[Federal Register Volume 60, Number 43 (Monday, March 6, 1995)]
[Rules and Regulations]
[Pages 12328-12330]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-5321]




[[Page 12327]]

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Part V





Department of Labor





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Pension and Welfare Benefits Administration



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29 CFR Part 2509



Interpretive Bulletins Relating to the Employee Retirement Income 
Security Act of 1974; Final Rule

  Federal Register / Vol. 60, No. 43 / Monday, March 6, 1995 / Rules 
and Regulations    
[[Page 12328]] 

DEPARTMENT OF LABOR

Pension and Welfare Benefits Administration

29 CFR Part 2509

[Interpretive Bulletin No. 95-1]


Interpretive Bulletins Relating to the Employee Retirement Income 
Security Act of 1974

AGENCY: PWBA, Department of Labor.

ACTION: Interpretive Bulletin.

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SUMMARY: This document announces the Department of Labor's (the 
Department's) view of the legal standard imposed by section 404(a)(1) 
(A) and (B) of part 4 of title I of the Employee Retirement Income 
Security Act of 1974 (ERISA) on a plan fiduciary's selection of an 
annuity provider when purchasing annuities for the purpose of 
distributing benefits under an employee pension benefit plan. Under 
this standard, plan fiduciaries choosing to purchase annuities have a 
duty to select the safest available annuity provider, unless under the 
circumstances it would be in the interests of participants and 
beneficiaries to do otherwise. The document also provides guidance to 
plan fiduciaries regarding circumstances when it may be in the interest 
of the participants and beneficiaries to purchase other than the safest 
available annuity.

EFFECTIVE DATE: The standard announced in this bulletin is effective 
January 1, 1975.

FOR FURTHER INFORMATION CONTACT:
William W. Taylor, Plan Benefits Security Division, Office of the 
Solicitor, U.S. Department of Labor, Rm N-4611, 200 Constitution Ave., 
NW., Washington, DC 20210, (telephone (202) 219-9141) or Mark Connor, 
Office of Regulations and Interpretations, Pension and Welfare Benefits 
Administration, U.S. Department of Labor, Rm N-5669, 200 Constitution 
Avenue NW., Washington, DC 20210, (telephone (202) 219-8671). These are 
not toll-free numbers.

SUPPLEMENTARY INFORMATION: In order to provide a concise and ready 
reference to its interpretations of ERISA, the Department of Labor 
publishes its Interpretive Bulletins in the Rules and Regulations 
section of the Federal Register.
    Published in this issue of the Federal Register is ERISA 
Interpretive Bulletin 95-1, which describes the application of the 
fiduciary standards set forth in section 404(a)(1) (A) and (B) of 
ERISA, 29 U.S.C. 1104(a)(1) (A) and (B), in selecting an insurer to 
provide pension benefit distribution annuities to plan participants and 
beneficiaries. The Department is publishing this Interpretive Bulletin 
because it believes there is a need for further guidance regarding the 
selection of such annuity providers by plan fiduciaries.

(Sec. 505, Pub. L. 93-406, 88 Stat. 894 (29 U.S.C. 1135))

Background

    Annuities are issued by insurers in a variety of forms designed to 
suit different purposes. This interpretive bulletin addresses only 
annuities that are purchased by pension plans with the intention to 
transfer liability for benefits promised under the plan to the annuity 
provider (i.e., the insurance company).\1\ Annuities designed to serve 
this purpose are sometimes referred to herein as benefit distribution 
annuities. Regulations issued by the Department explicitly recognize a 
transfer of liability from the plan when such an annuity is purchased 
from an insurance company licensed to do business in a State. 29 CFR 
2510.3-3(d)(2)(ii).\2\ Pension plans purchase benefit distribution 
annuity contracts in a variety of circumstances. Such annuities may be 
purchased for participants and beneficiaries in connection with the 
termination of a plan, or in the case of an ongoing plan, annuities 
might be purchased for participants who are retiring or separating from 
service with accrued vested benefits.

    \1\In particular, the interpretive bulletin does not address 
fiduciary responsibilities in connection with the purchase of 
annuities for investment purposes. See infra note 5.
    \2\This regulation defines the term ``participant covered under 
the plan'' for certain purposes under title I of ERISA. The 
Department notes that the regulation was issued primarily to define 
the class of participants entitled to receive copies of certain plan 
documents without charge and without request under ERISA sections 
101(a) and 104(b)(1), 29 U.S.C. 1021(a) and 1024(b)(1). 40 FR 24649 
(June 9, 1975), 40 FR 34528 (Aug. 15, 1975). A premise of the 
regulation was that, by using the term ``participant covered under 
the plan,'' Congress had provided a ground for distinguishing 
between the class of all participants within the meaning of ERISA 
Sec. 3(7) and participants entitled to receive copies of plan 
documents without charge and without request. 40 FR 24649 (June 9, 
1975). Thus, the regulation is not intended to define the term 
``participant'' or ``beneficiary'' for all purposes under ERISA, 
and, in particular, is not intended to define these terms for 
purposes of standing to bring a civil action under ERISA section 
502(a), 29 U.S.C. 1132(a).
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    The selection of an annuity provider under these circumstances is a 
fiduciary decision governed by part 4 of title I of ERISA. 
Specifically, pursuant to ERISA section 404(a)(1), 29 U.S.C. 
1104(a)(1), fiduciaries must discharge their duties with respect to the 
plan solely in the interest of the participants and beneficiaries. 
Section 404(a)(1)(A), 29 U.S.C. 1104(a)(1)(A), states that the 
fiduciary must act for the exclusive purpose of providing benefits to 
participants and beneficiaries and defraying reasonable plan 
administration expenses. In addition, section 404(a)(1)(B) requires a 
fiduciary to act with the care, skill, prudence and diligence under the 
prevailing circumstances that a prudent person acting in a like 
capacity would use.\3\

    \3\On March 13, 1986, the Department released an information 
letter addressed to John N. Erlenborn, who was then the Chairman of 
the Advisory Council on Employee Welfare and Plans. In the letter, 
the Department stated in pertinent part:
    Consistent with the functional analysis of fiduciary activity, 
the choice of an insurer would appear to involve the type of 
discretionary authority over the disposition of plan assets covered 
in section 3(21)(A) [of ERISA]. . . . Therefore, it appears that the 
fiduciary provisions of ERISA, including the prudence requirement of 
section 404(a)(1)(B), will apply to the choice of an insurer to 
issue annuities upon plan termination.
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    Several developments over the past few years have resulted in 
questions being raised about the security of the pension benefits 
promised to participants and beneficiaries under benefit distribution 
annuity contracts purchased on their behalf. In particular, concerns 
have been expressed about the ability of certain insurance carriers to 
satisfy their annuity liabilities because their investment portfolios 
contain or contained substantial amounts of high-risk, high-yield debt 
securities (also known as ``junk bonds'') or troubled real-estate 
loans, or a combination of both. The basis for such concerns is best 
exemplified by the well-publicized developments involving the Executive 
Life Insurance Companies of California and New York. State regulators 
in both California and New York were forced to take control of the 
operations of the Executive Life Companies, whose poor financial 
condition is principally attributable to substantial investments in 
high risk bonds. In response to such developments, the Department has 
acted in the following areas to enforce ERISA's fiduciary standards and 
determine whether additional regulatory action is warranted.

Litigation

    Subsequent to the failure of Executive Life, the Department's 
enforcement activities have centered on, among other things, the 
process by which plan fiduciaries selected annuity providers.
    The Department has filed lawsuits against numerous companies whose 
plans purchased annuities because the plan fiduciaries who, acting in 
their fiduciary capacities, failed to follow adequate procedures 
designed to select [[Page 12329]] the safety available insurance 
carrier when choosing an annuity provider. Cases have been brought 
against several companies which purchased annuities from Executive Life 
including Pacific Lumber Co., Magnetek, Inc., Smith International, 
Inc., Geosource, Inc., American National Can Company, AFG Industries, 
Inc., and Raymark Industries, Inc. as well as against the Strouse Adler 
Company which purchased annuities from Presidential Life Insurance 
Company. It is the Department's position that these fiduciaries 
breached their fiduciary responsibilities under ERISA in connection 
with their selection of annuity providers.\4\ Consent orders settling 
the Secretary's claims have been entered in certain of these cases.

    \4\The Pension Annuitant's Protection Act of 1994, Pub. L. No. 
103-401, 108 Stat. 4172 (1994) amended section 502(a) of ERISA to 
clarify the standing of pension annuitants to bring actions for 
fiduciary breaches that occurred. In addition, the Act specifies 
that a court may order appropriate relief to assure the annuitant's 
receipt of the amounts provided or to be provided by the annuity, 
plus reasonable prejudgment interest. The amendments made by the Act 
apply to any legal proceeding pending, or brought, on or after May 
31, 1993.
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Regulatory Action

    In addition to its enforcement activities, the Department and the 
Pension Benefit Guaranty Corporation (PBGC) sought to determine if, in 
addition to and independent of ERISA's fiduciary standards, minimum 
standards for annuity providers would be appropriate and necessary in 
order to ensure a reasonable likelihood that participants or 
beneficiaries on whose behalf annuities are purchased will receive 
their promised pension benefits. It was anticipated that such 
modification might be effected by amending the minimum standards which 
already exist under the regulation at 29 CFR 2510.3-3(d)(2)(ii). On 
June 21, 1991, both the Department and the PBGC published advanced 
notices of proposed rulemaking (ANPRMs) in the Federal Register (56 FR 
28638 and 56 FR 28642 respectively) soliciting information and comments 
from the public as to whether regulatory action relating to the 
purchase of annuity contracts was necessary and if so, what form such 
action should take.
    After receiving over thirty letters in response, the Department 
reviewed the comments and, after extensive deliberation, the Department 
has determined that no regulatory action should be taken at this time 
to amend the minimum standards under the regulation at 29 CFR 2510.3-
3(d)(2)(ii). More generally, the Department has decided not to 
promulgate any regulation limiting the circumstances under which the 
purchase of an annuity will be considered a full distribution of 
benefits for a participant or beneficiary such that the plan's and the 
employer's obligations to pay benefits have been served.
    The following interpretive bulletin concerns solely the fiduciary 
standard and is published in addition to and independent of the 
regulatory minimum standard at 29 CFR 2510.3-3(d)(2)(ii).

The Interpretive Bulletin

    The interpretive bulletin explains that, when choosing an annuity 
provider for purposes of a benefit distribution, whether for purposes 
of separation or retirement of a participant or upon termination of a 
plan, compliance with ERISA's fiduciary rules requires, at a minimum, 
that plan fiduciaries conduct an objective, thorough and analytical 
search for the purpose of identifying and selecting providers from 
which to purchase annuities. In conducting such a search, a fiduciary 
must evaluate a potential annuity provider's claims-paying ability and 
creditworthiness because the participants and beneficiaries whose 
entitlement to benefits will be transferred to the annuity provider 
have a paramount interest in the ability of the provider to make those 
payments. As a result, the interpretive bulletin states that a plan 
fiduciary choosing an annuity provider for the purpose of making a 
benefit distribution must take steps calculated to obtain the safest 
annuity available, unless under the circumstances, it would be in the 
interests of the plan participants and beneficiaries to do 
otherwise.\5\ The Department recognizes that, in many circumstances 
likely to arise under existing law, the interest of the plan 
participants and beneficiaries may require the selecting fiduciary to 
consider the cost of the annuity (to the extent that the cost is borne 
by the participants and beneficiaries) in addition to the annuity 
provider's claims-paying ability.\6\ Cost consideration may not, 
however, justify purchase of an unsafe annuity.

    \5\This standard does not apply to the purchase of annuities for 
plan investment purposes. As with any other ordinary investment 
decision, ERISA's fiduciary duty of prudence requires that the risk 
attendant to such products, in the context of the plan's investment 
portfolio, and its funding, liquidity and diversification needs, 
must be weighed against the promised return. Thus, fiduciaries may 
select such investments that involve greater risks, but that also 
provide an expected investment return that is commensurate with that 
greater risk. In this regard, the Department notes that in an 
investment contract with an annuity option, the standard described 
herein, while not applicable to the decision to invest in the 
investment product, nonetheless applies to the fiduciary's decision 
to exercise the annuity option.
    \6\Under IRC Sec. 4980, an excise tax of up to 50 percent may be 
imposed on the amount of any employer reversion from a qualified 
plan unless the employer establishes and maintains a qualified 
replacement plan to which assets are transferred, or provides 
certain benefit increases for participants.
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    The Interpretive bulletin also explains that an annuity provider's 
claims-paying ability and creditworthiness should be evaluated on the 
basis of a number of factors. Although ratings provided by insurance 
rating services may be a useful factor in evaluating a potential 
annuity provider, reliance solely on such ratings would not be 
sufficient to meet the requirement of a thorough and analytical search 
for an appropriate annuity provider.

List of Subjects in 29 CFR Part 2509

    Employee benefit plans, Pensions.

    For the reasons set forth in the preamble, Part 2509 of Title 29 of 
the Code of Federal Regulations is amended as follows:

PART 2509--INTERPRETIVE BULLETINS RELATING TO THE EMPLOYEE 
RETIREMENT INCOME SECURITY ACT OF 1974

    1. The authority citation for Part 2509 continues to read as 
follows:

    Authority: 29 U.S.C. 1135. Section 2509.75-1 is also issued 
under 29 U.S.C. 1114. Sections 2509.75-10 and 2509.75-2 are also 
issued under 29 U.S.C. 1052, 1053, 1054. Secretary of Labor's Order 
No. 1-87 (52 FR 13139).

    2. Part 2509 is amended by adding a new Sec. 2509.95-1 to read as 
follows:


Sec. 2509.95-1  Interpretive Bulletin relating to the fiduciary 
standard under ERISA when selecting an annuity provider.

    (a) Scope. This Interpretive Bulletin provides guidance concerning 
certain fiduciary standards under part 4 of title I of the Employee 
Retirement Income Security Act of 1974 (ERISA), 29 U.S.C. 1104-1114, 
applicable to the selection of annuity providers for the purpose of 
pension plan benefit distributions where the plan intends to transfer 
liability for benefits to the annuity provider.
    (b) In General. Generally, when a pension plan purchases an annuity 
from an insurer as a distribution of benefits, it is intended that the 
plan's liability for such benefits is transferred to the annuity 
provider. The Department's regulation defining the term ``participant 
covered under the plan'' for certain purposes under title I of ERISA 
recognizes that such a transfer occurs [[Page 12330]] when the annuity 
is issued by an insurance company licensed to do business in a State. 
29 CFR 2510.3-3(d)(2)(ii). Although the regulation does not define the 
term ``participant'' or ``beneficiary'' for purposes of standing to 
bring an action under ERISA Sec. 502(a), 29 U.S.C. 1132(a), it makes 
clear that the purpose of a benefit distribution annuity is to transfer 
the plan's liability with respect to the individual's benefits to the 
annuity provider.
    Pursuant to ERISA section 404(a)(1), 29 U.S.C. 1104(a)(1), 
fiduciaries must discharge their duties with respect to the plan solely 
in the interest of the participants and beneficiaries. Section 
404(a)(1)(A), 29 U.S.C. 1104(a)(1)(A), states that the fiduciary must 
act for the exclusive purpose of providing benefits to the participants 
and beneficiaries and defraying reasonable plan administration 
expenses. In addition, section 404(a)(1)(B), 29 U.S.C. 1104(a)(1)(B), 
requires a fiduciary to act with the care, skill, prudence and 
diligence under the prevailing circumstances that a prudent person 
acting in a like capacity and familiar with such matters would use.
    (c) Selection of Annuity Providers. The selection of an annuity 
provider for purposes of a pension benefit distribution, whether upon 
separation or retirement of a participant or upon the termination of a 
plan, is a fiduciary decision governed by the provisions of part 4 of 
title I of ERISA. In discharging their obligations under section 
404(a)(1), 29 U.S.C. 1104(a)(1), to act solely in the interest of 
participants and beneficiaries and for the exclusive purpose of 
providing benefits to the participants and beneficiaries as well as 
defraying reasonable expenses of administering the plan, fiduciaries 
choosing an annuity provider for the purpose of making a benefit 
distribution must take steps calculated to obtain the safest annuity 
available, unless under the circumstances it would be in the interests 
of participants and beneficiaries to do otherwise. In addition, the 
fiduciary obligation of prudence, described at section 404(a)(1)(B), 29 
U.S.C. 1104(a)(1)(B), requires, at a minimum, that plan fiduciaries 
conduct an objective, thorough and analytical search for the purpose of 
identifying and selecting providers from which to purchase annuities. 
In conducting such a search, a fiduciary must evaluate a number of 
factors relating to a potential annuity provider's claims paying 
ability and creditworthiness. Reliance solely on ratings provided by 
insurance rating services would not be sufficient to meet this 
requirement. In this regard, the types of factors a fiduciary should 
consider would include, among other things:
    (1) the quality and diversification of the annuity provider's 
investment portfolio;
    (2) the size of the insurer relative to the proposed contract;
    (3) the level of the insurer's capital and surplus;
    (4) the lines of business of the annuity provider and other 
indications of an insurer's exposure to liability;
    (5) the structure of the annuity contract and guarantees supporting 
the annuities, such as the use of separate accounts;
    (6) the availability of additional protection through state 
guaranty associations and the extent of their guarantees. Unless they 
possess the necessary expertise to evaluate such factors, fiduciaries 
would need to obtain the advice of a qualified, independent expert. A 
fiduciary may conclude, after conducting an appropriate search, that 
more than one annuity provider is able to offer the safest annuity 
available.
    (d) Costs and Other Considerations. The Department recognizes that 
there are situations where it may be in the interest of the 
participants and beneficiaries to purchase other than the safest 
available annuity. Such situations may occur where the safest available 
annuity is only marginally safer, but disproportionately more expensive 
than competing annuities, and the participants and beneficiaries are 
likely to bear a significant portion of that increased cost. For 
example, where the participants in a terminating pension plan are 
likely to receive, in the form of increased benefits, a substantial 
share of the cost savings that would result from choosing a competing 
annuity, it may be in the interest of the participants to choose the 
competing annuity. It may also be in the interest of the participants 
and beneficiaries to choose a competing annuity of the annuity provider 
offering the safest available annuity is unable to demonstrate the 
ability to administer the payment of benefits to the participants and 
beneficiaries. The Department notes, however, that increased cost or 
other considerations could never justify putting the benefits of 
annuitized participants and beneficiaries at risk by purchasing an 
unsafe annuity.
    In contrast to the above, a fiduciary's decision to purchase more 
risky, lower-priced annuities in order to ensure or maximize a 
reversion of excess assets that will be paid solely to the employer-
sponsor in connection with the termination of an over-funded pension 
plan would violate the fiduciary's duties under ERISA to act solely in 
the interest of the plan participants and beneficiaries. In such 
circumstances, the interests of those participants and beneficiaries 
who will receive annuities lies in receiving the safest annuity 
available and other participants and beneficiaries have no 
countervailing interests. The fiduciary in such circumstances must make 
diligent efforts to assure that the safest available annuity is 
purchased.
    Similarly, a fiduciary may not purchase a riskier annuity solely 
because there are insufficient assets in a defined benefit plan to 
purchase a safer annuity. The fiduciary may have to condition the 
purchase of annuities on additional employer contributions sufficient 
to purchase the safest available annuity.
    (e) Conflicts of Interest. Special care should be taken in 
reversion situations where fiduciaries selecting the annuity provider 
have an interest in the sponsoring employer which might affect their 
judgment and therefore create the potential for a violation of ERISA 
Sec. 406(b)(1). As a practical matter, many fiduciaries have this 
conflict of interest and therefore will need to obtain and follow 
independent expert advice calculated to identify those insurers with 
the highest claims-paying ability willing to write the business.

    Signed at Washington, DC, this 28th day of February 1995.
Olena Berg,
Assistant Secretary for Pension and Welfare Benefits, U.S. Department 
of Labor.
[FR Doc. 95-5321 Filed 3-3-95; 8:45 am]
BILLING CODE 4510-29-M