Advisory Opinion 2002-14A

Dear Mr. Davis and Ms. Vaino:

This is in response to your request for guidance concerning the selection of annuity providers, pursuant to Interpretive Bulletin 95-1 (29 C.F.R. § 2509.95-1), in connection with distributions from defined contribution plans. Specifically, you have requested the Department to address the application of specific requirements of Interpretive Bulletin 95-1 to defined contribution plans.

Interpretive Bulletin 95-1 (the IB) provides guidance concerning the fiduciary standards under Part 4 of Title I of the Employee Retirement Income Security Act (ERISA) applicable to the selection of annuity providers for purposes of pension plan benefit distributions. In general, the IB makes clear that the selection of an annuity provider in connection with benefit distributions is a fiduciary act governed by the fiduciary standards of section 404(a)(1), including the duty to act prudently and solely in the interest of the plan's participants and beneficiaries. In this regard, the IB provides that plan fiduciaries must take steps calculated to obtain the safest annuity available, unless under the circumstances it would be in the interest of the participants and beneficiaries to do otherwise. The IB also provides that fiduciaries must conduct an objective, thorough and analytical search for purposes of identifying providers from which to purchase annuities and sets forth six factors that should be considered by fiduciaries in evaluating a provider's claims paying ability and creditworthiness. ( §2509.95-1(c)). Further, the IB recognizes that there may be situations where it may be in the interest of participants and beneficiaries to purchase other than the safest available annuity, such as when an annuity is only marginally safer, but disproportionately more expensive than a competing annuity. However, the IB notes that increased costs or other considerations could never justify putting the benefits of participants and beneficiaries at risk by purchasing an unsafe annuity. (§ 2509.95-1(d)).

The following information is provided in response to the specific issues raised by your request.

The general fiduciary principles set forth in the IB with regard to the selection of annuity providers are equally applicable to defined benefit and defined contribution plans. Accordingly, the selection of annuity provider by the fiduciary of a defined contribution plan would be governed by section 404(a)(1) and, therefore, such fiduciary, in evaluating claims paying ability and creditworthiness of an annuity provider, should take into account the six factors set forth in § 2509.95-1(c).

With regard to factor six ( § 2509.95-1(c)(6)) relating to state guarantees, you requested a clarification as to the scope of a fiduciary's consideration. Factor six indicates that fiduciaries should consider "the availability of additional protection through state guaranty associations and the extent of their guarantees."  For purposes of factor six, fiduciaries should determine whether the provider and annuity product are covered by state guarantees and the extent of those guarantees, in terms of amounts (e.g., percentage limits on guarantees) and individuals covered (e.g., residents, as opposed to non-residents, of a state). Such information should be available to the public and easily accessible through state guaranty associations and state insurance departments. Of course, if there were facts known to the fiduciary calling into question the ability of a state association offering guarantees to meet its obligations under the guarantee, it would be incumbent on the fiduciary to weigh that information when selecting an annuity provider.

In evaluating the six factors, the IB indicates that, "[u]nless they possess the necessary expertise to evaluate such factors, fiduciaries would need to obtain the advice of a qualified, independent expert."  With regard to this provision, you express concern that fiduciaries should be able to make evaluations of annuity providers without becoming or hiring an expert in annuity matters. The standard set forth in the IB follows from the prudence standard of section 404(a)(1)(B). That section provides that a fiduciary shall discharge its duties "with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims." (Emphasis supplied). Accordingly, in those instances where the fiduciary responsible for the selection of an annuity provider has, at the time of the selection, a sufficient level of expertise or knowledge to meaningfully evaluate the claims paying ability and creditworthiness of an annuity provider, including the factors set forth in the IB, the fiduciary would not be required to engage a qualified, independent expert to evaluate such factors. For purposes of the IB, "independent" means independent of the annuity provider.

With regard to paragraph (d) of § 2509.95-1, relating to costs and other considerations, you request confirmation that, in evaluating competing products, cost is an appropriate consideration for the fiduciary of a defined contribution plan when the participant receives an increased benefit as a result of reduced costs. It is the view of the Department that it is appropriate for the fiduciary of a defined contribution plan in selecting an annuity provider to take into account the costs and benefits to the participant or beneficiary of competing annuity products. Consistent with the IB, however, a lower cost cannot justify the purchase of an unsafe annuity even when the annuity would pay a higher benefit amount to the participant or beneficiary.

Lastly, you raise a question concerning the applicability of paragraph (e) of § 2509.95-1 to defined contribution plans. Paragraph (e) requires that special care be taken in reversion situations where fiduciaries selecting annuity providers have an interest in the sponsoring employer that may affect their judgment. In such situations, the IB advises that the fiduciary 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. In the absence of any possibility of funds reverting to a plan sponsor in connection with the termination of a defined contribution plan, it is the view of the Department that paragraph (e) would not apply to such plan.

This letter constitutes an advisory opinion under ERISA Procedure 76-1. Accordingly, this letter is issued subject to the provisions of the procedure, including section 10 relating to the effect of advisory opinions.