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Home > Library > Stable Times > Volume 4, Issue 1
The quarterly publication of the Stable Value Investment Association
First Quarter 2000 • Volume 4 Issue 1
DOL PUBLISHES ERISA §401(C) REGULATION:
Protection from Fiduciary Liability for Certain Insurance Contracts
By Al Turco, Pepe & Hazard
On January 5, 2000, the Department
of Labor ("DOL") issued a final regulation pursuant to ERISA §401(c),
which regulates the terms of certain insurance contracts issued to ERISA
employee benefit plans that are backed by an insurer's general account
assets (See 65 Fed. Reg. 639 (January 5, 2000)). The regulation is intended
to provide a "safe harbor" from certain types of ERISA liability for insurers
that issued insurance contracts, particularly group annuity contracts,
before January 1, 1999, ("Transition Policies"). While the regulation
will likely affect the conduct of insurers, employers and stable value
funds that hold Transition Policies will also have an interest in its
implementation.
Background
Under ERISA §401(b)(2), if an insurer issues a "guaranteed benefit policy"
to a plan, the assets of the plan are deemed to include the policy, but
do not, solely by reason of the issuance of the policy, include any assets
of the insurer. In 1993, the Supreme Court held in John Hancock Mutual
Life Ins. Co. v. Harris Trust & Savings Bank, 510 U.S. 86 (1993), that
the "unallocated portion" of a John Hancock group annuity contract did
not constitute a guaranteed benefit policy. Consequently, assets attributable
to the unallocated funds were plan assets for purposes of ERISA's fiduciary
and prohibited transaction rules.
The Harris Trust decision did not provide detailed guidance as to what
types of insurance policies and what specific policy features would be
considered guaranteed benefit policies. As a result, insurers, plan fiduciaries,
and investors have been unable to reliably determine when contracts issued
to ERISA plans could result in the application of ERISA's fiduciary and
prohibited transaction rules to the management and operation of insurance
company general account assets.
As a result, in the Small Business Job Protection Act of 1996, Congress
established ERISA §401(c), which grants insurers retroactive relief from
the application of ERISA's fiduciary and prohibited transaction rules
for Transition Policies. ERISA §401(c) required the DOL to issue regulations
to extend this protection to insurers. Prospectively, Transition Policies
will remain protected and "plan assets" will not be created within an
insurer's general account, if the insurer complies with the conditions
of the final regulation.
The Regulation
The Regulation includes a prudence standard applicable to the management
of general account assets and a requirement that policies be purchased
by persons independent of the insurer. The regulation also requires a
number of disclosures, the provision of certain minimum termination rights
and protection from insurer-initiated amendments. These latter requirements,
which must be satisfied if the insurer is to avail itself of the "safe
harbor" protection, are summarized below.
Disclosure
An insurer must provide significant disclosure with respect to each Transition
Policy, both initially and annually.
A. Initial Disclosure. Given that all Transition Policies have been issued,
initial disclosure is required to be provided to each policyholder by
July 5, 2000. Generally, the content of the initial disclosure is to include:
- A description of the method used to determine the fees, charges or
expenses that are, or may be, assessed against the policyholder, including
the extent and frequency with which Transition Policy fees may be modified.
- A description of the method used to determine the return to be credited
under the Transition Policy, including the allocation of income and expenses
within and among lines of business and business segments.
- A description of the rights which the policyholder or plan participants
have to terminate contributions or to make withdrawals under the Transition
Policy and a description of any fees, credits, market value adjustments,
both positive and negative, that may apply to a withdrawal.
- Within 30 days of a policyholder request, the formula actually used
to calculate the Transition Policy's market value adjustment, if any,
a description of the component parts of any formula and, a market value
calculation.
- A statement describing the expense, income and benefit guarantees
under the Transition Policy, including the insurer's right, if any, to
modify or eliminate these guarantees.
B. Annual Disclosure. Annually, beginning after January 5, 2000, but not
later than July 5, 2001, the insurer must provide additional disclosure
to each policyholder. Generally, the content of the disclosure for each
annual reporting period is to include:
- The opening and closing Transition Policy balance, deposits, an itemized
income statement, the crediting rate (gross or net), an itemized expense
statement, an accounting of benefits paid, annuities purchased, withdrawals
made and other transactions affecting the Transition Policy balance.
- An estimate of the termination value of the Transition Policy as of
the end of each annual disclosure period.
- An explanation that the insurer will make available, upon request,
copies of publicly available financial data or other publicly available
reports relating to the financial condition of the insurer.
Termination Procedures
By July 5, 2001, an insurer must permit each policyholder to terminate
a Transition Policy, upon providing ninety days notice, including the
right to elect either of two required distribution options for payment
of unallocated amounts.
- The first distribution option provides for a lump sum payment to the
policyholder of all unallocated amounts. The insurer may apply a "two-way"
market value adjustment to the lump sum payment, and may recover costs
actually incurred by the insurer that would otherwise have been recovered
but for termination of the Transition Policy.
- The second distribution option allows the policyholder to receive
a book value payment of unallocated amounts in approximately equal annual
installments over a period of no longer than ten years. Under this option,
interest on the remaining Transition Policy balance must be credited at
a rate no less than the annual rate credited as of the date of termination,
minus one percent.
Insurer-Initiated Amendment
Effective immediately, an insurer must provide written notice to each
policyholder at least 60 days prior to the effective date of any insurer-initiated
amendment. An insurer-initiated amendment includes:
- An amendment to a Transition Policy made by the insurer pursuant to
a unilateral right to amend the Transition Policy terms that would have
a material adverse effect on the policyholder.
- Certain changes in the insurer's conduct or practice that has more
than a "de minimus" adverse effect, including:
- A change in methodology for assessing fees or for allocating income
or expenses within and among lines of business or business segments or
for determining the rate of return under the Transition Policy.
- A change in the policyholder's rights or in the insurers' methods
or practices applicable to the termination of the Transition Policy, withdrawal
of funds, or the purchase of annuities for plan participants.
Conclusion
Compliance with the regulation by an insurer will, in many instances,
likely involve development of disclosure material and the preparation
of a "compliance amendment". In some instances, an insurer may conclude
that a policy (or class of policies) it has issued, is an ERISA guaranteed
benefit policy for which a "safe harbor" is not needed. Should the insurer
later discover that the policy is not a guaranteed benefit policy or should
a Transition Policy not be in compliance, the regulation provides a remediation
process, intended to insulate the insurer from ERISA fiduciary liability
and to forestall plan asset status for assets held in the insurer's general
account for a limited period.
For the employer or stable value fund that holds a Transition Policy,
now may be an appropriate time to audit the contract or to arrange a restructuring
of its terms with the insurer.
Read Next: Congress Holds Hearings on ERISA Reform
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