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Employee Benefits Security Administration

EBSA Final Rule

Insurance Company General Accounts [01/05/2000]

[PDF Version]

Volume 65, Number 3, Page 613-643


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Part III





Department of Labor





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Pension Welfare Benefits Administration



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29 CFR Part 2550



Insurance Company General Accounts; Final Rule


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DEPARTMENT OF LABOR

Pension and Welfare Benefits Administration

29 CFR Part 2550

RIN 1210-AA58

 
Insurance Company General Accounts

AGENCY: Pension and Welfare Benefits Administration, Labor.

ACTION: Final rule.

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SUMMARY: This document contains a final regulation which clarifies the 
application of the Employee Retirement Income Security Act of 1974 as 
amended (ERISA or the Act) to insurance company general accounts. 
Pursuant to section 1460 of the Small Business Job Protection Act of 
1996, section 401 of ERISA was amended. Section 401 now provides that 
the Department of Labor (the Department) must issue regulations to: 
provide guidance for the purpose of determining, where an insurer 
issues one or more policies to or for the benefit of an employee 
benefit plan (and such policies are supported by assets of the 
insurer's general account), which assets held by the insurer (other 
than plan assets held in its separate accounts) constitute assets of 
the plan for purposes of Part 4 of Title I of ERISA and section 4975 of 
the Internal Revenue Code of 1986 (the Code), and provide guidance with 
respect to the application of Title I to the general account assets of 
insurers. This regulation affects participants and beneficiaries of 
employee benefit plans, plan fiduciaries and insurance company general 
accounts.

DATES: Effective Date: This rule is effective January 5, 2000.
    Applicability Dates: Except as provided below, section 2550.401c-1 
is applicable on July 5, 2001. Section 2550.401c-1(c) [except for 
paragraph (c)(4)] and (d) are applicable on July 5, 2000. The first 
annual disclosure required under Sec. 2550.401c-1(c)(4) shall be 
provided to each plan not later than 18 months following January 5, 
2000. Section 2550.401c-1(f) is applicable on January 5, 2000.

FOR FURTHER INFORMATION CONTACT: Lyssa E. Hall or Wendy M. McColough, 
Office of Exemption Determinations, Pension and Welfare Benefits 
Administration, U.S. Department of Labor, Room N-5649, 200 Constitution 
Avenue, N.W., Washington, DC 20210, (202) 219-8194, or Timothy Hauser, 
Plan Benefits Security Division, Office of the Solicitor, (202) 219-
8637. These are not toll-free numbers.

SUPPLEMENTARY INFORMATION: On December 22, 1997, the Department 
published a notice of proposed rulemaking in the Federal Register (62 
FR 66908) which clarified the application of ERISA to insurance company 
general accounts. The Department invited interested persons to submit 
written comments or requests that a public hearing be held on the 
proposed regulation. The Department received more than 37 written 
comments in response to the proposed regulation. A public hearing, at 
which 13 speakers testified, was held on June 1, 1998 in Washington, 
D.C.
    The following discussion summarizes the proposed regulation and the 
major issues raised by the commentators.1 It also explains 
the Department's reasons for the modifications reflected in the final 
regulation that is published with this notice.
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    \1\ References to ``comments'' and ``commentators'' include both 
written comment letters as well as prepared statements and oral 
testimony at the public hearing.
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Discussion of the Regulation and Comments

    Pursuant to section 1460 of the Small Business Job Protection Act 
of 1996 (SBJPA), Public Law 104-188, the proposed regulation amended 29 
CFR Part 2550 by adding a new section, 2550.401c-1. This new section 
was divided into ten major parts. Paragraph (a) of the proposed 
regulation described the scope of the regulation and the general rule. 
Proposed paragraphs (b) through (f) contained conditions which must be 
met in order for the general rule to apply. Specifically, paragraph (b) 
addressed the requirement that an independent fiduciary expressly 
authorize the acquisition or purchase of a Transition Policy. Paragraph 
(c) described the disclosures that an insurer must make both prior to 
the issuance of a Transition Policy to a plan and on an annual basis. 
Paragraph (d) provided for additional disclosures regarding separate 
account contracts. Paragraph (e) contained the procedures that must 
apply to the termination or discontinuance of a Transition Policy by a 
policyholder. Paragraph (f) contained notice provisions regarding 
contract terminations and withdrawals in connection with insurer-
initiated amendments. Proposed paragraph (g) set forth a prudence 
standard for the management of general account assets by insurers. The 
definitions of certain terms used in the proposed regulation were 
contained in paragraph (h). Proposed paragraph (i) described the effect 
of compliance with the regulation and proposed paragraph (j) contained 
the effective dates of the regulation. For a more complete statement of 
the background and description of the proposed regulation, refer to the 
notice published on December 22, 1997 at 62 FR 66908.

1. Scope and General Rule

    Proposed Sec. 2550.401c-1(a) and (b) essentially followed the 
language of section 401(c) of ERISA. Paragraph (a) described, in cases 
where an insurer issues one or more policies to or for the benefit of 
an employee benefit plan (and such policies are supported by assets of 
an insurance company's general account), which assets held by the 
insurer (other than plan assets held in its separate accounts) 
constitute plan assets for purposes of Subtitle A, and Parts 1 and 4 of 
Subtitle B, of Title I of the Act and section 4975 of the Internal 
Revenue Code, and provided guidance with respect to the application of 
Title I and section 4975 of the Code to the general account assets of 
insurers.
    Paragraph (a)(2) stated the general rule that when a plan acquires 
a policy issued by an insurer on or before December 31, 1998 
(Transition Policy), which is supported by assets of the insurer's 
general account, the plan's assets include the policy, but do not 
include any of the underlying assets of the insurer's general account 
if the insurer satisfies the requirements of paragraphs (b) through (f) 
of the regulation.
    One commentator stated that paragraph (a)(2) lacked clarity and did 
not properly cross-reference the definition of the term ``Transition 
Policy.'' In response to this comment, the Department has clarified 
paragraph (a)(2) to provide that ''* * * when a plan acquires a 
Transition Policy (as defined in paragraph (h)(6)), the plan's assets 
include the policy, but do not include any of the underlying assets of 
the insurer's general account if the insurer satisfies the requirements 
of paragraphs (c) through (f) of this section.''
    Several commentators requested that the final regulation contain a 
total exclusion from the definition of ``plan assets'' for all assets 
held in or transferred from the estate of an insurance company in 
delinquency proceedings in which an impaired or insolvent insurer is 
placed under court supervision pursuant to State insurance laws 
governing rehabilitation or liquidation. One commentator explained that 
delinquency proceedings are initiated when the insurance regulator in 
the State where the insurer is domiciled files a petition in State

[[Page 615]]

court requesting a takeover of the insurer's operations from existing 
management. Such a petition is predicated on the regulator's conclusion 
that continued operation of the insurer by management would be 
hazardous to policyholders, creditors or the public. The precipitating 
event is usually the insolvent condition of the insurer. Upon the 
granting of the petition, a new legal entity called the estate is 
created. The court gives control over the estate to a receiver who is 
charged under State law with the fiduciary duty to fairly represent the 
interests of all policyholders, creditors and shareholders of the 
insolvent insurer. To stabilize the situation, the court is almost 
always compelled to order a moratorium or other restrictions on cash 
withdrawals, subject to individual hardship exceptions. All activity in 
the proceedings is carried out under the close supervision of the 
court.
    In consideration of the concerns expressed by commentators, the 
Department has adopted a new paragraph (a)(3) which specifically 
provides that a plan's assets will not include any of the underlying 
assets of the insurer's general account if the insurer fails to satisfy 
the requirements of paragraphs (c) through (f) of the regulation solely 
because of the takeover of the insurer's operations as a result of the 
granting of a petition filed in delinquency proceedings by the 
insurance regulatory authority in the State court where the insurer is 
domiciled.

2. Authorization by an Independent Fiduciary

    Proposed paragraph (b)(1) stated the general requirement that an 
independent fiduciary ``who has the authority to manage and control the 
assets of the plan must expressly authorize the acquisition or purchase 
of the Transition Policy.'' A fiduciary is not independent if the 
fiduciary is an affiliate of the insurer issuing the policy. Paragraph 
(b)(2) of the proposed regulation contained an exception to the 
requirement of independent plan fiduciary authorization if the insurer 
is the employer maintaining the plan, or a party in interest which is 
wholly-owned by the employer maintaining the plan, and the requirements 
of section 408(b)(5) of ERISA are met.2
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    \2\ This exception for in-house plans of the insurer under 
section 401(c)(3) of ERISA is similar to the statutory exemption 
contained in section 408(b)(5) of ERISA which provides relief from 
the prohibitions of section 406 for purchases of life insurance, 
health insurance or annuities from an insurer if the plan pays no 
more than adequate consideration and if the insurer is the employer 
maintaining the plan.
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    The Department notes that, because section 401(c)(1)(D) of the Act 
and the definition of Transition Policy preclude the issuance of any 
additional Transition Policies after the publication of the final 
regulation, the requirement for independent fiduciary authorization of 
the acquisition or purchase of the Transition Policy no longer has any 
application. Accordingly, the Department generally has determined not 
to respond to the comments which raised issues regarding this 
requirement. However, the Department has determined to respond to the 
comments concerning the definition of ``affiliate'' contained in 
paragraph (h)(1) of the proposed regulation because of its potential 
relevance to other conditions under the final regulation.
    One commentator suggested that the definition of ``affiliate'' 
contained in paragraph (h)(1) of the proposed regulation should be 
expanded to include: (1) 10% or more shareholders or equity holders of 
insurers and of persons controlling, controlled by, or under common 
control with insurers; (2) businesses in which a person described in 
proposed subparagraph (h)(1)(ii) is a 10% or more shareholder or equity 
holder; and (3) relatives of persons who are officers, directors, 
partners or employees of the insurer. Other commentators requested that 
the definition of affiliate be narrowed. A commentator noted that the 
proposed definition of affiliate would include all insurance agents and 
brokers of the insurer, even non-exclusive agents, as well as all 
employees of the insurer and of all entities in which an employee of 
the insurer is an officer, director, partner or employee. The 
commentator noted that the proposed definition would force the insurer 
to assume a difficult monitoring function with respect to its 
employees, agents and brokers. As a result, this commentator argued 
that the definition of affiliate in the proposed regulation need not be 
broader than the affiliate definition contained in Prohibited 
Transaction Class Exemption 84-14 (the QPAM Exemption).3 
Additionally, according to this commentator, it was unclear under the 
definition of affiliate whether a ``partner of'' an insurer is intended 
to mean a partner in the insurer or a partner with the insurer.
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    \3\ Class Exemption for Plan Asset Transaction Determined by 
Independent Qualified Professional Asset Managers (QPAMs), 49 FR 
9494 (March 13, 1984) as corrected at 50 FR. 41430 (Oct. 10, 1985).
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    After consideration of the comments, the Department has determined 
that it would be appropriate to narrow the category of persons included 
under the affiliate definition and to clarify certain of the terms used 
in the definition. Accordingly, the Department has modified 
subparagraph (h)(1)(ii) to provide that an affiliate of an insurer 
includes any officer of, director of, 5 percent or more partner in, or 
highly compensated employee (earning 5 percent or more of the yearly 
wages of the insurer) of, such insurer or any person described in 
subparagraph (h)(1)(i) including in the case of an insurer, an 
insurance agent or broker (whether or not such person is a common law 
employee) if such agent or broker is an employee described above or if 
the gross income received by such agent or broker from such insurer or 
any person described in subparagraph (h)(1)(i) exceeds 5 percent of 
such agent's gross income from all sources for the year. In addition, 
under subparagraph (h)(1)(iii), the Department has determined to delete 
those corporations, partnerships, or unincorporated enterprises of 
which a person described in subparagraph (h)(1)(ii) is an employee or 
less than 5 percent partner.

3. Duty of Disclosure

    Section 401(c)(3)(B) of the Act provides that the regulations 
prescribed by the Secretary ``shall require in connection with any 
policy issued by an insurer to or for the benefit of an employee 
benefit plan to the extent the policy is not a guaranteed benefit 
policy * * * (B) that the insurer describe (in such form and manner as 
shall be prescribed in such regulations), in annual reports and in 
policies issued to the policyholder after the date on which such 
regulations are issued in final form * * *, (i) a description of the 
method by which any income and expenses of the insurer's general 
account are allocated to the policy during the term of the policy and 
upon termination of the policy, and (ii) for each report, the actual 
return to the plan under the policy and such other financial 
information as the Secretary may deem appropriate for the period 
covered by each such annual report.''
    Proposed paragraph (c)(1) of the regulation similarly imposed a 
duty on the insurer to disclose specific information to plan 
fiduciaries prior to the issuance of a Transition Policy and at least 
annually for as long as the policy is outstanding. Paragraph (c)(2) 
required that the disclosures be clear and concise and written in a 
manner calculated to be understood by a plan fiduciary.
    Although the Department did not mandate a specific format for the

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disclosures, the information should be presented in a manner which 
facilitates the fiduciary's understanding of the operation of the 
policy. The Department expected that, following disclosure of the 
required information and any other information requested by the 
fiduciary pursuant to proposed paragraph (c)(4)(xii), the plan 
fiduciary, with independent professional assistance, if necessary, 
would be able to ascertain how various values or amounts relevant to 
the plan's policy such as the actual return to be credited to any 
accumulation fund under the policy, would be determined.
    Many of the commentators expressed a number of general objections 
to the disclosure provisions. These commentators stated that the level 
of disclosure required by the proposed regulation exceeded 
Congressional intent and the requirements of section 401(c) of ERISA. 
They also asserted that the disclosure provisions were too broad and 
vague to provide an insurer who is attempting to comply with the 
regulation any level of comfort. Moreover, the commentators maintained 
that other financial service providers are not required to provide the 
same level of disclosure to their investors. The commentators further 
asserted that compliance by insurers with the regulation would result 
in increased costs for plans without adding anything of value. In this 
regard, many of the commentators expressed the belief that the 
disclosure provisions, as proposed, impose unnecessary financial and 
administrative burdens on plans and insurance companies. The 
commentators suggested that the information required to be disclosed 
goes well beyond that which is necessary for a plan fiduciary to 
determine whether or not to invest in or retain a Transition Policy. 
One commentator stated that disclosure should be limited to matters 
immediately connected to the contract and the contract's ``bottom 
line''. Finally, several commentators asserted that the proposed 
disclosure provisions require an insurer to disclose proprietary 
information but did not specifically identify which items would require 
the disclosure of such information as the Department requested in the 
preamble to the proposed regulation.
    Other commentators expressed the opposite view and generally 
supported the proposed disclosure provisions, stating that the 
provisions would allow plan fiduciaries to get the basic information 
necessary to analyze a general account contract for investment 
purposes. More specifically, one commentator offered the following 
concerns with respect to the level of disclosure currently provided in 
connection with insurance company general account contracts:

    The insurance companies issuing the general account contracts 
have not provided sufficient information for fiduciaries to monitor 
contractual compliance. The insurance companies have not provided 
sufficient information to allow fiduciaries to validate that all 
contractholders are receiving equitable treatment within the general 
account. The insurance companies have not provided sufficient 
information for fiduciaries to calculate the rate of return on 
general account contracts comparable to the rate of return 
information they obtain for other plan investments.

    Similarly, several commentators indicated that currently, plan 
fiduciaries often have a difficult time obtaining any meaningful 
information to assist them in making informed decisions concerning 
whether to purchase or retain a Transition Policy. In this regard, 
commentators also noted that the disclosures set forth in the proposed 
regulation are even more important for small plans, which do not 
normally have the economic leverage to negotiate any voluntary 
disclosure of information by the insurer. Another commentator expressed 
his belief that the proposed disclosure provisions are consistent with 
the intent of the Congressional Conferees.
    Two commentators supported the disclosures mandated by the proposed 
regulation but asserted that those provisions did not go far enough. 
These commentators suggested that a clear and comprehensive standard 
form for disclosures should be issued to assist plan fiduciaries as 
well as small insurance companies seeking to comply with the 
regulation. One commentator suggested that the Department create sample 
written disclosures or issue a guide to writing disclosures in plain 
English. The commentator also stated that the regulation does not 
provide any penalties for an insurer's failure to comply with a 
policyholder's request for information. In this regard, the Department 
notes that paragraph (i) of the final regulation contains an 
explanation of the consequences of an insurer's failure to comply with 
the provisions of the regulation.
    The Department has considered the comments regarding the scope and 
level of detail required by the proposed disclosure provisions in light 
of the Congressional mandate set forth in section 401(c)(3) of ERISA. 
The Department continues to believe that it was given broad discretion 
to require that insurers provide meaningful disclosure of information 
regarding Transition Policies in order to enable plan fiduciaries to 
evaluate the suitability of such policies. The Department notes that, 
with respect to the annual report, section 401(c)(3)(B) of ERISA 
expressly directs the Department to require the disclosure of ``* * * 
such other financial information as the Secretary may deem appropriate 
for the period covered by such annual report.'' The Department believes 
that a plan fiduciary, at a minimum, must be provided with sufficient 
information about the methods used by the insurer to allocate amounts 
to a Transition Policy, and the actual amounts debited against, or 
credited to, the Transition Policy on an ongoing and on a termination 
basis in order to evaluate whether to invest in or to retain the 
Policy. In this regard, the Department notes that an insurance company 
general account, which necessarily operates under a complex allocation 
structure for fees, expenses and income, is unlike other investment 
vehicles. Thus, the Department believes that the information that an 
investor must be furnished in order to compare an investment in a 
general account contract to other available investment options must 
necessarily be more comprehensive. However, the Department recognizes 
that providing a plan fiduciary with the financial information needed 
to evaluate the suitability of a particular policy may place additional 
administrative costs and burdens on both insurers and plans. After 
careful consideration of all of the comments, the Department has 
concluded that modifications to the disclosure provisions are necessary 
in order to balance the costs of additional disclosures against the 
fiduciary's need for sufficient information to make informed investment 
decisions. Accordingly, the Department has determined, as discussed 
further below, to modify paragraph (c) of the disclosure provisions in 
the final regulation to more precisely define the scope of the 
information which must be furnished to the policyholder. In recognition 
of the variety of insurance arrangements available to plans, the 
Department has not been persuaded that it is necessary or feasible for 
plan fiduciaries to receive the information required to be disclosed to 
them pursuant to the regulation in a standard format. Therefore, the 
Department has not adopted the commentator's suggestion regarding 
developing a standard format or a guide for writing such disclosures. 
In addition, the Department has made minor modifications to the final

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regulation to reflect the fact that the initial disclosures cannot be 
provided by an insurer prior to issuing a Transition Policy because no 
new Transition Policies can be issued after December 31, 1998.
    Proposed paragraph (c)(3) set forth the content requirement for the 
information which must be provided to the plan either as part of the 
Transition Policy, or as a separate written document which accompanies 
the Transition Policy. For Transition Policies issued before the date 
which is 90 days after the date of publication of the final regulation, 
the proposed regulation required the insurer to provide the information 
identified in paragraph (c)(3)(i) through (iv) no later than 90 days 
after publication of the final regulation. For Transition Policies 
issued 90 days after the date of publication of the final regulation, 
the proposed regulation required the insurer to provide the information 
to a plan before the plan makes a binding commitment to acquire the 
policy.
    Under paragraph (c)(3), an insurer must provide a description of 
the method by which any income and expenses of the insurer's general 
account are allocated to the policy during the term of the policy and 
upon its termination. The initial disclosure under this paragraph must 
include, among other things, a statement of the method used to 
determine ongoing fees and expenses that may be assessed against the 
policy or deducted from any accumulation fund under the policy. The 
term ``accumulation fund'' is defined in paragraph (h)(5) as the 
aggregate net considerations (i.e., gross considerations less all 
deductions from such considerations) credited to the Transition Policy 
plus all additional amounts, including interest and dividends, credited 
to the contract, less partial withdrawals and benefit payments and less 
charges and fees imposed against this accumulated amount under the 
Transition Policy other than surrender charges and market value 
adjustments.
    Under the proposed regulation, the insurer must also include, in 
its description of the method used to allocate income and expenses to 
the Transition Policy: an explanation of the method used to determine 
the return to be credited to any accumulation fund under the policy; a 
description of the policyholder's rights to transfer or withdraw all or 
a portion of any fund under the policy, or to apply such amounts to the 
purchase of benefits; and a statement of the precise method used to 
calculate the charges, fees or market value adjustments that may be 
imposed in connection with the policyholder's right to withdraw or 
transfer amounts under any accumulation fund. Upon request, the insurer 
must provide the information necessary to independently calculate the 
exact dollar amounts of the charges, fees or market value adjustments.
    A number of commentators objected to the provisions contained in 
subparagraphs (c)(2), (c)(3)(i)(D) and (c)(4) of the proposed 
regulation which, in their view, would require insurers to disclose or 
make available upon request by a plan fiduciary, information relating 
to the pricing of their products, internal cost calculations and/or 
methodologies sufficient to enable the fiduciary to independently 
calculate the insurer's adjustments. The commentators stated their 
belief that such information is proprietary. In this regard, the 
commentators argued that disclosure of very detailed pricing 
information would place insurance companies at a severe competitive 
disadvantage vis-a-vis other financial institutions that market 
products or services to employee benefit plans. Moreover, they stated 
that, while disclosure of fees and returns is common and appropriate, 
disclosure of the underpinnings of such fees and returns is neither 
common nor necessary. The commentators further asserted that plan 
fiduciaries do not need such information to make prudent investment 
decisions.
    Two commentators requested that the Department eliminate the last 
two sentences of paragraph (c)(2) of the proposed regulation and all of 
paragraph (c)(3)(i)(D) other than the following: ``A statement of the 
method used to calculate any charges, fees, credits or market value 
adjustments described in paragraph (i)(C) of this section.'' According 
to the commentators, these modifications would eliminate the 
requirement that an insurer provide all of the data necessary to enable 
a plan fiduciary to replicate the insurer's internal adjustments.
    One commentator suggested that, because the method used to 
determine a market value adjustment involves several layers of internal 
general account calculations, the Department should provide more 
clarity with respect to how far back an insurer should ``unpeel'' the 
market value adjustment calculation to satisfy the disclosure 
requirements in subparagraph (c)(3)(i)(D). The commentator further 
urged the Department to eliminate the requirements in paragraphs (c)(2) 
and (c)(3)(i)(D) that the insurer disclose any data necessary to permit 
the fiduciary, with or without professional assistance, to 
independently calculate the exact dollar amount of the charges, fees or 
adjustments. The commentator offered the following language in lieu of 
the deleted text in subparagraph (c)(3)(i)(D):

    Upon request of the plan fiduciary, the insurer must provide as 
of a stated date: (1) The formula actually used to calculate the 
market value adjustment, if any, to be applied to the unallocated 
amount in the accumulation fund upon distribution to the 
policyholder; and (2) the actual calculation of the applicable 
market value adjustment, including a reasonably detailed description 
of the specific variables used in the calculation.

    One commentator suggested that the final regulation establish a 30 
day time limit for responding to a fiduciary's request for information 
from an insurer pursuant to subsection (c)(3)(i)(D). Other commentators 
expressed general support for the disclosure provisions but maintained 
that the Department should require that additional items of information 
be disclosed to policyholders. Specifically, one commentator requested 
that the initial disclosure provisions be expanded to require that 
insurers disclose the following additional information upon the request 
of a policyholder: Copies of reports relating to the financial 
condition of the insurer pursuant to subparagraphs (c)(3)(i)(A) and 
(B); amounts which have been offset, subtracted or deducted from the 
gross earnings of the general account before income is credited to a 
Transition Policy pursuant to subparagraph (c)(3)(i)(B); gross and net 
return and income prior to returns being credited to the Transition 
Policy; and, pursuant to subparagraph (3)(c)(i)(C), any alternative 
withdrawal options which might scale-back charges, fees or adjustments 
in exchange for a longer withdrawal term. Finally, the commentator 
suggested that a condition should be imposed which would require 
insurers to disclose the treatment of capital gains and losses, any 
establishment of reserves or contingency funds, or smoothing or 
stabilization funds, as well as areas in which management of the 
insurer has discretion in creating or modifying the above.
    Another commentator stated that, in order to maintain transparency 
of all material features and aspects of general account contracts, the 
following requirements should be added to the regulation: disclosure of 
the assets supporting specific general account contracts; disclosure of 
data that permits comparison of a plan's contract to other contracts 
within the same class; and comparison of the class of contracts to all 
classes of contracts participating in the general account. The specific 
data

[[Page 618]]

would include: gross and net returns, and the methodology and data to 
verify such returns; investment income generated by the general 
account; allocation of contract assets within the general account; and 
allocation procedures, risk and reserve charges, and other expenses 
attributable to all classes of contracts, as well as quarterly 
disclosure of gross and net rates of return.
    As previously noted, the Department believes that it is important 
for plan fiduciaries to be provided with the information necessary to 
adequately assess the financial strength of an insurer, the suitability 
of a particular policy for the plan, as well as the appropriateness of 
continuing a plan's investment in a such policy. Nonetheless, the 
Department agrees with the commentators' views that a plan fiduciary 
need not replicate all of an insurer's internal cost calculations in 
order to make these assessments. However, the Department continues to 
believe that information necessary to calculate the exact dollar amount 
of the charges, fees or adjustments upon contract terminations must be 
disclosed to plan fiduciaries. In order for the termination provisions 
in the regulation to be meaningful, plan fiduciaries must have access 
to the information necessary to calculate and monitor the charges which 
would be assessed against a Transition Policy in the event of 
termination. Therefore, the Department has determined not to make all 
of the deletions to subparagraphs (c)(2) and (c)(3) requested by the 
commentators. However, the Department has determined that it would be 
appropriate to modify paragraph (c) to narrow the scope of the 
disclosures which must be provided in order to enable a plan fiduciary 
to determine the charges or adjustments applicable to the plan's 
policy. Pursuant to these modifications, the last two sentences of 
subparagraph (c)(2) have been deleted and subparagraphs (c)(3)(i)(A)-
(C) have been modified to delete the requirement regarding disclosure 
of the data necessary for application of the methods or methodologies 
for determining the various values or amounts relevant to the plan's 
policy. The Department has retained the requirement in subparagraph 
(c)(3)(i)(D) that the insurer provide, upon request of a policyholder, 
data relating to any charges, fees, credits or market value adjustments 
relevant to the policyholder's ability to withdraw or transfer all or a 
portion of any fund under the policy. However, this requirement has 
been restated to clarify the level of ``unpeeling'' which must be 
provided by the insurer and to require that such information must be 
provided to the policyholder within 30 days of the request for 
disclosure. Accordingly, upon the request of a plan fiduciary, the 
insurer must provide the formula actually used to calculate the market 
value adjustment, if any, applicable to the unallocated amount in the 
accumulation fund upon distribution of a lump sum payment to the 
policyholder, the actual calculation as of a specified date of the 
applicable market value adjustment, including a description of the 
specific variables used in the calculation, the value of each of the 
variables, and a general description of how the value of each of the 
variables was determined.
    In response to the commentators who suggested that the Department 
expand the disclosure requirements in the regulation, the Department 
agrees with their assertions that there are a number of additional 
items of financial information regarding an insurance company general 
account, which may be relevant to a plan's fiduciary's consideration of 
the appropriateness or the prudence of a Transition Policy. In this 
regard, the Department notes that the disclosure requirements in the 
regulation reflect what the Department believes is the minimum level of 
information that an insurer must provide to a fiduciary of a plan which 
has invested in a Transition Policy. If the fiduciary believes that 
there are additional items of information which must be reviewed to 
evaluate a Transition Policy, the Department encourages the fiduciary 
to request, or to negotiate for, where appropriate, such information 
from the insurer.
    Proposed paragraph (c)(4) described the information which must be 
provided at least annually to each plan to which a Transition Policy 
has been issued. The proposal required the insurer to provide the 
following information at least annually to each plan regarding the 
applicable reporting period: the balance in the accumulation fund on 
the first and last day of the period; any deposits made to the 
accumulation fund; all income attributed to the policy or added to the 
accumulation fund; the actual rate of return credited to the 
accumulation fund; any other additions to the accumulation fund; a 
statement of all fees, charges or expenses assessed against the policy 
or deducted from the accumulation fund; and the dates on which the 
additions or subtractions were credited to, or deleted from, the 
accumulation fund.
    In addition, the proposed regulation required insurers to annually 
disclose all transactions with affiliates which exceed 1 percent of 
group annuity reserves of the general account for the reporting year. 
The annual disclosure also had to include a description of any 
guarantees under the policy and the amount that would be payable in a 
lump sum pursuant to the request of a policyholder for payment of 
amounts in the accumulation fund under the policy after deduction of 
any charges and any deductions or additions resulting from market value 
adjustments.
    As part of the annual disclosure, the proposed regulation requires 
that an insurer inform policyholders that it will make available upon 
request certain publicly-available financial information relating to 
the financial condition of the insurer. Such information would include 
rating agency reports on the insurer's financial strength, the risk 
adjusted capital ratio, an actuarial opinion certifying to the adequacy 
of the insurer's reserves, and the insurer's most recent SEC Form 10K 
and Form 10Q (if a stock company).
    Several commentators objected to the annual disclosure provisions 
in subparagraph (c)(4)(xii) of the proposed regulation which required 
an insurer to make available on request of a plan, copies of certain 
publically available financial data or reports relating to the 
financial condition of the insurer, including the insurer's risk 
adjusted capital ratio, and the actuarial opinion with supporting 
documents certifying the adequacy of the insurer's reserves. The 
commentators asserted that the risk-based capital report and actuarial 
opinions should not be disclosed because the information contained 
therein could be misleading to plan fiduciaries. With respect to the 
risk-based capital reports, the commentators explained that these 
documents are designed as a regulatory tool and are not intended as a 
means to rank insurers. They noted that the NAIC Risk-Based Capital for 
Insurers Model Act specifically prohibits publication of such reports 
and recognizes that such information is confidential.4 The 
commentators further noted that the supporting memoranda to the 
actuarial opinions are not publically available and that the memoranda 
contain proprietary information such as interest margins and expense 
and pricing assumptions. With respect to the

[[Page 619]]

actuarial opinion, one commentator stated that pension plan 
administrators do not have the expertise and may not be sufficiently 
knowledgeable about insurance to understand the limitations of this 
opinion. This commentator also expressed concern regarding the 
Department's characterization of the actuarial opinion as a 
certification of the insurer's reserves, noting that ``no one can offer 
absolute assurance of the continued solvency of an insurance company.'' 
Lastly, the commentator was concerned that the provision of the 
actuarial opinion could subject the appointed actuary to unanticipated 
liability and costs as a plan fiduciary.5 Another 
commentator suggested that to the extent that information regarding the 
financial condition of the insurer is publicly available, the insurer 
should be required to inform policyholders where such information may 
be found on the Internet.
---------------------------------------------------------------------------

    \4\ The Department notes that subparagraph (c)(4)(xii)(C) of the 
proposed regulation required annual disclosure of the risk based 
capital ratio and a brief description of its derivation and 
significance, rather than disclosure of the risk based capital 
report as suggested by the commentators. It is the Department's 
further understanding that the risk based capital ratio is currently 
publicly available to policyholders. .
    \5\ In this regard, the Department notes that ERISA establishes 
a functional approach to determine whether an activity is fiduciary 
in nature. Under section 3(21) of ERISA, a fiduciary includes anyone 
who exercises discretion in the administration of an employee 
benefit plan; has authority or control over the plan's assets; or 
renders investment advice for a fee with respect to any plan assets. 
The Department has indicated that it examines the types of functions 
performed, or transactions undertaken, on behalf of the plan to 
determine whether such activities are fiduciary in nature and 
therefore subject to ERISA's fiduciary responsibility provisions. 
See 29 CFR 2509.75-8, D-2. To the extent that an actuary performs 
none of the functions discussed under section 3(21) or the 
applicable regulations, the actuary's activities would not be 
subject to ERISA's fiduciary responsibility provisions.
---------------------------------------------------------------------------

    The Department notes that there is nothing in the regulation that 
would preclude an insurer from providing a statement, accompanying the 
reports or data made available to a plan upon request, which contains a 
clear and concise explanation of the disclosures, including an 
objective recitation as to why such information may be misleading to 
policyholders. Accordingly, the Department has determined not to delete 
these disclosure requirements. However, in response to the concerns 
raised by the commentators, the Department has revised subparagraph 
(c)(4)(xii)(D) under the final regulation to delete the requirement 
that the supporting documentation be provided in connection with 
disclosure of the actuarial opinion.
    One commentator noted that the information regarding expense, 
income and benefit guarantees under the policy, which is required to be 
disclosed annually pursuant to subparagraph (c)(4)(x) of the proposed 
regulation, is contained in the contract. The commentator opined that, 
since contractholders already have this information, requiring insurers 
to reproduce it on an annual basis is unnecessary. As a result, the 
commentator urged the Department to delete this disclosure from the 
final regulation. The Department finds merit in this comment and has 
modified subparagraph (c)(4)(x) to require annual disclosure of the 
expense, income and benefit guarantees under the policy only if such 
information is not provided in the policyholder's contract, or is 
different from the information on guarantees previously disclosed in 
the contract.
    Two commentators expressed concern regarding the requirement in 
subparagraph (c)(4)(iv) that the actual rate of return credited to the 
accumulation fund under the policy be disclosed on an annual basis in 
connection with Transition Policies that are issued to individuals. 
According to the commentators, it will be difficult to determine the 
actual plan level rate of return in cases where interest is calculated 
at the participant level. Consequently, the commentators sought 
clarification that, in the case of individual policies issued by an 
insurer to plan participants, the requirement of subparagraph 
(c)(4)(iv) will be deemed satisfied by annual disclosure of the rate of 
return under the policy to the individual policyholder. The Department 
is of the view that subsection (c)(4)(iv) will be satisfied where an 
insurer which issues individual policies to plan participants makes an 
annual disclosure of the rate of return to the individual 
policyholders.
    With respect to the required annual disclosure of termination 
values in subparagraph (c)(4)(xi) of the proposed regulation, two 
commentators asserted that determining termination values is a manual 
time-consuming customized procedure which cannot be automated without 
significant difficulty and associated cost. One commentator noted that 
its pension division policyholders receive an annual statement which 
gives them, among other things, their account value, without charges 
being applied, and a ``surrender'' value, which is their account value 
less all applicable charges except the market value adjustment. The 
commentator maintains that it is impossible, if not almost impossible, 
to have a firm withdrawal amount reported to all pension division 
policyholders on an annual basis. The commentator recommended that 
subparagraph (c)(4)(xi) be modified to permit insurers to comply with 
this requirement by approximating the amount that would be payable in a 
lump sum at the end of such period.
    On the basis of these comments, the Department has determined to 
modify subparagraph (c)(4)(xi) of the final regulation to make clear 
that the insurer generally may comply with its annual disclosure 
obligations by disclosing to the plan the approximate amount that would 
be payable to the plan in a lump sum at the end of such period. In this 
regard, the Department expects that any approximation of the lump sum 
payment would be determined in good faith as a result of a rational 
decision-making process undertaken by the insurer. As modified, 
subparagraph (c)(4)(xi) additionally provides, however, that the 
policyholder may request that the insurer provide the more exact 
calculation of termination values specified in subparagraph 
(c)(3)(i)(D) as of a specified date that is no earlier than the last 
contract anniversary preceding the date of the request.
    One commentator stated that the disclosure of affiliate 
transactions is not relevant or useful to plan policyholders in 
evaluating the merits of a contract or the performance of an insurer. 
Moreover, the commentator argued that affiliate transactions are 
monitored and regulated by State insurance authorities which require, 
among other things, that any such transaction be effected on arm's-
length terms. Accordingly, the commentator requested that the 
Department delete subparagraph (c)(4)(ix) and replace that requirement 
with a statement in subparagraph (c)(3) to the effect that an insurer 
may engage in transactions with corporations or partnerships (including 
joint ventures), controlling, controlled by, or under common control 
with, the insurer along with a general description of the basis on 
which such transaction will be effected. Another commentator stated 
that the disclosure of related party transactions is necessary to 
evaluate the potential impact of such transactions on the general 
account contract and the potential impact the transaction may have in 
affecting a contract's returns. The commentator would add the following 
to subparagraph (c)(4)(ix):

    Whether the 1% threshold for reporting related party 
transactions has been met should be based on whether the aggregate 
of related party transactions exceeds this threshold, since there 
may be many cases when this threshold far exceeds any individual 
transaction amounts. If the threshold is met, all related party 
transactions should then be reported.

    In addition, the commentator suggests that the focus of the 
disclosure requirement in subparagraph (c)(4)(ix)

[[Page 620]]

should only be with respect to the reserves attributable to the assets 
that have been compartmentalized (segmented) within the general account 
to support the specific contract. In response to the comments, the 
Department continues to believe that disclosure of large affiliate 
transactions is relevant to a plan fiduciary's determination regarding 
the appropriateness of continuing a plan's investment in a Transition 
Policy. Accordingly, the Department has determined to retain this 
requirement in the final regulation.
    Several of the commentators believe that there is a need to further 
enhance the information required to be disclosed annually. One 
commentator suggested that the annual disclosure provisions be amended 
to require the following: pursuant to subparagraph (c)(4)(iii)--the 
disclosure of all gross investment results, including interest income 
and realized capital charges generated by the assets in the group 
annuity segment, and all of the offsets, deductions, charges, fees, 
reductions due to smoothing techniques, etc. that are taken off before 
a rate of return is credited to the policyholder or the accumulation 
fund. In addition, the commentators stated that plan fiduciaries need 
access to relevant general account portfolio statistics in order to 
assess risk and evaluate investment income in relation to risk. The 
commentators further stated that pension fiduciaries need to evaluate 
factors such as the vulnerability of the portfolio to manipulation such 
as churning. They concluded that the general information that should be 
made available with respect to a general account portfolio should 
include types of exposure for given asset classes, performance 
characteristics such as delinquencies and write-downs; the proportion 
of loans that are public, those that are direct placements and those in 
default. In addition, the commentators also urged disclosure of other 
types of information relative to risk assessment such as pending 
material litigation, adverse regulatory rulings and material corporate 
reorganizations.
    The Department believes that the annual disclosure provisions 
reflect a balance between the plans' need for information about general 
account contracts against the costs associated with providing such 
information. Accordingly, after consideration of the comments, the 
Department has determined that it would not be appropriate to mandate 
the disclosure of additional information. However, this determination 
does not preclude a plan fiduciary from requesting, or negotiating for, 
where appropriate, any additional information from an insurer which the 
fiduciary believes is necessary to properly evaluate a Transition 
Policy.
    Two commentators stated that there should be quarterly reporting in 
the following situations: significant write-downs, delinquencies, 
adverse events with respect to reinsurance, and the possibility of 
demutualization. Although the Department has determined not to require 
more frequent reporting, the Department notes that an insurer's 
unwillingness to provide more frequent disclosures with respect to 
material events that may impact on the insurer is a factor that should 
be considered by the fiduciary in its evaluation of the continued 
appropriateness of the Transition Policy.

4. Alternative Separate Account Arrangements

    Proposed paragraph (d)(1) contained an additional disclosure 
requirement regarding the availability of separate account contracts. 
Under this paragraph, the insurer must explain the extent to which 
alternative contract arrangements supported by assets of separate 
accounts of the insurer are available to plans; whether there is a 
right under the policy to transfer funds to a separate account; and the 
terms governing any such right. An insurer also must disclose the 
extent to which general account contracts and separate account 
contracts pose differing risks to the plan. Proposed paragraph (d)(2) 
contained a standardized statement describing the relative risks of 
separate accounts and general account contracts which, if provided to 
policyholders, will be deemed to comply with paragraph (d)(1)(iii) of 
the regulation.
    A commentator questioned whether the Department intended to require 
that the disclosure to policyholders concerning alternative separate 
account arrangements be provided both with the initial and annual 
disclosures, or only with the initial disclosure. The Department has 
clarified paragraph (d)(1) to require that the insurer provide the plan 
fiduciary with information about alternative separate account 
arrangements at the same time as the initial disclosure under 
subparagraph (c)(3).
    Another commentator suggested that the Department insert the 
following phrase within the parenthetical contained in the second 
sentence in subparagraph c. of the separate account disclosure 
statement ``and except any surplus in a separate account.'' The 
commentator noted that, to the extent that insurance companies place 
some of their funds in these separate accounts to provide for 
contingencies, this separate account ``surplus'' should not be subject 
to the fiduciary responsibility rules.6 Although the 
Department agrees with the commentator that the separate account 
surplus would not constitute plan assets with respect to other plan 
investors in the separate account, the Department is unable to conclude 
that such surplus would not constitute plan assets under all 
circumstances. Section 401(b)(2)(B) provides, in part, that the term 
``guaranteed benefit policy'' includes any surplus in a separate 
account, but excludes any other portion of the separate account. In 
light of the holding in the Harris Trust decision, the Department is 
unable to conclude that the surplus in an insurance company separate 
account would never constitute plan assets with respect to plan 
policyholders who have purchased general account contracts. Therefore, 
the Department has determined not to make the requested modification.
---------------------------------------------------------------------------

    \6\ The Department notes that language identical to the 
commentator's appears in the Report of the ERISA Conference 
Committee at pages 296 and 297. H.R. Conf. Rep. No. 1280, 93rd 
Cong., 2d Sess. 296 (1974).
---------------------------------------------------------------------------

    One commentator suggested that the Department delete subparagraph 
d. from the separate account disclosure statement based upon the view 
that State regulation of insurance company accounts is irrelevant to 
protections under the Act, and may lull plan fiduciaries into believing 
that they have protections for their investment decisions when they do 
not. In response to this comment, the Department clarified subparagraph 
(d)(2)d. of the separate account disclosure statement to provide that 
State insurance regulation of general accounts may not offer the same 
level of protection to plan policyholders as ERISA regulation.

5. Termination Procedures

    Paragraph (e)(1) of the proposed regulation provided that a 
policyholder must be able to terminate or discontinue a policy upon 90 
days notice to an insurer. Under the proposal, the policyholder must 
have the option to select one of two payout alternatives, both of which 
must be made available by the insurer.
    Under the first alternative, an insurer must permit the 
policyholder to receive, without penalty, a lump sum payment 
representing all unallocated amounts in the accumulation fund after 
deduction of unrecovered expenses and adjustment of the book value of 
the policy to its market value equivalency. The Department noted that, 
for purposes

[[Page 621]]

of paragraph (e), the term penalty did not include a market value 
adjustment (as defined in proposed paragraph (h)(7)) or the recovery of 
costs actually incurred, including unliquidated acquisition expenses, 
to the extent not previously recovered by the insurer.
    Under the second alternative contained in proposed paragraph 
(e)(2), an insurer must permit the policyholder to receive a book value 
payment of all unallocated amounts in the accumulation fund under the 
policy in approximately equal annual installments, over a period of no 
longer than five years, with interest.

General Comments

    Several commentators objected to the lump sum and five year book 
value payment requirements in the proposed regulation. The 
commentators' objections were based on their assertions that most 
insurers do not provide the termination rights set forth in the 
proposed regulation in their existing contracts. Many of the 
commentators stated that the Department should not impose retroactive 
amendment of in-force contracts.7 The commentators assert 
that the following problems would result from inclusion of the proposed 
termination provisions in existing contracts: requiring insurers to 
amend their contracts to include the new termination provisions would 
subject insurers to increased risk of disintermediation and anti-
selection that was not evaluated either when the contract was priced or 
when the types and durations of general account investments made to 
support the policies were determined; insurers would have to reduce the 
duration of the general account investment portfolios which support 
Transition Policies in order to mitigate the increased risks of 
disintermediation and anti-selection; the consequences of this change 
in duration would be reduced earnings for the general account, lower 
yields being realized by Transition Policies, and a limitation on the 
insurer's ability to participate in the private placement market.
---------------------------------------------------------------------------

    \7\ The Department recognizes that this regulation may give 
rights to plan policyholders which their contracts did not 
independently contain. The regulation, however, also benefits 
insurers by enabling them to limit exposure to the full panoply of 
fiduciary obligations and liabilities normally associated with the 
management of plan assets. If an insurer complies with the 
regulation, it avoids substantial potential liabilities to plan 
policyholders. In exchange, however, the regulation requires the 
insurer to give the plan the disclosures necessary to evaluate the 
contract's performance and the right to withdraw the plan's funds 
when that performance proves inadequate. The Department's insistence 
on these disclosure and termination rights is consistent with the 
requirement in section 401(c)(2)(B) that the regulation ``protect 
the interests and rights of the plan and of its participants and 
beneficiaries  * * *'' The Department cannot, consistent with the 
statute, give an insurer a safe-harbor from ERISA's fiduciary 
responsibility provisions without also granting additional rights to 
plan policyholders.
---------------------------------------------------------------------------

    Other commentators stated that the three standard termination 
options (lump sum payout, five year book out and ten year book out) in 
New York's Regulation 139 (11 NYCRR 40) afford ample protection to 
plans and their participants, without locking plans into 
disadvantageous relationships. One of the commentators noted that 
Regulation No. 139 permits additional flexibility in negotiating 
contract terms by permitting the ``Superintendent'' to waive or modify 
applicable requirements through the approval process. The commentator 
further stated that the lack of flexibility in the proposed regulation 
would impair the insurance industry's ability to satisfy plan sponsors' 
long-term investment goals and it would also force the costly 
realignment (or transfer) of general account assets and pass the 
realignment (or transfer) expenses and the losses on the sale of assets 
to general account policyholders. One commentator asserted that: (1) No 
State other than New York has set minimum termination standards 
applicable to group annuity contracts; (2) the proposed regulation is 
considerably more restrictive than New York's regulations, and (3) the 
New York regulation applies only to contracts issued after the 
regulation was adopted.
    One commentator stated that if the proposed termination rules are 
retained, the Department should revise the proposed regulation to allow 
an insurer the discretion to use an installment payout option that 
financially approximates the lump sum market value adjusted payout, in 
whatever combination of interest rate reduction and payout period that 
State insurance laws may permit. According to one commentator, 
permitting policyholders to terminate at any time, and to choose from 
the more favorable of a book value installment option or market value 
option, would create opportunities for some policyholders to ``game'' 
the system by timing terminations to take advantage of differing 
interest rate environments.
    The Department stated in the preamble to the proposed regulation 
that the proposed termination provisions were designed to protect the 
interests and rights of plans by ensuring that they were not locked 
into relationships which had become economically disadvantageous. The 
Department noted in footnote 5 of the proposed regulation that the 
termination provisions in the proposal were similar to the Department's 
rule governing contracts between plans and service providers under 29 
CFR section 2550.408b-2(c). Several commentators objected to this 
reference and enumerated the differences between group annuity 
contracts and service provider contracts. In this regard, the 
Department wishes to note that the reference to the two types of 
contracts was intended to indicate that the underlying rationale for 
the rule and the proposed termination provisions was similar, not that 
insurance contracts and service contracts are alike in all respects. 
Thus, the footnote was intended to express the Department's belief that 
plans should not be locked into economically disadvantageous 
relationships under either type of contract.
    A number of other commentators believe that the termination 
procedures in the proposed regulation should not be diminished in any 
respect in the final regulation. One commentator supported the 
Department's premise that the termination procedures are necessary to 
ensure that plans are not locked into economically disadvantageous 
relationships. The commentator stated that the inability to withdraw 
from a contract would be a result that would defeat the progress that 
would have been made by requiring insurers to provide additional 
disclosure. The commentator further stated that without such 
protections, plans may be subject to such large and arbitrary penalties 
at termination that the fiduciaries would be obligated to continue 
disadvantageous and poorly-performing contracts to the detriment of 
plan participants and beneficiaries. The commentator believed that the 
termination provisions would not materially change how most insurers 
invest contract assets because over time, market conditions and forces, 
as well as competitive factors, rather than termination procedures, 
would determine how assets are invested.
    Another commentator stated that the terms set forth in the proposed 
rule are all absolutely essential for the protection of plan and 
participant interests. The commentator further stated that, if insurers 
are left with the discretion to impose either an installment or lump 
sum option, in the commentator's experience the insurer would act out 
of self-interest, not the interest of plan participants, in selecting 
the option.
    One commentator stated that the regulation's disclosure provisions 
will

[[Page 622]]

be rendered nugatory without specified termination procedures. The 
commentator supported the regulation's attempts to balance the economic 
interests of employee benefit plans with the day-to-day operations of 
insurance company general accounts and stated that it is imperative to 
ensure that the regulation specifies an appropriate time frame and 
method for an insurer's payment to a plan upon the plan's termination 
of a contract. The commentator believed that without these procedures, 
insurers may hold plan assets longer than necessary, thus preventing 
participants and beneficiaries from gaining higher rates of return on 
their retirement monies.
    Pursuant to the SBJPA, Congress required the Department to 
promulgate regulations to implement the new amendment to section 401 of 
ERISA that would ensure the protection of the interests and rights of 
the plans and of its participants and beneficiaries. While the 
Department intended that the disclosure provisions in paragraphs (c) 
and (d) of this regulation would ensure that plan fiduciaries have 
sufficient information upon which to make appropriate decisions 
regarding a plan's investment in a Transition Policy, the Department 
continues to believe that those provisions would be rendered 
meaningless if plans were not offered the right to terminate their 
Transition Policies under terms which are both objective and fair for 
all parties. Therefore, the Department has determined to retain the 
termination provisions in paragraph (e) of the regulation with certain 
modifications, as discussed further below.

Lump Sum Payment

    Several commentators objected to proposed paragraph (e)(1) and the 
definition of the term ``market value adjustment'' as a method which 
permits both upward and downward adjustments to the book value of the 
accumulation fund. According to one commentator, a two-way market value 
adjustment requirement may provide an artificial incentive for 
contractholders to terminate their contracts. The commentators further 
asserted that if a disproportionate number of contractholders elect to 
terminate and withdraw their funds in a lump sum at any one time, the 
resulting disintermediation may impair the insurer's solvency.
    The commentator further argued that paying the contractholder the 
book value of the accumulation fund upon contract termination, when 
market value exceeds book value , is fair because the contractholder 
receives all guaranteed amounts, without reduction.
    One commentator asserted that a large number of group annuity 
contracts provide only for negative adjustments and that the particular 
market value adjustment terms contained in any group annuity contract 
were put in place at the inception of the policy. The commentator was 
concerned that the proposed regulation would retroactively graft 
positive market value adjustment terms upon policies in a way that 
would be inconsistent with reasonable insurer expectations. This 
commentator also observed that no State law requires insurers to offer 
positive market value adjustments.
    Other commentators stated that many insurers do not provide for 
positive market value adjustments because experience-rated group 
annuity contracts are intended to be long-term funding instruments 
supported by long-term investments. These commentators asserted that 
encouraging withdrawals from these contracts for arbitrage purposes by 
providing for positive market value adjustments disrupts the insurer's 
ability to make and implement investment decisions on the basis of 
accurate predictions of cash flow and interferes with asset-liability 
matching to the detriment of non-withdrawing contractholders.
    Based on the Department's understanding that the purpose of a 
market value adjustment is to protect the policyholders who remain 
invested in the insurer's general account, the Department defined the 
term ``market value adjustment'' under the proposed regulation to 
reflect the economic effect (positive and negative) on a Transition 
Policy of an early termination or withdrawal in the current market. 
Thus, depending upon the economic environment at the time of 
termination, the terminating policyholder would either bear the costs 
or receive the benefit of the adjustment. The Department is not 
persuaded by the commentators' objections to the condition in 
subsection (e)(1) of the proposed regulation which requires an upward 
as well as a downward adjustment of the book value of the Transition 
Policy. Since an insurer cannot predict the direction of the economic 
markets or the timing of a notice to terminate, the Department is not 
convinced that insurers price their contracts based on an assumption 
that a predictable proportion of contracts will terminate when a 
positive market value adjustment would otherwise apply. Although the 
commentators argue that policyholders will terminate their Transition 
Policies in order to take advantage of an economic market in which they 
would receive a positive adjustment, the Department notes that those 
same policyholders would have to take into account the fact that the 
same market that produced the favorable adjustment would produce lower 
returns on reinvestment of the Transition Policy's proceeds. As a 
result, a positive market value adjustment would not create an 
artificial incentive for policyholders to terminate Transition 
Policies. The denial of appropriate positive market value adjustments 
would, however, artificially penalize plans for the termination of 
Transition Policies by requiring them to accept less than fair market 
value for the funds associated with their policies. Such a result would 
be inconsistent with the regulation's goal of ensuring that plan 
policyholders are not locked into economically disadvantageous 
relationships. Because the Department has not been persuaded that 
application of an upward market value adjustment on termination of a 
Transition Policy would produce inequitable results or cause 
significantly larger numbers of policyholders to terminate those 
Transition Policies, as claimed by the commentators, subsection (e)(1) 
has not been modified as requested.
    One commentator asserted that the lump sum alternative in 
subparagraph (e)(1) creates serious problems for certain insurers that 
avoid registration of their annuity products with the Securities 
Exchange Commission under section 3(a)(8) of the Securities Act of 
1933. Section (3)(a)(8) excludes an annuity contract or optional 
annuity contract from the application of federal securities laws. Rule 
151 under the Securities Act of 1933 provides a ``safe harbor'' for 
certain forms of annuity contracts issued by insurance companies. An 
annuity contract which meets all of the conditions in the Rule comes 
within the ``safe harbor'' and is deemed to be an annuity contract 
within the meaning of section (3)(a)(8).8 As a result, the 
commentator requested that the Department eliminate the termination 
provisions in the final regulation.
---------------------------------------------------------------------------

    \8\ The safe harbor in Rule 151 is not available for a contract 
which permits a lump sum payment subject to a market value 
adjustment. However, the Rule provides that the presence of a market 
value adjustment should not create the negative inference that no 
such contract is eligible for the exclusion under section 3(a)(8). 
See Definition of Annuity Contract or Optional Annuity Contract, 
Securities Act Release No. 33-6645 (May 29, 1986).
---------------------------------------------------------------------------

    Another commentator stated that the proposed lump sum termination 
feature is contrary to Ohio's standard nonforfeiture law which provides 
that

[[Page 623]]

the insurer shall reserve the right to defer the payment of such cash 
surrender benefit for a period of six months after demand. See O.R.C. 
section 3915.073(C)(2). This provision applies to individual deferred 
annuity contracts. The commentator believes that amendment of the 
Transition Policies to include the lump sum termination provision will 
invalidate the policy under this provision of Ohio law. Similarly, one 
commentator determined that several States do not allow market value 
adjustments in individual annuity contracts that are subject to State 
nonforfeiture laws. Other States do not allow market value adjustments 
in individual annuity contracts except with respect to ``modified 
guaranteed annuities'' (MGAs). The commentator believes that none of 
the Transition Policies that would be subject to the regulation are 
MGAs and that, therefore, ERISA plan individual annuity contracts that 
would be subject to the regulation are not permitted, under State law, 
to impose a market value adjustment upon termination. The commentator 
believes that this information and the above comment concerning 
insurers that rely on section 3(a)(8) and Rule 151 of the Securities 
Act of 1933, present a strong case for only allowing a book value 
payout over time as one of the permitted termination options to be 
determined at the insurer's discretion under the regulation and not as 
a required option.
    The Department continues to believe that the disclosure provisions 
set forth in subparagraph (c) of this regulation will only be 
meaningful if an independent plan fiduciary with respect to a 
Transition Policy has the ability to act upon such information by 
terminating the Transition Policy and receiving a payout within a 
reasonably short time-frame. Moreover, the Department has not been 
convinced that changing the lump sum payment option in the manner 
requested by the commentators would be in the best interests of the 
affected plans. Therefore, the Department has determined that it would 
not be appropriate to eliminate or modify the lump sum payment option 
as suggested by the commentators.
    A commentator requested that the Department modify that portion of 
proposed paragraph (e)(1) that deals with contingent sales charges so 
that the phrase ``the term penalty does not include * * * the recovery 
of costs actually incurred'' is changed to ``the term penalty does not 
include * * * charges that are reasonably intended to recover costs.'' 
In addition, another commentator requested that the definition of 
``without penalty'' be revised so that it is similar to the definition 
already contained in the regulations under section 408(b)(2) of the Act 
which allows the recovery of ``reasonably foreseeable expenses'' upon 
early termination. The Department believes that the modifications 
suggested by the commentators would diminish the clarity of the 
proposed regulation. Subparagraph (e)(1) of the proposed regulation 
provides an insurer with an objective standard regarding the allowable 
costs which may be recovered in connection with termination of a 
Transition Policy under which the policyholder has chosen the lump sum 
payout option.
    Therefore, the Department has declined to modify the final 
regulation as requested by the commentators.
    One commentator requested that the language explaining what would 
not constitute a ``penalty'' for purposes of paragraph (e), be modified 
to refer to subparagraph (e)(1) rather than paragraph (e), to clarify 
that market value adjustments can be imposed only on lump sum payments. 
The commentator suggested that the cross reference language state, ``* 
* * For purposes of this subparagraph (e)(1) * * *.'' The Department 
acknowledges that this was the intended meaning of the language of 
proposed paragraph (e)(1) and has modified the final regulation 
accordingly.

Book Value Installment Option

    Several commentators asserted that, if contractholders are able to 
withdraw funds over a period of five years at book value at any point 
in time when the investment return on such funds was below current 
market rates, they will be able to obtain amounts in excess of the 
present value of their investment. According to the commentators, when 
interest rates are rising, contractholders would inevitably select 
against insurers and remaining contractholders by making book value 
withdrawals and reinvesting withdrawn funds at current market rates. 
The commentators believe that such massive withdrawals would require 
insurers to liquidate their assets at substantial losses, thus, 
seriously impairing some insurers' financial capability to meet their 
contractual obligations.
    A number of commentators noted that the terms and conditions of a 
book value installment payout are intended to serve the same purposes 
as market value adjustments, i.e. the equitable allocation of the 
effect of a withdrawal between the withdrawing and remaining 
contractholders, and the protection of the general account from severe 
anti-selection risks. The commentators represented that the terms of 
book value payouts are structured to produce an actuarially equivalent 
value to that produced by a lump sum market value adjusted payout. 
However, the commentators asserted that the proposed regulation's 
payout period of no more than 5 years, coupled with no more than a 1% 
interest rate reduction will deprive insurers of the opportunity to 
achieve the objective of approximate actuarial equivalence and 
undermine the insurer's ability to adequately protect itself and its 
non-withdrawing policyholders from anti-selection and 
disintermediation. The commentators explained, that for an installment-
payout provision to produce equity between withdrawing and non-
withdrawing contractholders, and to prevent anti-selection and 
disintermediation, the length of the payout period must bear some 
reasonable relationship to the maturities of the investment portfolio 
supporting the insurer's liability to the contractholder under such 
provision. The commentators concluded that a five-year payout with a 
maximum interest rate reduction of 1% is insufficient to adequately 
protect an insurer's general account based on the typically longer 
maturities of investments in insurers' general accounts that fund 
retirement benefits.
    To resolve these concerns, several commentators requested that the 
Department modify the proposed regulation to permit insurers to offer 
policyholders at least one of several termination methods, at the 
option of the insurer. Under this alternative, insurers would have the 
discretion to either not offer a lump sum option, offer a lump sum 
option without a positive market value adjustment, or offer a book 
value payment over a period in excess of 5 years e.g., 10 years) with 
interest at a credited rate reduced by more than 1 percent.
    The Department believes that allowing the insurer to determine the 
termination methods that will be offered to policyholders could have a 
negative impact on terminating Transition Policies. Therefore, the 
Department has decided not to adopt the commentators' requested 
modifications in the final exemption. However, the Department finds 
merit in the arguments submitted by the commentators with respect to 
the length of the book value payout term and has been persuaded that 
the term of the book value payout option should more closely reflect 
the maturity of the investments in the general account. Accordingly, on 
the basis of the comments, the Department has modified

[[Page 624]]

the book value alternative in subsection (e)(2) of the final regulation 
to permit a policyholder to receive book value payment over a period of 
no more than ten years with interest at the rate credited on the 
contract minus 1 percent.
    Several commentators requested that the Department provide an 
exception from the termination procedures during extraordinary 
circumstances to avoid the risk of severe disintermediation. The 
Department concurs with this request and has modified paragraph (e) to 
provide that the insurer may defer, for a period not to exceed 180 
days, amounts required to be paid to a policyholder under paragraph (e) 
for any period of time during which regular banking activities are 
suspended by State or federal authorities, a national securities 
exchange is closed for trading (except for normal holiday closings), or 
the Securities and Exchange Commission has determined that a state of 
emergency exists which may make such determination and payment 
impractical.

6. Insurer-Initiated Amendments

    Proposed paragraph (f) described the notice requirements and payout 
provisions governing insurer-initiated amendments. Under the proposed 
paragraph, if an insurer makes an insurer-initiated amendment, the 
insurer must provide written notice to the plan at least 60 days prior 
to the effective date of the amendment. The notice must contain a 
complete description of the amendment and must inform the plan of its 
right to terminate or discontinue the policy and withdraw all 
unallocated funds in accordance with paragraph (e)(1) or (e)(2) by 
sending a written request to the name and address contained in the 
notice. Proposed paragraph (f), unlike the more general termination 
provisions set forth in paragraph (e), was to be applicable upon 
publication of the final regulation in the Federal Register.
    An insurer-initiated amendment was defined in proposed paragraph 
(h)(8) as an amendment to a Transition Policy made by an insurer 
pursuant to a unilateral right to amend the policy terms that would 
have a material adverse effect on the policyholder; or certain 
unilateral enumerated changes that result in a reduction of existing or 
future benefits under the policy, a reduction in the value of the 
policy or an increase in the cost of financing the plan or plan 
benefits, if such change has more than a de minimis effect.
    One commentator expressed the view that the definition should be 
modified to include any insurer-initiated amendment that is unfavorable 
to the plan. Two commentators suggested that any insurer-initiated 
amendment to a general account contract should eliminate the contract's 
ability to qualify as a Transition Policy. In this regard, one of the 
commentators urged the Department to adopt a standard under which there 
would be a rebuttable presumption that any insurer-initiated amendment 
has a material adverse effect on the policyholder. The Department has 
determined not to revise this definition as requested in recognition of 
the fact that many Transition Policies represent long term 
relationships that may require minor changes over time.
    Other commentators requested that the Department reconsider the de 
minimis standard set forth in subparagraph (h)(8)(ii) of the 
definition. These commentators stated that the definition was so broad 
that it would be impossible for any insurer to know whether it is in 
compliance with these requirements. The commentators suggested that the 
Department modify the definition to include only unilateral changes 
that are ``material'' since this is a term that has a well understood 
meaning. After consideration of the comments, the Department has 
concluded that it would be appropriate under the final regulation to 
modify the definition of the term ``insurer-initiated amendment'' to 
include only unilateral changes that have a material adverse effect on 
the policyholder. To further clarify this matter, paragraph (h)(8) of 
the final regulation includes a definition of the term ``material.''
    Several commentators requested that the Department restate 
subparagraph (h)(8)(ii)(G), from ``[a] change in the annuity purchase 
rates'' to ``[a] change in the guaranteed annuity purchase rates.'' A 
commentator stated that changes in the market purchase rates for 
annuities are based on current interest rates and, accordingly, should 
not be considered an insurer-initiated amendment. Conversely, the 
commentator represented that modifying the guaranteed purchase rate 
would be considered an insurer-initiated amendment since it is usually 
prohibited by the contract or by State law. Another commentator 
suggested that the Department modify subparagraph (h)(8)(ii)(G) to 
include ``a change in the annuity purchase rates guaranteed under the 
terms of the contract or policy, unless the new rates are more 
favorable for the policyholder.'' On the basis of these comments, the 
Department has determined to make modifications to subparagraph 
(h)(8)(ii)(G).
    Several commentators requested that the Department clarify that any 
amendment or change that is required to be made to a Transition Policy 
to comply with applicable federal or State law or regulation (including 
this regulation), or to convert the policy to a ``guaranteed benefit 
policy,'' is not an insurer-initiated amendment. A number of 
commentators urged the Department to clarify that a demutualization 
9 or similar reorganization will not result in an insurer-
initiated amendment. The commentators represented that policyholders 
retain all of the benefits under the policies to which they would have 
been entitled if the reorganization had not occurred. The policies 
remain in force with no change in their terms, except that the 
membership interest in the mutual company is removed from the policy 
and evidenced separately (e.g., by shares of stock). In further support 
of their position, the commentators argue that the Internal Revenue 
Service has held that where the terms and conditions of the contracts 
remain the same, a reorganization will not cause contracts issued by 
the insurer on or before the date of the proposed reorganization to be 
treated as new contracts for purposes of determining the date of 
issuance of the contract.10
---------------------------------------------------------------------------

    \9\ This involves a conversion from a mutual insurance company 
to a publicly owned stock company.
    \10\ See Rev. Proc. 92-57, 1992-2 C.B. 410.
---------------------------------------------------------------------------

    The Department is unable to conclude that all changes made to a 
Transition Policy in order to comply with any applicable federal or 
State law, or to convert the policy to a guaranteed benefit policy, are 
changes that would not have a material adverse effect on a 
policyholder. However, the Department has determined to modify 
subparagraph (h)(8)(iv) to clarify that amendments or changes which are 
made: (1) With the affirmative consent of the policyholder; (2) in 
order to comply with section 401(c) of the Act and this regulation; or 
(3) pursuant to a merger, acquisition, demutualization, conversion, or 
reorganization authorized by applicable State law, provided that the 
premiums, policy guarantees, and the other terms and conditions of the 
policy remain the same, except that a membership interest in a mutual 
insurance company may be relinquished in exchange for separate 
consideration (e.g. shares of stock or policy credits); are not 
insurer-initiated amendments for purposes of the final regulation. The 
Department also has made parallel changes to subparagraph (h)(6)(ii) of 
the final regulation to clarify that such changes will not cause a 
policy to fail to be a Transition Policy.

[[Page 625]]

    One commentator suggested that subparagraph (h)(8)(iii) be revised 
to omit the word ``affirmative'' which precedes the word ``consent'' in 
the proposed regulation. According to the commentator, it should be 
acceptable to the Department for the insurer to send notice of a 
prospective change to the policyholder with an appropriate lead time 
during which the policyholder has time to object to the change. The 
policyholder's affirmative consent to an amendment or change was a 
necessary element of the Department's determination to exclude such 
amendments or changes from the definition of insurer-initiated 
amendment. Because the Department continues to believe that the 
policyholder's affirmative consent is a necessary protection against 
insurer-initiated amendments which may be adverse to the policyholder, 
it has determined not to adopt the commentator's suggested 
modification.

7. Prudence

    Proposed paragraph (g) set forth the prudence standard applicable 
to insurance company general accounts. Unlike the prudence standard 
provided in section 404(a)(1)(B) of ERISA, prudence for purposes of 
section 401(c)(3)(D) of ERISA is determined by reference to all of the 
obligations supported by the general account, not just the obligations 
owed to plan policyholders.11
---------------------------------------------------------------------------

    \11\ In this regard, the Department notes in the proposal that 
nothing contained in the proposal's prudence standard modified the 
application of the more stringent standard of prudence set forth in 
section 404(a)(1)(B) of ERISA as applicable to fiduciaries, 
including insurers, who manage plan assets maintained in separate 
accounts, as well as to assets of the general account which support 
policies issued after December 31, 1998.
---------------------------------------------------------------------------

    Two commentators concurred with the standard of prudence 
established in the regulation. One of the commentators was pleased 
because paragraph (g) makes it clear that the prudence standard applies 
regardless of whether general account assets are also considered to be 
plan assets under ERISA. The commentator believed that the prudence 
standard contained in paragraph (g) addresses the conflict between 
State insurance laws which require that general account assets be 
managed so as to maintain equity among all contractholders, 
policyholders, creditors and shareholders and the ERISA fiduciary rules 
which require that plan assets be managed solely in the interests of, 
and for the exclusive purpose of, providing benefits to plan 
participants and their beneficiaries. The other commentator suggested 
that application of this standard could lead to more limited investment 
opportunities for general account assets and lower returns than 
currently achievable under State investment laws. In turn, this could 
lead to increased plan contributions for defined benefit plans in order 
to maintain current benefit levels. In this regard, the Department 
notes that the prudence standard set forth in the proposal merely 
implements subsection 401(c) of ERISA which contains the prudence 
standard that is the subject of the commentator's concern.

8. Definitions

Accumulation Fund
    Proposed paragraph (h)(5) defined the term ``accumulation fund'' as 
the aggregate net considerations (i.e., gross considerations less all 
deductions from such considerations) credited to the Transition Policy 
plus all additional amounts, including interest and dividends, credited 
to such Transition Policy less partial withdrawals, benefit payments 
and less all charges and fees imposed against this accumulated amount 
under the Transition Policy other than surrender charges and market 
value adjustments.
    A commentator requested modification of the term ``accumulation 
fund'' to satisfy the commentator's concern that upon termination, a 
policyholder would not be able to withdraw from the policy amounts set 
aside to pay benefits under the policy. The commentator suggested that 
the definition be revised to read as follows:

    The term ``accumulation fund'' means the aggregate net 
considerations (i.e., gross considerations less all deductions from 
such considerations) credited to the Transition Policy plus all 
additional amounts, including interest and dividends, credited to 
such Transition Policy less partial withdrawals, benefit payments, 
amounts accrued or received under the Transition Policy for the 
purpose of providing benefits which are guaranteed by the insurer 
and less all charges and fees imposed against this accumulated 
amount under the Transition Policy other than surrender charges and 
market value adjustments.

    The Department believes that the term ``accumulation fund'' as 
defined and used in context in the proposed regulation correctly 
reflects the meaning intended by the Department. Therefore, after 
consideration of the comment, the Department has determined not to 
adopt the requested modification.
Market Value Adjustment
    Proposed paragraph (h)(7) defined the term ``market value 
adjustment'' as an adjustment to the book value of the accumulation 
fund to accurately reflect the effect on the value of the accumulation 
fund of its liquidation in the prevailing market for fixed income 
obligations, taking into account the future cash flows that were 
anticipated under the policy. An adjustment is a ``market value 
adjustment'' within the meaning of this definition only if the insurer 
has determined the amount of the adjustment pursuant to a method which 
was previously disclosed to the policyholder in accordance with 
paragraph (c)(3)(i)(D), and the method permits both upward and downward 
adjustments to the book value of the accumulation fund.
    One commentator stated that the market value adjustment definition 
needs to be clarified and modified in order to encompass all reasonable 
types of market value adjustment formulas currently in use by the 
industry, but did not suggest any specific types of market value 
adjustment formulas for the Department's consideration. A commentator 
suggested that, for purposes of clarification, the first sentence of 
the market value adjustment definition in paragraph (h)(7) should be 
revised to read as follows:

    For purposes of this regulation, the term ``market value 
adjustment'' means an adjustment to the book value of the 
accumulation fund to accurately reflect the effect on the value of 
the accumulation fund of its liquidation in the prevailing market 
for fixed income obligations, taking into account the future cash 
flows that were anticipated under general account assets.

    After consideration of the comments regarding market value 
adjustment, the Department believes that the definition, as set forth 
in the proposed regulation, is sufficiently flexible to address the 
commentator's concerns and that no further modification is necessary.

9. Limitation on Liability

    Proposed paragraph (i)(1) provided that no person shall be liable 
under Parts 1 and 4 of Title I of the Act or section 4975 of the Code 
for conduct which occurred prior to the effective dates of the 
regulation on the basis of a claim that the assets of an insurer (other 
than plan assets held in a separate account) constitute plan assets. 
Paragraph (i)(1) further provided that the above limitation on 
liability will not apply to: (1) An action brought by the Secretary of 
Labor pursuant to paragraph (2) or (5) of section 502(a) of the Act for 
a breach of fiduciary responsibility which would also constitute a 
violation of Federal or State criminal law; (2) the application of any 
Federal criminal law; or (3) any civil

[[Page 626]]

action commenced before November 7, 1995.
    Proposed paragraph (i)(2) stated that the regulation does not 
relieve any person from any State law regulating insurance which 
imposes additional obligations or duties upon insurers to the extent 
not inconsistent with this regulation. Thus, for example, nothing in 
this regulation would preclude a state from requiring an insurer to 
make additional disclosures to policyholders, including plans.
    Proposed paragraph (i)(3) of the regulation made clear that nothing 
in the regulation precludes a claim against an insurer or others for a 
violation of ERISA which does not require a finding that the underlying 
assets of a general account constitute plan assets, regardless of 
whether the violation relates to a Transition Policy. For example, a 
Transition Policy would give rise to fiduciary status on the part of 
the insurer if the insurer had discretionary authority over the 
administration or management of the plan. See section 3(21) of the Act. 
Thus, nothing in ERISA or this regulation would preclude a finding that 
an insurer is liable under ERISA for breaches of its fiduciary 
responsibility in connection with plan management or administration. 
Similarly, neither ERISA nor the regulation precludes a finding that an 
insurer is a fiduciary by reason of its discretionary authority or 
control over plan assets. If the insurer breaches its fiduciary 
responsibility with respect to plan assets, it would be liable under 
ERISA regardless of whether the insurer has issued a Transition Policy 
to a plan or ultimately placed the plan's assets in its general 
account.
    Paragraph (i)(4) of the proposed regulation provided that if an 
insurer fails to meet the requirements of paragraphs (b) through (f) of 
the regulation with respect to a specific plan policyholder, the result 
of such failure would be that the general account would be subject to 
ERISA's fiduciary responsibility provisions with respect to the 
specific plan for that period of time during which the requirement of 
the regulation was not met. Once back in compliance with the 
regulation, the insurer would no longer be subject to ERISA (other than 
this regulation) or have potential liability under ERISA's fiduciary 
responsibility provisions for subsequent periods of time when the 
requirements of the regulation are met. In addition, the regulation 
made clear that the underlying assets of the general account would not 
constitute plan assets for other Transition Policies to the extent that 
the insurer was in compliance with the requirements of the regulation.
    Several commentators were concerned that under proposed paragraph 
(i)(4), an insurer's single (or de minimis) inadvertent failure to 
satisfy the conditions in the regulation might require a portion of 
every asset in the insurer's general account to be a plan asset for the 
period of noncompliance, thus subjecting the insurer to increased 
liability for fiduciary violations. The commentators believed that this 
``all or nothing'' rule could cause significant disruption to the 
insurer and hinder the insurer's investment activities. The 
commentators believed that this result was not compelled by section 
401(c) of the Act.
    The commentators suggested that the Department: (1) Clarify that 
any finding that assets of an insurer are plan assets as a result of an 
instance of noncompliance should be operative only with respect to the 
dispute between the policyholder and the insurer; (2) modify the 
proposed regulation to state that the transition relief provided will 
be available if the insurer adopts reasonable procedures to implement 
the requirements of the regulation and takes reasonable steps to 
implement those procedures; (3) provide that an insurer's unintentional 
failure to comply with the regulation, that is not a result of willful 
neglect, will not cause any general account assets to become plan 
assets if the insurer cures such failure within 60 (or 90) days after 
discovering or being notified of the failure to comply and makes the 
plan or plans whole for any monetary loss resulting from the non-
compliance. Alternatively, commentators suggested that the Department 
permit the insurer to remedy any failure to comply with the regulation, 
due to reasonable cause and not to willful neglect, within 30 days of 
receipt of notice of such noncompliance and to extend this ``cure'' 
period if state insurance department approval is required. 
Additionally, a commentator urged the Department to provide that 
failure to comply with the regulation should only be effective with 
respect to the adjudication of the action in which the finding is made.
    The Department concurs with the commentators' assertions that the 
consequences of an insurer's de minimis or inadvertent failure to 
comply with the regulation may be too severe. Accordingly, the 
Department has amended subparagraph (i)(4) of the regulation to provide 
that a plan's assets will not include an undivided interest in the 
underlying assets of the insurer's general account notwithstanding the 
fact that the insurer has failed to comply with the requirements of 
paragraphs (c) through (f) of the regulation with respect to a plan if 
the insurer cures the non-compliance in accordance with the 
requirements of subparagraph (i)(5), which describes the steps that an 
insurer may take to avoid plan asset treatment with respect to the 
underlying assets of the insurer's general account.
    Pursuant to subparagraph (i)(5), an insurer must have in place 
written procedures that are reasonably designed to assure compliance 
with the regulation, including procedures reasonably designed to detect 
and correct instances of non-compliance. In addition, within 60 days of 
either detecting an instance of non-compliance or receipt of written 
notice of non-compliance from a plan, whichever occurs earlier, the 
insurer must comply with the regulation. Under this cure provision, the 
insurer would be required to make the plan whole for any losses 
resulting from the non-compliance. By following the procedure described 
in subparagraph (i)(5), the insurer could continue to take advantage of 
the safe harbor provided by the regulation, notwithstanding its initial 
failure to comply with one or more of the regulation's requirements. 
The Department believes that giving insurers a limited opportunity to 
cure their non-compliance and to compensate affected policyholders for 
any losses resulting from the non-compliance, will both address the 
concerns expressed by the commentators and continue to protect the 
interests of the policyholders from expense and unnecessary delays.

10. Effective Date

    Proposed paragraph (j)(1) stated the general rule that the 
regulation is effective 18 months after its publication in the Federal 
Register. Paragraph (j)(2), (3) and (4) of the proposed regulation 
provided earlier effective dates for paragraph (b) relating to 
independent fiduciary approval, paragraphs (c) and (d) relating to 
disclosures, and paragraph (f) relating to insurer-initiated 
amendments.
    Paragraph (j)(2) of the proposed regulation stated that if a 
Transition Policy was issued before the date which is 90 days after the 
date of publication of the final regulation, the disclosure provisions 
in paragraphs (c) and (d) would take effect 90 days after the 
publication of the final regulation. Paragraph (j)(3) of the proposed 
regulation provided that paragraphs (c) and (d) were effective 90 days 
after the date of publication of the regulation for a Transition Policy 
issued after such date.

[[Page 627]]

    Proposed paragraph (j)(4) provided that the effective date for 
paragraphs (b) and (f) of the proposed regulation is the date of 
publication of the final regulation in the Federal Register. In 
addition, this paragraph provided a special rule for insurer-initiated 
amendments which are made during the period between the dates of 
publication of the proposed and final regulations. The rule provided 
that, if a plan elected to receive a lump sum payment on termination or 
discontinuance of the policy as a result of an insurer-initiated 
amendment, the insurer must use the more favorable (to the plan) of the 
market value adjustments determined on either the effective date of the 
amendment or determined upon receipt of the written request from the 
plan in calculating the lump sum representing the unallocated funds in 
the accumulation fund.
    A number of commentators believed that, in the case of Transition 
Policies issued after a date that is 120 days after the date of 
issuance of the final regulations, the initial disclosures may be 
provided at the time of issuance of the policy. In their view, no other 
exception to the general 18 month effective date contained in section 
401(c)(1) of the Act is appropriate or would allow insurers sufficient 
time to prepare the necessary disclosure with respect to thousands of 
previously issued policies to ensure compliance. In addition, the 
commentators requested that the date required for distribution of 
annual disclosures (contained in paragraph (c)(4) of the proposed 
regulation) be extended from 90 days to 180 days following the period 
to which it relates to allow for sufficient time for the substantial 
amount of information to be disclosed. Another commentator stated that 
the earlier effective dates for insurer-initiated amendments do not 
provide the insurer with sufficient time to implement the changes 
necessary to be able to comply with the regulation or to be able to 
determine precisely what constitutes an insurer-initiated amendment.
    In the case of a plan electing a lump sum payment, one commentator 
objected to the proposed paragraph (j)(4) provision that the insurer 
must use the market value adjustment determined on either the effective 
date of the amendment or determined upon receipt of the plan's written 
request, depending on which is more favorable to the plan. The 
commentator believed that this will create serious and damaging anti-
selection potential as the contractholder will have the ability to 
determine, at its option, the more favorable of the two dates for the 
determination of the market value adjustment. To avoid this result, the 
commentator suggested that the market value adjustment should be 
determined as of the date the funds are actually withdrawn.
    The Department continues to believe that the earlier effective 
dates for the disclosure provisions are consistent with section 
401(c)(3)(B) of the Act, as added by SBJPA, which states that the 
disclosures required by the regulation be provided after the date that 
the regulations are issued in final form. In addition, section 
401(c)(5)(B)(i) of the Act, as added by SBJPA, provides an exception to 
the general 18-month effective date for regulations intended to prevent 
the avoidance of the regulations set forth herein. Thus, the Department 
proposed an earlier effective date for the provisions relating to the 
independent fiduciary approval, disclosure and insurer-initiated 
amendments because the Department believed that the earlier effective 
dates would protect the interests and rights of a plan and its 
participants and beneficiaries by minimizing the potential for insurers 
to change their conduct in ways which are disadvantageous to plan 
policyholders without compliance with the terms and conditions of the 
regulation. The Department, therefore, finds good cause for waiving the 
customary requirement to delay the effective date of a final rule for 
30 days following publication.
    The Department notes that, because no new Transition Policies can 
be issued after December 31, 1998, it is no longer necessary to 
differentiate between Transition Policies issued before and after the 
date of publication of the final regulation. Therefore, those 
provisions in proposed subparagraphs (j)(2) and (j)(3) which contain 
different effective dates based upon the date of issuance of the 
Transition Policy have been eliminated. In response to a number of 
comments which indicated that state insurance departments may require 
that insurers file for approval of amendments to policies, the 
Department has adopted a new subparagraph (j)(2) which states that the 
initial disclosure provision and separate account disclosure provision 
in paragraphs (c) and (d) are applicable six months after publication 
of the final regulation. The Department believes that a period of six 
months from the date of publication would allow insurers sufficient 
time to produce the disclosure materials and seek any necessary state 
approvals.
    Several commentators requested that the Department clarify the 
applicable date for the initial annual report. The Department has 
modified subparagraph (j)(3) to provide that the initial annual report 
required under subparagraph (c)(4) must be provided to each plan no 
later than 18 months after publication of the final regulation. 
Subsequent reports shall be provided at least annually and not later 
than 90 days following the period to which it relates. In consideration 
of the comments regarding the harshness of the special rule in 
subparagraph (j)(4) for insurer-initiated amendments which were made 
during the period between publication of the proposed and final 
regulations, the Department has determined to eliminate that provision. 
The Department has added a new paragraph (k) which contains the 
effective date for the regulation.

11. Miscellaneous Comments

    Several commentators represented that the Department exceeded the 
scope of its authority with respect to a number of the provisions 
contained in the proposed regulation. In this regard, the Department 
notes that section 401(c)(1)(A) of the Act authorizes the Secretary of 
Labor to issue regulations to provide guidance in determining which 
assets held by the insurer (other than plan assets held in its separate 
accounts) constitute plan assets and to provide guidance with respect 
to the application of Title I of ERISA to the general account assets of 
insurers. The Department believes that this broad grant of authority to 
provide guidance authorized the issuance of the regulations proposed by 
the Department. Accordingly, the Department believes that the 
commentators' arguments have no legal basis.
    A commentator urged the Department to clarify in the preamble to 
the final regulation that certain ``traditional'' guaranteed investment 
contracts (GICs) are guaranteed benefit policies under the Act. In 
support of its position, the commentator explained that, under a 
traditional GIC, an insurance company promises to pay a guaranteed rate 
of interest for a fixed period (i.e., until a stated maturity date) 
with the rate of interest being a fixed rate (e.g., 6.0% ) guaranteed 
for the fixed period, or a rate which is periodically reset by 
reference to an independently maintained index (e.g., LIBOR ). Under 
this type of GIC, the principal invested is guaranteed to be repaid at 
maturity, and the rate of return on the amount invested is not 
dependent on the performance of the assets in the insurer's general 
account or any other assets. In the Department's view, a GIC containing 
the above described terms would constitute a guaranteed benefit policy 
within the meaning of section 401(b)(2)(B) of the Act. In addition, the 
Department wishes

[[Page 628]]

to take the opportunity to state that no presumption should be drawn, 
from its determination to provide limited interpretive guidance, 
regarding the status of other insurance policies under section 
401(b)(2)(B) of the Act.
    Some commentators expressed concern that an insurer's decision to 
comply with the conditions in the regulation with respect to certain 
general account contracts issued to plans would be perceived as a 
determination that such policies are not guaranteed benefit policies. 
In this regard, the Department notes that no inference should be drawn 
regarding the status of any general account contract issued to a plan 
merely because the insurer has elected to comply with the regulation.

Economic Analysis Under Executive Order 12866

    Under Executive Order 12866 (58 FR 51735, Oct. 4, 1993), the 
Department must determine whether a regulatory action is 
``significant'' and therefore subject to review by the Office of 
Management and Budget (OMB). Section 3(f) of the Executive Order 
defines a ``significant regulatory action'' as an action that is likely 
to result in, among other things, a rule raising novel policy issues 
arising out of the President's priorities. Pursuant to the terms of the 
Executive Order, the Department has determined that this is a 
``significant regulatory action'' as that term is used in Executive 
Order 12866 because the action would raise novel policy issues arising 
out of the President's priorities. Therefore, the Department has 
undertaken to assess the benefits and costs of this regulatory action. 
The Department's assessment, and the analysis underlying that 
assessment, are detailed below.
    The main features of the regulation which cause an economic impact: 
(1) Provide for greater disclosure to employee benefit plans concerning 
certain general account contracts with insurance companies; (2) 
provide, in those cases where an insurance company chooses to comply 
with the regulation, that some employee benefit plans may receive 
enhanced termination options; (3) provide insurance companies guidance 
in determining the circumstances under which a contract with an 
employee benefit plan will cause the general account to hold plan 
assets; (4) relieve insurance companies from certain requirements 
imposed by ERISA if they were to hold plan assets; and (5) provide 
insurers an opportunity to correct compliance errors with respect to 
the regulation without facing the full consequences of noncompliance in 
terms of being considered to hold plan assets.
    The regulation establishes conditions that must be met in order for 
certain contractual arrangements to not result in the insurer's general 
account holding ERISA plan assets. Compliance with the regulation is 
voluntary, except for a general prudence standard. Its economic 
consequences, therefore, arise only when insurance companies elect to 
avail themselves of this opportunity, presumably only those insurance 
companies expecting the benefits of the regulation to exceed its costs.
    The Department believes that the benefits of the regulation to 
insurance companies, although difficult to quantify, will exceed its 
costs to them, and expects that all insurance companies affected by the 
Harris Trust decision will choose to comply. Because the regulation 
also provides benefits to plans, participants and beneficiaries, as 
well as to financial markets generally, while imposing little costs on 
them, the Department expects that the benefits of the regulation will 
considerably exceed its costs.
    The costs and benefits of the regulation concern ``Transition 
Policies.'' Transition Policies are general account contracts issued on 
or before December 31, 1998 which are, at least in part, not guaranteed 
benefit policies. In particular, the value of the benefit provided is 
related to the investment performance of the insurer's general account.
    The regulation does not apply to general account contracts written 
after December 31, 1998, and for that reason the Department believes 
that it causes neither benefits nor costs with respect to those 
contracts. However, in the absence of the safe harbor provided by this 
regulation, the costs to an insurance company of any of those contracts 
which would result in the general account holding ERISA plan assets are 
so great relative to the benefits that no insurance company will offer 
general account contracts with nonguaranteed elements.
    The regulation will result in a range of benefits that will 
primarily accrue to parties directly involved in the affected 
contracts, the insurance companies that have sold the policies and the 
employee benefit plans that entered into these arrangements. Insurance 
companies will benefit from the clarity regarding the circumstances in 
which they will be holding plan assets. This will afford greater 
flexibility in their efforts to manage the risks associated with 
engaging in transactions with employee benefit plans and the capacity 
to more efficiently make investment decisions. They will also obtain 
some benefit from the provisions that enable them to correct certain 
errors that would otherwise result in their holding plan assets.
    Employee benefit plans, and by extension the participants who are 
the beneficial owners of the contracts, will obtain some advantages as 
a result of the increased disclosure of information that will improve 
their ability to develop and adjust investment strategies and through 
potentially more favorable circumstances under which contracts could be 
terminated. In addition, the regulation will provide some more general 
indirect benefits to the economy through greater transparency and 
efficiency in the operation of financial markets.
    There will be some expenses incurred by insurance companies to 
achieve these benefits. The Department perceives these as generally 
falling into two categories: (1) Expenses associated with fulfilling 
procedural requirements which represent costs in an economic sense, and 
(2) expenses that represent payments by insurance companies associated 
with the liquidation of contracts at levels above what might have been 
made absent the regulation. The Department views the second category as 
transfers between affected parties with the expense of one exactly 
offset by the gain of another and therefore not to be costs in an 
economic sense.
    It has also been suggested that the regulation would impose some 
indirect costs on insurance companies and employee benefit plans 
because insurers electing to restructure their contracts to comply with 
the terms of the regulation would alter the composition of their 
general account portfolios. Particular attention was focused on the 
question of insurers hedging their exposure to interest rate movements 
that might diminish the returns available to the policyholders of 
general account products. The Department does not interpret this 
potential outcome as a cost by virtue of the fact that compliance with 
the regulation is elective and employee benefit plans have access to a 
range of substitutes for general account products. This enables them to 
purchase investment products across the full range of risk and return 
available without regard to products offered by insurance companies.
    The Department does not construe the outcome of competition in 
financial markets by itself to represent economic costs. These outcomes 
are instead interpreted to be benefits to the extent that regulatory 
actions enhance the transparency and therefore the

[[Page 629]]

efficiency of markets. Changes in relative market share that may result 
from enhanced competition are reflective of the reallocation of 
resources in a manner more reflective of the preferences of market 
participants and, absent direct evidence to the contrary, to represent 
efficiency gains.
    As is the case with most regulations of this nature, the benefits 
of this regulation are difficult if not impossible to specifically 
quantify. Most of the advantages accrue through indirect mechanisms or 
represent changes relative to a baseline of future behavior and 
outcomes that cannot be readily observed or predicted. Some elements of 
the costs are similarly difficult to estimate. Others, primarily the 
expenses associated with meeting certain procedural or disclosure 
requirements are more easily estimated. Recognizing these limitations, 
a more complete discussion of the various elements of costs and 
benefits relevant to the regulation and specific estimates of the 
magnitude where feasible is presented below.

Benefits of the Regulation

    The regulation is expected to have significant direct benefits to 
employee benefit plans. It satisfies the requirement in section 
401(c)(2)(B) of ERISA that the interests of employee benefit plans that 
hold insurance company general account contracts be protected, and thus 
their participants and beneficiaries, through the requirement of 
certain disclosure and termination rights. Through mandatory disclosure 
by insurance companies of information concerning the determination of 
costs and income from general account contracts, disclosure of the 
conditions under which termination may occur, and disclosure of 
information about the financial strength of the insurance company, the 
regulation will increase the amount of information available to 
employee benefit plans concerning insurance company general account 
contracts. The information insurance companies disclose will allow 
employee benefit plan fiduciaries and participants to fully understand 
how insurance companies determine the expenses and rate of return they 
assign to a contract.
    Greater disclosure of information will enable employee benefit 
plans to improve the quality of investment decisions. The complex 
nature of the insurance products can make it difficult for employee 
benefit plans to determine the risks associated with contracts backed 
by insurance company general accounts. With the improved disclosure, 
employee benefit plans will better understand the risks associated with 
general account contracts and the net rate of return they can expect to 
receive. The enhanced information will increase their ability to manage 
their portfolios and allocate assets in a manner consistent with the 
specific needs and circumstances of the plan. Plans making decisions to 
restructure their asset allocation or change other aspects of their 
investment strategy will benefit from a clearer explanation of their 
rights under specific policies. Enhancing the information about the 
specific attributes of complex financial products will have a positive 
effect on market efficiency as the purchasers incorporate this 
information into investment decisions and vendors respond to the 
resulting competitive pressures.
    Expected rate of return, risk and correlation of risks are three 
elements critical to effective portfolio decisions. The provision of 
more complete information by insurance companies due to this regulation 
allows employee benefit plans to better approximate the ideal 
portfolios that they would choose if they had full information about 
the financial characteristics of all possible investments.
    This benefit of the regulation in principle could be measured by 
determining the increase in total investment income received on the 
portfolio the employee benefit plan has, holding constant its level of 
portfolio risk. This measure of the benefits of the regulation is 
difficult to quantify because of changing conditions over time in 
financial markets, so that any change in portfolio rate of return may 
be due to other factors. A further complicating factor is that the 
provision of more detailed information may also cause employee benefit 
plans to change the amount of risk they wish to hold. It is difficult 
to assess the value to plans of having better information about the 
financial risks associated with these contracts.
    The termination provisions are another major source of benefits 
from the regulation to employee benefit plans and their participants. 
The termination provisions in the regulation may require insurers to 
give additional rights to employee benefit plan policyholders that 
their general account contracts did not previously contain. For many 
general account contracts, the regulation will liberalize payout 
options for employee benefit plans beyond those that were previously 
available. For other general account contracts, it will create new 
payout options. The termination provisions provide at least three 
benefits. First, the termination provisions allow employee benefit 
plans to terminate general account contracts that contain provisions or 
changes in provisions they view as unfavorable. Second, the termination 
provisions may discourage some insurance companies from making 
unilateral contract changes that are adverse to employee benefit plans. 
Third, the termination provisions provide greater liquidity that allows 
plans to adjust to changing financial market conditions. A discussion 
of these three benefits of the termination provision follows.
    First, employee benefit plans will benefit from the regulation by 
being able to terminate a general account contract if an insurance 
company unilaterally modifies such a contract to the detriment of the 
employee benefit plan. The termination provisions considerably enhance 
the value to employee benefit plans of the disclosure provisions since 
they increase the range of actions that can be taken as a result of 
better information being disclosed. Thus, the regulation gives employee 
benefit plans greater protection against unilateral action taken by 
insurance companies.
    A second benefit of the termination provisions to employee benefit 
plans is that those provisions will discourage insurance companies from 
making some contract changes that are detrimental to the interests of 
employee benefit plans that they would otherwise make.
    A third benefit of the termination provisions is that they provide 
employee benefit plans increased liquidity in their general account 
contracts. If an employee benefit plan faces an unanticipated expense 
and is forced to terminate its general account contract to obtain cash, 
the plan may be able to do so under more favorable conditions. In some 
cases, the plans will receive greater proceeds from a contract 
liquidation. For lump sum payouts, this is because the regulation 
requires that positive market value adjustments be given where they 
would not otherwise have been prior to the effective date of the 
regulation. Also for structured payouts, a minimum crediting rate that 
is also higher than some contracts provide is required. The choice of 
two payout options provides increased flexibility to many employee 
benefit plans.
    The increased liquidity provided by the termination provisions also 
allows employee benefit plans to profit from changing conditions. For 
example, a change in interest rates may cause an employee benefit plan 
to adjust investment strategies. The regulation may permit the plan to 
terminate its general account insurance contract and

[[Page 630]]

move its funds to the more attractive alternative.
    The value of the benefit to employee benefit plans derived from the 
enhanced ability to terminate contracts following unilateral contract 
amendments by insurance companies is difficult to quantify. Plans will 
not be forced to accept contract modifications that they view as 
undesirable. The value of this benefit depends on the frequency that 
such modifications would occur and the value placed on this protection 
by employee benefit plans. The value of the benefit to employee benefit 
plans of discouraging some contract modifications by insurance 
companies is also difficult to quantify because there is no reliable 
way to estimate the number of contract modifications with adverse 
implications for plans that would otherwise occur.
    As well as providing benefits to employee benefit plans and their 
participants and beneficiaries, the regulation provides benefits to 
insurance companies. The most significant of these results from the 
ability of insurance companies to expand the universe of investments 
that otherwise would be prohibited. In the absence of the regulation, 
with insurance companies holding plan assets in their general accounts, 
some investments would not be possible because they would involve 
potential self-dealing and conflicts of interest.
    The regulation may provide significant benefits to insurance 
companies because it clarifies and mitigates the constraints imposed by 
ERISA on the operation of insurance company general accounts. It does 
so by providing that insurance companies that comply with the specific 
requirements of the regulation will receive some assurance that their 
general accounts do not contain plan assets. Insurance companies thus 
could have reduced litigation costs and liabilities with respect to 
their general accounts. They will be shielded from the fiduciary 
responsibility and prohibited transactions rules under ERISA that would 
otherwise apply to them as a result of the Harris Trust decision.
    Because of the retroactive effect of the Supreme Court decision, 
numerous transactions by insurance company general accounts may have 
violated ERISA's prohibited transaction and general fiduciary 
responsibility provisions. Without the safe harbor the regulation 
affords, some insurance companies would be liable under part 4 of Title 
I of ERISA as a result of the operation of their general accounts.
    This regulation provides insurance companies the benefit of reduced 
uncertainty concerning the application of ERISA. Some insurance 
companies may be uncertain as to whether the general account contracts 
they have with employee benefit plans are affected by the Harris Trust 
decision. This uncertainty arises primarily from what constitutes a 
guaranteed benefit policy.
    The value to insurance companies of less uncertainty arises in part 
through lower fees they would pay to attorneys and other benefits 
specialists to try to resolve the uncertainty. Also, insurance 
companies may be overly conservative in attempting to avoid holding 
ERISA plan assets. The lowering of risk in this regard will allow 
insurance companies to pursue business they might otherwise avoid.
    The cure provision in the regulation is an additional source of 
benefits. Insurance companies under certain circumstances can correct 
certain errors in compliance with the regulation without causing the 
company to hold employee benefit plan assets. This feature of the 
regulation greatly reduces the risk of an inadvertent failure of an 
insurer to comply with the regulation that would result in them holding 
plan assets.
    This cure provision should reduce the likelihood of litigation 
between employee benefit plans and life insurance companies. The 
ability to correct errors without incurring the risk of future 
liability should reduce the incidence of noncompliance and 
substantially reduce costs for insurance companies to correct 
inadvertent errors.
    The value of the benefits arising from the cure provision are 
positive but impossible to accurately measure. They will depend on the 
extent that insurance companies make inadvertent or good faith errors 
and then use the cure provision to correct them. The level depends on 
the cost to insurance companies of correcting the errors under the 
regulation in relation to what would have otherwise occurred. The cure 
provision also affords benefits to employee benefit plans because it 
reduces the likelihood of failure to comply with the regulation. This 
is similarly impossible to quantify.
    The value of these benefits to insurance companies should be 
substantially shifted to employee benefit plans over time through a 
higher net rate of return received on life insurance company general 
account contracts so long as insurance companies remain competitive. 
This will increase the investment income of defined benefit plans 
holding those contracts. An increase in investment income will over the 
longer term lead to either a reduction in contributions required or 
allowed by plan sponsors or to an increase in benefits. A reduction in 
contributions by plan sponsors would reduce their corporate income tax 
deductions and raise their corporate tax payments. Increased benefits 
will result in higher taxable income received by beneficiaries.
    The regulation will have a relatively small but positive benefit to 
the Federal government, and thus taxpayers, by reducing the need for 
employee benefit investigation, enforcement and litigation activities 
of the government. By reducing the number of violations of ERISA 
through compliance with the safe harbor provisions of the regulation, 
and by providing through the cure provision the incentive for insurance 
companies to self-correct minor compliance problems, investigation, 
enforcement and litigation expenses of the government may be reduced.
    As well as the direct benefits discussed above, the regulation has 
indirect benefits through improved functioning of financial markets. 
The indirect benefits are positive externalities that benefit all 
participants in financial markets through the greater efficiency of the 
functioning of those markets. The positive externalities are benefits 
received by parties other than insurance companies and employee benefit 
plans, participants and beneficiaries. With more efficiently 
functioning capital markets, capital is directed to its best use, which 
benefits not only the investor but also enterprises seeking investors. 
Thus, this is a benefit to the economy at large. The termination 
provisions of the regulation also provide positive externalities in 
that by providing greater financial market liquidity, there is freer 
movement of capital so it can be applied to its best use.

Costs of the Regulation

    As with the benefits, the costs of the regulation are both direct 
and indirect. Direct costs should fall nearly exclusively on insurance 
companies rather than on plans, participants and beneficiaries. 
Although, some commentators have argued that there may be indirect 
costs to the economy through effects on the functioning of capital 
markets, as discussed in more detail below, the Department believes 
those costs to be insignificant or nonexistent.
    Three types of direct costs are relevant. Insurance companies will 
bear some costs that are effectively transfers to plans. While these 
may be viewed as costs in the accounting sense, they result in little 
or no net cost to the economy, as the cost to the insurance

[[Page 631]]

company is exactly offset by the benefit received by the employee 
benefit plan.
    Second, there are direct costs that arise because insurance 
companies undertake certain activities in order to fall within the 
requirements of the regulation. These will primarily take the form of 
increased payments to service providers or insurance company employees. 
These type of costs represent costs in both an accounting as well as an 
economic sense and are the primary burden imposed by the regulation.
    A third type of cost are those potentially associated with a 
distortion of economic activity. These also represent a net cost to the 
economy. Typically these distortions are associated with taxation. 
Distortions can also potentially result from government regulations 
requiring activities or expenditures which exceed the associated 
benefits.
    Insurance companies will incur administrative costs due to the 
disclosure and termination requirements. To comply with increased 
disclosure requirements, they will incur costs to prepare and 
distribute the annual statement to employee benefit plans explaining 
the methods by which income and expenses of the insurance company's 
general account are allocated to the policy. To minimize these costs, 
the regulation requires disclosure of materials that are prepared for 
other purposes. One time only administrative costs will be incurred by 
insurance companies to modify contracts so that they will comply with 
the regulation and to file revised contracts with state regulatory 
authorities.
    The enhanced options for employee benefit plans to terminate their 
contracts will create administrative costs for insurance companies in 
that they will be discouraged from making some unilateral contract 
modifications they otherwise would make. The magnitude of this cost to 
insurance companies is difficult to quantify because the number and 
effect of contract modifications that will be discouraged from 
occurring is not readily determinable. This cost to insurance companies 
is largely a benefit to employee benefit plans and participants and 
beneficiaries.
    Some commentators have argued that the regulation will impose costs 
on insurance companies in financial markets. Because the termination 
options will permit some contracts to be terminated earlier than 
otherwise, insurance companies may adjust the investments in their 
portfolios. The increased probability of early termination shortens the 
period over which the preponderance of payments are made. To the extent 
that insurance companies attempt to match the timing of their receipts 
and payouts, they will shorten the timing of their receipts.
    Insurance companies with a significant percentage of affected funds 
in their general account may make fewer long maturity investments and 
private placements. Long maturity investments are investments where the 
preponderance of the payments are received relatively far into the 
future. Private placements are investments that are not publicly traded 
on financial market exchanges. They may reduce those investments due to 
their needs for reduced maturity and greater liquidity of investments 
because of the increased probability of early termination of general 
account contracts. Both of these changes in maturity of investments and 
in private placements would reduce the expected rate of return on their 
portfolios. Lower maturity investments generally receive a lower rate 
of return than longer maturity investments. Private placements tend to 
have relatively low liquidity because they are not publicly traded. 
Liquidity is a desirable aspect of investments and therefore investors 
must pay a price for it in terms of lowered rate of return. The 
termination requirements may also cause insurance companies to incur 
costs in determining the market value of some assets that are not 
publicly traded, such as private placements. These costs will 
discourage investments in those types of assets because they will 
reduce the net rate of return (after costs) on those investments.
    Because of the sophistication of capital markets, with a large 
number of competent purchasers and sellers, any initial effect on 
capital markets due to insurance companies changing their portfolios 
and their investment strategies probably would be offset by a re-
allocation of investments among investors. If insurance companies 
reduce their investments in a certain class of assets, the price of 
those assets will fall due to the reduced demand for the investment, 
which will raise the rate of return on that investment. The lowered 
price and increased rate of return will motivate other investors to 
invest in those assets, which will in turn drive the price up towards 
its original level. One time only transaction costs will be incurred by 
insurance companies and other investors as they adjust their 
portfolios. These costs are primarily fees paid to other financial 
institutions to transact sales and purchases.
    The cure provision creates administrative costs for insurance 
companies that choose to use it because they are required to establish 
administrative procedures to detect and correct failures to comply with 
the regulation. Costs will be incurred in terms of staff time required 
for creating and maintaining these procedures. These costs are largely 
quantifiable in terms of specific actions that are required, with the 
cost of those actions being estimable.
    While the increased administrative costs are borne initially by 
insurance companies choosing to comply with the regulation, they may be 
shifted at least partially through a reduced rate of return net of 
expenses to employee benefit plans and then to participants, and to 
other investors who have contracts supported by the general accounts of 
those companies. A reduction in the net rate of return received on the 
general account portfolio may be passed on to employee benefit plans 
having contracts with participating features. Whether that occurs may 
be a business decision made by insurance companies depending on the 
competitive pressures they face or may be determined by their 
contracts. It may also reduce the rate of return insurance companies 
offer on new contracts. The extent to which they do that depends in 
part on the competitive pressures faced by insurance companies. It 
should be noted again in this context that new contracts will not be 
covered by the regulation.
    These effects on the rate of return received by insurance companies 
on their general account portfolios generally will be small. For most 
insurance companies the percentage of general account assets affected 
is small and thus the effect on the insurance company's portfolio rate 
of return, which is proportional to the share of those assets in the 
general account portfolio, is also small. The effects on employee 
benefit plan rates of return is further diminished to the extent that 
plans hold other investments. The effect on participants may be even 
further reduced to the extent that employee benefit plan sponsors bear 
the effects that are shifted to employee benefit plans.
    Employee benefit plans can offset lower risk and expected return 
from their insurance contracts by increasing the risk and expected 
return of their other investments. They may also reduce their 
investments held with insurance companies and shift funds to other 
financial intermediaries. If these changes are made, there may be no 
effect on the expected portfolio rate of return for employee benefit 
plans.

[[Page 632]]

Cost Estimates

    The following are the Department's estimates of the potential costs 
associated with the regulation. The Department's analysis is responsive 
to the public comments received on the economic impact of the proposed 
regulation that focused on the potential costs attributable to the 
regulation. This discussion also reflects additional analysis by the 
Department in response to changes to the substantive provisions of the 
regulation and the availability of more recent data.

Direct Costs

    The direct costs associated with the regulation are attributable to 
the disclosure and termination requirements. The discussion that 
follows provides details of the direct costs associated with the 
regulation.
1. Impact on the Insurance Industry--Amount of Assets Affected
    In connection with its publication of the proposed regulation, the 
Department solicited comments from the interested public regarding the 
economic impact of the proposed regulation. Specifically, the 
Department requested current data on the number and characteristics of 
potentially affected insurance contracts that would provide the basis 
for a more extensive analysis of the costs and benefits of the proposed 
regulation.
    The Department received a few comments which disagreed with its 
estimate of the value of the accounts potentially affected by the 
regulation of $40 billion in 1994 (slightly less than 3 percent of 
general account assets). These comments provided limited data on the 
number of potentially affected insurance contracts. For example, one 
commentator estimates that based on their reading of the 1997 Life 
Insurance Fact Book (1996 data), the total value of contracts 
potentially affected by the regulation is $261.8 billion (15.4 percent 
of general account assets). It appears that this estimate includes the 
allocated portions of general account group insurance contracts, 
whereas the Department excludes the allocated portions of group annuity 
contracts from its estimates. Allocated group annuity contracts are 
excluded because the benefits from the contracts are guaranteed and the 
employee benefit plans do not participate in the risk associated with 
those contracts. Representatives of the insurance industry estimated 
for 1996 that the amount of unallocated assets that would be affected 
by this regulation was approximately $100 billion (6.7 percent of 
general account assets).
    In response to these comments, the Department asked the insurance 
industry to provide specific information on the amount of affected 
assets. The industry declined to provide the information, contending 
the proprietary nature of the data. As an alternative data source the 
Department used information reported on the Form 5500 reports and 
attached Schedule A's filed for the 1995 plan year. The Schedule A 
attachment is required to be filed for all pension plans holding 
insurance contracts with unallocated funds. Both the amount of 
unallocated funds and the name of the insurance carrier issuing the 
policy are reported on the Schedule A. While the manner of reporting 
unallocated funds held in insurance policies does not enable a precise 
determination of whether the policies are Transition Policies or other 
types of policies, the Department believes that reasonable estimates 
can be derived from the data. Using Form 5500 data, the Department 
revised its earlier estimates of the amount of assets potentially 
affected by the regulation and the distribution of those assets within 
the life insurance industry. The Department now estimates between $80 
and $98 billion (between 5.8 and 7.1 percent of general account assets) 
would have been potentially affected by the regulation in 1995. The 
Department believes that this estimate comports with that provided by 
the representatives of the insurance industry.
    For the 1995 plan year, a total of 123,567 Schedule A reports were 
filed by pension plans reporting assets held in contracts with 
unallocated funds that appear to be used to pay benefits or purchase 
annuities. It is the Department's belief that these policies are most 
commonly immediate participation guarantee (IPG) contracts, in which 
the value is directly related to the investment performance of the 
insurer's general account. These contracts will therefore meet the 
definition of a Transition Policy. The total amount of assets reported 
in Schedule A for these types of contracts was $98 billion.
    The following discussion explains how the figures of between $80 
and $98 billion were determined. The Schedule A is used both for the 
reporting of assets in accounts used to provide benefits and for the 
reporting of assets in accounts used solely for investments. The 
Schedule A does not have a specific identifier for the type of policy 
being reported. Contracts were assumed to be purely investment 
contracts if the Schedule A showed no assets disbursed to pay benefits 
or purchase annuities during the year and the Form 5500 report 
indicated that all plan benefits were either paid from a trust or, in 
the case of a defined contribution plan, were paid through a 
combination of a trust and insurance carrier.12 These 
filings were excluded from the analysis based on the assumption that 
they are most likely to be guaranteed investment contracts and would 
therefore not meet the definition of a Transition Policy. The remaining 
Schedule A's fell into two categories:
---------------------------------------------------------------------------

    \12\ It appears that defined contribution plans which check that 
benefits are provided through both a trust fund and an insurance 
carrier and which attach a Schedule A are generally trust funded 
plans (with investments in insurance products) that commonly offer 
participants the choice of a lump sum distribution or an annuity. 
For participants choosing the latter form of payment, the value of 
the participant's account is used to purchase an individual annuity. 
Thus, it was assumed that the assets reported on Schedule A were in 
investment accounts rather than Transition Policy accounts used to 
provide benefits.
---------------------------------------------------------------------------

    (1) If a Schedule A showed funds being disbursed from the account 
to pay benefits or purchase annuities or the Form 5500 report indicated 
that all benefits were provided through an insurance carrier, then the 
funds reported in Item 6 of the Schedule A were assumed to be held in 
policies meeting the definition of a Transition Policy. The total 
amount of such funds in 1995 was $80 billion. This amount was used as 
the lower bound for estimating total general account assets held in 
Transition Policies.
    (2) If a Schedule A showed no assets disbursed to pay benefits or 
purchase annuities and the Form 5500 report indicated that the plan was 
a defined benefit plan and benefits were paid both through the trust 
and an insurance carrier, then the type of contract funds reported in 
Item 6 of Schedule A was categorized as undeterminable. The total 
amount of such funds was $18 billion.
    The $18 billion estimate of funds in the undeterminable category, 
combined with the $80 billion in general account funds determined to be 
used to pay benefits, was used as the upper bound for estimating total 
general account funds in Transition Policies. There is no way of 
accurately estimating how much of the $18 billion in the undeterminable 
category was held in Transition Policies. Therefore, in estimating the 
total amount of funds held in Transition Policies, the entire $18 
billion was added to the lower bound of $80 billion to provide a total 
estimate of $98 billion held in Transition Policies.13 This

[[Page 633]]

amount is in line with the $100 billion estimate provided by the 
representatives of the insurance industry.
---------------------------------------------------------------------------

    \13\ The DOL had developed an earlier estimate of $40 billion 
held in Transition Policies. This estimate was based on data 
reported in Item 31c(16)--(Value of funds held in insurance company 
general account)and Item 32e(2)--(Payments to insurance carriers for 
the provision of benefits) of the 1994 Form 5500 reports alone and 
did not make use of Schedule A data. The use of the Schedule A 
attachment in combination with data reported on the Form 5500 allows 
for a much more refined estimate to be developed, particularly for 
small plans which do not separately report assets held in insurance 
company general accounts.
---------------------------------------------------------------------------

    One commentator disagreed with the Department's use of an industry 
average, i.e., slightly less than 3 percent of general account assets, 
to demonstrate the percent of total contracts potentially affected by 
the regulation. The commentator stated that this is inappropriate 
because many insurers have a significantly higher proportion of assets 
supporting contracts potentially affected by the regulation than the 
Department's estimate in the proposed regulation for the industry as a 
whole. In its re-estimate of the amount of assets affected based on the 
most recent complete Form 5500 data available (1995), the Department 
determined that approximately 104 insurance companies each managed $25 
million or more of private pension plan unallocated assets in insurance 
company general accounts and about 63 of those insurance companies 
managed $100 million or more in such accounts.
    To estimate the impact of the proposed regulation on both the 
insurance industry as a whole and on individual companies within the 
industry, the ratio of funds in Transition Policies (as reported on 
Schedule A of the Form 5500 series) to an insurer's general account 
funds was computed. This is one of a number of reasonable measures of 
insurer net exposure that could have been chosen. For example, the 
ratio of funds in Transition Policies to insurer net worth would be 
another reasonable measure.
    The ACLI reports that at year-end 1995, a total of $1.683 trillion 
was held in the general accounts of life insurance 
companies.14 In order to estimate the total value of general 
account assets in the 104 companies which have issued Transition 
Policies with a total value of $25 million or more, data from the 1996 
and 1998 editions of the Best Insurance Reports and Standard & Poor's 
Claims-Paying Ability Reports were used along with information provided 
by insurance representatives. For a few companies for which data were 
not available from the above two sources, telephone calls were made to 
the companies to obtain general account asset information. The general 
accounts of these 104 companies in 1995 were estimated to be $1.372 
trillion. The $98 billion estimated as held to support Transition 
Policies by the 104 companies represent 7.1 percent of total general 
account assets.
---------------------------------------------------------------------------

    \14\ ``1996 Life Insurance Fact Book,'' American Council of Life 
Insurance, p. 89.
---------------------------------------------------------------------------

    The percentage of general account assets held to support Transition 
Policies varied widely among insurance companies, ranging from a low of 
0.1 percent to a high of 44 percent. For 74 percent of the companies 
(77 companies), the assets held in support of Transition Policies made 
up less than 10 percent of total general account assets. For 13 percent 
of the companies (14 companies), assets held in support of Transition 
Policies made up from 10 to 19 percent of total general account assets, 
and for the remaining 13 percent (13 companies), assets in Transition 
Policies made up 20 percent or more of general account assets, with a 
maximum percentage of 44 percent.
    The Department estimates that the proposed regulation will have a 
significant impact on the 13 companies in which assets held in 
Transition Policies (as reported on Schedule A of the Form 5500 series) 
exceed 20 percent of the insurer's general account assets. While any 
threshold measure of impact is, to some extent, arbitrary, we believe 
that the 20 percent level is a reasonable measure, given the estimated 
costs of bringing contracts into compliance and any increased exposure 
represented by required changes in policy termination provisions.
2. Costs of Compliance
    Insurance industry representatives disagreed with the Department's 
estimate of the aggregate cost of compliance with the proposed 
regulation of no more than $2 to $5 million per year, indicating that 
they believe the costs will be a significant multiple of this estimate. 
However, these insurance industry representatives indicated that they 
did not have specific information as to the aggregate cost of 
compliance with the regulation. The representatives did not provide any 
analysis of the sources and methodologies used to derive their cost 
bases. Thus, the Department could not replicate these estimates.
    The Department now estimates based on the cost estimates provided 
by 6 insurance companies and from Form 5500 series reports that the 
average annual aggregate costs over the first 10 years of compliance 
with the regulation to be approximately $37 million (initial costs plus 
the annual costs over 10 years divided by 10 years). This estimate 
includes initial costs to insurers for reviewing the language in 
current contracts concerning termination provision, drafting policy 
riders or amendments, and mailing new policies to policyholders of $1.7 
million. The estimate also includes the initial cost to insurers of 
preparing the initial disclosure statement to give to employee benefit 
plans of $52.7 million and an annual cost for disclosure in subsequent 
years of $37 million. The basis for these estimates is provided in the 
Paperwork Reduction Act section of this preamble.

Disclosure Provisions

    The Department received several comments regarding the disclosure 
provisions in the proposed regulation. In response to these comments, 
the disclosure provisions have been modified in the final regulation, 
thus clarifying the requirements and reducing any potential burdens 
associated with these provisions. For example, the Department limited 
the disclosure requirements to those items relevant to the 
policyholder's ability to withdraw or transfer funds under the policy. 
In addition, the Department eliminated the requirement that the insurer 
make available upon request of a plan copies of the documents 
supporting the actuarial opinion of the insurer's Appointed Actuary. 
The Department has determined that these changes have no significant 
impact on the costs associated with the regulation.

Termination Provisions

    The proposed regulation included two forms of termination payment 
that would be available to transition policy holders--a lump sum 
payment with a market value adjustment and a book value payout, in 
essentially equal installments, over a period of no more than five 
years calculated using an interest rate of no less than 1 percent less 
than the rate currently crediting on the policy at the time of 
termination. The final regulation also includes the two forms of 
termination payment but, in response to comments received, lengthens 
the period for book value payouts to over no more than ten years and 
with a crediting rate of no more than 1 percent less than the current 
crediting rate. The Department based this change on a New York state 
insurance regulation. The New York regulation serves as the 
Department's model because most insurers of group annuity contracts are 
licensed to do business in New York. That regulation has applied since 
1987 to insurers licensed to do business in New York. The New York 
regulation requires that unallocated group annuity contracts issued 
after 1987 provide that the policyholder can terminate the contract and 
receive either a lump sum payment with a market value adjustment or a

[[Page 634]]

book value payout over no more than 10 years (including a 5 year payout 
option) with a crediting rate no less than 1.5 percent less than the 
current crediting rate.
    For many group annuity contracts, the regulation will liberalize 
payout options that were previously available. For other contracts, it 
will create new payout options. These changes will have two principal 
effects: (1) In situations where contracts did not previously allow for 
a positive market value adjustment, they will increase payouts to some 
terminating group annuity policyholders, thus transferring value from 
insurance companies or their continuing policyholders to pension plans 
which terminate their arrangements, and (2) they will tend to change 
the investment policies for the assets supporting group annuity 
contracts because of the increased likelihood of early terminations of 
contracts, in particular shortening the maturity structure and shifting 
the asset mix toward a larger portion in marketable securities.
    While the transfer of value in situations where contracts did not 
previously allow for a positive market value adjustment, may result in 
a loss to some insurance companies, at the level of the economy as a 
whole that effect will be offset by gains to some pension plans. The 
ultimate distributions of the burden and gain are difficult to 
determine. The gain may be realized by plan participants or 
shareholders of firms sponsoring pension plans and the loss borne by 
shareholders of insurance companies or by other purchasers of life 
insurance products. While any increase in an insurer's liabilities may 
increase the probability of a future insolvency, the Department is 
unable to quantify this effect. It believes, however, that those 
insurers for whom this regulation has the greatest impact will 
aggressively seek to lessen the effects on their financial structures 
by appropriate asset/liability matching techniques.
    The decrease in insurers' group annuity liability duration is 
likely to trigger changes in the way insurers manage the assets 
supporting those contracts. That response is likely to take the form of 
shifting to assets that are less sensitive to interest rate changes 
(i.e., assets with shorter durations). Life insurers will also likely 
shift their investments to assets with greater liquidity.
    Many of the analyses supplied by the insurance industry in response 
to the proposed regulation assumed insurers would shorten their asset 
structure to correspond to the interest rate sensitivity of a 5 year 
payout of the book value of their Transition Policies. Under the final 
regulation, a similar analysis would imply that insurers will shorten 
their asset structure to correspond to the interest rate sensitivity of 
a 10 year payout of the book value. The 10 year option would imply a 
small shortening of insurers' liabilities and thus probably of their 
assets. The shortening of the duration of assets would imply, under 
most circumstances, a decrease in portfolio rates of return. The 10 
year option would require a relatively small reduction in the duration 
of the group annuity portfolio for most insurance companies. Because 
the yield curve for bonds with respect to maturity is usually fairly 
flat in the relevant range of maturities, the difference in the rates 
of return associated with such restructuring is fairly small. Thus the 
decrease in the portfolio rates of the return would be generally far 
smaller than the industry estimates of 50 to 100 basis points that were 
derived based on the 5 year book value payout required by the proposed 
regulation.
    Some commentators have argued that plans will terminate contracts 
to take advantage of the upward market adjustments or the difference in 
value between the two termination payout options. The Department 
believes that few such terminations will occur because other 
contractual features, such as guaranteed annuity purchase rates, also 
have value. In addition, long-established business relationships are 
valuable and Transition Policy contract holders will attempt to 
negotiate mutually beneficial agreements for continuing relationships.
    Further, as indicated earlier, New York state insurance regulation 
requires for recently issued unallocated group annuity contracts issued 
by insurers licensed to do business in New York termination provisions 
similar to those of this regulation. Most of the major issuers of group 
annuity products are licensed to do business in New York. The 
Department notes that while there has been more than a decade of 
experience with the New York regulation, no written or oral testimony 
was submitted to indicate that experience with respect to termination 
of such contracts differs from that of other contracts with less 
favorable termination provisions.

Cure Provision

    As described earlier in this preamble, the Department has added a 
cure provision to the final regulation in response to public comment. 
This cure provision would allow insurers that have made reasonable and 
good faith efforts to comply with the requirements of the regulation up 
to 60 days from either the date of the insurers' detection of the 
problem or the date of the receipt of written notice of non-compliance 
from the plan to comply with the requirements of the regulation. In 
addition, interest must be credited on any amounts due the policyholder 
on termination or discontinuance of the policy if not paid within 90 
days of receipt of notice from the policyholder.
    In order for an insurer to make use of the cure, it must have 
established written procedures that are reasonably designed to assure 
compliance and to detect instances of noncompliance. While the 
Department is unable to quantify the benefit of the cure provision, it 
is anticipated that the cure provision will allow insurers to avail 
themselves of the protections of the regulation with somewhat greater 
administrative flexibility. Although there may be certain expenses 
associated with the establishment of written compliance procedures, the 
Department believes that many insurers would implement such procedures 
as part of their usual management practices, and would satisfy the 
conditions for use of the cure only if the provision offered a net 
benefit to the insurer.

Indirect Costs

    The indirect costs associated with the regulation are negative 
effects of the regulation on the functioning of capital markets. Some 
commentators have argued that the regulation will affect long-term 
lending and the availability of capital in the national economy. The 
discussion that follows provides details of the indirect costs 
associated with the regulation.
Effect on Long-Term Lending and the Availability of Capital in the 
National Economy
    Several commentators have argued that a shortening of insurers' 
portfolios (reducing the investment duration of debt holdings) would 
reduce the overall amount and raise the price of long-term lending in 
the economy. They further assert that insurers are one of the major 
providers of long-term capital, and that if insurers choose in the 
future to invest more of their portfolios in shorter term debt 
securities, the effect could be a significant reduction in the amount 
of capital invested in long-term projects overall.
    They support their premise by reporting that the total dollar 
figure of insurance industry investment in long-term corporate debt is 
$531 billion dollars as of year end 1996 ($885 billion invested in 
corporate debt of which 60

[[Page 635]]

percent is long-term). This figure is minimal when considered in terms 
of the total long-term debt outstanding in the capital markets.
    The Department disagrees with the commentators' above assessment of 
the impact of the insurance industry's investment in long-term 
securities. According to a recent Federal Reserve statistical release 
titled, ``Flow of Funds Accounts of the United States, Flows and 
Outstanding, Third Quarter 1998,'' life insurance and other insurance 
companies provide a relatively small proportion of total capital 
compared to other major participants in the economy. Of the $22.630 
trillion Total Credit Market Debt 15 Outstanding at 
September 30, 1998, Life insurance and Other insurance companies 
holdings represented a total of $2.342 trillion, or 10.35 percent of 
the total market. While this report does not specify what percentage of 
the $2.3 trillion are in general account assets, nor break out the debt 
holdings by maturity, the general information does help to present a 
broad and balanced picture of the insurance industry's influence on the 
long term debt and private placement markets, when analyzed in 
conjunction with statistics available from other sources.
---------------------------------------------------------------------------

    \15\ As Defined in Table L.1, Credit Market Debt includes these 
federal government securities: mortgage pool securities, U.S. 
government loans, and government-sponsored enterprise securities, 
and these private financial sector instruments: open market paper, 
corporate bonds, bank loans (not elsewhere classified), other loans 
and advances, and mortgages.
---------------------------------------------------------------------------

    Regarding the potential effects on the availability of financing 
for small business entities and on the private placement markets, 
further comments are addressed in the Regulatory Flexibility Act 
section of this preamble.

Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (PRA 95), 44 U.S.C. 3507(d)(2), 
and 5 CFR 1320.11(f) require Federal agencies to publish collections of 
information contained in final rules for the public in the Federal 
Register. Modifications have been made to the collection of information 
that appeared in the Notice of Proposed Rulemaking (NPRM). These 
modifications are in response to comments received to the NPRM and 
reflect the availability of more recent Form 5500 data. The basis for 
these modifications is described in detail in the Economic Analysis 
section of this preamble.
    The Department of Labor submitted the information collection as 
modified to the Office of Management and Budget (OMB) for its review in 
accordance with 44 U.S.C. 3507 (d) and OMB has approved the information 
collection request included in this final rule under control number 
1210-0114.
    Estimated Reporting and Recordkeeping Burden: The Department 
estimates that there are approximately 123,500 Transition Policies for 
private employer pension plans currently in effect. These policies have 
been issued by an estimated 104 different insurance companies. While 
the burden on the pension plans holding Transition Policies is expected 
to be minimal, the final regulation will impose costs in the following 
two areas on insurance companies which have issued Transition Policies:
    (1) The regulation would require that policies provide that a 
policyholder must be able to terminate or discontinue a policy upon 90 
days notice to an insurer. The policy must also offer the policyholder 
the option to select either a lump sum payment or a series of 
installments over a period of no more than ten years. Insurance 
companies that have policies not already in compliance with these 
requirements will incur costs in preparing riders or amending these 
policies and in providing copies of these riders or amendments to 
policyholders.
    (2) The regulation would require that insurers disclose to each 
policyholder certain information, including the methods used by the 
insurer to allocate any income and expenses of the insurer's general 
account to the policy during the term of the policy and upon its 
termination. Disclosure would consist of an initial statement to the 
policyholder, either as part of the amended Transition Policy, or as a 
separate written document, and an annual statement to the policyholder 
as long as the Transition Policy is in effect. The direct cost of 
compliance will be borne by the 104 insurance companies estimated to 
have Transition Policies and is as follows:

1. Policy Statement

    The insurance industry has indicated that the relevant contracts 
typically already permit the termination and withdrawal of plan assets. 
The final regulation will require they change any policies in which the 
language of the provision on the right of the policyholder to terminate 
the contract does not meet the minimum requirements of the regulation. 
Each insurance company affected is expected to develop a standard 
statement to be added to or to replace the existing termination 
provision in each contract. The Department estimates that a total of 40 
person hours of professional time per insurance company will be 
required to review whether existing policy termination provisions meet 
the proposed requirements and, if not, to develop a standard 
termination statement. Total estimated time for all affected insurers 
would be 4,160 hours (104 insurers  x  40 hrs.)
    The Department assumes that one-half of all policies will require a 
statement on termination rights of the policyholder to be added in 
place of existing language. Insertion of the statement into each policy 
and the mailing to policyholders is estimated to require \1/2\ hour per 
policy, or a total of 30,875 hours (61,750 policies  x  \1/2\ hr.). We 
assume that the average of \1/2\ hour per policy would be split evenly 
between professional and clerical staff.
    For purposes of estimating total costs to insurers of reviewing the 
language in current contracts and drafting policy statements, the costs 
of professional staff time are estimated to be $75 per hour and the 
costs of clerical staff time are estimated to be $12 per hour. Costs 
are therefore estimated to be $312,000 (4,160 hrs.  x  $75) to develop 
a standard termination statement and $1.3 million (30,875 hrs.  x  
$43.50 (average of the $75 per hour professional rate and the $12 per 
hour clerical rate)) to insert the statement into each contract and 
mail the contracts to policyholders. Mailing costs are estimated at 
$.50 per policy, or a total of $30,875 (61,750 policies  x  $.50). 
Total costs to insurers would be approximately $1.7 million.

2. Disclosure Statements

    The documentation needed by each insurer for the disclosure 
material should currently exist, either as data prepared for other 
reporting requirements or as data needed for internal computations by 
the insurer to allocate income and expenses. However, the time needed 
by each insurer to collect and incorporate the data into disclosure 
packages is expected to vary widely among insurers. While only one 
standard disclosure statement will likely be needed for prototype 
contracts, data for some individualized contracts will have to be 
customized on a contract-by-contract basis. Insurers with a large 
number of individualized policies will require more time to prepare the 
disclosure material than insurers making use of prototype contracts for 
all or most of their policies. The time needed and costs to develop the 
initial and annual statements are therefore dependent upon both the 
total number of policies and the number of individualized policies.
    In response to the Department's request for information regarding 
the costs and benefits of the proposed

[[Page 636]]

regulation, cost estimates to meet the proposed disclosure requirements 
were provided for 6 insurance companies. These cost estimates varied. 
Most of the estimates broke out the costs into three components: The 
costs of preparing the initial statements; the costs for system changes 
to facilitate the development of annual statements; and the ongoing 
costs of preparing the annual statements.
    The data provided on total insurer costs, together with Department 
estimates from Form 5500 reports on the total number of policies for 
each of the 6 insurers providing the cost data, were used to estimate 
the average costs per policy of the disclosure statement. The estimates 
for providing the initial disclosure among the 6 insurers ranged from a 
low of $68 per policy to a high of $1,962 per policy. The average cost 
per policy was $427. The average of $427 per policy times the estimate 
of 123,500 policies yields an estimated total cost for the initial 
disclosure statement of $52.7 million. This amounts to .05 percent of 
the total asset value of the policies.
    Ongoing cost estimates for the annual disclosure statements ranged 
from a low of $21 per policy to a high of $1,226 per policy. This 
reflects both the direct annual costs estimated for the disclosure 
statements and the estimate for the costs of system changes, amortized 
over a 10-year period. The average annual cost for the 6 companies was 
$283 per policy. Total annual costs would be $35 million. (This annual 
cost estimate assumes that no policies are terminated.)
    The combined costs for the policy statements and the disclosure 
statements are estimated to be $54.4 million in the initial year 
following adoption of the regulation and $35 million in each succeeding 
year.
    The cost data provided by the six insurance companies did not 
include any estimates of the hourly burden involved in preparing the 
disclosure statements. The Department assumes that the preparation of 
the statements will require professional staff time. Based on an 
average of $75 per professional staff hour, the total hour estimate for 
preparing the initial disclosure statement will be 702,667 hours ($52.7 
million/$75 per hour). Total estimated combined hours for the policy 
statements and disclosure statement in the initial year will be 737,702 
hours (35,035 hours for policy statements plus 702,667 hours for 
disclosure statements). Total estimated hours in each subsequent year 
for the annual disclosure statement would be 466,667 hours ($35 
million/$75).
    Representatives of the insurance industry indicated that based on a 
survey of 14 member companies, the cost per company of creating the 
initial disclosure information would be $7,600,000. However, unlike the 
estimates of the six insurance companies, the basis for this estimate 
was not disclosed. Therefore the Department was unable to factor this 
estimate into its calculations.
    The Department appreciates the comment informing us that contracts 
may be customized and that our earlier estimates did not take into 
account this customization. However, the Department disagrees with 
commentators' contention that our estimates did not account for the 
costs of preparation and distribution of standardized disclosure forms. 
More accurately, the Department's current estimate reflects the fact 
that some contracts allow for standardized disclosure and others must 
be customized on a contract-by-contract basis. In addition, the current 
analysis takes into consideration the Department's modifications to the 
disclosure requirements outlined earlier.
    Respondents to these new information collection requirements are 
not required to respond unless this collection displays a currently 
valid OMB control number.

Regulatory Flexibility Act

    The Regulatory Flexibility Act (5 U.S.C. 601 et seq.) (RFA), 
imposes certain requirements with respect to Federal rules that are 
subject to the notice and comment requirements of section 553(b) of the 
Administrative Procedure Act (5 U.S.C. 551 et seq.) and likely to have 
a significant economic impact on a substantial number of small 
entities. If an agency determines that a final rule is likely to have a 
significant economic impact on a substantial number of small entities, 
section 604 of the RFA requires that the agency present a final 
regulatory flexibility analysis at the time of the publication of the 
notice of final rulemaking describing the impact of the rule on small 
entities. Small entities include small businesses, organizations, and 
governmental jurisdictions.
    PWBA has conducted a final regulatory flexibility analysis which is 
summarized below.
    (1) PWBA is promulgating this regulation because it is required to 
do so under section 1460 of the Small Business Job Protection Act of 
1996 (Pub. L. 104-188).
    (2) The objective of the regulation is to provide guidance on the 
application of ERISA to policies held in insurance company general 
accounts. The legal basis for the regulation is found in ERISA section 
401(c); an extensive list of authorities may be found in the Statutory 
Authority section, below.
    (3) The direct cost of compliance will be borne by insurance 
companies. As noted in the proposed regulation, the Department 
estimates that no ``small'' insurance companies (as defined by the 
Small Business Administration at 61 FR 3280, January 31, 1996) offer 
the types of policies regulated here. The Department received no 
comments to the proposed regulation disagreeing with this conclusion. 
In addition, no small governmental jurisdictions, as defined in 5 
U.S.C. section 601, will be affected.
    With respect to employee benefit plans, the results of this 
analysis remain valid regardless of whether one uses the most 
applicable definition found in the regulations issued by the Small 
Business Administration (13 CFR section 121.201) or one defines small 
entity on the basis of section 104(a)(2) of ERISA as a plan with fewer 
than 100 participants. All employee benefit plans that purchased the 
regulated policies will receive the benefit of the enhanced disclosure 
provided by the regulation. Some of the costs of the disclosure may be 
passed on to the plans by the insurers. However, assuming that all 
disclosure costs are passed on to plans by the insurers, the Department 
estimates that these costs would be on average $441 per policy for 
providing initial disclosures (including the cost of amending policies) 
and $283 per policy for annual disclosures. This estimate assumes an 
equal distribution of the costs to all plans, both large and small.
    A few commentators expressed concern that the start-up costs 
associated with disclosure requirements can be significant to a small 
plan. For example, one commentator indicated that the Department's 
original estimate of $100 to $200 per contract ignores the amortization 
of costs associated with the initial development of reporting 
capabilities. They argued that, for example, their firm services 
several plans with general account balances of $10,000 or less. They 
argue therefore, that if the annual disclosure cost is $150, this 
amounts to 1.5 percent of assets annually for a $10,000 contract; 
whereas for a $50,000 contract the cost would be 0.3 percent annually. 
The result will be that insurers that are forced to incur these costs 
will ultimately pass them on to the plan sponsor, and that for a small 
plan these costs are unaffordable. This assumes that insurers will pass 
on their aggregate

[[Page 637]]

costs for compliance with the regulation by charging each plan the same 
dollar amount per contract, regardless of the size or nature of the 
contract or contracts involved, rather than a different method which 
may comport with the insurer's business plan.
    While insurance companies may pass along costs to plan sponsors, 
the Department believes that such costs will be passed on, if at all, 
on the basis of the cost of compliance with respect to a particular 
contract or type of contract. In this regard, the Department believes 
that the cost of compliance will be low for the types of policies most 
commonly held by small plans. Compliance cost estimates we received 
from insurance companies varied widely. The cost estimates, along with 
comments received from industry representatives, indicate a particular 
concern about high costs in the case of individualized policies which 
may require customized amendments and disclosure statements. 
Individualized policies generally appear to be limited to older 
contracts which tend to have large dollar values (generally $5 million 
or more) and are held by larger, long-established plans. These 
contracts are the result of numerous amendments of the original 
contract forms which are no longer issued. Except for large value 
contracts, more recent contracts are prototypes rather than 
individually drafted. These prototype policies are more cost effective 
for contracts with smaller dollar values. For example, of the estimated 
100,000 policies issued to plans with fewer than 100 participants, the 
average value in 1995 was $240,000. The Department understands that 
most small plans are likely to hold prototype contracts. This is 
because prototype polices are more cost effective than individualized 
policies for contracts with small dollar values. For example, of the 
123,000 Transition Polices issued to all plans, an estimated 100,000 
policies were issued to plans with fewer than 100 participants. The 
average value of such policies in 1995 was only $240,000. An estimated 
17,000 policies were issued to plans with between 100 and 500 
participants. The average value in 1995 was $1.8 million. For the 
remaining 6,000 plans, which had more than 500 participants, the 
average value was $7.2 million. The average contract value for all 
policies is only $800,000. It is evident that only a few (less than 5%) 
of plans holding Transition Policies are likely to hold individualized 
policies and these are the largest plans.
    For each type of prototype policy only a single standard amendment 
to bring policies into compliance with the termination requirements of 
the regulation (for policies not already in compliance) and a single 
standard disclosure statement need be developed. The cost of the 
disclosure statement and any needed rider or amendment can be spread 
across a large number of contracts, thus minimizing the cost per 
contract of compliance. These costs, even if passed on to the plan 
sponsors by the insurers, are expected to be a minimal percentage of 
the asset value of the contracts.
    As noted in the initial regulatory flexibility analysis of the 
proposed regulation, no significant alternatives which would minimize 
the impact on small entities have been identified. Although the 
Department considered whether it would be appropriate to reduce the 
costs that might be passed on to small plans by providing fewer 
disclosures or termination rights for small plans than is provided by 
large plans, such an approach was not adopted. The nature of the 
protective provisions is such that it would make little sense to 
provide a lower level of protections to contracts held by small plans 
in an effort to minimize the cost impact to those plans. The policies 
involved, although of lesser total value than policies issued to large 
plans, often represent a significant proportion of the assets of the 
plans that hold them. They also guarantee all or most of the benefits 
of the participants whose pensions they cover. Finally, thee 
fiduciaries of small plans may be less knowledgeable of insurance 
products and may have less bargaining power in dealing with insurers. 
Therefore, the protections in the regulation may be more important to 
the participants of small plans than to those of large plans. No 
comments received by the Department suggested that the regulation 
should provide small plans a lower level of protections than large 
plans.
    In addition, no alternatives were identified by the commentators or 
have otherwise come to the attention of the Department. As discussed 
previously, in response to comments received, the Department made 
several modifications to the requirements of the proposed regulation. 
These modifications include relaxation of the disclosure requirements, 
an increase in the book value payout period in the termination 
provisions from 5 years to 10 years, and the introduction of the 
``cure'' provision. These modifications are designed to minimize the 
impact of the regulation on small and large entities alike, consistent 
with the objectives of the requirements of the Small Business Job 
Protection Act of 1996 and ERISA. It would be inconsistent with these 
statutory requirements to create an alternative with lower compliance 
criteria, or an exemption from the regulation, for small plans because 
these are the entities that have the greatest need for the disclosure 
and other protections afforded by the regulation.
    (4) The Department received one comment from representatives of the 
insurance industry regarding the initial regulatory flexibility 
analysis in the proposed regulation. They stated that the regulation 
will have collateral and potentially serious adverse effect on small 
businesses. In addition, they argue that the regulation, as proposed, 
will create a preferred class of policyholders and hurt the 
participants and beneficiaries of a large number of small plans that 
purchase insurance arrangements backed by insurance company general 
accounts. They further state that the termination requirements would 
seriously restrict an important source of capital for small businesses.
    As described in the Economic Analysis section of this preamble, the 
termination requirements may result in transfer of value from some 
insurance companies or their continuing policyholders to pension plans 
that terminate their arrangements in situations where contracts 
otherwise did not previously allow for positive market value 
adjustments. However, despite the assertion by insurance industry 
representatives that this will adversely affect participants and 
beneficiaries in a large number of small plans, no statistical evidence 
has been provided to substantiate this claim. The Department finds no 
reason to assume, for example, that small plans would be less likely 
than large plans to terminate these contracts and thus suffer the 
adverse impact (if any) of transfers to the terminating policyholders.
    (5) Several commentators have stated, without any supporting 
analysis, not only that the insurance industry is an important provider 
of long-term capital, but also that small and medium sized businesses 
rely heavily on insurance companies as a source of long-term credit. 
The Department disagrees with the above statements, based on its 
analysis of several prominent sources of data regarding small business 
financing 16; its findings are summarized below.
---------------------------------------------------------------------------

    \16\ The studies analyzed include the Federal Reserve Board's, 
``Report to the Congress of Availability of Credit to Small 
Businesses,'' issued in October 1997; ``New Information on Lending 
to Small Businesses and Small Farms: the 1996 CAR Data,'' published 
in the Federal Reserve Bulletin in January 1998; and ``Bank and 
Nonbank Competition for Small Business Credit: Evidence from the 
1987 and 1993 National Surveys of Small Business Finances,'' 
published in the Federal Reserve Bulletin in November 1996.

---------------------------------------------------------------------------

[[Page 638]]

    The Federal Reserve Board's 1997 ``Report to the Congress on the 
Availability of Credit to Small Business,'' indicates that small 
business credit needs continue to be met primarily by commercial banks. 
The report also documents that business debt growth has risen steadily 
since 1993, at an average rate of 5 percent, and that the increasing 
credit demands of small companies seem to have been easily accommodated 
by financial intermediaries and in the capital markets overall.
    Assuming the insurance industry's supply of long-term lending is 
somewhat less than their 10 percent participation in the credit market 
overall, it appears from these recent debt growth trends that other 
financial institutions and suppliers of capital would be able to fill 
any gap left by an insurance retrenchment in long-term lending/
investment.
    The Federal Reserve Board's 1998 report, ``New Information on 
Lending to Small Businesses and Small Farms: the 1996 CAR Data,'' 
indicates that a vast majority of the reported small business loans 
were either originated or purchased by commercial banks or their 
affiliates. As of year-end 1996, of the total dollar amount of $146.98 
billion loaned, commercial banks originated or purchased 95.6 percent, 
or $140.5 billion. Other institutions originated the remaining 4.4 
percent.
    The Federal Reserve Board's 1996 study, ``Bank and Nonbank 
Competition for Small Business Credit: Evidence from the 1987 and 1993 
National Surveys of Small Business Finances,'' reported on the 
competition for small business credit, and the sources of credit used 
by small firms, including credit lines, mortgage loans, equipment 
loans, motor vehicle loans, and ``other'' loans.17 The 
survey reports that as of 1993, insurance and mortgage companies 
together provided a 1.9 percent dollar share of the outstanding credit 
lent to small businesses by nonbank institutions (nonbanks provided 
38.7 percent of all outstanding credit, versus 61.3 percent provided by 
banks).
---------------------------------------------------------------------------

    \17\ ``Other'' loans refer to loans not elsewhere classified, 
primarily unsecured term loans and loans collateralized by assets 
other than real estate, equipment loans, motor vehicles and loans 
not taken down under credit lines.
---------------------------------------------------------------------------

    In sum, the Department believes that the statistics included in the 
above-discussed Federal Reserve reports and surveys point to the 
conclusion that commercial banks are the major supplier of credit 
financing to small businesses. The reports further show that the 
insurance industry's participation is not large in the long-term credit 
markets overall, nor is the insurance industry a large provider of 
financing for small to medium-sized firms. Therefore, we do not believe 
an insurance industry retrenchment from longer term debt investing will 
adversely affect capital investments or small business financing.
    Several commentators stated that not only are insurers a major 
source of long-term lending, but further posited that if insurers 
retrenched from the long-term debt market, the results would be a 
decrease in the amount of capital allocated to long-term projects, 
which in turn could have a detrimental impact on the private placement 
markets, which predominantly serve small and medium-sized businesses. 
Ultimately, this would have a negative effect on the availability of 
financing for small businesses. One commentator in the investment 
banking field supported this argument by stating that of the $20 
billion total the commentator placed in private securities in 1997, 
life insurance companies bought 80 percent, or $16 billion of the 
offerings.
    This statistic does not present a full picture of the private 
placement market, nor does it shed any light about the magnitude, 
influence or significance of insurers' participation in the market. It 
further does not provide any pertinent information about small 
business' dependence on or utilization of this source of capital.
    The Department has found significant evidence to refute the 
commentators' above concerns. A study conducted specifically on the 
private placement markets, published in August, 1998 18 
gives an overview of the nature of the private equity and debt markets 
19 in which small businesses are financed.
---------------------------------------------------------------------------

    \18\ ``The Economics of Small Business Finance: The Roles of 
Private Equity and Debt Markets in the Financial Growth Cycle,'' 
Journal of Banking and Finance, Volume 22.
    \19\ Private equity and debt are also referred to as private 
placements, and make up the private placement market.
---------------------------------------------------------------------------

    This study reports data on the distribution of private financing 
for U.S. small businesses. Generally, it shows that within the private 
placement markets, small firms depend on both private equity (49.6 
percent) and private debt (50.4 percent).
    The largest source of private equity financing is the ``principal 
owner'' (typically the person who has the largest ownership share and 
has the primary authority to make financial decisions) at 31.3 percent 
of the total market, which represents 66 percent of total private 
equity. The next biggest equity category is ``other equity'' at 12.86 
percent, which includes members of the start-up team other than the 
owner, family and friends. ``Angel finance'' accounts for an estimated 
3.59 percent. (``Angels'' are high net worth individuals who provide 
direct funding to early-stage new businesses). Venture capital provides 
1.86 percent of small business private equity financing.
    There are nine categories of debt which are divided into three 
categories of funding that are provided by financial institutions--
commercial banks providing 18.75 percent of total finance, finance 
companies 4.91 percent and other financial institutions 20 
3.00 percent; the six other categories funded by nonfinancial and 
government sources make up the remainder of private debt funding.
---------------------------------------------------------------------------

    \20\ ``Other'' financial institutions include thrift 
institutions, leasing companies, brokerage firms, mortgage companies 
and insurance companies.
---------------------------------------------------------------------------

    In summary, insurance companies at most may provide some portion of 
the 1.86 percent in small business equity financing funded by the 
venture capital sector. Alternatively, they at most may provide some 
portion of the 3% funded by ``other'' financial institutions to the 
small business private debt market, which includes 4 other types of 
institutional investors.
    The Department believes that these figures clearly show the 
commentators' concerns about the regulation's effect on the private 
placement market, and ultimately, small business financing, to be 
unfounded.

Small Business Regulatory Enforcement Fairness Act

    The final rule being issued here is subject to the provisions of 
the Small Business Regulatory Enforcement Act of 1996 (5 U.S.C. 801 et 
seq.) (SBREFA) and has been transmitted to the Congress and the 
Comptroller General for review.

Unfunded Mandates Reform Act

    For purposes of the Unfunded Mandates Reform Act of 1995 (Pub. L. 
104-4), as well as Executive Order 12875, this final rule does not 
include any Federal mandate that may result in the expenditure by 
state, local and tribal governments in the aggregate, or by the private 
sector, of $100,000,000 or more in any one year.

Statutory Authority

    The regulation set forth herein is issued pursuant to the authority 
contained in sections 401(c) and 505 of ERISA (Pub. L. 93-406, Pub. L. 
104-188,

[[Page 639]]

88 Stat. 894; 29 U.S.C. 1101(c), 29 U.S.C. 1135) and section 102 of 
Reorganization Plan No. 4 of 1978 (43 FR 47713, October 17, 1978), 
effective December 31, 1978 (44 FR 1065, January 3, 1979), 3 CFR 1978 
Comp. 332, and under Secretary of Labor's Order No. 1-87, 52 FR 13139 
(April 21, 1987).

List of Subjects in 29 CFR Part 2550

    Employee benefit plans, Employee Retirement Income Security Act, 
Employee stock ownership plans, Exemptions, Fiduciaries, Insurance 
Companies, Investments, Investment foreign, Party in interest, 
Pensions, Pension and Welfare Benefit Programs Office, Prohibited 
transactions, Real estate, Securities, Surety bonds, Trusts and 
Trustees.

    For the reasons discussed in the preamble, 29 CFR Part 2550 is 
amended as follows:

PART 2550--[AMENDED]

    1. The authority for part 2550 is revised to read as follows:

    Authority: 29 U.S.C. 1135. Section 2550.401b-1 also issued under 
sec. 102, Reorganization Plan No. 4 of 1978, 3 CFR, 1978 Comp., p. 
332. Section 2550.401c-1 also issued under 29 U.S.C. 1101. Section 
2550.404c-1 also issued under 29 U.S.C. 1104. Section 2550.407c-3 
also issued under 29 U.S.C. 1107. Section 2550.408b-1 also issued 
under sec. 102, Reorganization Plan No. 4 of 1978, 3 CFR, 1978 
Comp., p. 332, and 29 U.S.C. 1108(b)(1). Section 2550.412-1 also 
issued under 29 U.S.C. 1112. Secretary of Labor's Order No. 1-87 (52 
FR 13139).

    2. New Sec. 2550.401c-1 is added to read as follows:


Sec. 2550.401c-1  Definition of ``plan assets''--insurance company 
general accounts.

    (a) In general. (1) This section describes, in the case where an 
insurer issues one or more policies to or for the benefit of an 
employee benefit plan (and such policies are supported by assets of an 
insurance company's general account), which assets held by the insurer 
(other than plan assets held in its separate accounts) constitute plan 
assets for purposes of Subtitle A, and Parts 1 and 4 of Subtitle B, of 
Title I of the Employee Retirement Income Security Act of 1974 (ERISA 
or the Act) and section 4975 of the Internal Revenue Code (the Code), 
and provides guidance with respect to the application of Title I of the 
Act and section 4975 of the Code to the general account assets of 
insurers.
    (2) Generally, when a plan has acquired a Transition Policy (as 
defined in paragraph (h)(6) of this section), the plan's assets include 
the Transition Policy, but do not include any of the underlying assets 
of the insurer's general account if the insurer satisfies the 
requirements of paragraphs (c) through (f) of this section or, if the 
requirements of paragraphs (c) through (f) were not satisfied, the 
insurer cures the non-compliance through satisfaction of the 
requirements in paragraph (i)(5) of this section.
    (3) For purposes of paragraph (a)(2) of this section, a plan's 
assets will not include any of the underlying assets of the insurer's 
general account if the insurer fails to satisfy the requirements of 
paragraphs (c) through (f) of this section solely because of the 
takeover of the insurer's operations from management as a result of the 
granting of a petition filed in delinquency proceedings in the State 
court where the insurer is domiciled.
    (b) Approval by fiduciary independent of the issuer. (1) In 
general. An independent plan fiduciary who has the authority to manage 
and control the assets of the plan must expressly authorize the 
acquisition or purchase of the Transition Policy. For purposes of this 
paragraph, a fiduciary is not independent if the fiduciary is an 
affiliate of the insurer issuing the policy.
    (2) Notwithstanding paragraph (b)(1) of this section, the 
authorization by an independent plan fiduciary is not required if:
    (i) The insurer is the employer maintaining the plan, or a party in 
interest which is wholly owned by the employer maintaining the plan; 
and
    (ii) The requirements of section 408(b)(5) of the Act are 
met.1
---------------------------------------------------------------------------

    \1\ The Department notes that, because section 401(c)(1)(D) of 
the Act and the definition of Transition Policy preclude the 
issuance of any additional Transition Policies after December 31, 
1998, the requirement for independent fiduciary authorization of the 
acquisition or purchase of the Transition Policy in paragraph (b) no 
longer has any application.
---------------------------------------------------------------------------

    (c) Duty of disclosure. (1) In general. An insurer shall furnish 
the information described in paragraphs (c)(3) and (c)(4) of this 
section to a plan fiduciary acting on behalf of a plan to which a 
Transition Policy has been issued. Paragraph (c)(2) of this section 
describes the style and format of such disclosure. Paragraph (c)(3) of 
this section describes the content of the initial disclosure. Paragraph 
(c)(4) of this section describes the information that must be disclosed 
by the insurer at least once per year for as long as the Transition 
Policy remains outstanding.
    (2) Style and format. The disclosure required by this paragraph 
should be clear and concise and written in a manner calculated to be 
understood by a plan fiduciary, without relinquishing any of the 
substantive detail required by paragraphs (c)(3) and (c)(4) of this 
section. The information does not have to be organized in any 
particular order but should be presented in a manner which makes it 
easy to understand the operation of the Transition Policy.
    (3) Initial disclosure. The insurer must provide to the plan, 
either as part of an amended policy, or as a separate written document, 
the disclosure information set forth in paragraphs (c)(3)(i) through 
(iv) of this section. The disclosure must include all of the following 
information which is applicable to the Transition Policy:
    (i) A description of the method by which any income and any expense 
of the insurer's general account are allocated to the policy during the 
term of the policy and upon its termination, including:
    (A) A description of the method used by the insurer to determine 
the fees, charges, expenses or other amounts that are, or may be, 
assessed against the policyholder or deducted by the insurer from any 
accumulation fund under the policy, including the extent and frequency 
with which such fees, charges, expenses or other amounts may be 
modified by the insurance company;
    (B) A description of the method by which the insurer determines the 
return to be credited to any accumulation fund under the policy, 
including a description of the method used to allocate income and 
expenses to lines of business, business segments, and policies within 
such lines of business and business segments, and a description of how 
any withdrawals, transfers, or payments will affect the amount of the 
return credited;
    (C) A description of the rights which the policyholder or plan 
participants have to withdraw or transfer all or a portion of any 
accumulation fund under the policy, or to apply the amount of a 
withdrawal to the purchase of guaranteed benefits or to the payment of 
benefits, and the terms on which such withdrawals or other applications 
of funds may be made, including a description of any charges, fees, 
credits, market value adjustments, or any other charges or adjustments, 
both positive and negative;
    (D) A statement of the method used to calculate any charges, fees, 
credits or market value adjustments described in paragraph (c)(3)(i)(C) 
of this section, and, upon the request of a plan fiduciary, the insurer 
must provide within 30 days of the request:
    (1) The formula actually used to calculate the market value 
adjustment, if any, to be applied to the unallocated

[[Page 640]]

amount in the accumulation fund upon distribution of a lump sum payment 
to the policyholder, and
    (2) The actual calculation, as of a specified date that is no 
earlier than the last contract anniversary preceding the date of the 
request, of the applicable market value adjustment, including a 
description of the specific variables used in the calculation, the 
value of each of the variables, and a general description of how the 
value of each of those variables was determined.
    (3) If the formula is based on interest rate guarantees applicable 
to new contracts of the same class or classes, and the duration of the 
assets underlying the accumulation fund, the contract must describe the 
process by which those components are ascertained or obtained. If the 
formula is based on an interest rate implicit in an index of publicly 
traded obligations, the identity of the index, the manner in which it 
is used, and identification of the source or publication where any data 
used in the formula can be found, must be disclosed;
    (ii) A statement describing the expense, income and benefit 
guarantees under the policy, including a description of the length of 
such guarantees, and of the insurer's right, if any, to modify or 
eliminate such guarantees;
    (iii) A description of the rights of the parties to make or 
discontinue contributions under the policy, and of any restrictions 
(such as timing, minimum or maximum amounts, and penalties and grace 
periods for late payments) on the making of contributions under the 
policy, and the consequences of the discontinuance of contributions 
under the policy; and
    (iv) A statement of how any policyholder or participant-initiated 
withdrawals are to be made: first-in, first-out (FIFO) basis, last-in, 
first-out (LIFO) basis, pro rata or another basis.
    (4) Annual disclosure. At least annually and not later than 90 days 
following the period to which it relates, an insurer shall provide the 
following information to each plan to which a Transition Policy has 
been issued:
    (i) The balance of any accumulation fund on the first day and last 
day of the period covered by the annual report;
    (ii) Any deposits made to the accumulation fund during such annual 
period;
    (iii) An itemized statement of all income attributed to the policy 
or added to the accumulation fund during the period, and a description 
of the method used by the insurer to determine the precise amount of 
income;
    (iv) The actual rate of return credited to the accumulation fund 
under the policy during such period, stating whether the rate of return 
was calculated before or after deduction of expenses charged to the 
accumulation fund;
    (v) Any other additions to the accumulation fund during such 
period;
    (vi) An itemized statement of all fees, charges, expenses or other 
amounts assessed against the policy or deducted from the accumulation 
fund during the reporting year, and a description of the method used by 
the insurer to determine the precise amount of the fees, charges and 
other expenses;
    (vii) An itemized statement of all benefits paid, including annuity 
purchases, to participants and beneficiaries from the accumulation 
fund;
    (viii) The dates on which the additions or subtractions were 
credited to, or deducted from, the accumulation fund during such 
period;
    (ix) A description, if applicable, of all transactions with 
affiliates which exceed 1 percent of group annuity reserves of the 
general account for the prior reporting year;
    (x) A statement describing any expense, income and benefit 
guarantees under the policy, including a description of the length of 
such guarantees, and of the insurer's right, if any, to modify or 
eliminate such guarantees. However, the information on guarantees does 
not have to be provided annually if it was previously disclosed in the 
insurance policy and has not been modified since that time;
    (xi) A good faith estimate of the amount that would be payable in a 
lump sum at the end of such period pursuant to the request of a 
policyholder for payment or transfer of amounts in the accumulation 
fund under the policy after the insurer deducts any applicable charges 
and makes any appropriate market value adjustments, upward or downward, 
under the terms of the policy. However, upon the request of a plan 
fiduciary, the insurer must provide within 30 days of the request the 
information contained in paragraph (c)(3)(i)(D) as of a specified date 
that is no earlier than the last contract anniversary preceding the 
date of the request; and
    (xii) An explanation that the insurer will make available promptly 
upon request of a plan, copies of the following publicly available 
financial data or other publicly available reports relating to the 
financial condition of the insurer:
    (A) National Association of Insurance Commissioners Statutory 
Annual Statement, with Exhibits, General Interrogatories, and Schedule 
D, Part 1A, Sections 1 and 2 and Schedule S--Part 3E;
    (B) Rating agency reports on the financial strength and claims-
paying ability of the insurer;
    (C) Risk adjusted capital ratio, with a brief description of its 
derivation and significance, referring to the risk characteristics of 
both the assets and the liabilities of the insurer;
    (D) Actuarial opinion of the insurer's Appointed Actuary certifying 
the adequacy of the insurer's reserves as required by New York State 
Insurance Department Regulation 126 and comparable regulations of other 
States; and
    (E) The insurer's most recent SEC Form 10K and Form 10Q (stock 
companies only).
    (d) Alternative separate account arrangements. (1) In general. An 
insurer must provide the plan fiduciary with the following additional 
information at the same time as the initial disclosure required under 
paragraph (c)(3) of this section:
    (i) A statement explaining the extent to which alternative contract 
arrangements supported by assets of separate accounts of insurers are 
available to plans;
    (ii) A statement as to whether there is a right under the policy to 
transfer funds to a separate account and the terms governing any such 
right; and
    (iii) A statement explaining the extent to which general account 
contracts and separate account contracts of the insurer may pose 
differing risks to the plan.
    (2) An insurer will be deemed to comply with the requirements of 
paragraph (d)(1)(iii) of this section if the disclosure provided to the 
plan includes the following statement:

    a. Contractual arrangements supported by assets of separate 
accounts may pose differing risks to plans from contractual 
arrangements supported by assets of general accounts. Under a 
general account contract, the plan's contributions or premiums are 
placed in the insurer's general account and commingled with the 
insurer's corporate funds and assets (excluding separate accounts 
and special deposit funds). The insurance company combines in its 
general account premiums received from all of its lines of business. 
These premiums are pooled and invested by the insurer. General 
account assets in the aggregate support the insurer's obligations 
under all of its insurance contracts, including (but not limited to) 
its individual and group life, health, disability, and annuity 
contracts. Experience rated general account policies may share in 
the experience of the general account through interest credits, 
dividends, or rate adjustments, but assets in the general account 
are not segregated for the exclusive benefit of any particular 
policy or obligation. General

[[Page 641]]

account assets are also available to the insurer for the conduct of 
its routine business activities, such as the payment of salaries, 
rent, other ordinary business expenses and dividends.
    b. An insurance company separate account is a segregated fund 
which is not commingled with the insurer's general assets. Depending 
on the particular terms of the separate account contract, income, 
expenses, gains and losses associated with the assets allocated to a 
separate account may be credited to or charged against the separate 
account without regard to other income, expenses, gains, or losses 
of the insurance company, and the investment results passed through 
directly to the policyholders. While most, if not all, general 
account investments are maintained at book value, separate account 
investments are normally maintained at market value, which can 
fluctuate according to market conditions. In large measure, the 
risks associated with a separate account contract depend on the 
particular assets in the separate account.
    c. The plan's legal rights vary under general and separate 
account contracts. In general, an insurer is subject to ERISA's 
fiduciary responsibility provisions with respect to the assets of a 
separate account (other than a separate account registered under the 
Investment Company Act of 1940) to the extent that the investment 
performance of such assets is passed directly through to the plan 
policyholders. ERISA requires insurers, in administering separate 
account assets, to act solely in the interest of the plan's 
participants and beneficiaries; prohibits self-dealing and conflicts 
of interest; and requires insurers to adhere to a prudent standard 
of care. In contrast, ERISA generally imposes less stringent 
standards in the administration of general account contracts which 
were issued on or before December 31, 1998.
    d. On the other hand, State insurance regulation is typically 
more restrictive with respect to general accounts than separate 
accounts. However, State insurance regulation may not provide the 
same level of protection to plan policyholders as ERISA regulation. 
In addition, insurance company general account policies often 
include various guarantees under which the insurer assumes risks 
relating to the funding and distribution of benefits. Insurers do 
not usually provide any guarantees with respect to the investment 
returns on assets held in separate accounts. Of course, the extent 
of any guarantees from any general account or separate account 
contract will depend upon the specific policy terms.
    e. Finally, separate accounts and general accounts pose 
differing risks in the event of the insurer's insolvency. In the 
event of insolvency, funds in the general account are available to 
meet the claims of the insurer's general creditors, after payment of 
amounts due under certain priority claims, including amounts owed to 
its policyholders. Funds held in a separate account as reserves for 
its policy obligations, however, may be protected from the claims of 
creditors other than the policyholders participating in the separate 
account. Whether separate account funds will be granted this 
protection will depend upon the terms of the applicable policies and 
the provisions of any applicable laws in effect at the time of 
insolvency.

    (e) Termination procedures. Within 90 days of written notice by a 
policyholder to an insurer, the insurer must permit the policyholder to 
exercise the right to terminate or discontinue the policy and to elect 
to receive without penalty either:
    (1) A lump sum payment representing all unallocated amounts in the 
accumulation fund. For purposes of this paragraph (e)(1), the term 
penalty does not include a market value adjustment (as defined in 
paragraph (h)(7)of this section) or the recovery of costs actually 
incurred which would have been recovered by the insurer but for the 
termination or discontinuance of the policy, including any unliquidated 
acquisition expenses, to the extent not previously recovered by the 
insurer; or
    (2) A book value payment of all unallocated amounts in the 
accumulation fund under the policy in approximately equal annual 
installments, over a period of no longer than 10 years, together with 
interest computed at an annual rate which is no less than the annual 
rate which was credited to the accumulation fund under the policy as of 
the date of the contract termination or discontinuance, minus 1 
percentage point. Notwithstanding paragraphs (e)(1) and (e)(2) of this 
section, the insurer may defer, for a period not to exceed 180 days, 
amounts required to be paid to a policyholder under this paragraph for 
any period of time during which regular banking activities are 
suspended by State or federal authorities, a national securities 
exchange is closed for trading (except for normal holiday closings), or 
the Securities and Exchange Commission has determined that a state of 
emergency exists which may make such determination and payment 
impractical.
    (f) Insurer-initiated amendments. In the event the insurer makes an 
insurer-initiated amendment (as defined in paragraph (h)(8) of this 
section), the insurer must provide written notice to the plan at least 
60 days prior to the effective date of the insurer-initiated amendment. 
The notice must contain a complete description of the amendment and 
must inform the plan of its right to terminate or discontinue the 
policy and withdraw all unallocated funds without penalty by sending a 
written request within such 60 day period to the name and address 
contained in the notice. The plan must be offered the election to 
receive either a lump sum or an installment payment as described in 
paragraph (e)(1) and (e)(2) of this section. An insurer-initiated 
amendment shall not apply to a contract if the plan fiduciary exercises 
its right to terminate or discontinue the contract within such 60 day 
period and to receive a lump sum or installment payment.
    (g) Prudence. An insurer shall manage those assets of the insurer 
which are assets of such insurer's general account (irrespective of 
whether any such assets are plan assets) 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, 
taking into account all obligations supported by such enterprise. This 
prudence standard applies to the conduct of all insurers with respect 
to policies issued to plans on or before December 31, 1998, and differs 
from the prudence standard set forth in section 404(a)(1)(B) of the 
Act. Under the prudence standard provided in this paragraph, prudence 
must be determined by reference to all of the obligations supported by 
the general account, not just the obligations owed to plan 
policyholders. The more stringent standard of prudence set forth in 
section 404(a)(1)(B) of the Act continues to apply to any obligations 
which insurers may have as fiduciaries which do not arise from the 
management of general account assets, as well as to insurers' 
management of plan assets maintained in separate accounts. The terms of 
this section do not modify or reduce the fiduciary obligations 
applicable to insurers in connection with policies issued after 
December 31, 1998, which are supported by general account assets, 
including the standard of prudence under section 404(a)(1)(B) of the 
Act.
    (h) Definitions. For purposes of this section:
    (1) An affiliate of an insurer means:
    (i) Any person, directly or indirectly, through one or more 
intermediaries, controlling, controlled by, or under common control 
with the insurer,
    (ii) Any officer of, director of, 5 percent or more partner in, or 
highly compensated employee (earning 5 percent or more of the yearly 
wages of the insurer) of, such insurer or of any person described in 
paragraph (h)(1)(i) of this section including in the case of an 
insurer, an insurance agent or broker thereof (whether or not such 
person is a common law employee) if such agent or broker is an employee 
described in this paragraph or if the gross income received by such 
agent or broker from such insurer exceeds 5 percent of such agent's 
gross income from all sources for the year, and

[[Page 642]]

    (iii) Any corporation, partnership, or unincorporated enterprise of 
which a person described in paragraph (h)(1)(ii) of this section is an 
officer, director, or a 5 percent or more partner.
    (2) The term control means the power to exercise a controlling 
influence over the management or policies of a person other than an 
individual.
    (3) The term guaranteed benefit policy means a policy described in 
section 401(b)(2)(B) of the Act and any regulations promulgated 
thereunder.
    (4) The term insurer means an insurer as described in section 
401(b)(2)(A) of the Act.
    (5) The term accumulation fund means the aggregate net 
considerations (i.e., gross considerations less all deductions from 
such considerations) credited to the Transition Policy plus all 
additional amounts, including interest and dividends, credited to such 
Transition Policy less partial withdrawals, benefit payments and less 
all charges and fees imposed against this accumulated amount under the 
Transition Policy other than surrender charges and market value 
adjustments.
    (6) The term Transition Policy means:
    (i) A policy or contract of insurance (other than a guaranteed 
benefit policy) that is issued by an insurer to, or on behalf of, an 
employee benefit plan on or before December 31, 1998, and which is 
supported by the assets of the insurer's general account.
    (ii) A policy will not fail to be a Transition Policy merely 
because the policy is amended or modified:
    (A) To comply with the requirements of section 401(c) of the Act 
and this section; or
    (B) Pursuant to a merger, acquisition, demutualization, conversion, 
or reorganization authorized by applicable State law, provided that the 
premiums, policy guarantees, and the other terms and conditions of the 
policy remain the same, except that a membership interest in a mutual 
insurance company may be eliminated from the policy in exchange for 
separate consideration (e.g., shares of stock or policy credits).
    (7) For purposes of this section, the term market value adjustment 
means an adjustment to the book value of the accumulation fund to 
accurately reflect the effect on the value of the accumulation fund of 
its liquidation in the prevailing market for fixed income obligations, 
taking into account the future cash flows that were anticipated under 
the policy. An adjustment is a market value adjustment within the 
meaning of this definition only if the insurer has determined the 
amount of the adjustment pursuant to a method which was previously 
disclosed to the policyholder in accordance with paragraph (c)(3)(i)(D) 
of this section, and the method permits both upward and downward 
adjustments to the book value of the accumulation fund.
    (8) The term insurer-initiated amendment is defined in paragraphs 
(h)(8)(i), (ii) and (iii) of this section as:
    (i) An amendment to a Transition Policy made by an insurer pursuant 
to a unilateral right to amend the policy terms that would have a 
material adverse effect on the policyholder; or
    (ii) Any of the following unilateral changes in the insurer's 
conduct or practices with respect to the policyholder or the 
accumulation fund under the policy that result in a material reduction 
of existing or future benefits under the policy, a material reduction 
in the value of the policy or a material increase in the cost of 
financing the plan or plan benefits:
    (A) A change in the methodology for assessing fees, expenses, or 
other charges against the accumulation fund or the policyholder;
    (B) A change in the methodology used for allocating income between 
lines of business, or product classes within a line of business;
    (C) A change in the methodology used for determining the rate of 
return to be credited to the accumulation fund under the policy;
    (D) A change in the methodology used for determining the amount of 
any fees, charges, expenses, or market value adjustments applicable to 
the accumulation fund under the policy in connection with the 
termination of the contract or withdrawal from the accumulation fund;
    (E) A change in the dividend class to which the policy or contract 
is assigned;
    (F) A change in the policyholder's rights in connection with the 
termination of the policy, withdrawal of funds or the purchase of 
annuities for plan participants; and
    (G) A change in the annuity purchase rates guaranteed under the 
terms of the contract or policy, unless the new rates are more 
favorable for the policyholder.
    (iii) For purposes of this definition, an insurer-initiated 
amendment is material if a prudent fiduciary could reasonably conclude 
that the amendment should be considered in determining how or whether 
to exercise any rights with respect to the policy, including 
termination rights.
    (iv) For purposes of this definition, the following amendments or 
changes are not insurer-initiated amendments:
    (A) Any amendment or change which is made with the affirmative 
consent of the policyholder;
    (B) Any amendment or change which is made in order to comply with 
the requirements of section 401(c) of the Act and this section; or
    (C) Any amendment or change which is made pursuant to a merger, 
acquisition, demutualization, conversion, or reorganization authorized 
by applicable State law, provided that the premiums, policy guarantees, 
and the other terms and conditions of the policy remain the same, 
except that a membership interest in a mutual insurance company may be 
eliminated from the policy in exchange for separate consideration 
(e.g., shares of stock or policy credits).
    (i) Limitation on liability. (1) No person shall be subject to 
liability under Parts 1 and 4 of Title I of the Act or section 4975 of 
the Internal Revenue Code of 1986 for conduct which occurred prior to 
the applicability dates of the regulation on the basis of a claim that 
the assets of an insurer (other than plan assets held in a separate 
account) constitute plan assets. Notwithstanding the provisions of this 
paragraph (i)(1), this section shall not:
    (i) Apply to an action brought by the Secretary of Labor pursuant 
to paragraphs (2) or (5) of section 502(a) of ERISA for a breach of 
fiduciary responsibility which would also constitute a violation of 
Federal or State criminal law;
    (ii) Preclude the application of any Federal criminal law; or
    (iii) Apply to any civil action commenced before November 7, 1995.
    (2) Nothing in this section relieves any person from any State law 
regulating insurance which imposes additional obligations or duties 
upon insurers to the extent not inconsistent with the provisions of 
this section. Therefore, nothing in this section should be construed to 
preclude a State from requiring insurers to make additional disclosures 
to policyholders, including plans. Nor does this section prohibit a 
State from imposing additional substantive requirements with respect to 
the management of general accounts or from otherwise regulating the 
relationship between the policyholder and the insurer to the extent not 
inconsistent with the provisions of this section.
    (3) Nothing in this section precludes any claim against an insurer 
or other person for violations of the Act which do not require a 
finding that the underlying assets of a general account constitute plan 
assets, regardless of whether the violation relates to a Transition 
Policy.
    (4) If the requirements in paragraphs (c) through (f) of this 
section are not met

[[Page 643]]

with respect to a plan that has purchased or acquired a Transition 
Policy, and the insurer has not cured the non-compliance through 
satisfaction of the requirements in paragraph (i)(5) of this section, 
the plan's assets include an undivided interest in the underlying 
assets of the insurer's general account for that period of time for 
which the requirements are not met. However, an insurer's failure to 
comply with the requirements of this section with respect to any 
particular Transition Policy will not result in the underlying assets 
of the general account constituting plan assets with respect to other 
Transition Policies if the insurer is otherwise in compliance with the 
requirements contained in this section.
    (5) Notwithstanding paragraphs (a)(2) and (i)(4) of this section, a 
plan's assets will not include an undivided interest in the underlying 
assets of the insurer's general account if the insurer made reasonable 
and good faith attempts at compliance with each of the requirements of 
paragraphs (c) through (f) of this section, and meets each of the 
following conditions:
    (i) The insurer has in place written procedures that are reasonably 
designed to assure compliance with the requirements of paragraphs (c) 
through (f) of this section, including procedures reasonably designed 
to detect any instances of non-compliance.
    (ii) No later than 60 days following the earlier of the insurer's 
detection of an instance of non-compliance or the receipt of written 
notice of non-compliance from the plan, the insurer complies with the 
requirements of paragraphs (c) through (f) of this section. If the 
insurer has failed to pay a plan the amounts required under paragraphs 
(e) or (f) of this section within 90 days of receiving written notice 
of termination or discontinuance of the policy, the insurer must make 
all corrections and adjustments necessary to restore to the plan the 
full amounts that the plan would have received but for the insurer's 
non-compliance within the applicable 60 day period; and
    (iii) The insurer makes the plan whole for any losses resulting 
from the non-compliance as follows:
    (A) If the insurer has failed to comply with the disclosure or 
notice requirements set forth in paragraphs (c), (d) and (f) of this 
section, then the insurer must make the plan whole for any losses 
resulting from its non-compliance within the earlier of 60 days of 
detection by the insurer or sixty days following the receipt of written 
notice from the plan; and
    (B) If the insurer has failed to pay a plan any amounts required 
under paragraphs (e) or (f) of this section within 90 days of receiving 
written notice of termination or discontinuance of the policy, the 
insurer must pay to the plan interest on any amounts restored pursuant 
to paragraph (i)(5)(ii) of this section at the ``underpayment rate'' as 
set forth in 26 U.S.C. sections 6621 and 6622. Such interest must be 
paid within the earlier of 60 days of detection by the insurer or sixty 
days following receipt of written notice of non-compliance from the 
plan.
    (j) Applicability dates. (1) In general. Except as provided in 
paragraphs (j)(2) through (4) of this section, this section is 
applicable on July 5, 2001.
    (2) Paragraph (c) relating to initial disclosures and paragraph (d) 
relating to separate account disclosures are applicable on July 5, 
2000.
    (3) The first annual disclosure required under paragraph(c)(4) of 
this section shall be provided to each plan not later than 18 months 
following January 5, 2000.
    (4) Paragraph (f), relating to insurer-initiated amendments, is 
applicable on January 5, 2000.
    (k) Effective date. This section is effective January 5, 2000.

    Signed at Washington, D.C. this 21st day of December, 1999.
Leslie Kramerich,
Acting Assistant Secretary for Pension and Welfare Benefits 
Administration, U.S. Department of Labor.
[FR Doc. 00-32 Filed 01-04-00; 8:45 am]
BILLING CODE 4510-29-P