Earlier this week, the U.S. Department of Labor issued final rules pertaining to annuity purchases by retirement plan fiduciaries.  Both defined benefit pension plans and defined contribution plans (the latter often  referred to as “individual account plans”) may encounter situations where plan fiduciaries will purchase an individual annuity contract  to provide benefit distributions to one or more individual participants.  Such a purchase invokes fiduciary duties under ERISA, and in 1995 the DOL issued guidance on selecting the “safest annuity available” for defined benefit pension plans, which it later opined should apply to defined contribution plans.  The Pension Protection Act of 2006 (PPA) directed the DOL to issue regulations clarifying that annuity contract selection for defined contribution plans was not subject to the 1995 guidance, but is subject to otherwise applicable fiduciary standards.  This essentially appears to allow for a less stringent standard for defined contribution plan fiduciaries in selecting annuity contracts, perhaps to encourage greater use of income annuities in such plans.  Final regulations and an accompanying final rule modifying the 1995 guidance issued earlier this week fulfill the PPA directive, while providing a safe harbor for fiduciaries making annuity purchases in individual account plans.

Under the final regulations, a fiduciary satisfies the requirements for the safe harbor when it:

(1)  Engages in an objective, thorough and analytical search for the purpose of identifying and selecting providers from which to purchase annuities;
(2)  Appropriately considers information sufficient to assess the ability of the annuity provider to make all future payments under the annuity contract;
(3)  Appropriately considers the cost (including fees and commissions) of the annuity contract in relation to the benefits and administrative services to be provided under such contract;
(4)  Appropriately concludes that, at the time of the selection, the annuity provider is financially able to make all future payments under the annuity contract and the cost of the annuity contract is reasonable in relation to the benefits and services to be provided under the contract; and
(5)  If necessary, consults with an appropriate expert or experts for purposes of compliance with the above steps.

The final regulations eliminated provisions from proposed regulations issued in September 2007 which directed fiduciaries to consider certain information, including an “annuity provider’s ratings by insurance ratings services” and the “availability and extent of additional protection through state guaranty associations.”  However, the preamble specifically noted that this information may nonetheless be useful to fiduciaries in meeting the safe harbor conditions.

Again, the final regulations only establish a safe harbor, and meeting the conditions of the safe harbor in selecting annuities for individual account plans is not the sole means by which fiduciaries can satisfy their fiduciary duties.  The final regulations also clarify that the safe harbor is not intended to set minimum requirements for satisfying fiduciary obligations.

Much has been written recently about advantages of using annuities to provide guaranteed lifetime income to defined contribution plan participants.  Fiduciaries who are required, or who elect to provide such annuities, may want to consider satisfying the safe harbor in meeting their fiduciary duties (including documenting steps taken in doing so).