Insurance Company General Accounts [01/05/2000]
Volume 65, Number 3, Page 613-643
[[Page 613]]
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
[[Page 616]]
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.
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\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 |
