12328 Federal Register / Vol. 60, No. 43 / Monday, March 6, 1995 / Rules and Regulations

1 In particular, the interpretive bulletin does not

address fiduciary responsibilities in connection

with the purchase of annuities for investment

purposes. See infra note 5.

2This regulation defines the term ‘‘participant

covered under the plan’’ for certain purposes under

title I of ERISA. The Department notes that the

regulation was issued primarily to define the class

of participants entitled to receive copies of certain

plan documents without charge and without

request under ERISA sections 101(a) and 104(b)(1),

29 U.S.C. 1021(a) and 1024(b)(1). 40 FR 24649 (June

9, 1975), 40 FR 34528 (Aug. 15, 1975). A premise

of the regulation was that, by using the term

‘‘participant covered under the plan,’’ Congress had

provided a ground for distinguishing between the

class of all participants within the meaning of

ERISA § 3(7) and participants entitled to receive

copies of plan documents without charge and

without request. 40 FR 24649 (June 9, 1975). Thus,

the regulation is not intended to define the term

‘‘participant’’ or ‘‘beneficiary’’ for all purposes

under ERISA, and, in particular, is not intended to

define these terms for purposes of standing to bring

a civil action under ERISA section 502(a), 29 U.S.C.

1132(a).

3On March 13, 1986, the Department released an

information letter addressed to John N. Erlenborn,

who was then the Chairman of the Advisory

Council on Employee Welfare and Plans. In the

letter, the Department stated in pertinent part:

Consistent with the functional analysis of

fiduciary activity, the choice of an insurer would

appear to involve the type of discretionary authority

over the disposition of plan assets covered in

section 3(21)(A) [of ERISA]. . . . Therefore, it

appears that the fiduciary provisions of ERISA,

including the prudence requirement of section

404(a)(1)(B), will apply to the choice of an insurer

to issue annuities upon plan termination.

DEPARTMENT OF LABOR

Pension and Welfare Benefits

Administration

29 CFR Part 2509

[Interpretive Bulletin No. 95–1]

Interpretive Bulletins Relating to the

Employee Retirement Income Security

Act of 1974

AGENCY: PWBA, Department of Labor.

ACTION: Interpretive Bulletin.

SUMMARY: This document announces the

Department of Labor’s (the

Department’s) view of the legal standard

imposed by section 404(a)(1) (A) and (B)

of part 4 of title I of the Employee

Retirement Income Security Act of 1974

(ERISA) on a plan fiduciary’s selection

of an annuity provider when purchasing

annuities for the purpose of distributing

benefits under an employee pension

benefit plan. Under this standard, plan

fiduciaries choosing to purchase

annuities have a duty to select the safest

available annuity provider, unless under

the circumstances it would be in the

interests of participants and

beneficiaries to do otherwise. The

document also provides guidance to

plan fiduciaries regarding circumstances

when it may be in the interest of the

participants and beneficiaries to

purchase other than the safest available

annuity.

EFFECTIVE DATE: The standard

announced in this bulletin is effective

January 1, 1975.

FOR FURTHER INFORMATION CONTACT:

William W. Taylor, Plan Benefits

Security Division, Office of the

Solicitor, U.S. Department of Labor, Rm

N–4611, 200 Constitution Ave., NW.,

Washington, DC 20210, (telephone (202)

219–9141) or Mark Connor, Office of

Regulations and Interpretations, Pension

and Welfare Benefits Administration,

U.S. Department of Labor, Rm N–5669,

200 Constitution Avenue NW.,

Washington, DC 20210, (telephone (202)

219–8671). These are not toll-free

numbers.

SUPPLEMENTARY INFORMATION: In order to

provide a concise and ready reference to

its interpretations of ERISA, the

Department of Labor publishes its

Interpretive Bulletins in the Rules and

Regulations section of the Federal

Register.

Published in this issue of the Federal

Register is ERISA Interpretive Bulletin

95–1, which describes the application of

the fiduciary standards set forth in

section 404(a)(1) (A) and (B) of ERISA,

29 U.S.C. 1104(a)(1) (A) and (B), in

selecting an insurer to provide pension

benefit distribution annuities to plan

participants and beneficiaries. The

Department is publishing this

Interpretive Bulletin because it believes

there is a need for further guidance

regarding the selection of such annuity

providers by plan fiduciaries.

(Sec. 505, Pub. L. 93–406, 88 Stat. 894 (29

U.S.C. 1135))

Background

Annuities are issued by insurers in a

variety of forms designed to suit

different purposes. This interpretive

bulletin addresses only annuities that

are purchased by pension plans with the

intention to transfer liability for benefits

promised under the plan to the annuity

provider (i.e., the insurance company).1

Annuities designed to serve this

purpose are sometimes referred to

herein as benefit distribution annuities.

Regulations issued by the Department

explicitly recognize a transfer of liability

from the plan when such an annuity is

purchased from an insurance company

licensed to do business in a State. 29

CFR 2510.3–3(d)(2)(ii).2 Pension plans

purchase benefit distribution annuity

contracts in a variety of circumstances.

Such annuities may be purchased for

participants and beneficiaries in

connection with the termination of a

plan, or in the case of an ongoing plan,

annuities might be purchased for

participants who are retiring or

separating from service with accrued

vested benefits.

The selection of an annuity provider

under these circumstances is a fiduciary

decision governed by part 4 of title I of

ERISA. Specifically, pursuant to ERISA

section 404(a)(1), 29 U.S.C. 1104(a)(1),

fiduciaries must discharge their duties

with respect to the plan solely in the

interest of the participants and

beneficiaries. Section 404(a)(1)(A), 29

U.S.C. 1104(a)(1)(A), states that the

fiduciary must act for the exclusive

purpose of providing benefits to

participants and beneficiaries and

defraying reasonable plan

administration expenses. In addition,

section 404(a)(1)(B) requires a fiduciary

to act with the care, skill, prudence and

diligence under the prevailing

circumstances that a prudent person

acting in a like capacity would use.3

Several developments over the past

few years have resulted in questions

being raised about the security of the

pension benefits promised to

participants and beneficiaries under

benefit distribution annuity contracts

purchased on their behalf. In particular,

concerns have been expressed about the

ability of certain insurance carriers to

satisfy their annuity liabilities because

their investment portfolios contain or

contained substantial amounts of highrisk, high-yield debt securities (also

known as ‘‘junk bonds’’) or troubled

real-estate loans, or a combination of

both. The basis for such concerns is best

exemplified by the well-publicized

developments involving the Executive

Life Insurance Companies of California

and New York. State regulators in both

California and New York were forced to

take control of the operations of the

Executive Life Companies, whose poor

financial condition is principally

attributable to substantial investments

in high risk bonds. In response to such

developments, the Department has acted

in the following areas to enforce

ERISA’s fiduciary standards and

determine whether additional regulatory

action is warranted.

Litigation

Subsequent to the failure of Executive

Life, the Department’s enforcement

activities have centered on, among other

things, the process by which plan

fiduciaries selected annuity providers.

The Department has filed lawsuits

against numerous companies whose

plans purchased annuities because the

plan fiduciaries who, acting in their

fiduciary capacities, failed to follow

adequate procedures designed to select
Federal Register / Vol. 60, No. 43 / Monday, March 6, 1995 / Rules and Regulations 12329

4The Pension Annuitant’s Protection Act of 1994,

Pub. L. No. 103–401, 108 Stat. 4172 (1994) amended

section 502(a) of ERISA to clarify the standing of

pension annuitants to bring actions for fiduciary

breaches that occurred. In addition, the Act

specifies that a court may order appropriate relief

to assure the annuitant’s receipt of the amounts

provided or to be provided by the annuity, plus

reasonable prejudgment interest. The amendments

made by the Act apply to any legal proceeding

pending, or brought, on or after May 31, 1993.

5This standard does not apply to the purchase of

annuities for plan investment purposes. As with

any other ordinary investment decision, ERISA’s

fiduciary duty of prudence requires that the risk

attendant to such products, in the context of the

plan’s investment portfolio, and its funding,

liquidity and diversification needs, must be

weighed against the promised return. Thus,

fiduciaries may select such investments that

involve greater risks, but that also provide an

expected investment return that is commensurate

with that greater risk. In this regard, the Department

notes that in an investment contract with an

annuity option, the standard described herein,

while not applicable to the decision to invest in the

investment product, nonetheless applies to the

fiduciary’s decision to exercise the annuity option.

6Under IRC § 4980, an excise tax of up to 50

percent may be imposed on the amount of any

employer reversion from a qualified plan unless the

employer establishes and maintains a qualified

replacement plan to which assets are transferred, or

provides certain benefit increases for participants.

the safety available insurance carrier

when choosing an annuity provider.

Cases have been brought against several

companies which purchased annuities

from Executive Life including Pacific

Lumber Co., Magnetek, Inc., Smith

International, Inc., Geosource, Inc.,

American National Can Company, AFG

Industries, Inc., and Raymark Industries,

Inc. as well as against the Strouse Adler

Company which purchased annuities

from Presidential Life Insurance

Company. It is the Department’s

position that these fiduciaries breached

their fiduciary responsibilities under

ERISA in connection with their

selection of annuity providers.4 Consent

orders settling the Secretary’s claims

have been entered in certain of these

cases.

Regulatory Action

In addition to its enforcement

activities, the Department and the

Pension Benefit Guaranty Corporation

(PBGC) sought to determine if, in

addition to and independent of ERISA’s

fiduciary standards, minimum

standards for annuity providers would

be appropriate and necessary in order to

ensure a reasonable likelihood that

participants or beneficiaries on whose

behalf annuities are purchased will

receive their promised pension benefits.

It was anticipated that such

modification might be effected by

amending the minimum standards

which already exist under the regulation

at 29 CFR 2510.3–3(d)(2)(ii). On June 21,

1991, both the Department and the

PBGC published advanced notices of

proposed rulemaking (ANPRMs) in the

Federal Register (56 FR 28638 and 56

FR 28642 respectively) soliciting

information and comments from the

public as to whether regulatory action

relating to the purchase of annuity

contracts was necessary and if so, what

form such action should take.

After receiving over thirty letters in

response, the Department reviewed the

comments and, after extensive

deliberation, the Department has

determined that no regulatory action

should be taken at this time to amend

the minimum standards under the

regulation at 29 CFR 2510.3–3(d)(2)(ii).

More generally, the Department has

decided not to promulgate any

regulation limiting the circumstances

under which the purchase of an annuity

will be considered a full distribution of

benefits for a participant or beneficiary

such that the plan’s and the employer’s

obligations to pay benefits have been

served.

The following interpretive bulletin

concerns solely the fiduciary standard

and is published in addition to and

independent of the regulatory minimum

standard at 29 CFR 2510.3–3(d)(2)(ii).

The Interpretive Bulletin

The interpretive bulletin explains

that, when choosing an annuity

provider for purposes of a benefit

distribution, whether for purposes of

separation or retirement of a participant

or upon termination of a plan,

compliance with ERISA’s fiduciary

rules requires, at a minimum, that plan

fiduciaries conduct an objective,

thorough and analytical search for the

purpose of identifying and selecting

providers from which to purchase

annuities. In conducting such a search,

a fiduciary must evaluate a potential

annuity provider’s claims-paying ability

and creditworthiness because the

participants and beneficiaries whose

entitlement to benefits will be

transferred to the annuity provider have

a paramount interest in the ability of the

provider to make those payments. As a

result, the interpretive bulletin states

that a plan fiduciary choosing an

annuity provider for the purpose of

making a benefit distribution must take

steps calculated to obtain the safest

annuity available, unless under the

circumstances, it would be in the

interests of the plan participants and

beneficiaries to do otherwise.5 The

Department recognizes that, in many

circumstances likely to arise under

existing law, the interest of the plan

participants and beneficiaries may

require the selecting fiduciary to

consider the cost of the annuity (to the

extent that the cost is borne by the

participants and beneficiaries) in

addition to the annuity provider’s

claims-paying ability.6 Cost

consideration may not, however, justify

purchase of an unsafe annuity.

The Interpretive bulletin also explains

that an annuity provider’s claims-paying

ability and creditworthiness should be

evaluated on the basis of a number of

factors. Although ratings provided by

insurance rating services may be a

useful factor in evaluating a potential

annuity provider, reliance solely on

such ratings would not be sufficient to

meet the requirement of a thorough and

analytical search for an appropriate

annuity provider.

List of Subjects in 29 CFR Part 2509

Employee benefit plans, Pensions.

For the reasons set forth in the

preamble, Part 2509 of Title 29 of the

Code of Federal Regulations is amended

as follows:

PART 2509—INTERPRETIVE

BULLETINS RELATING TO THE

EMPLOYEE RETIREMENT INCOME

SECURITY ACT OF 1974

1. The authority citation for Part 2509

continues to read as follows:

Authority: 29 U.S.C. 1135. Section

2509.75–1 is also issued under 29 U.S.C.

1114. Sections 2509.75–10 and 2509.75–2 are

also issued under 29 U.S.C. 1052, 1053, 1054.

Secretary of Labor’s Order No. 1–87 (52 FR

13139).

2. Part 2509 is amended by adding a

new § 2509.95–1 to read as follows:

§ 2509.95–1 Interpretive Bulletin relating to

the fiduciary standard under ERISA when

selecting an annuity provider.

(a) Scope. This Interpretive Bulletin

provides guidance concerning certain

fiduciary standards under part 4 of title

I of the Employee Retirement Income

Security Act of 1974 (ERISA), 29 U.S.C.

1104–1114, applicable to the selection

of annuity providers for the purpose of

pension plan benefit distributions

where the plan intends to transfer

liability for benefits to the annuity

provider.

(b) In General. Generally, when a

pension plan purchases an annuity from

an insurer as a distribution of benefits,

it is intended that the plan’s liability for

such benefits is transferred to the

annuity provider. The Department’s

regulation defining the term

‘‘participant covered under the plan’’ for

certain purposes under title I of ERISA

recognizes that such a transfer occurs
12330 Federal Register / Vol. 60, No. 43 / Monday, March 6, 1995 / Rules and Regulations

when the annuity is issued by an

insurance company licensed to do

business in a State. 29 CFR 2510.3–

3(d)(2)(ii). Although the regulation does

not define the term ‘‘participant’’ or

‘‘beneficiary’’ for purposes of standing

to bring an action under ERISA § 502(a),

29 U.S.C. 1132(a), it makes clear that the

purpose of a benefit distribution annuity

is to transfer the plan’s liability with

respect to the individual’s benefits to

the annuity provider.

Pursuant to ERISA section 404(a)(1),

29 U.S.C. 1104(a)(1), fiduciaries must

discharge their duties with respect to

the plan solely in the interest of the

participants and beneficiaries. Section

404(a)(1)(A), 29 U.S.C. 1104(a)(1)(A),

states that the fiduciary must act for the

exclusive purpose of providing benefits

to the participants and beneficiaries and

defraying reasonable plan

administration expenses. In addition,

section 404(a)(1)(B), 29 U.S.C.

1104(a)(1)(B), requires a fiduciary to act

with the care, skill, prudence and

diligence under the prevailing

circumstances that a prudent person

acting in a like capacity and familiar

with such matters would use.

(c) Selection of Annuity Providers.

The selection of an annuity provider for

purposes of a pension benefit

distribution, whether upon separation

or retirement of a participant or upon

the termination of a plan, is a fiduciary

decision governed by the provisions of

part 4 of title I of ERISA. In discharging

their obligations under section 404(a)(1),

29 U.S.C. 1104(a)(1), to act solely in the

interest of participants and beneficiaries

and for the exclusive purpose of

providing benefits to the participants

and beneficiaries as well as defraying

reasonable expenses of administering

the plan, fiduciaries choosing an

annuity provider for the purpose of

making a benefit distribution must take

steps calculated to obtain the safest

annuity available, unless under the

circumstances it would be in the

interests of participants and

beneficiaries to do otherwise. In

addition, the fiduciary obligation of

prudence, described at section

404(a)(1)(B), 29 U.S.C. 1104(a)(1)(B),

requires, at a minimum, that plan

fiduciaries conduct an objective,

thorough and analytical search for the

purpose of identifying and selecting

providers from which to purchase

annuities. In conducting such a search,

a fiduciary must evaluate a number of

factors relating to a potential annuity

provider’s claims paying ability and

creditworthiness. Reliance solely on

ratings provided by insurance rating

services would not be sufficient to meet

this requirement. In this regard, the

types of factors a fiduciary should

consider would include, among other

things:

(1) the quality and diversification of

the annuity provider’s investment

portfolio;

(2) the size of the insurer relative to

the proposed contract;

(3) the level of the insurer’s capital

and surplus;

(4) the lines of business of the annuity

provider and other indications of an

insurer’s exposure to liability;

(5) the structure of the annuity

contract and guarantees supporting the

annuities, such as the use of separate

accounts;

(6) the availability of additional

protection through state guaranty

associations and the extent of their

guarantees. Unless they possess the

necessary expertise to evaluate such

factors, fiduciaries would need to obtain

the advice of a qualified, independent

expert. A fiduciary may conclude, after

conducting an appropriate search, that

more than one annuity provider is able

to offer the safest annuity available.

(d) Costs and Other Considerations.

The Department recognizes that there

are situations where it may be in the

interest of the participants and

beneficiaries to purchase other than the

safest available annuity. Such situations

may occur where the safest available

annuity is only marginally safer, but

disproportionately more expensive than

competing annuities, and the

participants and beneficiaries are likely

to bear a significant portion of that

increased cost. For example, where the

participants in a terminating pension

plan are likely to receive, in the form of

increased benefits, a substantial share of

the cost savings that would result from

choosing a competing annuity, it may be

in the interest of the participants to

choose the competing annuity. It may

also be in the interest of the participants

and beneficiaries to choose a competing

annuity of the annuity provider offering

the safest available annuity is unable to

demonstrate the ability to administer

the payment of benefits to the

participants and beneficiaries. The

Department notes, however, that

increased cost or other considerations

could never justify putting the benefits

of annuitized participants and

beneficiaries at risk by purchasing an

unsafe annuity.

In contrast to the above, a fiduciary’s

decision to purchase more risky, lowerpriced annuities in order to ensure or

maximize a reversion of excess assets

that will be paid solely to the employersponsor in connection with the

termination of an over-funded pension

plan would violate the fiduciary’s duties

under ERISA to act solely in the interest

of the plan participants and

beneficiaries. In such circumstances, the

interests of those participants and

beneficiaries who will receive annuities

lies in receiving the safest annuity

available and other participants and

beneficiaries have no countervailing

interests. The fiduciary in such

circumstances must make diligent

efforts to assure that the safest available

annuity is purchased.

Similarly, a fiduciary may not

purchase a riskier annuity solely

because there are insufficient assets in

a defined benefit plan to purchase a

safer annuity. The fiduciary may have to

condition the purchase of annuities on

additional employer contributions

sufficient to purchase the safest

available annuity.

(e) Conflicts of Interest. Special care

should be taken in reversion situations

where fiduciaries selecting the annuity

provider have an interest in the

sponsoring employer which might affect

their judgment and therefore create the

potential for a violation of ERISA

§ 406(b)(1). As a practical matter, many

fiduciaries have this conflict of interest

and therefore will need to obtain and

follow independent expert advice

calculated to identify those insurers

with the highest claims-paying ability

willing to write the business.

Signed at Washington, DC, this 28th day of

February 1995.

Olena Berg,

Assistant Secretary for Pension and Welfare

Benefits, U.S. Department of Labor.

[FR Doc. 95–5321 Filed 3–3–95; 8:45 am]

BILLING CODE 4510–29–M