Advisory Opinion 2001-03A

Dear Mr. Groom:

This is in response to your request for an advisory opinion from the Department of Labor (department) regarding the applicability of Title I of the Employee Retirement Income Security Act of 1974 (ERISA) in connection with The Prudential Insurance Company of America's (Prudential) proposed plan of demutualization. Your inquiry specifically relates to certain payroll deduction individual retirement annuities (IRAs) and tax deferred annuities (TDAs) issued as group contracts to employers acting as the contract holder on behalf of their employees covered under the contracts. You ask whether such IRAs and TDAs that are otherwise exempt from coverage under Title I of ERISA by virtue of the department's regulations at 29 CFR 2510.3-2(d) and (f) would remain exempt if the employer as the contract holder: (1) votes on the proposed plan of demutualization; (2) selects an allocation method for distributing the demutualization proceeds among the employees covered under the group contract.

You represent that Prudential is a mutual life insurance company. As a mutual life insurance company, Prudential has no authorized, issued, or outstanding stock. Instead, the insurance and annuity policies issued by Prudential combine both insurance coverage and proprietary ownership rights (sometimes referred to as membership rights) in Prudential. You indicate that Prudential is reviewing a proposed draft plan of reorganization (Plan or Plan of Reorganization) to convert from a mutual life insurance company to a stock life insurance company (a process known as demutualization). The Plan of Reorganization is subject to the review and approval of Prudentials Board of Directors and the Commissioner of Banking and Insurance of the State of New Jersey (New Jersey Commissioner). The Plan will propose that 100% of the equity value of Prudential (currently estimated to be between 15 and 20 billion dollars) will be distributed to eligible policyholders in the form of stock, cash, or policy credits. All of Prudentials policyholder obligations will remain unchanged and fully in force after the conversion.

You state that New Jersey law requires that policyholders who are qualified voters vote as to whether the Plan should be approved. N.J. Stat. Ann. § 17:17C-5. The demutualization will not be approved unless at least one million policyholders (or such lesser number as approved by the New Jersey Commissioner) cast votes and at least two thirds of those voting vote yes. Id. Each qualified voter is entitled to cast only one vote, irrespective of the number or value of policies held, unless the mutual insurer's charter or bylaws provide otherwise. Id. A qualified voter is defined as a policyholder who is 18 years of age or more and whose policy has been in force for at least 1 year. N.J. Stat. Ann. §§ 17:17C-1; 17B:18-13; 17B:18-23. Sections 17B18- 13 and 17B:18-23 of the New Jersey statutes confirm the qualified voter shall be the policyholder in the case of a group life or health policy and the contract holder in the case of a group annuity contract.

You indicate that under New Jersey law, the term policy means an individual or group policy of insurance or annuity contract issued, or deemed by the plan of reorganization to have been issued, by the mutual insurer. The individual certificates or similar evidence of interests in a group annuity contract that are given to employees covered under a contract issued to an employer as group contract holder are not treated as separate policies. However, for certain group policies or contracts issued to a trust or group established by the insurer, the certificates or evidence of interests may be deemed to be a policy solely for purposes of determining the right to receive consideration under the Plan of Reorganization. N.J. Stat. Ann. § 17:17C-1. Thus, you represent the vote on the Prudential Plan of Reorganization will be exercisable by the group contract holder (who will generally be the employer in the case of TDAs and IRAs) and not individual certificate holders under a group contract.

If the Plan of Reorganization is approved, all policyholder's membership rights in Prudential will be extinguished. Payments of stock, cash, or policy credits (i.e., enhancements to policy values) will be made in consideration of the policyholder's extinguished membership rights. You represent that Prudential, like other insurance companies that already have demutualized, will grant policy credits instead of stock or cash distributions to TDAs, IRAs, and certain individual contracts held under plans qualified under section 401(a) of the Internal Revenue Code. You represent that distributing only policy credits to TDAs and IRAs is necessary to permit these plans to continue to operate in a manner consistent with federal tax laws, to maintain the consideration in a tax-favored retirement solution, and still to participate equitably in the demutualization.

The amount of the distributions will be established pursuant to actuarial valuations reviewed and approved by the New Jersey Commissioner. You represent that under Prudential's proposed demutualization, there are two components of compensation for eligible policyholders -- fixed and variable. Each eligible policyholder will be allocated the same basic fixed component. The variable component will be provided to those eligible policyholders whose policies produce a positive contribution to Prudentials surplus. The variable component focuses on the contribution of the policy as a whole to Prudential's surplus, including both the historical and anticipated future contributions to surplus. A policy's contribution to surplus is determined by identifying the profit and expense associated with that contract. Profits and expenses can be affected by, for example, the type of policy, the date it was issued, and the period during which it was outstanding. Moreover, Prudential's surplus, as reflected on applicable financial statements, will not be distributed to policyholders. Instead, the relative contribution to surplus of each eligible contract is determined, and then each policyholder is given a corresponding percentage allocation. That percentage allocation is then translated into a number of shares, and the results of the initial public offering will determine the value of those shares.

With respect to the allocation of policy credits among individual certificate holders under group IRA and TDA contracts, you note that the most likely of the possible allocation methods among individual participants in a group policy are pro rata by account balance (or premiums paid) or per capita. You indicate that neither method is necessarily more appropriate in all cases. For example, the pro rata approach may recognize the relative amounts paid into the contract by individual participants (certificate holders), but it allocates to current participants with large current balances (or premium histories) a higher share of the historical surplus, a surplus that may have been attributable to long-departed employees. The per capita approach generally will allocate an equal share of the group contract's demutualization proceeds to all the individual participants (certificate holders) covered under the group contract (even lower-paid participants with small overall account balances) and will not favor highly compensated employees, but does not recognize that the higher premiums paid by certain certificate holders might have contributed to Prudential's profitability. You represent that Prudential will use the per capita method as the default allocation method for those IRA and TDA policyholders (as well as other record- keeping clients) who do not affirmatively designate an allocation method. The per capita method was chosen because Prudential concluded it was fair under the circumstances.⁽¹⁾

Finally, you represent that in connection with the vote, each policyholder, including group policyholders, will be provided with a Policyholder Information Booklet, that provides: (1) notice of a public hearing to be held by the insurance department; (2) notice of the policyholder vote; (3) a detailed summary of the proposed Plan. Prudential will also provide a Group Guide to group policyholders. The Group Guide identifies issues that must be addressed by plans, group TDAs and group IRAs receiving demutualization proceeds, including the possibility that proceeds will have to be allocated among individual participants covered by a group contract. Following the distribution of the Group Guide, Prudential will send a letter to each group policyholder: (1) specifically describing the methods of allocating the proceeds among the individual participants/certificate holders covered by the group policy that Prudential is administratively able to implement; (2) soliciting the group policyholder's direction as to its desired participant allocation method (Allocation Letter). A follow-up letter (Follow-up Letter) will be sent to those group policyholders who have not provided an affirmative participant allocation direction within 30 days after the Allocation Letter is sent. The Follow-up Letter will reiterate Prudential's request for an affirmative direction, but indicate that if a direction is not received by a date that is at least 30 days from the date of the Follow-up Letter, the policyholder will be deemed to have directed Prudential to implement the default allocation method (i.e., the per capita method).

Under provisions of the Internal Revenue Code (Code), individual taxpayers may establish IRAs and TDAs that are tax-favored if operated within the requirements of the Code. With respect to Title I coverage of such IRAs and TDAs, the department published regulations at 29 CFR 2510.3-2(d) and (f), establishing safe harbors under which an IRA or TDA established by employees and funded through payroll deductions will not be considered to be an ERISA- covered "pension plan within the meaning of section 3(2) of Title I when the conditions of the regulation are satisfied.⁽²⁾ If one or more of the conditions of the regulations are not met, the employer may be considered to have established or maintained an ERISA-covered pension plan. The department has acknowledged that group annuity contract arrangements may offer cost advantages to employees and has agreed that an employer may become the holder of such a group contract and may exercise certain rights with respect to the contract on behalf of its employees without exceeding the limits on employer involvement set forth in 29 CFR 2510.32(f). See 44 Fed. Reg. 23525 (April 20, 1979). The department emphasized, however, that an employer who wishes to meet the terms of the regulation could not exercise rights under a group contract except as an authorized representative of its employees covered under the contract. Id. Similarly, the department believes that an employer may be the holder of a group IRA contract and may exercise certain rights with respect to the contract as an authorized representative of its employees without exceeding the limits on employer involvement set forth in 29 CFR 2510.3-2(d).

The department further believes that even in cases where employer actions may not fully conform with the safe harbor provisions in 29 CFR 2510.3-2(d) and (f), an IRA or TDA program may nevertheless be treated as not established or maintained by an employer for the purposes of Title I of the Act. In this case, it is the department's view that group annuity arrangements consisting of either payroll deduction IRAs or TDAs that are otherwise exempt from coverage under Title I of ERISA by virtue of the safe harbors in 29 CFR 2510.3-2(d) and (f) would not be treated as pension plans covered by Title I of ERISA solely as a result of the employer in whose name the group policy is issued voting on the Plan of Reorganization as provided for by New Jersey law and selecting one of the allocation methods for distributing the demutualization proceeds among the employees covered under the group contract.⁽³⁾ In reaching this conclusion, we note in particular that: (1) actions of Prudential independent of the employer gave rise to the employer's need, as the titled group contract holder, to take action on behalf of the covered employees with respect to the demutualization; (2) the employer would be acting in accordance with specific provisions in New Jersey law governing the demutualization and pursuant to the requirements of Prudential's Plan of Reorganization that is being approved and supervised by the New Jersey Commissioner of Insurance; (3) the vote on the demutualization and the decision on the method for allocation of proceeds thereunder are unique, one-time acts that do not involve the employer retaining any discretion regarding the on-going administration or operation of the IRAs or TDAs.

As noted above, however, the employer may be considered to have established or maintained an ERISA covered pension plan if the IRA or TDA arrangements do not otherwise meet the requirements of 29 CFR 2510.3-2(d) or (f), including the requirement that the employer receive no direct or indirect consideration or compensation in cash or otherwise other than reasonable compensation to cover the actual costs of the salary reduction or payroll deduction program of the employer described in subparagraphs (d)(1)(iv) or (f)(4). In that regard, so long as all the demutualization proceeds are distributed among the individual participants covered under the group IRA or TDA contract, the department would not view the receipt of an allocated share by an employer who is also a participant in the group contract in and of itself to be employer consideration within the meaning of 29 CFR 2510.3-2(d)(1)(iv) and (f)(4).

This letter constitutes an advisory opinion under ERISA Procedure 76-1, 41 Fed. Reg. 36281 (1976). Accordingly, this letter is issued subject to the provisions of that procedure, including section 10 thereof, relating to the effect of advisory opinions.