ERISA

Keep Private Equity out of 401(k) Target Date Funds

/ ChrisTobe / Leave a comment

Over half of all 401(k) assets are invested in Target Date Funds (TDFs), the default investment for most workers. Proposals to embed 15% allocations to private equity (PE) in these TDFs raise severe fiduciary, legal, and policy concerns.

Private equity’s opaque self-valuations, smoothed returns, and layered fees (≈600 bps) make it wholly unsuitable for retirement savers—particularly in default funds where workers have no choice. This is not innovation; it is regulatory arbitrage designed to funnel billions in hidden fees out of participant accounts.

Key Findings

1. Fees 100x higher than index funds.

  • PE all-in costs: ~6.0% annually (Phalippou 2020).
  • Index funds: 0.03%–0.05%.
  • A 15% sleeve adds 0.90% annual drag to the entire TDF—cutting lifetime wealth by 20–25%.

2. Fraudulent return smoothing.

  • PE funds self-price and delay write-downs.
  • Reported volatility and correlations are artificially low.
  • Asset allocation models therefore over-allocate to PE, embedding mispriced risk in retirement glidepaths.

3. Liquidity mismatch.

  • TDFs promise daily liquidity.
  • PE funds lock up capital for 10+ years.
  • Participants could face redemption delays, gates, or markdowns inconsistent with plan representations.

4. Weakest regulator wins.

  • SEC and OCC rules demand transparency and independent valuation.
  • Sponsors are instead turning to state-chartered CITs, where oversight is minimal and disclosure optional.
  • This is textbook regulatory arbitrage.

5. Fiduciary red flags.

  • ERISA requires prudence and reasonable fees.
  • Supreme Court precedent (Tibble; Hughes) obligates ongoing monitoring and removal of high-cost options.
  • Embedding PE in QDIAs (defaults) is especially egregious because workers never affirmatively opt in.

Policy Recommendations

  1. DOL & SEC Joint Guidance: Prohibit private equity allocations in QDIAs until independent valuation and full fee disclosure are mandatory.
  2. State CIT Oversight: Close the loophole by requiring federal standards (SEC/OCC level) for any retirement-plan CIT.
  3. Fee Disclosure Reform: Mandate reporting of all fees, including portfolio company monitoring and transaction charges.
  4. Participant Protections: Require opt-in consent, with plain-English disclosures, before allocating participant funds to PE.

Conclusion

Private equity in 401(k) Target Date Funds is not diversification—it is defaulting American workers into opaque, fee-rich products they cannot understand or escape. This violates fiduciary duty under ERISA and undermines retirement security. Regulators and policymakers should act now to prevent a massive transfer of wealth from retirement savers to private equity sponsors.

With Annuity Rates in 401(k) Plans: You Get What You Negotiate

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Welcome Back to the Dealership—Without the Internet

There was a time not too long ago when buying a car meant walking into a dealership and bracing for a battle. You knew better than to pay the sticker price. There was no CarFax, no Kelly Blue Book at your fingertips—only your grit and your negotiating skills stood between you and a bad deal. Fast forward to today, and while consumers have gained power in most financial transactions thanks to transparency and competition, one part of the retirement world remains stubbornly stuck in that old sales model: fixed annuities in 401(k) plans.

When it comes to these insurance-based investments, especially general account fixed annuities, the rate you receive isn’t always about the market—it’s about your leverage. Your negotiating power. And for too many plans, that means quietly accepting returns well below what other, savvier plans are earning. The result? A two-tiered system where uninformed or unempowered fiduciaries leave millions on the table while others cash in.

Sticker-Price Rates for the Uninitiated

Let’s start with what most plan sponsors and fiduciaries are seeing: general account fixed annuity 2 to 3% rates with some less than 2%. In most cases, these rates have been locked in for years. Plan fiduciaries assume that’s the best available. They’ve never asked for better. They trust the insurance company’s glossy marketing and ratings and their consultants.

Prudential, for example, publicly posts general account rates of 3%–4% on consultant platforms like FI360/Broadridge. Some like TIAA and Mass Mutual post rates of 4%-5% for basically the same or less risky product.  But the rates with many insurers like Prudential can vary from 1.5% to nearly 7%, with little rhyme or reason.  In at least one case, a savvy union plan in New Jersey negotiated a general account fixed annuity rate of 6.8%—within the same 401(k) framework.

Yes, you read that right. Nearly five full percentage points higher than what other plans were receiving from the same insurer for the same product type. The only difference? They knew they could ask.

A Broken Marketplace

What we’re seeing is not an efficient marketplace. It’s a holdover from a time when product pricing was opaque and negotiation was king. But here’s the problem: this isn’t used car sales. These are retirement assets regulated by ERISA, with fiduciary standards that prohibit arbitrary pricing structures that benefit one plan over another without justification.

If an insurance company retains total discretion over annuity rates, then it also retains the ability to allocate higher yields to preferred clients—possibly to reward larger assets, political influence, or favored consultants—and lower yields to everyone else. This unequal treatment is not only unfair; it’s potentially unlawful under ERISA.

As I argued in this recent piece, annuities in 401(k) plans often constitute prohibited transactions when they are offered with non-transparent, discretionary pricing structures. If plan fiduciaries do not negotiate, they are not fulfilling their duty of loyalty or prudence under ERISA.

Consultants Are Not Always Your Friend

A deeper concern is that some consultants—the very advisors plan sponsors rely on to protect them—are complicit. Rather than push for higher negotiated rates or run competitive bids, some simply accept posted rates or worse, recommend insurers where they may have their own compensation arrangements or conflicts.  Some consultants have insurance licensees where they can receive hidden insurance commissions.  Sometimes rates are burned off to pay for recordkeeping fees, consultant fees etc. 

Some consultants may use databases like FI360/Broadridge, which show insurer-published general account rates many conflicted consultants do not even do that. But unless they go further—soliciting competitive proposals or uncovering the higher rates being granted to others—they are not doing their job. Worse, in some cases they actively steer plans toward underperforming fixed annuities while pocketing fees from the insurers themselves.

A Fiduciary Wake-Up Call

The key message for fiduciaries of 401(k) plans is this: you get what you negotiate.

If your plan holds a general account annuity yielding 2%-4%, and you’ve never asked for more, you may be in violation of your fiduciary duty. Your peers—especially in larger or union-affiliated plans—may be earning triple your rate simply because they demanded better terms.

That’s not just a bad deal. It’s a fiduciary breach.

The Solution: Demand Transparency and Competition

  1. Require Competitive Bids – Treat your annuity provider like any other investment manager. Get multiple quotes. Benchmark rates.
  2. Disclose the Spread – Insist on full transparency on how the insurer earns money. What’s the gross yield on their general account? What are they keeping?
  3. Use Independent Experts – Be cautious of consultants who may have undisclosed relationships with insurers. Get independent advice or a second opinion.
  4. Document the Negotiation – Keep records of the steps you took to secure the best rate. It’s your defense in any potential ERISA litigation.
  5. Over time get rid of your Conflicted Non-Transparent fixed annuities,  switch to a diversified Synthetic based stable value fund like the Vanguard RST, or Fidelity MIPS, this may take time because many fixed annuities are known as “Roach Motels” you easily get in but getting out may require a substantial penalty

Conclusion

Fixed annuities in 401(k) plans should not be sold like used cars. They should reflect a competitive, prudent process.

In the end, it’s simple: when it comes to annuity rates, you get what you negotiate—or what you fail to.

“Diversification Abandoned: Why Plan Fiduciaries Must Rethink Fixed Annuities and Pension Risk Transfers”

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In an era where fiduciary prudence should be paramount, many plan sponsors have dangerously abandoned the foundational ERISA principle of diversification in favor of single-insurer annuity contracts. Billions of dollars in retirement savings are now concentrated in fixed annuities—both general and separate account types—as well as through pension risk transfer (PRT) annuities. These contracts rely entirely on the credit risk of a single private insurance company. In doing so, plan sponsors not only increase participant risk—they also take on an additional fiduciary burden: to evaluate the solvency of that insurer, going far beyond the superficial comfort of a credit rating.

The Mirage of Ratings

Credit ratings are not a shield against fiduciary liability. The 2008 financial crisis laid bare the failures of the rating agencies, with AIG maintaining top-tier ratings until days before its collapse. Even today, insurers like Prudential—formerly designated as a Systemically Important Financial Institution (SIFI)—have lobbied to remove that designation to escape heightened scrutiny. As the Stanford Graduate School of Business has documented, this de-designation eliminates oversight that might have prevented excessive risk-taking within the general account structure.

Despite this, insurers continue to receive high ratings from S&P, Moody’s, and Fitch, often with little transparency about underlying investment risks—particularly with respect to private debt. As discussed in “Private Debt Problematic in ERISA Plans”, these opaque, illiquid assets dominate many insurer portfolios and are used to inflate yield—benefiting the insurer through spread profits while increasing default exposure for plan participants.

S&P has itself acknowledged that state-level regulation of Separate Accounts differs so widely that an identical contract could receive different ratings depending on the state of issuance. In their own words:

“While there have been insolvencies involving separate accounts, the circumstances under which a separate account might be consolidated with the insurer’s general account remain substantially undefined.”

In other words, despite claims that Separate Accounts are “insulated,” policyholders—including ERISA plans—have no clear priority in an insolvency. The assumption that Separate Accounts are safer than General Accounts is unsubstantiated without state-specific legal protections and a higher, documented rating. Yet, no recent insurer appears to have sought such enhanced Separate Account ratings for fixed annuity products—despite billions flowing into them through 401(k) and PRT deals.

State Guarantee Associations: False Security

Plan fiduciaries also wrongly assume that State Guarantee Associations (SGAs) provide meaningful protection in the event of insurer failure. As explained in “State Guarantee Associations Behind Annuities Are a Joke”, these entities are riddled with limitations:

  • Coverage caps often top out at $250,000 per participant.
  • Coverage is limited to annuities considered insurance policies—a classification that remains unsettled in many states for group annuity contracts.
  • Plans that invest via Separate Accounts may not be covered at all.
  • SGAs are slow to pay and require insolvency proceedings to trigger.

This patchwork system of protection undermines the uniform national standards intended under ERISA, replacing them with the legal uncertainty of 50 different state frameworks.

Pension Risk Transfer: A Regulatory Shell Game

In the PRT context, the problem becomes even more acute. Plan sponsors offload pension liabilities to an insurer and call it a day. But as outlined in “Pension Risk Transfer Annuities Should Be Prohibited”, this shift removes ERISA protections from participants and exposes them to pure credit risk—often without even basic downgrade protection.

These annuities, once purchased, are irrevocable. There is no mark-to-market pricing, no participant choice, and no fiduciary oversight after transfer. Unlike defined contribution plan assets—where fiduciaries can replace a fund or manager—PRT annuities place participants in the hands of a single insurer, often for life.

Incentives Misaligned: Kickbacks and Structuring Fees

Plan sponsors frequently benefit from “structuring fees,” “rebalance profits,” or “rebates” paid by insurers to corporate treasury departments. These functionally operate as kickbacks that create a dangerous conflict of interest: the employer’s financial interest in closing the pension or reducing balance sheet liabilities directly conflicts with the participants’ need for long-term security. The insurer’s profit model—maximizing spread between illiquid, risky investments and low fixed crediting rates—comes at participant expense.

Going Beyond Ratings: The Fiduciary Obligation

ERISA fiduciaries are held to the highest duties of care and loyalty. In choosing a single-issuer annuity, they must:

  • Conduct independent credit analysis beyond agency ratings.
  • Evaluate the insurer’s asset allocation, exposure to private debt, and leverage.
  • Require downgrade protections, triggers, and collateralization where appropriate.
  • Consider alternative structures, including diversified stable value arrangements that maintain ERISA protections.
  • Avoid reliance on state-level guarantees or superficial representations of safety.

In the capital structure, plan participants in annuities without downgrade protections are subordinated to sophisticated Wall Street creditors, private equity owners, and even commercial reinsurers. They deserve better.

Conclusion

If an ERISA fiduciary would not invest 100% of a participant’s 401(k) balance into the high-yield bonds of a single insurer, they should not do so implicitly by placing it into an annuity backed by that insurer’s general or separate account. Ratings are not a fiduciary process. Participants cannot diversify away from default once locked into a single-issuer annuity.

The burden is on the fiduciary to prove prudence—not to presume it.

Private Debt problematic in ERISA Plans

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Private Debt is in DB and DC pension plans.  In 401k plans it is limited so far mostly to Insurance Company Separate Accounts and other stable value products, but there are plans to increase its use dramatically by hiding it in Target Date Funds.   Private Debt is problematic for a number of reasons The following is from ChatGPT

VIOLATION OF ERISA’S DUTY OF PRUDENCE

Inclusion of Private Credit, Private Mortgages, and Other Illiquid, Self-Priced Assets

  1. Plans breached their fiduciary duties by offering and/or maintaining investments in private credit, private mortgages, and other illiquid private debt instruments within the Plan’s investment lineup, in violation of the prudent man standard of care and the Impartial Conduct Standards incorporated by regulation under ERISA.
  2. ERISA §404(a)(1)(B), 29 U.S.C. §1104(a)(1)(B), mandates that plan fiduciaries act “with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use.”
  3. Under ERISA’s Impartial Conduct Standards, fiduciaries must:
    • Act in the best interest of the plan and participants;
    • Charge no more than reasonable compensation;
    • Refrain from making misleading statements or omissions about risks or characteristics of investments.
  4. The growing use of Private Credit, Private Mortgages, and similar private debt instruments in ERISA retirement plans—either through direct investments, pooled vehicles such as collective investment trusts (CITs), or via allocations in target-date funds (TDFs)—fails to meet these obligations for the following reasons:

A. Self-Pricing and Lack of Transparency Violates Prudent Fiduciary Conduct

  1. Unlike publicly traded debt securities, private credit and mortgage loans are generally not marked to market and lack reliable, third-party price discovery. Many are valued using internal models by asset managers or by affiliated valuation agents—creating obvious conflicts of interest.
  2. Industry studies and academic research have documented how private debt assets are often “smoothly priced” or marked to model, which artificially suppresses volatility, misleading fiduciaries and participants about the true risk of these investments.
  3. As noted in the CFA Institute’s guidance on fair value pricing (Refresher Readings on GIPS and Risk Standards), reliance on self-pricing undermines comparability, transparency, and ultimately fiduciary prudence:

“Valuations derived from internal models, absent market validation, are inherently susceptible to bias and present conflicts when used to report performance or fees.”

B. Credit Risk Not Accurately Reflected: Ratings by Unregulated or Conflicted Firms

  1. Many private debt instruments are assigned credit ratings not by nationally recognized statistical rating organizations (NRSROs) but by smaller, conflicted firms such as Egan-Jones, which have been previously sanctioned by the SEC for rating conflicts and failing to properly manage issuer-pay conflicts.
  2. In SEC v. Egan-Jones Ratings Co., the SEC found repeated compliance failures, reinforcing that ratings used for fiduciary investment decisions must be independently verifiable and subject to rigorous controls. Use of such ratings in retirement plans undermines ERISA’s prudence standard and exposes plan participants to credit losses that are systematically under-disclosed.

C. Lack of Liquidity Creates Participant Harm in Defined Contribution Plans

  1. Many private credit and mortgage assets are held in vehicles with multi-year lockups or limited redemption terms, inappropriate for the liquidity needs of daily-valued, participant-directed ERISA plans.
  2. Target-date funds (TDFs) and pooled vehicles holding private credit often fail to disclose liquidity limitations or redemption restrictions clearly to participants, despite ERISA’s requirement that plan information not be misleading. This structure raises the same concerns that led the SEC to place limits on illiquid investments in mutual funds.

D. Valuation and Risk Mischaracterization Is a Fiduciary Breach

  1. In Whitley v. JPMorgan Chase & Co., No. 12 Civ. 2548 (S.D.N.Y.), plaintiffs alleged that synthetic stable value funds using smoothed or manipulated private credit valuations constituted imprudent investments. Similarly, the American Century arbitration with JPMorgan uncovered concealed private credit holdings in layers of CITs, affirming the systemic risk of hidden illiquidity and valuation opacity.
  2. These cases demonstrate that failure to properly vet, monitor, and disclose the true risks of private debt and mortgage exposures may constitute fiduciary imprudence and violate the statutory obligations imposed by ERISA §404.

E. Excessive Fees Hidden in Complex Structures

  1. Private credit and private real estate vehicles often layer management, servicing, origination, and performance fees, resulting in total compensation that exceeds reasonable bounds—in violation of ERISA’s requirement that only reasonable compensation be paid to service providers (§408(b)(2)).
  2. The lack of pricing transparency and comparables in private debt enables fee padding, where fiduciaries cannot accurately benchmark fees against public alternatives. This inability to assess the reasonableness of compensation itself constitutes a breach of fiduciary duty.

F. New Study Debunks Private Credit Craze

The Journal of Private Markets Investing (Fall 2025) just published a seminal study that debunks the private credit performance ‘pitch’:

  • Across all seasoned vintage years (2015–2020), a significant share of Total Value to Paid-In (TVPI) is composed of Residual Value (RVPI or unliquidated loans) rather than realized cash returns (DPI).
  • This underscores a potential major risk in the private credit asset class as this illiquid investment performance is largely dependent upon fund managers’ assessment of their values (“mark-to-myth”).
  • When compared to appropriate public market benchmarks, the study find that private credit funds – both senior (direct lending) and mezzanine – do not exhibit significant outperformance.

The three authors are affiliated with Johns Hopkins Carey Business School and UC Davis Graduate Management School, respectively.

The study is attached and the link. https://www.pm-research.com/content/iijpriveq/24/1/109

Target Date Benchmarks – ChatGPT

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Target-date funds are over 50% of 401(k) assets.  Litigation around target date funds I think shows a lack of knowledge around investment performance.    Target date funds were created to hide fees and mask performance concerns, and are impossible to benchmark.  In fact, many were created to manipulate benchmarks.   I feel many plaintiff attorneys are not getting the full potential out of their cases by not looking under the hood of Target Date funds to find out what is really going on. 

In my testimony for the June 2009 joint SEC-DOL hearing on target date funds, I contended that it’s huge growth would further concentrate management into an oligopoly and higher fees. I also criticized the target date structure as a step backward for transparency of fees, performance, and risk. I thought it would push plans toward a one-provider, closed platform that would lead to conflicts of interest and higher fees.

Target Date Fund Asset Allocation Drives Risk and Performance

Asset allocation is the main driver of performance and risk.  Because of the lack of transparency and investment policy guidelines, performance gaming of the benchmark in target date funds in invited.  Target date fund specialist Ron Surz warns against target date funds holding high equity allocations for those close to retirement

Joe Nagengast of Target Date Analytics in the June 2009 joint SEC-DOL hearing on target date funds. “The way to win the short-term performance horse race for target date funds (and the resulting market share) has been, in many time periods, through higher equity allocations.”

I asked ChatGPT to elaborate on this issue and specifically benchmarking to the S&P target date fund index

—————————————————————————-

From ChatGPT.  Asset allocation explains ~90% of return variability, then comparing TDFs with vastly different glide paths or allocations is not apples-to-apples.

⚖️ Why It’s a Problem

401(k) Target Date Funds often differ dramatically in:

  • Equity vs. bond allocations (e.g., 90/10 vs. 60/40 at the same “target date”)
  • Glide path design (to retirement vs. through retirement)
  • Exposure to alternatives, real assets, or high-yield bonds
  • Risk levels (volatility and drawdown potential)

So, simply comparing returns (e.g., over 1, 3, or 5 years) may reward higher-risk funds during bull markets, misleading fiduciaries and participants.

🧠 Bottom Line

You cannot responsibly compare TDFs on return alone when their asset allocations diverge. Fiduciaries must benchmark based on:

  • Risk-adjusted performance
  • Glide path risk levels
  • Appropriateness for the participant demographic
  • Alignment with ERISA’s fiduciary standards

ChatGPT said:

benchmarking Target Date Funds (TDFs) to something like the S&P Target Date Fund Index can be misleading and easily gamed, particularly because:

  1. Benchmarks like the S&P Target Date Index only reflect the average allocation (e.g., average equity/glidepath of funds in that vintage),
  2. There is no requirement that the TDF match the risk profile of the benchmark, and
  3. A higher equity allocation will often outperform the benchmark in bull markets, misleading fiduciaries into thinking the fund is “better managed” rather than just riskier.

🔎 How This Benchmarking Can Be Gamed

TDF managers can “game” the benchmark by:

  • Allocating more to equities (especially international or small-cap)
  • Taking more duration risk in bonds
  • Adding alternative assets like private equity or real estate (often with smoothed NAVs)
  • Using leverage (in CITs especially)

These tactics may result in higher performance in a rising market compared to the benchmark, even though the fund is taking on significantly more risk.

📊 Examples of Equity Overweighting vs. Benchmark

Let’s compare some common 2040 TDFs with the S&P Target Date 2040 Index, which in 2024 had approximately:

  • Equity: ~74%
  • Fixed Income: ~24%
  • Cash/Other: ~2%
Target Date FundEquity AllocationOverweight vs S&P IndexComments
Fidelity Freedom 2040 (Investor)~84%+10%Higher US equity tilt, more aggressive glidepath
T. Rowe Price Retirement 2040~89%+15%Very equity-heavy approach; often leads in returns in bull markets
American Funds 2040~78%+4%Slight overweight, includes active mgmt in underlying funds
Vanguard Target Retirement 2040~72%-2%Closest to S&P Index; more conservative relative to peers
BlackRock LifePath Index 2040~74%0%Benchmarked tightly to average; often used as a baseline
State Street Target Retirement 2040 (CIT)~78%+4%Slightly more risk in equity; often embeds alternatives in CITs

Sources: Fund prospectuses, Morningstar, 2024 allocation snapshots

⚠️ Fiduciary Implications under ERISA

  • Plan fiduciaries may be misled into thinking a fund is “better performing” when it simply takes more risk.
  • Impartial Conduct Standards under ERISA require fiduciaries to consider both performance and risk—a higher return via higher risk is not inherently better.
  • Courts may ask: Did the fiduciary understand that this TDF’s outperformance came from taking more risk than the benchmark?
  • This is especially risky when plan sponsors do not document why they selected or retained a more aggressive fund.

🧠

2. How Much Does It Matter?

  • The 1986 Brinson, Hood & Beebower (BHB) study found that asset allocation explained 93.6% of the variation in quarterly returns of pension fund portfolios.
  • Later updates and critiques (e.g., by Ibbotson & Kaplan in 2000) clarified that while asset allocation doesn’t explain everything, it still dominates over market timing or security selection in terms of predicting return variability.
    • Strategic asset allocation (long-term mix) accounts for about 90% of return variability.
    • Tactical allocation, timing, and security selection account for much less.

3. Impact on Performance vs. Variability

  • Asset allocation drives risk-adjusted returns, not just variability.
  • Picking the right mix of stocks, bonds, and alternatives greatly affects total returns, especially over longer horizons.
  • During market crises or recoveries, asset classes behave very differently—diversification reduces drawdowns.

Key Takeaway

  • TDFs should not be benchmarked only on return versus the S&P TDF Index—risk-adjusted performance and glidepath assumptions matter. A 2040 fund with 90% equity will likely beat the benchmark in good years, but may collapse harder in downturns—especially harming near-retirement investors if the glidepath is too steep.

There are no valid benchmarks for Target Date Funds.  Comparing funds with different asset allocations does not work either.  Target date funds are specifically designed to avoid accountability and thus need the most scrutiny. You have to look under the hood at the individual investment allocations and benchmark those.   Attorneys are defying investment principles and basic math in insisting on using TDF benchmarks in litigation.

SCOTUS’ 9-0 ERISA decision in Cunningham v. Cornell University case– confirms my view on Annuities as Prohibited Transactions

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SCOTUS 9-0 ERISA decision – confirms my view on Annuities as Prohibited Transactions

By Chris Tobe, CFA, CAIA

The Supreme Court ruled unanimously in favor of 401(k) Transparency, while also placing the burden of proof on plan sponsors alleging that they are protected under an exception to the Prohibited Transaction rules.  This rule facilitates forcing disclosures on conflicts of interest and hidden fees.[i]  Investments that the managers have the potential for a conflict of interest are labeled “Parties of Interest” in the DOL/IRS 5500 forms attached financials for ERISA plans.  These parties in interest have the burden of proof that they have an exemption from the Prohibited Transactions rules. 

Fixed Annuities, known as IPG’s, are prevalent in large ERISA DC plans.  The largest IPG is TIAA Retirement Choice Annuity which is central in the Cornell plan and, along with Fidelity, the focus of the SCOTUS decision.

I believe that all annuities are prohibited transactions due to the inherent conflict of interest issues, and in most cases, the annuity issuer and annuity salesperson  are labeled in plans as parties in interest.  Prohibited transaction exemptions are subject to meeting certain requirements.  But the DOL does not even attempt to enforce them.   Many plans just blindly accept the claims of annuity salesmen that these contracts have a “get out of jail free card” in the form of a PTE.

Prohibited Transactions Exemption PTE 84-24

Annuities for decades have claimed Prohibited transaction exemptions behind PTE 84-24.  However, plans are responsible for verifying that the prohibited transaction exemptions apply to the insurance products they put in their plans.   This SCOTUS decision and future similar cases may force accountability for the first time.

ERISA PTE 84-24, which is  based on the Restatement of Trust,  states the annuities must meet the following requirements called the Impartial Conduct Standards and Written Disclosures and Policies and Procedures backing up these standards.  Most annuities I have seen do not even come close.

The Impartial Conduct Standards have 4 major obligations.   A. Care Obligation    B. Loyalty Obligation C. Reasonable compensation limitation  D. No materially misleading statements (including by omission)

Care Obligation This obligation reflects the care, skill, prudence, and diligence – similar to Prudent Person Fiduciary standard.   Diversification is one of the most basic fiduciary duties.  Fixed annuities flunk this with single entity credit and liquidity risk. Diligence is nearly impossible with misleading, nontransparent contracts, and the lack of plan/participant ownership of securities.[ii] The Federal Reserve in 1992 exposed the weak state regulatory and reserve claims.[iii]

Loyalty Obligation Annuity contracts are designed to avoid all fiduciary obligation with no loyalty to participants.   Secret kickbacks and commissions place the financial interests of the Insurers and their affiliates over those of retirement investors. In most cases, the annuity investor has little chance of even breaking even on the investment. The exemption requires the advisor to show their loyalty with a “Fiduciary Acknowledgement Disclosure.”   Annuity contracts avoid any fiduciary language or responsibility.

Reasonable compensation limitation Annuities have a total lack of disclosure of profits, fees and compensation – effectively denying any chance for a prospective purchaser to make an “informed decision.” They also have secret kickback commissions.[iv]   A number of lawsuits have settled with claims of excessive secret fees and spreads. An insurance executive bragged at a conference of fees over 200 basis points (2%) in 2013. [v]

No materially misleading statements (including by omission) Annuities have numerous material misleading statements, including the total lack of disclosure of spread/fees.  They claim principal protection, but some fixed annuity contracts recently have “broken the buck” and violated their contracts.  The written disclosures under weak state regulations omit critical information on risks and fees also prevents any opportunity for an “informed decision.”

GOING FORWARD

While Annuities are by far the largest area involved, I believe SCOTUS’ Cunningham decision will result in some significant consequwemces:

  1.  ERISA class action 401k litigation will explode especially against conflicted products like annuities[vi]
  2. Plans are now talking about taking legal action against vendors, who tricked them into these non-transparent products[vii]
  3. Plans will be more reluctant to take on non-transparent products like annuities[viii]
  4. Plans will be more reluctant to take on non-transparent products like crypto and private equity[ix]
  5. Plans will be more reluctant to do non-transparent administrative practices like revenue sharing[x] 

Plan Sponsors with fixed annuity contracts should demand
: 1. A MFN clause to make sure they have the best rate. A MNF (Most Favored Nation) clause is a clause that states that money managers are getting the lowest fee for their pension clients.
2. A downgrade lause that allows liquidity at full book value if the insurance company issuing the annuity is downgraded.

Annuities are clearly prohibited transactions that do not qualify for an exemption but have used their lobbying power in Washington and in states, to exempt themselves from all accountability.  This recent SCOTUS decision  may  help get accountability and transparency in plans through litigation.

[i] https://www.fingerlakes1.com/2025/04/18/supreme-court-cornell-erisa-401k-fees-decision-2025

[ii] https://commonsense401kproject.com/2024/03/26/just-how-safe-are-safe-annuity-retirement-products-new-paper-shows-annuity-risks-are-too-high-for-any-fiduciary/

[iii] Federal Reserve Bank of Minneapolis Summer 1992  Todd, Wallace  SPDA’s and GIC’s http://www.minneapolisfed.org/research/QR/QR1631.pdf

[iv] https://consumerfed.org/annuity-industry-kickbacks-cost-retirement-savers-billions/

[v] https://www.bloomberg.com/news/articles/2013-03-06/prudential-says-annuity-fees-would-make-bankers-dance?embedded-checkout=true

[vi] https://commonsense401kproject.com/2024/11/19/burden-of-proof-is-on-plan-sponsors-hoping-to-qualifyfor-annuity-prohibited-transactions-exemption/

[vii] https://commonsense401kproject.com/2024/07/31/chris-tobe-dol-testimony/

[viii] https://fiduciarywise.com/cunninghamvcornelluniversity/

[ix] https://www.linkedin.com/pulse/retirement-plan-sponsors-investment-advisors-should-take-ron-rhoades-zfp8c/?trackingId=cl6WVzR8TvCNYE2H6M59WQ%3D%3D

[x] https://commonsense401kproject.com/2022/04/02/revenue-sharing-in-401k-plans/

Cerulli Study Exposes Guaranteed Income Annuities on Fiduciary Issues

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By Chris Tobe, CFA, CAIA

A recent Cerulli Study exposes Guaranteed Income Annuities not only as unnecessary, but as creating ERISA Fiduciary Issues.[i]  I warned of this in my 2022 blog post on how income annuities are a fiduciary minefield.[ii]

“Cerulli Edge—U.S. Retirement Edition,” finds that as of 2024, 91% of asset managers believe guaranteed lifetime income options carry a negative stigma.  “Annuities continue to face perception issues due to high fees, complexity, lack of transparency, and concerns about insurer solvency, all of which deter plan participants,” says Idin Eftekhari, a senior analyst at Cerulli. “The tradeoff between liquidity and a guaranteed income stream is unappealing for many participants.[iii]

The argument that you need annuities to provide lifetime income is debunked as well.

Cerulli also points to lower cost transparent liquid methods of providing monthly income called “structured drawdown strategies” as superior alternatives to annuities.[iv] 

Annuities are a Fiduciary Breach

I wrote in 2022 that all annuities are a fiduciary breach [v]  While Guaranteed Income Annuities are still small in 401(k)s, I believe they are being used to justify even worse annuity products like IPG Fixed Annuities and Index annuities. Immediate Participation Guarantee (IPG)  is a Group fixed annuity contract (GAC) written to a group of investors in a DC Plan and not individuals. [v]  

IPG group annuities have no maturity, and set whatever rate they want without a set formula.

https://www.dfs.ny.gov/system/files/documents/2021/04/out_ipg_da_2000.pdf

Annuities are contracts that are an ERISA Prohibited Transaction.   Annuity providers claim their products are subject to Prohibited Transaction Exemption 84-4, but I have found that most annuities I have seen do not qualify for the exemption.[vi]

Annuity contracts are regulated by weak state insurance commissioners, and most plan sponsors are clueless to that fact.   The National Association of Insurance Commissioners (NAIC) sets weak national standards, but some state insurance commissioners have even weaker regulations.  NAIC’s prime goal is to prevent any national regulation or transparency as evidenced in this letter to Congress. [vii]   NAIC is currently trying to hide insurers Risk Based Capital (RBC) scores to hide significant risk from consumers. [viii]

There is an attempt to hide annuities in Target Date Funds in weak state regulated CIT’s in which I testified on to the DOL Advisory Committee in July 2024.[ix]

Annuity contracts shift all the fiduciary burden from themselves to the plan.   Thus, the burden of proof is on plan sponsors regarding if their plan annuity qualifies for an exemption from being classified as a prohibited transaction.[x]

 Annuities Credit & Liquidity Risk High & Getting Higher

A recent Federal Reserve paper exposes poor state & offshore regulation of Life Insurance companies that issue Annuities.  The FED’s main problem is the hiding and understating of credit, liquidity & leverage risks.[xi]

The FED economists contend that life and annuity issuers make investments in what amount to loans to risky firms look stronger by funneling the weak loans through arrangements — such as business development companies, broadly syndicated loan pools, collateralized loan obligations, middle-market CLOs and joint venture loan funds — that qualify for higher credit ratings.[xii]  “These arrangements seek to shift portfolio allocations towards risky corporate debt while exploiting loopholes stemming from rating agency methodologies and accounting standards.”[xiii]

Insurance risk experts Larry Rybka, Thomas Gober, Dick Weber Michelle Gordon highlight the addition of risks from Reinsurance in a recent trade publication.  Rybka says  The life insurance and annuities industry, he said, has become “like the Wild West.” Carriers are abusing reinsurance,”[xiv]  “It’s a shell game and, in general, the regulators are not paying attention,” said Dick Weber,[xv]  Gober says It’s not just offshore reinsurers that can largely skirt U.S. accounting standards, he said. There are also “captive” reinsurance companies within the U.S. mostly in Vermont, South Carolina, and Delaware.  “The lack of transparency with these affiliated reinsurance companies, both captive and offshore, is the single biggest threat to U.S. policyholders and annuitants,” said Gober.[xvi]

Michelle Gordon says that advisors should check the creditworthiness of any insurance companies they recommend to clients, she said, though most don’t or can’t because of lax ratings standards. “The non-codification of insurance advisement results in sub-optimization of consumer protections,” she said.[xvii]

Fiduciaries should be aware of these risks and have a duty to defend and justify these risks if they put annuities in their plans.

[i] https://401kspecialistmag.com/offering-guaranteed-income-not-as-essential-as-initially-perceived/

[ii] https://commonsense401kproject.com/2022/02/10/401k-lifetime-income-a-fiduciary-minefield/

[iii] https://401kspecialistmag.com/offering-guaranteed-income-not-as-essential-as-initially-perceived/

[iv] https://401kspecialistmag.com/offering-guaranteed-income-not-as-essential-as-initially-perceived/

[v] https://www.dfs.ny.gov/system/files/documents/2021/04/out_ipg_da_2000.pdf

[vi] https://commonsense401kproject.com/2022/05/11/annuities-are-a-fiduciary-breach/

[vii]  https://commonsense401kproject.com/2024/10/10/annuities-exposed-as-prohibited-transaction-in-401k-plans/

[viii] https://content.naic.org/sites/default/files/naic2025federalfinancialprioritiesletter.pdf

[ix] https://insurancenewsnet.com/innarticle/state-regulators-want-insurers-to-downplay-key-financial-strength-figure

[x] https://commonsense401kproject.com/2024/07/31/chris-tobe-dol-testimony/

[xi] https://commonsense401kproject.com/2024/11/19/burden-of-proof-is-on-plan-sponsors-hoping-to-qualifyfor-annuity-prohibited-transactions-exemption/

[xii] https://www.federalreserve.gov/econres/notes/feds-notes/life-insurers-role-in-the-intermediation-chain-of-public-and-private-credit-to-risky-firms-20250321.html

[xiii] https://www.thinkadvisor.com/2025/03/24/fed-researchers-see-life-insurers-filling-up-on-junk-assets/

[xiv] https://www.federalreserve.gov/econres/notes/feds-notes/life-insurers-role-in-the-intermediation-chain-of-public-and-private-credit-to-risky-firms-20250321.html

[xv] https://www.fa-mag.com/news/annuities-and-life-insurance-are-at-risk–advisors-warn-81810.html?section=303

[xvi] https://www.fa-mag.com/news/annuities-and-life-insurance-are-at-risk–advisors-warn-81810.html?section=303

[xvi] https://www.fa-mag.com/news/annuities-and-life-insurance-are-at-risk–advisors-warn-81810.html?section=303 [1] https://www.fa-mag.com/news/annuities-and-life-insurance-are-at-risk–advisors-warn-81810.html?section=303

Private Equity in 401k Plans- A Fiduciary Minefield for Plan Sponsors

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By Christopher B. Tobe, CFA, CAIA

Economic and Policy Research’s Eileen Appelbaum said “Much as private equity firms may wish it were different, they have been mostly unable to worm their way into workers’ 401(k)s and abscond with their retirement savings,”[i]

The Private Equity industry’s limited success and future success depends on Private Equity and related contracts like Private Debt finding tricks that block transparency to hide their excessive fees and risks, and inferior performance in ERISA plans.

The first trick is to exempt the actual Private Equity contact itself exempt from ERISA by a loophole of commingling it with non-ERISA public pensions and other non-ERISA plans.

In the context of a Private Equity contract, a “20% ERISA exemption” generally refers to a situation where a fund is considered exempt from full ERISA regulations if less than 20% of its total investor base consists of “benefit plan investors” (like retirement plans), meaning that the fund doesn’t need to adhere to the stricter rules of ERISA as long as the percentage of ERISA-regulated money invested remains below 20% of the total fund size.[ii] 

The second trick is to domicile the Private Equity contract in a place with lax laws.   Roughly a third of the private equity contracts are domiciled in the Cayman Islands and much of the rest in the State of Delaware.[iii]

The third trick is one I warned the DOL ERISA Advisory council in July 2024.   I focused on the hiding of Private Equity and other illiquid contracts buried in Target Date Funds.[iv]   SEC registered Mutual funds require too much transparency on fees and risks so Private Equity has avoided them.   Federal OCC regulated Collective Investment Trusts (CIT’s) also require too much transparency.  Instead, the Private Equity Industry needs a weak regulator that requires minimum transparency, and they have found it by cherry picking the laxest of 50 state banking regulators.   In May 2023, SEC chair Gary Gensler sounded the alarms on CIT’s “Rules for these funds lack limits on illiquid investments and minimum levels of liquid assets. There is no limit on leverage, or requirement for regular reporting on holdings to investors”[v]

Private Equity DOL Guidance

DOL guidance seems to shift with the political winds.  Around 4 years ago Forbes Columnist Ted Siedle wrote “Trump DOL throws 401k Investors to the Wolves” [vi]   At Berkshire Hathaway annual meeting  (2019) Buffett stated, “We have seen a number of proposals from private equity firms where the returns are not calculated in a manner that I would regard as honest… If I were running a pension fund, I would be very careful about what was being offered to me.” Other publications warned of Leading U.S. Retirees ‘Lik Lambs to the Slaughter’[vii]

This was due to the trade press and Private Equity industry interpreting a June 2020 DOL letter as a “get out of jail free card” for plan sponsors to load up on Private Equity if it is buried in Target Date Funds.   What the letter says is that theoretically the perfect Private Equity fund with a high level of transparency and independent verifiable valuation could be included in a diversified Target Date Fund.

  I do not thing this perfect Private Equity contract investment exists, and the burden of proof is on the plan sponsor to prove that it does exist when they went into the contract and to continually monitor the contract to make sure it stays “perfect”. [viii]
 

Morningstar asks Can the presence of a largely illiquid fund comply with DC ERISA regulation?  An answer arrived in a June 2020 “Information Letter” in which the Department of Labor addressed a proposal by Pantheon Ventures LP, and Partners Group, Inc. to put private equity within a target-date fund. The DOL letter states that this would not violate ERISA provided the vehicle resided within a diversified managed solution like a target-date fund or managed account, and that it was otherwise walled off to participants. Additionally, the fund within which the illiquid investment resides must have a “sufficient” level of liquidity—that is, investment in public-market vehicles to meet likely participant demands. These are guidelines rather than specific rules, but they appear sufficiently actionable for a competent fiduciary.[ix]

But if you look at the actual information letter, you can see this part was cherry picked to spin a positive story for sneaking in Private Equity 401(k).[x]  The DOL in full, warns plan sponsors of numerous potential fiduciary issues.   Statements like plan fiduciaries have duties to prudently select and monitor any designated investment alternative under the plan, and liability for losses resulting from a failure to satisfy those duties.[xi] In evaluating … fiduciary must engage in an objective, thorough, and analytical process[xii]  Warns of typically, higher fees and that you must evaluate the risks and benefits returns net of fees including management fees, performance compensation, or other fees or costs that would impact the returns received)…, including cost, complexity, disclosures, and liquidity, and has adopted features related to liquidity and valuation designed to permit the asset allocation fund to provide liquidity for participants [xiii] Ensure that private equity investments be independently valued according to agreed-upon valuation procedures. [xiv]   DOL also shows a duty to monitor “The fiduciary also must periodically review whether the investment vehicle continues to be prudent[xv]    DOL also talks about the requirement to be fully transparent to participants whether plan participants will be furnished adequate information regarding the character and risks of the investment alternative to enable them to make an informed assessment [xvi] Especially noted a higher level of fiduciary duty for a qualified default investment alternative (QDIA) [xvii]

The DOL clarified these requirements early in the Biden Administration in late 2021. [xviii] “Cautions plan fiduciaries against the perception that private equity is generally appropriate as a component of a designated investment alternative in a typical 401(k) plan. [xix] The DOL letter did not endorse or recommend PE investments.[xx]

During the Trump administration, Private Equity is expecting a friendlier DOL on messaging.   The DOL has never really engaged in any broad investment enforcement, and I expect we will see more of the same during the Trump administration.

Private Equity Does not meet exemptions standards for being a Prohibited Transaction.

Plan sponsors do not need to fear the DOL, but they do need to fear litigation if they invest in Private Equity.   Looking at all the ERISA attributes that Private Equity needs to be exempted from Prohibited Transactions – Private Equity flunks all the impartial conduct standards in numerous ways.

Private equity offering documents generally prominently state (in capital, bold letters) that an investment in a private equity fund is speculative, involves a high degree of risk, and is suitable only for persons who are willing and able to assume the risk of losing their entire investment.  Most contracts that PE can engage in borrowing, or leverage, on a moderate or unlimited basis.  There is no assurance of diversification since funds generally reserve the right to invest 100 percent of their assets in one investment.  There are also heightened legal, regulatory, operational and custody risk. [xxi]      

Private Equity has a myriad of conflicts of interest, self-dealing practices. The investment manager determines the value of the securities held by the fund. Such a valuation affects both reported fund performance as well as the calculation of the management fee and any performance fee payable to the manager. [xxii]    

Private Equity has business practices that violate ERISA in many ways. Private equity fund offering documents often disclose that investors agree to permit managers to withhold complete and timely disclosure of material information regarding assets in their funds. Further, the fund may have agreed to permit the investment manager to retain absolute discretion to provide certain mystery investors with greater information and the managers are not required to disclose such arrangements. As a result, the fund you invest in is at risk that other unknown investors are profiting at its expense—stealing from you. [xxiii] 

A Private Equity-like structure technically private debt has cost JP Morgan over $400 million in damages in 401(k) litigation.  This private debt was put in a state regulated JP Morgan CIT, which was put in JPM broad bond CIT, with was put in a JPM stable value CIT.[xxiv] 

Plan sponsors will have a tough time justifying Private Equity as being exempted as a prohibited transaction given these facts.   

Private Equity Performance and Valuation Issues

With such a lack of controls over the contracts, reliable valuation and performance in Private Equity is almost impossible and benchmarks are mostly useless.[xxv]

The entire justification Fiduciaries must rely on is the superior performance of Private Equity which has been proven to be mostly false after excessive fees.[xxvi] A report by University of Oxford professor Ludovic Phalippou shows that in the last 15 years, private equity firms generally have not provided better returns to investors than low-fee stock index funds. Prof. Phalippou has shown excess mostly hidden fees and expenses to exceed 6% killing net returns.[xxvii]   

Noted founder of investment consulting firm Richard Ennis in quoting Beath & Flynn 2020 study says that private equity (as a class of investment) in fact ceased to be a source of value-added more than a decade ago. [xxviii] Jeff Hooke of Johns Hopkins book the “Myth of Private Equity” goes into detail on the asset class and its numerous fiduciary flaws.  He documents that many performance claims are made up by the managers with no independent verification and are greatly exaggerated. [xxix]   Academic Wayne Lim finds Fees and Expenses totaling over 6-8%     The corresponding fee drag on gross-to-net total value to paid-in capital is 0.1x to 0.7x and 5% to 8% in annualized terms. [xxx]

Conclusion

Private Equity along with other illiquid contract investments are a potential Fiduciary Time Bomb for plans and their participants.   Does the fiduciary even know if the Private Equity contract is subject to ERISA or exempt.  Is the contract domiciled in the Cayman Islands?  If its buried in a target date fund, is it in a mutual fund, or a poorly regulated state CIT?

A lack of transparency makes it impossible for fiduciaries to prove that Private Equity contracts are worthy of a Prohibited Transaction exemption.   Worse, most have excessive fees and risks which cause real damages to participants.   While the Private Equity industry may be able to prevent regulation, the real threat of litigation will lead to prudent fiduciaries keeping Private Equity out of ERISA plans.

[i] https://commonsense401kproject.com/2022/02/15/private-equity-in-401k-plans-a-ticking-time-bomb/

[ii] https://www.wlrk.com/webdocs/wlrknew/AttorneyPubs/WLRK.25307.15.pdf https://www.ropesgray.com/-/media/files/prax-pages/erisa/erisa-compliance-2019.pdf

[iii] https://www.sec.gov/files/investment/private-funds-statistics-2023-q4.pdf

[iv] https://commonsense401kproject.com/2024/07/31/chris-tobe-dol-testimony/   In addition  Annuity providers bury mostly Private Debt in their weak state insurance regulators.

[v] https://www.sec.gov/newsroom/speeches-statements/gensler-etam-051624

[vi] https://www.forbes.com/sites/edwardsiedle/2020/06/13/dol-throws-401k-investors-to-the-wolves/

[vii]

[viii] Hal.Ratner@morningstar.com   Private Equity and Private-Market Funds in Managed Defined Contribution Plans  https://www.morningstar.com/business/insights/research/private-market-funds-dc-plans?utm_source=referral&utm_medium=center&utm_campaign=private-market-funds-dc-plans

[ix] Hal.Ratner@morningstar.com   Private Equity and Private-Market Funds in Managed Defined Contribution Plans  https://www.morningstar.com/business/insights/research/private-market-funds-dc-plans?utm_source=referral&utm_medium=center&utm_campaign=private-market-funds-dc-plan

[x] https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/information-letters/06-03-2020

[xi] See, e.g., 29 CFR 2550.404c-1(d)(2)(iv) and 29 CFR 2550.404c5(b).

[xii] https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/information-letters/06-03-2020

[xiii] https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/information-letters/06-03-2020

[xiv] that satisfy the Financial Accounting Standards Board Accounting Standards Codification (ASC) 820, “Fair Value Measurements and Disclosures,”9 and require additional disclosures needed to meet the plan’s ERISA obligations to report information about the current value of the plan’s investments.

[xv] https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/information-letters/06-03-2020

[xvi] https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/information-letters/06-03-2020

[xvii] for the plan under 29 CFR 2550.404c-5. Moreover, as noted above, the fiduciary responsible for including the fund on the plan’s investment menu always retains responsibility for ensuring that the decision to retain the fund is consistent with the fiduciary responsibility provisions of Section 404 of ERISA.

[xviii] https://www.dol.gov/newsroom/releases/ebsa/ebsa20211221

[xix] https://www.dol.gov/newsroom/releases/ebsa/ebsa20211221

[xx] https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/information-letters/06-03-2020-supplemental-statement

[xxi] https://commonsense401kproject.com/2022/02/15/private-equity-in-401k-plans-a-ticking-time-bomb/

[xxii] https://commonsense401kproject.com/2022/02/15/private-equity-in-401k-plans-a-ticking-time-bomb/

[xxiii] https://commonsense401kproject.com/2022/02/15/private-equity-in-401k-plans-a-ticking-time-bomb/

[xxiv] https://www.nytimes.com/2012/03/23/business/jpmorgan-discloses-it-lost-in-arbitration-to-american-century.html

[vii] https://casetext.com/brief/whitley-v-jp-morgan-chase-co-et-al_memorandum-of-law-in-opposition-re-49-motion-to-dismiss-first-amended

[viii] 

[xxv] https://commonsense401kproject.com/2024/11/29/crypto-private-equity-annuity-contracts-are-impossible-to-benchmark/

[xxvi] https://commonsense401kproject.com/2022/02/15/private-equity-in-401k-plans-a-ticking-time-bomb/ 

[xxvii] https://blogs.cfainstitute.org/investor/2024/11/22/a-reality-check-on-private-markets-part-iii/  https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3623820  an Inconvenient Fact Private Equity Returns U.of Oxford  Ludovic Phalippou

[xxviii]  https://richardmennis.com/blog/how-to-improve-institutional-fund-performance

[xxix] https://cup.columbia.edu/book/the-myth-of-private-equity/9780231198820

[xxx] https://rpc.cfainstitute.org/research/financial-analysts-journal/2024/accessing-private-markets-what-does-it-cost

Pension Risk Transfer Annuities should be Prohibited.  The Burden of proof is on plan sponsors to justify that they are prudent

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By Christopher B. Tobe, CFA, CAIA

Pension Risk Transfer Annuities (PRT’s) replace a solid diversified defined benefit plan with federal (PBGC) insurance, with a high single entity risk annuity with higher risks and weak state regulation. 

Pension Risk Transfers (PRT’s) shift the risk off the plan sponsor onto the backs of the participants.   This allows plan sponsors to lower costs and insurance companies billions at the expense of participants and retirees.

It appears that large pension plans have been in a hurry to close Pension Risk Transfer deals, before their victims the participants wake up and see the raw deal they are getting.[i] Regulators, to my knowledge, have never tested this risk with actuarial analysis.  Under industry pressure they came up after the Executive Life defaults IB95-1 a weak rule to pick the “safest available annuity”.  I think the premise of a least risky annuity would is like a less risky plane crash.

However, plan sponsors are not off the hook, due to the ability of plaintiffs to recover these losses through litigation.   The Burden of proof is on plan sponsors that their plan PRT Annuity contract has low enough risk to be exempted from being a Prohibited Transaction and is at a reasonable cost.

Fiduciary Breaches of PRT Annuity Contracts

PRT Annuity Contracts are a Fiduciary Breach for 4 basic reasons.[ii] 

  1. Single Entity Credit Risk[iii]  
  2. Single Entity Liquidity Risk in illiquid investments [iv]   
  3. Hidden fees spread and expenses [v]  
  4. Structure -weak cherry-picked state regulated contracts, not securities and useless reserves [vi]    

These breaches make it impossible for most annuity products to qualify for exemptions to Prohibited Transactions.[vii]  

The Federal Reserve in 1992 exposed the weak state regulatory and reserve claims of Fixed annuities in retirement plans.[viii]   In 2008 Federal Reserve Chairman Ben Bernanke said about these annuity products “workers whose 401(k) plans had purchased $40 billion of insurance from AIG against the risk that their stable-value funds would decline in value would have seen that insurance disappear.”[ix]  In the major stable value annuity source book,  single annuity like PRTs are shown to have 10 times the risk of a diversified fixed portfolio. [x]

.

The Burden of proof is on plan sponsors that they have documented due diligence on these risk issues and that their PRT Annuity contract is exempted from being a Prohibited Transactions. [xi]  

Fiduciary Transparency Conflicts Tests – Loyalty Excessive Compensation

As a plan sponsor you should put all products through these fiduciary transparency tests, I contend that annuities almost always flunk this basic level of care.

Annuities avoid transparency with poor state regulated structures which allow them to hide excessive risks and fees.    Annuity providers fight hard to avoid any Federal Regulations usually favoring state regulation in their home states where they are major employers and have higher political influence. Even industry insiders admit hidden fees are problematic to adopting annuities.[xii]

After the 2008 financial crisis several Insurers were forced into Federal Regulation under SIFI (too big to fail) they did everything to get out of the higher transparency and higher capital requirements.[xiii] 

Annuity contracts have been characterized by retirement group NAGDCA as having serious fiduciary issues.  “Due to the fact that the plan sponsor does not own the underlying investments, the portfolio holdings, performance, risk, and management fees are generally not disclosed.

It also makes it nearly impossible for plan sponsors to know the fees (which can be increased without disclosure) paid by participants in these funds—a critical component of a fiduciary’s responsibility “  [xiv]

Plans need to put their Loyalty to plan participants first which is their fiduciary duty.   They do not have loyalty to vendors such as money managers and annuity providers.

Annuities have an Inherent conflict because investment dollars leave the ownership of the plan and participants and become part of the balance sheet of the insurance company.   

Annuity contracts are designed to avoid all fiduciary obligation with no loyalty to participants.   Most annuity providers refuse to sign a “Fiduciary Acknowledgement Disclosure.” 

DOL official Khawar said. “” Under the National Association of Insurance Commissioners’ model rule, for example, “compensation is not considered a conflict of interest,” [xv]

Annuities have a total lack of disclosure of profits, fees and compensation.  They have secret kickback commissions.    How can a plan claim any of the compensation annuity provider receives is reasonable if it is secret and not disclosed.

Current Cases – Worst of Worst Athene-Apollo

PRTs have been operating under a weak DOL rule to pick the “safest available annuity”.  Over decades traditional insurers have made millions.  While default risk is present with traditional insurers, they do want to sustain the business long-term and avoid default.  When Private Equity players got involved, with their short-term mentality, they are set to strip billions in profits, not afraid to bankrupt companies and “kill the Golden Goose” for the traditional part of the business.

With these significant differences in risks and profit for the private equity insurers, it has created measurable damages that has jump started litigation. 

From Piercy v. AT&T filed on 3/11/24 says, AT&T turned its back on its retired workers, choosing to put the pensions of almost 100,000 AT&T retirees in peril, to secure AT&T an enormous profit. AT&T stood to gain—and did gain—more than $360 million in profit from this scheme The only losers in the transaction were AT&T’s retirees, who face the danger—now and in the future—that their lifelong pensions will go unpaid while they have lost all the protections of federal law.

As pointed out above the standard PRT is at least 10 times that of a diversified portfolio, but that an even riskier single entity credit risk like private equity backed Athene could have 20 times the risk. [xvi]

Most of the current PRT cases are against Apollo owned Athene.   Apollo is infamous with over

684 regulatory violations. [xvii]  Fines range from the DOJ $210 million fine for accounting fraud, to $53 Million by the SEC for misleading investors on fees. [xviii]   Other claims against Apollo are around investor protection violations, consumer protection violations, and the false claims act.

In early 2021 Apollo founder & CEO Leon Black resigned after paying $158 million in “tax advice” to Jeffrey Epstein.[xix]   In 2015 Apollo was involved in a massive pay to play scheme involving a trustee and CEO of CALPERS the US largest public pension.  The CALPERS CEO Buenrostro was sent to prison and the trustee Villalobos committed suicide before serving his term.[xx] 

Conclusion

In a submitted academic paper on Annuity risks it touts the risks of PRT’s.   It states the “Emperor has no Clothes” as the life insurance industry has poured billions of dollars into advertising, lobbying, commissions & trade articles with misinformation on annuities with everyone afraid to call out the obvious.[xxi]

The ultimate responsibility and the burden of proof goes on to the plan sponsor to prove this annuity purchase was for the benefit of participants.  Those who have pulled the trigger on these questionable annuity deals will probably face litigation. 

[i] https://www.chicagofed.org/publications/economic-perspectives/2024/5   https://www.chicagofed.org/publications/chicago-fed-letter/2024/494

[ii] https://commonsense401kproject.com/2022/05/11/annuities-are-a-fiduciary-breach/   https://commonsense401kproject.com/2024/11/29/crypto-private-equity-annuity-contracts-are-impossible-to-benchmark/

[iii] https://commonsense401kproject.com/2024/03/26/just-how-safe-are-safe-annuity-retirement-products-new-paper-shows-annuity-risks-are-too-high-for-any-fiduciary/  https://www.thinkadvisor.com/2024/11/20/yes-life-and-annuity-issuers-can-suddenly-collapse-treasury-risk-tracker-warns/ 

[iv] https://www.chicagofed.org/publications/economic-perspectives/2024/5   https://www.chicagofed.org/publications/chicago-fed-letter/2024/494

[v] https://www.bloomberg.com/news/articles/2013-03-06/prudential-says-annuity-fees-would-make-bankers-dance?embedded-checkout=true   TIAA https://www.nbcnews.com/investigations/tiaa-pushes-costly-retirement-products-cover-losses-whistleblower-rcna161198

[vi] Federal Reserve Bank of Minneapolis Summer 1992  Todd, Wallace  SPDA’s and GIC’s http://www.minneapolisfed.org/research/QR/QR1631.pdf  https://www.chicagofed.org/publications/economic-perspectives/1993/13sepoct1993-part2-brewer 

[vii] https://commonsense401kproject.com/2024/10/10/annuities-exposed-as-prohibited-transaction-in-401k-plans/

[viii] Federal Reserve Bank of Minneapolis Summer 1992  Todd, Wallace  SPDA’s and GIC’s http://www.minneapolisfed.org/research/QR/QR1631.pdf

[ix] http://www.federalreserve.gov/newsevents/testimony/bernanke20090324a.htm

[x] The Handbook of Stable Value Investments 1st Edition by Frank J. Fabozzi 1998 Jacquelin Griffin Evaluating Wrap Provider Credit Risk in Synthetic GICs pg. 272  https://www.amazon.com/Handbook-Stable-Value-Investments/dp/1883249422

[xi] https://commonsense401kproject.com/2024/11/19/burden-of-proof-is-on-plan-sponsors-hoping-to-qualifyfor-annuity-prohibited-transactions-exemption/

[xii] https://riabiz.com/a/2024/5/11/fidelity-voya-and-boa-smooth-blackrocks-launch-of-guaranteed-paycheck-etfs-but-401k-plan-participants-may-yet-balk-at-high-unseeable-fees-and-intangibility-of-benefits

[xiii] https://www.stanfordlawreview.org/online/the-last-sifi-the-unwise-and-illegal-deregulation-of-prudential-financial/

[xiv] http://www.nagdca.org/documents/StableValueFunds.pdf_ The National Association of Government Defined Contribution Administrators, Inc. (NAGDCA) September 2010.

[xv] https://www.thinkadvisor.com/2024/10/07/top-dol-official-sees-a-nonsensical-reality-at-heart-of-fiduciary-fight/

[xvi] The Handbook of Stable Value Investments 1st Edition by Frank J. Fabozzi 1998 Jacquelin Griffin Evaluating Wrap Provider Credit Risk in Synthetic GICs pg. 272  https://www.amazon.com/Handbook-Stable-Value-Investments/dp/1883249422

[xvii] https://violationtracker.goodjobsfirst.org/?company=Apollo

[xviii] https://www.ai-cio.com/news/apollo-fined-53-million-over-fees/

[xix] https://www.nytimes.com/2021/01/26/business/jeffrey-epstein-leon-black-apollo.html

[xx] https://www.latimes.com/business/la-fi-villalobos-suicide-20150115-story.html 

[xxi] Lambert, Thomas E. and Tobe, Christopher B., “Safe” Annuity Retirement Products and a Possible US Retirement Crisis (March 18, 2024). Available at SSRN: https://ssrn.com/abstract=4763269

Burden of Proof is on Plan Sponsors Hoping to Qualify for Annuity Prohibited Transactions Exemption

/ jwatkins / Leave a comment

By Christopher B. Tobe, CFA, CAIA

The burden of proof is on plan sponsors regarding their plan annuity qualifies for an exemption from being classified as a prohibited transaction.  Likewise, they are also liable for proving that any annuity option or investment option that contains annuities qualifies for a prohibited ransaction Exemption,

I believe that most annuities in 401(k) and other ERISA plans do not fully qualify for a prohibited transaction exemption. [i]  The primary basis for my opinion is that the single entity credit and liquidity risk in annuity contracts violates one of the most basic standards of care diversification.[ii]    CFA Investment Standards lay out specific standards for 401(k) and other defined contribution (D.C.) plans. Diversification—each investment option, as a standalone investment, must be sufficiently diversified that plan participants, if they chose only that option would not be at serious risk of unsustainable investment losses because of a relatively small segment of the capital markets experiencing distress [iii]

Assuming that as plan sponsor that you can get over the single entity credit and liquidity risk, how can you justify any connection to annuities.   Perhaps your advisors will talk you into smaller amounts buried and hidden in a target date fund or in a lifetime income option.  It is common term in the financial world that “Annuities are sold not bought”.

I contend that annuities violate fiduciary standards in so many ways that it is very difficult for a plan sponsor to prove that these contracts qualify for a prohibited transaction exemption.


Fiduciary Transparency Tests of Care

As a plan sponsor you should put all products through these fiduciary transparency tests, I contend that annuities almost always flunk this basic level of care.

Is the annuity in a well-regulated transparent structure like a SEC registered mutual fund?

Most likely the answer is “no,” as annuities, with their lack of transparency around fees, are typically not allowed in SEC registered mutual funds.  Many plans avoid this issue by using SEC registered mutual funds.   SEC registered mutual funds have transparent fees and performances, have uniform federal regulations and are the gold standard for the 401(k).  SEC registered mutual funds do not allow annuities for the same reasons that I think most annuities flunk prohibited transaction exemptions.

CFA Institute Global Investment Performance Standards (GIPS) also have transparency standards on performance and fees.[iv]  Annuities typically do not comply with CFA GIPS standards. [v]  

Another way for plans to have Transparency and fiduciary control are achieved in a plan by an Investment Policy Statement (IPS).  However, plans with annuities avoid an IPS because they usually cannot comply with one.  [vi]

Noted Morningstar analyst John Rekenthaler said in April 2022 that in selecting 401(k) investment options, “inappropriate are investments that don’t price daily.  Annuities typically do not price daily and do not provide valuation transparency.[vii]  

Annuities avoid transparency with poor state regulated structures which allow them to hide excessive risks and fees.    Annuity providers fight hard to avoid any federal regulations, especially those imposing on them any type of true fiduciary standard and/or transparency, usually favoring state regulation in their home states where they are major employers and have higher political influence. Even industry insiders admit hidden fees are problematic to adopting annuities.[viii]

After the 2008 financial crisis several insurers were forced into federal regulation under SIFI (too big to fail) they did everything to get out of the higher transparency and higher capital requirements.[ix] 

Fiduciary Conflicts Tests – Loyalty and Excessive Compensation

Plans need to put their loyalty to plan participants first, which is their fiduciary duty.   They do not have loyalty to vendors such as money managers and annuity providers.

Annuities have an inherent conflict because upon annuitization, a common prerequisite to receiving the alleged benefit – guaranteed stream of income for life – investment dollars leave the ownership of the plan and participants, and become part of the balance sheet of the insurance company.   

Annuity contracts are designed to avoid all fiduciary obligation with no loyalty to participants.   Most annuity providers refuse to sign a “Fiduciary Acknowledgement Disclosure.” 

DOL official Khawar said. “” Under the National Association of Insurance Commissioners’ model rule, for example, “compensation is not considered a conflict of interest,” [x]

Reasonable Compensation Limitation

Annuities have a total lack of disclosure of profits, fees and compensation.  They have secret kickback commissions.    How can a plan claim any of the compensation annuity provider receives is reasonable if it is secret and not disclosed?

Secret kickback and commissions place the financial interests of the insurers and their affiliates over those of retirement investors.[xi]  In summer 2024 the GAO report on Self-Dealing [xii],  and Senator Warrens reported on Annuity kickbacks.[xiii]

A number of lawsuits have settled with claims of excessive secret fees and spreads. An insurance executive bragged at a conference of secret fees r3agrding spreads of over 200 basis points (2%) in 2013. [xiv]   Most observers of 401(k) plans do not feel that 200 basis points of compensation is reasonable.

Fixed Annuity Applications

In 1992, The Federal Reserve exposed the weak state regulatory and reserve claims of fixed annuities in retirement plans.[xv]   In 2008, Federal Reserve Chairman Ben Bernanke said about these annuity products “workers whose 401(k) plans had purchased $40 billion of insurance from AIG against the risk that their stable-value funds would decline in value would have seen that insurance disappear.”[xvi]

The version of annuity that is most common in DC plans larger than $100mm in total assets or 1000 employees is the Immediate Participation Guarantee (IPG)  which is a group annuity contract (GAC) written to a group of investors in a defined contribution (DC) plan, not to individuals.[xvii]   The largest IPG is the TIAA Traditional Annuity with over $290 billion in assets, making it one of the largest options in DC plans in the United States. [xviii]

These IPG contracts have been characterized by DC plan group NAGDCA as having serious fiduciary issues.  “Due to the fact that the plan sponsor does not own the underlying investments, the portfolio holdings, performance, risk, and management fees are generally not disclosed. This limits the ability of plan sponsors to compare returns with other SVFs [stable-value funds]. It also makes it nearly impossible for plan sponsors to know the fees (which can be increased without disclosure) paid by participants in these funds—a critical component of a fiduciary’s responsibility “  [xix]

The industry defense on prohibited transactions is a bait and switch around a hyped politically popular concept of lifetime annuities which, in reality, do not hold material assets in DC plans.  The industry also uses language realtive to Pension Risk Transfers that apply to DB plans not DC plans.   

My estimates, based on looking at 100s of DC plans over $100mm in assets, is that overall around 12% of plans currently have any type of annuity. Of those with an annuity,  less than 1% is in lifetime annuities and variable annuities, 5% is in miscellaneous insurance company Separate Account products,  83% in Fixed Annuities IPG General account accumulation group annuity contracts, and 11%  in Fixed Annuities IPGs Separate account accumulation group annuity contracts

While I believe that lifetime income and pension risk transfers in DB plans have fiduciary issues,  plan sponsors do not really have any defense for the IPG type fixed annuities that make up the bulk of prohibited assets in larger Defined Contribution plans. https://www.metlife.com/retirement-and-income-solutions/insights/final-clarification-annuity-selection-safe-harbor/

Plan sponsors who choose to use IPG annuities in their 401(k) plans clearly need to document why they believe it deserves a prohibited transaction exemption.

[i] https://commonsense401kproject.com/2024/10/10/annuities-exposed-as-prohibited-transaction-in-401k-plans/

[ii] https://commonsense401kproject.com/2022/05/11/annuities-are-a-fiduciary-breach/

[iii] https://rpc.cfainstitute.org/-/media/documents/book/rf-publication/2017/rf-v2017-n3-1.pdf

[iv] https://www.cfainstitute.org/en/membership/professional-development/refresher-readings/gips-overview

[v] https://commonsense401kproject.com/2023/02/01/401k-plan-sponsors-should-look-to-cfa-code-for-investment-governance/

[vi] https://commonsense401kproject.com/2023/03/12/investment-policy-statements-crucial-to-fiduciary-duty/

[vii] https://www.morningstar.com/articles/1090732/what-belongs-in-401k-plans

[viii] https://riabiz.com/a/2024/5/11/fidelity-voya-and-boa-smooth-blackrocks-launch-of-guaranteed-paycheck-etfs-but-401k-plan-participants-may-yet-balk-at-high-unseeable-fees-and-intangibility-of-benefits

[ix] https://www.stanfordlawreview.org/online/the-last-sifi-the-unwise-and-illegal-deregulation-of-prudential-financial/

[x] https://www.thinkadvisor.com/2024/10/07/top-dol-official-sees-a-nonsensical-reality-at-heart-of-fiduciary-fight/

[xi] https://consumerfed.org/annuity-industry-kickbacks-cost-retirement-savers-billions/

[xii] https://www.gao.gov/products/gao-24-104632

[xiii] https://www.warren.senate.gov/imo/media/doc/senator_warrens_annuity_report_-_sept_2024.pdf    Secret kickback commissions

[xiv] https://www.bloomberg.com/news/articles/2013-03-06/prudential-says-annuity-fees-would-make-bankers-dance?embedded-checkout=true

[xv] Federal Reserve Bank of Minneapolis Summer 1992  Todd, Wallace  SPDA’s and GIC’s http://www.minneapolisfed.org/research/QR/QR1631.pdf

[xvi] http://www.federalreserve.gov/newsevents/testimony/bernanke20090324a.htm

[xvii] https://www.dfs.ny.gov › ipgdac_word_20121214  

[xviii] https://www.tiaa.org/public/plansponsors/investment-solutions/lifetime-income/tiaa-traditional-overview

https://www.nbcnews.com/investigations/tiaa-pushes-costly-retirement-products-cover-losses-whistleblower-rcna161198

[xix] http://www.nagdca.org/documents/StableValueFunds.pdf_ The National Association of Government Defined Contribution Administrators, Inc. (NAGDCA) September 2010.