the core fiduciary doctrines embedded in ERISA.
Downgrade clauses are not anti-insurer “gotchas” — they are the contractual oxygen that allows an annuity to breathe under fiduciary scrutiny. Annuity-friendly commentators who insist such clauses are unavailable are implicitly admitting that the underlying margins are too generous (and too opaque) to withstand rigorous fiduciary or litigation pressure.
By insisting on downgrade clauses, plan fiduciaries can align annuity allocations with transparency, accountability, and true participant protection—transforming what is often a “black box” into a manageable, contestable instrument.
The CommonSense 401k Project 