“Individual Annuities”-that is, annuity contracts which each cover a single person and their beneficiaries-are uncommon in 401(a) plans (403(b) plans are quite another story, to be discussed in a later writing).”Group annuities” -where a single annuity contract covers a group of participants-are, on the other hand, quite commonplace in retirement plans (yes, even 403(b) plans). The reason for this may well be both historical and technological: in a plan that, let’s say, covers 1000 employees, it has in the past been a bit klutzy to enter into (and administer) each one of those individual annuity contracts for each participant. Yet there are a number of elements of an individual annuity which makes them uniquely suited to address some of the more vexing logistical issues that arise in the implementation of a DC Lifetime Income program.
Enter technology, without which I don’t believe providing any sort of robust DC Lifetime Income program can really be possible. Each of the innovative programs we are seeing enter into the Lifetime Income market are heavily reliant on technology, often provided by what is commonly referred to as “middleware,” a term with which fiduciaries will become well aware. This middleware does a number of things, the most important of which is serving effectively as the “translator” between the sophisticated products providing lifetime income and the plan’s own participant records. That middleware is often used as the technological solution for the use of individual annuities where they haven’t been able to be used before.
There is an important cautionary note, however, in the use of individual annuities in plans. What has happened over time is that a large number of insurance companies have developed two different sets of internal compliance and administrative processes, one which which applies to individual annuities (as they have been sold on a retail basis to individual consumers) and another, separate set of them which applies to group annuities (which have been largely sold to retirement plans).
Take group annuities. They can vary widely in design, from merely being a plan level investment of the plan, all the way to the insurer establishing formal legal relationships with the participant through the issuance of a “certificate.” There exists a very sophisticated industry established around the provisions of the group annuity in the retirement plan space, which is focused on ERISA’s fiduciary rules and matters of plan level compliance. Regardless of the particulars of any group annuity design, the one thing these contracts have in common is that they are designed to comply with the whole panoply of rules which apply when a retirement plan purchases an insurance contract. There is, for example, an extensive set of ERISA rules which govern the use of annuities in retirement plans, from the ubiquitous PT exemption 84-24, to the Form 5500’s Schedule A, and many other requirements in between. The FINRA rules which apply to the sale of annuities to plans are also different than those which apply to the sale of annuities to individuals, and the various anti-money laundering and OFAC rules apply in much different ways as well. Even the state laws governing the filing and approval of these contracts can be different. Insurers, though, are well skilled at these retirement plan practices.
Then there is, on the other hand, also a very sophisticated industry established around the provisions of the individual annuity in the consumer driven retirement income space, which is focused on ways to enhance and protect an individual’s financial well being-but outside of retirement plans. There are impressive mathematical models which continue to be developed (see, for example Wade Pfau’s and Alex Murguia’s new RISA being amongst the most prominent of them)which are designed to enable the design and implementation of personalized retirement income planning strategies aligned with individual preferences. All of these kinds of services rely heavily upon the appropriate use of different types of guarantees provided by insurance companies, and matching them up with an individual’s own risk profile and preference. Like group annuities, individual annuities also have their own wide range of compliance requirements, which apply in different ways than to the sale of annuity products to retirement plans. Insurers are also well skilled at these rules governing the individual annuities.
For the valuable, well established, elements of the individual annuity retirement income space to successfully “crossover” into the DC Lifetime Income market, the group annuity “infrastructure” needs to be exported to the individual product side of things. This is where the “engineering” comes in, as aligning these products with new infrastructure is not necessarily a simple task.
Simply put, this means that most of the commonly available individual annuities sold to consumers are not suitable for the purchase by most 401(a) plans as part of their DC Lifetime Income program without changes being made to the design, administration and compensation (it is also worthwhile to note that the pricing and disclosure rules related to individual and retirement plan products can be vastly different). The differences can range from the types of disclosures being made, to the handling of money in and money out, to the manner in which it is all reported on required annual statements, along with a basketful of other sorts of requirements.
A number of insurers have made the investment necessary to accomplish this feat. It does, however, become a key fiduciary inquiry as to whether or not the annuity being purchased has been designed for use by retirement plans. Recognize also that different products of the same insurer might be supported by different systems and processes, and the fiduciary will need to make sure it is getting to the right one.