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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

Crypto, Private Equity, Annuity Contracts Are Impossible to Benchmark

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By Christopher B. Tobe, CFA, CAIA

Crypto, Private Equity, and Annuity contracts are impossible to Benchmark because of a lack of transparency accountability and liquidity.   Valid Benchmarks require investable securities.   These issues make it nearly impossible for any of these contracts to be exempted from being a prohibited transaction in an ERISA plan. [i]

According to the CFA Institute, a valid benchmark should meet the following criteria:

  • Specified in advance: The benchmark is defined before the evaluation period begins. 
  • Measurable: The benchmark’s return can be calculated regularly and in a timely manner. 
  • Unambiguous: The identities and weights of the securities in the benchmark are clearly defined. 
  • Reflective of current investment opinions: The manager is knowledgeable about the securities in the benchmark and their factor exposures. 
  • Accountable: The manager is aware of and accepts responsibility for the benchmark’s performance and constituents. 
  • Investable: The assets of the underlying index are available for purchase by investors. 

These attributes are impossible for contract-based investments like Crypto, Private Equity, and Annuities since you do not own any securities.  There is no accountability, they are ambiguous and use different forms of accounting than securities. 


Benchmarks can work when you compare a security-based active investment fund with a security-based index fund as highlighted in Brotherston vs. Putnam.[ii]

These are one sided contracts, not securities, in favor of the vendor and to the detriment of the investor.    Looking at these from an ERISA particularly 401(k) context these contracts have severe fiduciary issues which I feel prevent them from an exemption from prohibited transaction rules.  The Burden of Proof is on the Plan Sponsor to document that these contracts are not Prohibited Transactions.[iii]

 I think the conflicted contract nature of these investments allows them to manipulate or avoid benchmarks altogether.    While plan sponsors should never have entered into these contracts in the first place, how do you hold them accountable for the damages they have caused participants.   If you compare them against benchmarks to the lower risk investments they should have invested in, it conceals the damages.   You must find comparable contracts with the same types of high risk to find the actual damages.

Annuity Contracts

I wrote last month that Annuities should not be allowed in 401(k)s as Prohibited Transactions.  Annuities are a Fiduciary Breach for 4 basic reasons. [iv]

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

These breaches make it impossible for most annuity products to qualify for exemptions to Prohibited Transactions which need to fill these 4 major obligations.  [ix]

A. Care Obligation

B. Loyalty Obligation

C. Reasonable compensation limitation

D. No materially misleading statements (including by omission

I do not believe few if any annuities meet these 4 obligations, and the

burden of proof is on the plan sponsor that the annuities they use in their ERISA plans have a valid exemption. [x]

I have extensive experience showing damage by annuity contracts in large 401(k) and 403(b) plans.   These are primarily fixed annuity IPG contracts within the broad category of stable value with no maturity and discretion by the insurer to pay rates that maximize their profits, at the detriment of participants.   Some Fixed Annuity providers will claim money markets as a benchmark, despite having over 20 times the risk.   The Federal Thrift Savings Plan has a high-quality stable value product, the G fund which they state is impossible to benchmark. [xi]    

Single entity Fixed annuity providers have attempted to compare to the diversified Hueler Stable Alue Index despite having 10 times the risk.  The proper comparable has been to other IPG fixed annuities with single entity risk, which has used in over a dozen cases specifically comparables like TIAA and MassMutual cited in detail in 2 ERISA Hospital Cases: Columbus, GA and Norton Hospital.

Private Equity Contracts

Private Equity contracts have mostly been contained in non-ERISA plans but this may be changing.  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,”[xii]

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.  Can engage in borrowing, or leverage, on a moderate or unlimited basis.  No assurance of diversification since funds generally reserve the right to invest 100 percent of their assets in one investment.  Heightened offshore legal, regulatory, operational and custody risk.[xiii]  

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. [xiv]

Private Equity has business practices that may violate ERISA. 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. [xv]

Plan sponsors will have a tough time justifying Private Equity as being exempted as a prohibited transaction given these facts.   With such a lack of controls on the contracts, benchmarks are mostly useless.

Private Equity Benchmarks have been manipulated in U.S. public pensions to get higher bonuses not only for the Private Equity managers but for public government staff.  [xvi]   Private Equity benchmarks typically add a premium of 2%-6% to small cap index for leverage and liquidity.  I think the high end of this range could be appropriate for damage comparisons given the fiduciary issues of the assets.  

Crypto Contracts

Crypto has not been used extensively in ERISA plans as of now, but it is increasing.[xvii]

It was first discovered in Brokerage Windows, in which plans feel they have less fiduciary accountability.   Companies running Brokerage Windows have been paid $millions by Crypto companies to put their options on their Brokerage Window Platform. In the article, “401(k)s with Bitcoin Should Expect Lawsuits: Lawyers,” the trade publication “Ignites” quotes Jerry Schlichter as saying that.  Any employer who would follow the Fidelity lead by offering cryptocurrency and a 401(k) plan is exposing itself to very serious risk of a fiduciary breach…. As an unproven, highly volatile investment, Bitcoin would test the prudence standard under the Employee Retirement Income Security Act….The account will carry a fee of up to 90 basis points plus undisclosed commission fees, which would be 20 times as much as a simple index fund. Any 401(k) plans with a brokerage window will be subject to severe fiduciary liability unless they can prove they have provided 100% prudent options. This will most likely lead to much more litigation and many more settlements, as the cost of proving 100% prudent options will be extremely expensive. [xviii]   

Burden of proof is on plan sponsors that Prohibited Transactions crypto in their plans qualify for a Prohibited Transaction Exemption.  I have seen no evidence that any form of Crypto has met the qualifications for an exemption. 

The Department of Labor in 2022 severely questions the reliability and accuracy of cryptocurrency valuations.  A major concern is that cryptocurrency market intermediaries may not adopt consistent accounting treatment and may not be subject to the same reporting and data integrity requirements with respect to pricing as other intermediaries working with more traditional investment products.[xix]   Under that guidance, which the DOL issued last month (April 22), employers could be responsible for risky crypto trades their workers make in workplace 401(k)s. The DOL’s employee benefits enforcement agency will launch what it’s calling “an investigative program” that requires plan officials to “square their actions with their duties of prudence and loyalty” if they allow crypto investments in self-directed accounts, according to the guidance.[xx]

The CFA institute writes.  The unfortunate reality is that none of the proposed valuation models are as sound or academically defensible as traditional discounted cash flow analysis is for equities or interest and credit models are for debt. This should not come as a surprise. Crypto assets are more similar to commodities or currencies than to cash-flow producing instruments, such as equities or debt, and valuation frameworks for commodities and currencies are challenging.  Custody is challenging and there is significant technological risk.  As recently as 2018, researchers uncovered a bug in the bitcoin code that, if left unchecked and exploited, could have led to significant (theoretically infinite) inflation in the issuance of new bitcoin [xxi]

The lack of any valuation parameters makes benchmarks impossible.  Comparisons should be flexible.  One of the main comparisons should be the most popular Crypto asset Bitcoin. 

Corrupt Structures

Crypto, Private Equity and Annuities in ERISA plan are mostly hidden in corrupt structures.    Besides brokerage windows poorly state regulated separate account annuity products and Collective investment Trusts are places to hide these prohibited assets.  

Over 50% of 401(k) assets are in Target Date Funds which are made up of underlying funds.  This allows for less transparency of the underlying funds. 

However, historically the largest structure for Target Date Funds has been SEC registered Mutual Funds.   Mutual Funds have transparency and fiduciary standards that do not allow Crypto, Private Equity and Annuities. [xxii]    Federal OCC regulated Collective Investment Trusts (CITs) have transparency and fiduciary standards that do not allow Crypto, Private Equity and Annuities.[xxiii]  However, many state regulated CIT’s have weak or no transparency or fiduciary standards, so you can allow Crypto, Private Equity and Annuities.

Currently I believe the biggest threat of prohibited investments like Crypto, Private Equity and Annuities will be hidden in target date funds structured as state regulated CIT’s that I outlined in my DOL Advisory testimony in July 2024.[xxiv] 

Conclusions

 Since Crypto, Private Equity, Annuity contracts are impossible to Benchmark you need to use Comparables.     To make valid comparisons you have to compare them to other prohibited transactions that are materially similar, and looking at those similar funds with the best performance is valid for damages.    

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

[ii] 117https://www.plansponsor.com/supreme-court-will-not-weigh-burden-proof-index-fund-comparison/ https://401kspecialistmag.com/brotherston-v-putnamsfar-reaching-401k-fallout/

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

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

[v] 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/ 

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

[vii] 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

[viii] 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 

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

[x] https://commonsense401kproject.com/2024/11/19/burden-of-proof-is-on-plan-sponsors-hoping-to-qualifyfor-annuity-prohibited-transactions-exemption/  https://fiduciaryinvestsense.com/2024/09/25/chief-judge-of-the-5th-circuit-calls-out-his-brethren-on-decision-to-stay-the-dols-retirement-security-rule/#:~:text=As%20to%20coverage%20under%20the,of%20whether%20advice%20is%20given.

[xi] https://www.tsp.gov/funds-individual/g-fund/      https://www.frtib.gov/pdf/reading-room/InvBMarks/2017Oct_Benchmark-Evaluation-Report.pdf     

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

[xiii] https://www.sec.gov/comments/s7-03-22/s70322-267369.htm 

[xiv] https://www.sec.gov/comments/s7-03-22/s70322-267369.htm 

[xv] https://www.sec.gov/comments/s7-03-22/s70322-267369.htm 

[xvi] https://www.nakedcapitalism.com/2022/04/calpers-consultant-global-governance-advisors-recommends-further-overpaying-grossly-underperforming-calpers-staff.html

[xvii] https://commonsense401kproject.com/2022/06/18/brokerage-windows-exposed-by-crypto/

[xviii] https://www.ignites.com/lead/c/3622614/465124?referrer_module=t.co: https://uselaws.com/media-turns-to-jerry-schlichter-for-guidance-following-fidelity-bitcoin-announcement/

[xix] https://www.dol.gov/agencies/ebsa/employers-and-advisers/plan-administration-and-compliance/compliance-assistance-releases/2022-01

[xx] https://www.dol.gov/agencies/ebsa/employers-and-advisers/plan-administration-and-compliance/compliance-assistance-releases/2022-01

[xxi] http://www.coindesk.com/the-latest-bitcoinbug-was-so-bad-developers-kept-its-full-details-a-secret.

Click to access 20200806.pdf

[xxii] https://commonsense401kproject.com/2022/02/22/cits-collective-investment-trusts-in-401k-the-good-and-the-bad/

[xxiii] https://www.occ.treas.gov/topics/supervision-and-examination/capital-markets/asset-management/collective-investment-funds/index-collective-investment-funds.html

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

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

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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.

Liability-Driven Designed 401(k)/403(b) Plans

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Liability-driven investing is a common concept in connection with defined benefit plans. I first heard the term used in a article by Marcia Wagner of the Wagner Group. Liability-driven investing refers to the selection of investments that are best designed to help the plan secure the returns needed by the plan to fulfill their obligations under the terms of the plan.

It has always struck me that the liability-driven concept is equally applicable to designing defined contribution plans such as 401(k) and 403(b) plans. Better yet, by factoring in fiduciary risk management principles, defined contribution plans can create the best of both worlds, win-win plans that provide prudent investment options while minimizing or eliminating fiduciary risk.

Plan sponsors often unnecessarily expose themselves to fiduciary liability simply because they do not truly understand what their duties are under ERISA. One’s fiduciary duties under ERISA can be addressed by asking two simple questions.

1. Does Section 404(a) of ERISA explicity require that a plan offer the category of investments under consideration?
2. If so, could/would inclusion of the investment under consideeration result in uunecessary liability exposure for the plan?

As for the first question, Section 404(a)1 of ERISA does not explicity require that any specific category of investment be offered within a plan. As SCOTUS stated in the Hughes decision2, the only requirement under Section 404(a) is that each investment option offered within a plan be prudent under fiduciary law. Furthermore, as SCOTUS stated in its Tibble decision3, the Restatement of Trusts (Restatement) is a valuable resource in addressing and resolving fiduciary issues.

As for the second question, Section 90 of the Restatement, more commonly known as the “Prudent Investor Rule,” offers three fundamental guidelines addressing the importance of cost-consciousness/cost-efficiency of a plan’s investment options:

The last bullet point highlights a key aspect of 401(k)/403(b) fiduciary prudence and cost-efficiency – commensurate return for the additional costs and risks assumed by the plan participant. In terms of actively managed mutual funds, research has consistently and overwhelmingly shown that the majority of actively managed mutual funds are cost-inefficient:

  • 99 % of actively managed funds do not beat their index fund alternatives over the long term net of fees.4
  • Increasing numbers of clients will realize that in toe-to-toe competition versus near-equal competitiors, most active managers will not and cannot recover the costs and fees they charge.5
  • [T]here is strong evidence that the vast majority of active managers are uable to produce excess returns that cover their costs.6
  • [T]he investment costs of expense ratios, transaction costs and load fees all have a direct, negative impact on performance….[The study’s findings] suggest that mutual funds, on average, do not recoup their investment costs through higher returns.7  

The Active Management Value RatioTM (AMVR)
Several years ago I created a simple metric, the AMVR. The AMVR is based on the research of investment icons such as Nobel laureate Dr. William F. Sharpe, Charles D. Ellis, and Burton L. Malkiel. The AMVR allows plan sponsors, trustees, and other investment fiduciaries to quickly determine whether an actively managed fund is cost-efficient relative to a comparable index fund. The AMVR allows the user to assess the cost-efficiency of an actively managed fund from several perspecitives.

The slide below shows an AMVR analysis comparing the retirement shares of a popular actively managed fund, the Fidelity Contrafund Fund (FCNKX), and the retirement shares of Vanguard’s Large Cap Growth Index Fund (VIGAX). The analysis compares the two funds over a recent 5-year time period. When InvestSense provides forensic services, we provide both a five-year and ten-year analysis to determine the consistency of any cost-efficiency/cost-inefficiency trend.

An AMVR analysis can provide any amount of detail the user desires. On a basic level, the fact that the actively managed fund failed to outperform the comparable index fund benchmark immediately indicates that the actively managed fund is imprudent relative to the Vanguard fund.

Add to that the fact that the actively managed fund imposed an incremental, or additional, cost of 42 basis points without providing any corresponding benefit for the investor. A basis point is a term commonly used in the investment world. A basis point equals 1/100th of one percent (0.01). 100 basis points equals 1 percent.

So the bottom line is that the actively managed fund underperformed the benchmark Vanguard fund and imposed an additional charge without providing a commensurate return for the extra charge. A fiduciary’s actions that result in wasting a client’s or a beneficiary’s money is never prudent.8

If we treat the actively managed fund’s underpreformance as an opportunity cost, and combine that cost with the excess fee, we get a total cost of 2.06. The Department of Labor and the General Accountability Office have determined that over a twenty year time period, each additional 1 percent in costs reduces an investor’s end-return by approximately 17 percent.9 So, in our example, we could estimate that the combined costs would reduce an investor’s end-return by approximately 34 percent. This is not an example of effective wealth management.

The AMVR is calculated by dividing an actively managed fund’s incremental correlation-adjusted costs by the fund’s incremental risk-adjusted return. The goal is an AMVR score greater than zero, but equalt to or less than one, which indicates that costs did not exceed return. While the user can simply use the actively managed fund’s incremental cost and incremental returns based on the two funds’ nominal, or publicly reported, numbers, the value of such an AMVR calculation is very questionable.

A common saying in the investment industry is that return is a function of risk. In other words, as comment h(2) of Section 90 of the Restatement states, investors have a right to receive a return that compensates them for any additional costs and risks they assumed in investing in the investment. The Department of Labor has taken a similar stand in two interpretive bulletins.10 That is why a proper forensic analysis always uses a fund’s risk-adjusted returns.

While the concept of correlation-adjusted returns is relatively new, it arguably provides a better analysis of the alleged value-added benefits, if any, of active management. The basis premise behind correlation-adjusted costs is that passive management often provides all or most of the same return provided by a comparable actively managed fund. As a result, the argument can be made that the actively managed fund was imprudent since the same return could have been achieved by passive management alone, without the wasted excess costs of the actively managed fund.

Professor Ross Miller created a metric called the Active Expense Ratio (AER).11 Miller explained that actively managed funds often combine the costs of passive and active management in such a way that it is hard for investors to determine if they are receiving a commensurate return. The AER provides a method of separating the cost of active management from the costs of passive management.

The AER also calculates the implicit amount of active management provided by an actively managed fund, a term that Miller refers to as the actively managed fund’s “active weight.” Miller then divides the active fund’s incemental costs by the fund’s active weight to calculate the actively managed fund’s AER.

Miller found that an actively managed fund’s AER is often 400-500 percent higher than the actively managed fund’s stated expense ratio. In the AMVR example shown above, dividing the actively managed fund’s incremental correlation-adjusted costs by the fund’s active weight would result in an implicit expense ration approximately 700 percent higher than the fund’s publicly stated incremental cost (3.31 vs. 0.42). Based on the AER, these significantly higher costs would be incurred to receive just 12.5 percent of active management.

Using the same 1:17 percent analysis for each additional 1 percent in costs/fees, using the AER metric and the active fund’s underperformance would result in a projected loss of approximately 84 percent over twenty years. So much for “retirement readiness.”

Additional information on the AMVR can be found at my “The Prudent Investment Fiduciary Rules” blog and searching under “Active Management Value Ratio.”

Fiduciary Risk Management and Annuities
I have written numerous posts about annuities on both my “The Prudent Investment Fiduciary Rules” blog and my “CommonSense InvestSense” blog. Fortunately, the inherent fiduciary liability issues can be addressed by using the same two question fiduciary risk management approach that was mentioned earlier, with the answer to both questions being “yes.” Therefore, a liability-designed 401(k)/403(b) plan will totally avoid the inclusion of annuities, in any form, within the plan.

As a former securities compliance director, I am very familiar with the questionable marketing techniques used by some annuity companies, including the ongoing refusal to provide full transparency with regard to spreads and other financial information. Both ERISA and Department of Labor interpretive bulletions have stressed the importance of providing material information to plan sponsors and plan participants so that they can make informed decisions about including annuities within a plan and about whether to invest in annuities.

The two blogs provide analyses of various types of annuities, especially variable annuities and fixed indexed annuities. My basic advice to my fiduciary risk management clients is simple – “if you don’t have to go there…don’t!”

Annuities are complex and confusing investments, with numerous potential fiduciary liability “traps.” Annuity advocates often try to further confuse and intimidate plan sponsors by engaging in technical details. I strongly recommend adopting my response – stop them before they begin and simply explain that ERISA does not require that pension plans offer annuities within a plan. Therefore, from a fiduciary risk management standpoint, there is no reason to offer any type of annuity within the plan.

Going Forward
Three fiduciary risk management questions that I often ask both myself and my fiduciary clients:

  • Why is it that cost/benefit analysis is often used by businesses to determine the cost-efficiency of a proposed project, but yet cost-efficiency is rarely used by plan sponsors and other investment fiduciaries to determine the cost-efficiency of investments being considered by a pension plan or other fiduciary entity?
  • Why is it that plan sponsors will blindly accept conflicted advice from “advisers” without requiring that the adviser document the prudence of their recommendations througn prudence/breakeven analyses such as the AMVR or an annuity breakeven analysis?
  • Why do plan sponsors insist on making it so unnecessarily difficult and costly by refusing to see the simplicity, praticality, and prudence of the federal government’s Thrift Saving Plan?

The three bullet points remind me of one of my favorite quotes – “there are none so blind, as they who will not see.” I am not sure to whom it should be properly atttributed. The two most cited sources are the Bible and Jonathan Swift.

The point of this post is to emphasize that ERISA compliance is not that difficult to accomplish if a plan talks with the right people and approaches the compliance issues right from the start, when actually designing or re-designing the plan . If that is not possible, there are relatively simple ways to transaction into a liability-driven plan.

One of the services InvestSense provides is fiduciary prudence oversight services. By using fiduciary prudence and risk management compliance tools such as the AMVR and annuity breakeven analyses, and requiring that all plan advisers and investment consultants document their value-added proposition with such validating documents, a plan sponsor can significantly and efficiently simplify the required administration and monitoring of their 401(k) or 403(b) plan.

Notes
1. 29 CFR § 2550.404(a); 29 U.S.C. § 1104(a).
2. Hughes v. Northwestern University., 142 S. Ct. 737, 211 L. Ed. 2d 558 (2022)
3. Tibble v. Edison International, 135 S. Ct 1823 (2015).
4. Laurent Barras, Olivier Scaillet and Russ Wermers, False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas, 65 J. FINANCE 179, 181 (2010).
5. Charles D. Ellis, The Death of Active Investing, Financial Times, January 20, 2017, available online at https://www.ft.com/content/6b2d5490-d9bb-11e6-944b-eb37a6aa8e. 
6. Philip Meyer-Braun, Mutual Fund Performance Through a Five-Factor Lens, Dimensional Fund Advisors, L.P., August 2016.
7. Mark Carhart, On Persistence in Mutual Fund Performance,  52 J. FINANCE, 52, 57-8 (1997).99
8. Uniform Prudent Investor Act, https://www.uniformlaws.org/viewdocument/final-act-108?CommunityKey=58f87d0a-3617-4635-a2af-9a4d02d119c9 (UPIA).
9. Pension and Welfare Benefits Administration, “Study of 401(k) Plan Fees and Expenses,” (DOL Study) http://www.DepartmentofLabor.gov/ebsa/pdf; “Private Pensions: Changes needed to Provide 401(k) Plan Participants and the Department of Labor Better Information on Fees,” (GAO Study).
10. 29 CFR Section 2509.94-1 )(IB 94-1) and Section 2509.15-1 (IB 15-1).
11. Ross Miller, “Evaluating the True Cost of Active Management by Mutual Funds,” Journal of Investment Management, Vol. 5, No. 1, 29-49 (2007) https://papers.ssrn.com/sol3/papers.cfm?abstract_id=746926.

Copyright InvestSense, LLC 2024. All rights reserved.

This article is for informational purposes only, and is neither designed nor intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances.  If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought

Just How Safe Are “Safe” Annuity Retirement Products? – New Paper Shows Annuity Risks Are Too High for Any Fiduciary

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By Chris Tobe, CFA, CAIA

To invest in annuities, you must look the other way at one of most basic investment principals -diversification, i.e., “do not put your eggs in one basket”[1]

In my latest submitted paper, cowritten with economist Tom Lambert, ““Safe” Annuity Retirement Products and a Possible U.S. Retirement Crisis,” we expose the fact that the “emperor has no clothes,” as the life insurance Industry has flooded billions of dollars into advertising, lobbying, commissions, and trade articles with misinformation on annuities with everyone afraid to call out the obvious fiduciary problems – single entity credit and liquidity risk. Excessive monopolistic profits through secret spread fees have remained hidden with no federal regulation or oversight.


We disprove the misleading claim by insurance companies that annuities are primarily backed by a portfolio of high-quality fixed income securities.  We show that only 12.5% of the portfolio of the highest rated insurer, TIAA, is highly rated securities (AA & AAA bonds).

We reveal the weakness of the state guarantee associations behind annuities, which are so flimsy they cannot even get the lowest junk grade rating from S&P or Moody’s.

We show that annuities have the highest liquidity risk of any investment in retirement plans. Even when an annuity provider’s credit risk is downgraded, investors cannot get out, even when downgraded to junk and are stuck in a death spiral all the way to default.

Hopefully, the Department of Labor’s new fiduciary rules will be enacted and protect participants in private sector retirement plans from these risks.[2]

Plans and Investors need greater transparency and true fiduciaries, not insurance salesmen – advisors who do not have insurance licenses and who will not be tempted by the huge commissions in annuities.

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

[2] https://ir.library.louisville.edu/faculty/943/ 

[3] https://commonsense401kproject.com/2023/11/05/annuity-junk-fees-in-current-401k-plans/

Annuity Junk Fees in Current 401(k) Plans

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By Chris Tobe, CFA, CAIA

I want to applaud the Biden Administration on bringing Annuity Junk fees into the light of day to protect investors.

I want to focus on the effect of annuity junk fees in current ERISA protected defined contribution plans (I will address 401(k) and 403(b) and cover rollover junk annuity fees in another article.)   While the White House release mentions the savings in current plans from index annuities, I think that fixed annuities savings could be much larger over $9 billion a year.  (It is important to note that fixed annuities and index annuities in government defined contribution plans in both 457 and 403(b) are not protected by ERISA and add to many more billions of dollars.)

My $9 billion a year comes from industry figures on General Account fixed annuities at $386 billion and separate account fixed annuities at $76 billion in ERISA defined contribution assets. [i]

However, it is important to note that the largest provider of fixed annuities in defined contribution plans (governed by ERISA) is TIAA, which has substantially lower fees and commissions, than the other mainstream insurance providers 

Fixed annuities for the most part do not disclose fees and are rate based. For example, when a similar competitive fixed annuity in a plan like TIAA pays 4% many insurers only pay 2% – pocketing the spread. Bloomberg quoted an insurance executive bragging about these hidden 2%+ in fees at a Wall Street conference.[ii] These hidden spread fees have the same negative effect on investors that disclosed mutual fund fees have.

HOW DO I KNOW THIS
I currently consult on excessive fees in insurance products.   I spent 7 years making insurance products for Transamerica Life (TA), one of the largest U.S. insurance companies.  I was an officer of seven different TA companies governed by four different states.  I saw the need for federal intervention, as insurers had the ability to select the state regulator with the loosest regulations and lowest capital requirements.    

RISKS
One of the most basic fiduciary principles is diversification.  Annuities make a mockery of this principle with their single entity credit and liquidity risk. [iii]

After the first annuity risk crisis in 1992 the Federal Reserve wrote a major paper on the weakness of state regulations in the insurance area. [iv]

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.”[v] Even when the federal government steped up to control risk in annuity products after the 2008 financial crisis, the insurance industry used its immense lobbying ability to thwart regulations and maximize profits. [vi] 

ACCOUNTABILITY
In light of recent money market rates of over 5%, these low 2-3% annuity rates in 401(k)’s in far riskier products are especially troubling, costing investors billions of dollars in retirement savings while taking much higher risks.

Hopefully, these junk fee rules will slow the growth of these high fee high risk products inside of 401k plans.   The latest con game is selling annuities under the guise of Guaranteed Income. [vii]

Hopefully, this junk annuity initiative will expose some of the 401(k) target date funds which are burying index and fixed annuities inside weakly state regulated Collective Investment Trusts (CIT)s. [viii]

Hopefully, 401(k) consultants who claim to be somewhat independent will be exposed by showing how they use their insurance licenses for additional backdoor commissions.[ix]

Hopefully, within 401(k) plans they will either replace fixed annuities with diversified lower risk synthetic stable value products or at the minimum pay competitive rates like TIAA. [x]

This Biden Annuity Junk Fee initiative will save retirement investors billions.  Please do not let the Insurance Industry water it down to line their own pockets.

Chris Tobe, CFA, CAIA is a national expert on excessive fees in retirement plans.    He has written 4 books and dozens of articles on transparency, excessive fees & corruption in investments.  His own firm Tobe Consulting has advised on over 70 ERISA legal cases on behalf of investors who have lost money through risky and/or high fee investments.    He serves as Chief Investment Officer for a minority woman owned pension consulting firm out of New Orleans the Hackett Robertson Tobe group

[i] https://www.stablevalue.org/stable-value-at-a-glance/

[ii] https://www.bloomberg.com/news/articles/2013-03-06/prudential-says-annuity-fees-would-make-bankers-dance#xj4y7vzkg

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

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

[v] Eleanor Laise, “ ‘Stable’ Funds in Your 401(k) May Not Be,” Wall Street Journal , March 26, 2009. Available at http://online.wsj.com/article/SB123802645178842781.html

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

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

[viii] https://commonsense401kproject.com/2022/06/07/toxic-target-date-case-study-of-the-worst-of-the-worst/

[ix] https://commonsense401kproject.com/2022/03/09/conflicted-401k-consultants-should-plan-sponsors-fire-them-sue-them-or-both/   

[x] https://commonsense401kproject.com/2022/02/28/stable-value-the-goood-the-bad-and-the-ugly-avoiding-litigation/

Investment Policy Statements Crucial to Fiduciary Duty

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by Chris Tobe, CFA, CAIA

The Investment Policy Statement (IPS) for a pension plan or other investment pool is a critical element in the governance and is a main fiduciary control on investments.   

As stated in the IFEBP Investment Policy Handbook, “If an employee benefit plan does not have an investment policy statement, it does not have an investment policy.” [i]  Chris Carosa, in his Forbes column, says a “401(k) IPS is a legal document that serves as the solid compliance backbone of the plan”.[ii] Josh Itzoe in his book, the Fiduciary Formula, says about an IPS, “I believe a written investment policy is the only way to demonstrate a thoughtful process and make well informed, prudent investment decisions consistent with the fiduciary requirements imposed by ERISA.” [iii]


A major U.S. regional ERISA law firm for plans remarked,

Since most plans maintain an IPS, not having one can be seen as ‘outside the lines’ and may subject the plan’s fiduciary compliance to greater scrutiny. In fact, it is not hard to imagine a plaintiff’s firm arguing that a plan’s failure to have an IPS is de facto evidence of a fiduciary breach.[iv]

In the CFA standards for Pension Trustees says  “Effective trustees develop and implement comprehensive written investment policies that guide the investment decisions of the plan (the “policies”).” [v] The CFA Code assumes any investments of any size will have an Investment Policy Statement (IPS). 

The Society for Human Resources Management (SHRM) outlined the percentage of defined contribution plans with an Investment Policy Statement.  Basically 90% for plans over $50mm in 2008, most likely much higher today[ii] The complete breakdown was as follows:

$10 million or less – 68%

$10 million to $50 million – 78%

$50 million to $500 million – 90%

$500 million to $1 billion – 89%

More than $1 billion – 92%

I believe any plan without an IPS is in fiduciary breach and they should be reviewed annually. [i].  

[i] 4.5.2   The investment policy statement is reviewed at least annually to ensure it is aligned with current facts and circumstances.

www.fi360.com/uploads/media/handbook_stewards_2020.pdf

[i] http://www.cfainstitute.org/-/media/documents/code/other-codes-standards/pension-trustee-code-of-conduct-2019.pdf

[ii]  Benefits Magazine 2008 https://www.shrm.org/resourcesandtools/hr-topics/benefits/pages/401kinvestmentstatement.aspx