[Federal Register Volume 65, Number 3 (Wednesday, January 5, 2000)]
[Rules and Regulations]
[Pages 614-643]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-32]
[[Page 613]]
Part III
Department of Labor
_______________________________________________________________________
Pension Welfare Benefits Administration
_______________________________________________________________________
29 CFR Part 2550
Insurance Company General Accounts; Final Rule
Federal Register / Vol. 65, No. 3 / Wednesday, January 5, 2000 /
Rules and Regulations
[[Page 614]]
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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
[[Page 617]]
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 disclosed. Thus, the regulation gives employee
benefit plans greater protection against unilateral action taken by
insurance companies.
A second benefit of the termination provisions to employee benefit
plans is that those provisions will discourage insurance companies from
making some contract changes that are detrimental to the interests of
employee benefit plans that they would otherwise make.
A third benefit of the termination provisions is that they provide
employee benefit plans increased liquidity in their general account
contracts. If an employee benefit plan faces an unanticipated expense
and is forced to terminate its general account contract to obtain cash,
the plan may be able to do so under more favorable conditions. In some
cases, the plans will receive greater proceeds from a contract
liquidation. For lump sum payouts, this is because the regulation
requires that positive market value adjustments be given where they
would not otherwise have been prior to the effective date of the
regulation. Also for structured payouts, a minimum crediting rate that
is also higher than some contracts provide is required. The choice of
two payout options provides increased flexibility to many employee
benefit plans.
The increased liquidity provided by the termination provisions also
allows employee benefit plans to profit from changing conditions. For
example, a change in interest rates may cause an employee benefit plan
to adjust investment strategies. The regulation may permit the plan to
terminate its general account insurance contract and
[[Page 630]]
move its funds to the more attractive alternative.
The value of the benefit to employee benefit plans derived from the
enhanced ability to terminate contracts following unilateral contract
amendments by insurance companies is difficult to quantify. Plans will
not be forced to accept contract modifications that they view as
undesirable. The value of this benefit depends on the frequency that
such modifications would occur and the value placed on this protection
by employee benefit plans. The value of the benefit to employee benefit
plans of discouraging some contract modifications by insurance
companies is also difficult to quantify because there is no reliable
way to estimate the number of contract modifications with adverse
implications for plans that would otherwise occur.
As well as providing benefits to employee benefit plans and their
participants and beneficiaries, the regulation provides benefits to
insurance companies. The most significant of these results from the
ability of insurance companies to expand the universe of investments
that otherwise would be prohibited. In the absence of the regulation,
with insurance companies holding plan assets in their general accounts,
some investments would not be possible because they would involve
potential self-dealing and conflicts of interest.
The regulation may provide significant benefits to insurance
companies because it clarifies and mitigates the constraints imposed by
ERISA on the operation of insurance company general accounts. It does
so by providing that insurance companies that comply with the specific
requirements of the regulation will receive some assurance that their
general accounts do not contain plan assets. Insurance companies thus
could have reduced litigation costs and liabilities with respect to
their general accounts. They will be shielded from the fiduciary
responsibility and prohibited transactions rules under ERISA that would
otherwise apply to them as a result of the Harris Trust decision.
Because of the retroactive effect of the Supreme Court decision,
numerous transactions by insurance company general accounts may have
violated ERISA's prohibited transaction and general fiduciary
responsibility provisions. Without the safe harbor the regulation
affords, some insurance companies would be liable under part 4 of Title
I of ERISA as a result of the operation of their general accounts.
This regulation provides insurance companies the benefit of reduced
uncertainty concerning the application of ERISA. Some insurance
companies may be uncertain as to whether the general account contracts
they have with employee benefit plans are affected by the Harris Trust
decision. This uncertainty arises primarily from what constitutes a
guaranteed benefit policy.
The value to insurance companies of less uncertainty arises in part
through lower fees they would pay to attorneys and other benefits
specialists to try to resolve the uncertainty. Also, insurance
companies may be overly conservative in attempting to avoid holding
ERISA plan assets. The lowering of risk in this regard will allow
insurance companies to pursue business they might otherwise avoid.
The cure provision in the regulation is an additional source of
benefits. Insurance companies under certain circumstances can correct
certain errors in compliance with the regulation without causing the
company to hold employee benefit plan assets. This feature of the
regulation greatly reduces the risk of an inadvertent failure of an
insurer to comply with the regulation that would result in them holding
plan assets.
This cure provision should reduce the likelihood of litigation
between employee benefit plans and life insurance companies. The
ability to correct errors without incurring the risk of future
liability should reduce the incidence of noncompliance and
substantially reduce costs for insurance companies to correct
inadvertent errors.
The value of the benefits arising from the cure provision are
positive but impossible to accurately measure. They will depend on the
extent that insurance companies make inadvertent or good faith errors
and then use the cure provision to correct them. The level depends on
the cost to insurance companies of correcting the errors under the
regulation in relation to what would have otherwise occurred. The cure
provision also affords benefits to employee benefit plans because it
reduces the likelihood of failure to comply with the regulation. This
is similarly impossible to quantify.
The value of these benefits to insurance companies should be
substantially shifted to employee benefit plans over time through a
higher net rate of return received on life insurance company general
account contracts so long as insurance companies remain competitive.
This will increase the investment income of defined benefit plans
holding those contracts. An increase in investment income will over the
longer term lead to either a reduction in contributions required or
allowed by plan sponsors or to an increase in benefits. A reduction in
contributions by plan sponsors would reduce their corporate income tax
deductions and raise their corporate tax payments. Increased benefits
will result in higher taxable income received by beneficiaries.
The regulation will have a relatively small but positive benefit to
the Federal government, and thus taxpayers, by reducing the need for
employee benefit investigation, enforcement and litigation activities
of the government. By reducing the number of violations of ERISA
through compliance with the safe harbor provisions of the regulation,
and by providing through the cure provision the incentive for insurance
companies to self-correct minor compliance problems, investigation,
enforcement and litigation expenses of the government may be reduced.
As well as the direct benefits discussed above, the regulation has
indirect benefits through improved functioning of financial markets.
The indirect benefits are positive externalities that benefit all
participants in financial markets through the greater efficiency of the
functioning of those markets. The positive externalities are benefits
received by parties other than insurance companies and employee benefit
plans, participants and beneficiaries. With more efficiently
functioning capital markets, capital is directed to its best use, which
benefits not only the investor but also enterprises seeking investors.
Thus, this is a benefit to the economy at large. The termination
provisions of the regulation also provide positive externalities in
that by providing greater financial market liquidity, there is freer
movement of capital so it can be applied to its best use.
Costs of the Regulation
As with the benefits, the costs of the regulation are both direct
and indirect. Direct costs should fall nearly exclusively on insurance
companies rather than on plans, participants and beneficiaries.
Although, some commentators have argued that there may be indirect
costs to the economy through effects on the functioning of capital
markets, as discussed in more detail below, the Department believes
those costs to be insignificant or nonexistent.
Three types of direct costs are relevant. Insurance companies will
bear some costs that are effectively transfers to plans. While these
may be viewed as costs in the accounting sense, they result in little
or no net cost to the economy, as the cost to the insurance
[[Page 631]]
company is exactly offset by the benefit received by the employee
benefit plan.
Second, there are direct costs that arise because insurance
companies undertake certain activities in order to fall within the
requirements of the regulation. These will primarily take the form of
increased payments to service providers or insurance company employees.
These type of costs represent costs in both an accounting as well as an
economic sense and are the primary burden imposed by the regulation.
A third type of cost are those potentially associated with a
distortion of economic activity. These also represent a net cost to the
economy. Typically these distortions are associated with taxation.
Distortions can also potentially result from government regulations
requiring activities or expenditures which exceed the associated
benefits.
Insurance companies will incur administrative costs due to the
disclosure and termination requirements. To comply with increased
disclosure requirements, they will incur costs to prepare and
distribute the annual statement to employee benefit plans explaining
the methods by which income and expenses of the insurance company's
general account are allocated to the policy. To minimize these costs,
the regulation requires disclosure of materials that are prepared for
other purposes. One time only administrative costs will be incurred by
insurance companies to modify contracts so that they will comply with
the regulation and to file revised contracts with state regulatory
authorities.
The enhanced options for employee benefit plans to terminate their
contracts will create administrative costs for insurance companies in
that they will be discouraged from making some unilateral contract
modifications they otherwise would make. The magnitude of this cost to
insurance companies is difficult to quantify because the number and
effect of contract modifications that will be discouraged from
occurring is not readily determinable. This cost to insurance companies
is largely a benefit to employee benefit plans and participants and
beneficiaries.
Some commentators have argued that the regulation will impose costs
on insurance companies in financial markets. Because the termination
options will permit some contracts to be terminated earlier than
otherwise, insurance companies may adjust the investments in their
portfolios. The increased probability of early termination shortens the
period over which the preponderance of payments are made. To the extent
that insurance companies attempt to match the timing of their receipts
and payouts, they will shorten the timing of their receipts.
Insurance companies with a significant percentage of affected funds
in their general account may make fewer long maturity investments and
private placements. Long maturity investments are investments where the
preponderance of the payments are received relatively far into the
future. Private placements are investments that are not publicly traded
on financial market exchanges. They may reduce those investments due to
their needs for reduced maturity and greater liquidity of investments
because of the increased probability of early termination of general
account contracts. Both of these changes in maturity of investments and
in private placements would reduce the expected rate of return on their
portfolios. Lower maturity investments generally receive a lower rate
of return than longer maturity investments. Private placements tend to
have relatively low liquidity because they are not publicly traded.
Liquidity is a desirable aspect of investments and therefore investors
must pay a price for it in terms of lowered rate of return. The
termination requirements may also cause insurance companies to incur
costs in determining the market value of some assets that are not
publicly traded, such as private placements. These costs will
discourage investments in those types of assets because they will
reduce the net rate of return (after costs) on those investments.
Because of the sophistication of capital markets, with a large
number of competent purchasers and sellers, any initial effect on
capital markets due to insurance companies changing their portfolios
and their investment strategies probably would be offset by a re-
allocation of investments among investors. If insurance companies
reduce their investments in a certain class of assets, the price of
those assets will fall due to the reduced demand for the investment,
which will raise the rate of return on that investment. The lowered
price and increased rate of return will motivate other investors to
invest in those assets, which will in turn drive the price up towards
its original level. One time only transaction costs will be incurred by
insurance companies and other investors as they adjust their
portfolios. These costs are primarily fees paid to other financial
institutions to transact sales and purchases.
The cure provision creates administrative costs for insurance
companies that choose to use it because they are required to establish
administrative procedures to detect and correct failures to comply with
the regulation. Costs will be incurred in terms of staff time required
for creating and maintaining these procedures. These costs are largely
quantifiable in terms of specific actions that are required, with the
cost of those actions being estimable.
While the increased administrative costs are borne initially by
insurance companies choosing to comply with the regulation, they may be
shifted at least partially through a reduced rate of return net of
expenses to employee benefit plans and then to participants, and to
other investors who have contracts supported by the general accounts of
those companies. A reduction in the net rate of return received on the
general account portfolio may be passed on to employee benefit plans
having contracts with participating features. Whether that occurs may
be a business decision made by insurance companies depending on the
competitive pressures they face or may be determined by their
contracts. It may also reduce the rate of return insurance companies
offer on new contracts. The extent to which they do that depends in
part on the competitive pressures faced by insurance companies. It
should be noted again in this context that new contracts will not be
covered by the regulation.
These effects on the rate of return received by insurance companies
on their general account portfolios generally will be small. For most
insurance companies the percentage of general account assets affected
is small and thus the effect on the insurance company's portfolio rate
of return, which is proportional to the share of those assets in the
general account portfolio, is also small. The effects on employee
benefit plan rates of return is further diminished to the extent that
plans hold other investments. The effect on participants may be even
further reduced to the extent that employee benefit plan sponsors bear
the effects that are shifted to employee benefit plans.
Employee benefit plans can offset lower risk and expected return
from their insurance contracts by increasing the risk and expected
return of their other investments. They may also reduce their
investments held with insurance companies and shift funds to other
financial intermediaries. If these changes are made, there may be no
effect on the expected portfolio rate of return for employee benefit
plans.
[[Page 632]]
Cost Estimates
The following are the Department's estimates of the potential costs
associated with the regulation. The Department's analysis is responsive
to the public comments received on the economic impact of the proposed
regulation that focused on the potential costs attributable to the
regulation. This discussion also reflects additional analysis by the
Department in response to changes to the substantive provisions of the
regulation and the availability of more recent data.
Direct Costs
The direct costs associated with the regulation are attributable to
the disclosure and termination requirements. The discussion that
follows provides details of the direct costs associated with the
regulation.
1. Impact on the Insurance Industry--Amount of Assets Affected
In connection with its publication of the proposed regulation, the
Department solicited comments from the interested public regarding the
economic impact of the proposed regulation. Specifically, the
Department requested current data on the number and characteristics of
potentially affected insurance contracts that would provide the basis
for a more extensive analysis of the costs and benefits of the proposed
regulation.
The Department received a few comments which disagreed with its
estimate of the value of the accounts potentially affected by the
regulation of $40 billion in 1994 (slightly less than 3 percent of
general account assets). These comments provided limited data on the
number of potentially affected insurance contracts. For example, one
commentator estimates that based on their reading of the 1997 Life
Insurance Fact Book (1996 data), the total value of contracts
potentially affected by the regulation is $261.8 billion (15.4 percent
of general account assets). It appears that this estimate includes the
allocated portions of general account group insurance contracts,
whereas the Department excludes the allocated portions of group annuity
contracts from its estimates. Allocated group annuity contracts are
excluded because the benefits from the contracts are guaranteed and the
employee benefit plans do not participate in the risk associated with
those contracts. Representatives of the insurance industry estimated
for 1996 that the amount of unallocated assets that would be affected
by this regulation was approximately $100 billion (6.7 percent of
general account assets).
In response to these comments, the Department asked the insurance
industry to provide specific information on the amount of affected
assets. The industry declined to provide the information, contending
the proprietary nature of the data. As an alternative data source the
Department used information reported on the Form 5500 reports and
attached Schedule A's filed for the 1995 plan year. The Schedule A
attachment is required to be filed for all pension plans holding
insurance contracts with unallocated funds. Both the amount of
unallocated funds and the name of the insurance carrier issuing the
policy are reported on the Schedule A. While the manner of reporting
unallocated funds held in insurance policies does not enable a precise
determination of whether the policies are Transition Policies or other
types of policies, the Department believes that reasonable estimates
can be derived from the data. Using Form 5500 data, the Department
revised its earlier estimates of the amount of assets potentially
affected by the regulation and the distribution of those assets within
the life insurance industry. The Department now estimates between $80
and $98 billion (between 5.8 and 7.1 percent of general account assets)
would have been potentially affected by the regulation in 1995. The
Department believes that this estimate comports with that provided by
the representatives of the insurance industry.
For the 1995 plan year, a total of 123,567 Schedule A reports were
filed by pension plans reporting assets held in contracts with
unallocated funds that appear to be used to pay benefits or purchase
annuities. It is the Department's belief that these policies are most
commonly immediate participation guarantee (IPG) contracts, in which
the value is directly related to the investment performance of the
insurer's general account. These contracts will therefore meet the
definition of a Transition Policy. The total amount of assets reported
in Schedule A for these types of contracts was $98 billion.
The following discussion explains how the figures of between $80
and $98 billion were determined. The Schedule A is used both for the
reporting of assets in accounts used to provide benefits and for the
reporting of assets in accounts used solely for investments. The
Schedule A does not have a specific identifier for the type of policy
being reported. Contracts were assumed to be purely investment
contracts if the Schedule A showed no assets disbursed to pay benefits
or purchase annuities during the year and the Form 5500 report
indicated that all plan benefits were either paid from a trust or, in
the case of a defined contribution plan, were paid through a
combination of a trust and insurance carrier.12 These
filings were excluded from the analysis based on the assumption that
they are most likely to be guaranteed investment contracts and would
therefore not meet the definition of a Transition Policy. The remaining
Schedule A's fell into two categories:
---------------------------------------------------------------------------
\12\ It appears that defined contribution plans which check that
benefits are provided through both a trust fund and an insurance
carrier and which attach a Schedule A are generally trust funded
plans (with investments in insurance products) that commonly offer
participants the choice of a lump sum distribution or an annuity.
For participants choosing the latter form of payment, the value of
the participant's account is used to purchase an individual annuity.
Thus, it was assumed that the assets reported on Schedule A were in
investment accounts rather than Transition Policy accounts used to
provide benefits.
---------------------------------------------------------------------------
(1) If a Schedule A showed funds being disbursed from the account
to pay benefits or purchase annuities or the Form 5500 report indicated
that all benefits were provided through an insurance carrier, then the
funds reported in Item 6 of the Schedule A were assumed to be held in
policies meeting the definition of a Transition Policy. The total
amount of such funds in 1995 was $80 billion. This amount was used as
the lower bound for estimating total general account assets held in
Transition Policies.
(2) If a Schedule A showed no assets disbursed to pay benefits or
purchase annuities and the Form 5500 report indicated that the plan was
a defined benefit plan and benefits were paid both through the trust
and an insurance carrier, then the type of contract funds reported in
Item 6 of Schedule A was categorized as undeterminable. The total
amount of such funds was $18 billion.
The $18 billion estimate of funds in the undeterminable category,
combined with the $80 billion in general account funds determined to be
used to pay benefits, was used as the upper bound for estimating total
general account funds in Transition Policies. There is no way of
accurately estimating how much of the $18 billion in the undeterminable
category was held in Transition Policies. Therefore, in estimating the
total amount of funds held in Transition Policies, the entire $18
billion was added to the lower bound of $80 billion to provide a total
estimate of $98 billion held in Transition Policies.13 This
[[Page 633]]
amount is in line with the $100 billion estimate provided by the
representatives of the insurance industry.
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\13\ The DOL had developed an earlier estimate of $40 billion
held in Transition Policies. This estimate was based on data
reported in Item 31c(16)--(Value of funds held in insurance company
general account)and Item 32e(2)--(Payments to insurance carriers for
the provision of benefits) of the 1994 Form 5500 reports alone and
did not make use of Schedule A data. The use of the Schedule A
attachment in combination with data reported on the Form 5500 allows
for a much more refined estimate to be developed, particularly for
small plans which do not separately report assets held in insurance
company general accounts.
---------------------------------------------------------------------------
One commentator disagreed with the Department's use of an industry
average, i.e., slightly less than 3 percent of general account assets,
to demonstrate the percent of total contracts potentially affected by
the regulation. The commentator stated that this is inappropriate
because many insurers have a significantly higher proportion of assets
supporting contracts potentially affected by the regulation than the
Department's estimate in the proposed regulation for the industry as a
whole. In its re-estimate of the amount of assets affected based on the
most recent complete Form 5500 data available (1995), the Department
determined that approximately 104 insurance companies each managed $25
million or more of private pension plan unallocated assets in insurance
company general accounts and about 63 of those insurance companies
managed $100 million or more in such accounts.
To estimate the impact of the proposed regulation on both the
insurance industry as a whole and on individual companies within the
industry, the ratio of funds in Transition Policies (as reported on
Schedule A of the Form 5500 series) to an insurer's general account
funds was computed. This is one of a number of reasonable measures of
insurer net exposure that could have been chosen. For example, the
ratio of funds in Transition Policies to insurer net worth would be
another reasonable measure.
The ACLI reports that at year-end 1995, a total of $1.683 trillion
was held in the general accounts of life insurance
companies.14 In order to estimate the total value of general
account assets in the 104 companies which have issued Transition
Policies with a total value of $25 million or more, data from the 1996
and 1998 editions of the Best Insurance Reports and Standard & Poor's
Claims-Paying Ability Reports were used along with information provided
by insurance representatives. For a few companies for which data were
not available from the above two sources, telephone calls were made to
the companies to obtain general account asset information. The general
accounts of these 104 companies in 1995 were estimated to be $1.372
trillion. The $98 billion estimated as held to support Transition
Policies by the 104 companies represent 7.1 percent of total general
account assets.
---------------------------------------------------------------------------
\14\ ``1996 Life Insurance Fact Book,'' American Council of Life
Insurance, p. 89.
---------------------------------------------------------------------------
The percentage of general account assets held to support Transition
Policies varied widely among insurance companies, ranging from a low of
0.1 percent to a high of 44 percent. For 74 percent of the companies
(77 companies), the assets held in support of Transition Policies made
up less than 10 percent of total general account assets. For 13 percent
of the companies (14 companies), assets held in support of Transition
Policies made up from 10 to 19 percent of total general account assets,
and for the remaining 13 percent (13 companies), assets in Transition
Policies made up 20 percent or more of general account assets, with a
maximum percentage of 44 percent.
The Department estimates that the proposed regulation will have a
significant impact on the 13 companies in which assets held in
Transition Policies (as reported on Schedule A of the Form 5500 series)
exceed 20 percent of the insurer's general account assets. While any
threshold measure of impact is, to some extent, arbitrary, we believe
that the 20 percent level is a reasonable measure, given the estimated
costs of bringing contracts into compliance and any increased exposure
represented by required changes in policy termination provisions.
2. Costs of Compliance
Insurance industry representatives disagreed with the Department's
estimate of the aggregate cost of compliance with the proposed
regulation of no more than $2 to $5 million per year, indicating that
they believe the costs will be a significant multiple of this estimate.
However, these insurance industry representatives indicated that they
did not have specific information as to the aggregate cost of
compliance with the regulation. The representatives did not provide any
analysis of the sources and methodologies used to derive their cost
bases. Thus, the Department could not replicate these estimates.
The Department now estimates based on the cost estimates provided
by 6 insurance companies and from Form 5500 series reports that the
average annual aggregate costs over the first 10 years of compliance
with the regulation to be approximately $37 million (initial costs plus
the annual costs over 10 years divided by 10 years). This estimate
includes initial costs to insurers for reviewing the language in
current contracts concerning termination provision, drafting policy
riders or amendments, and mailing new policies to policyholders of $1.7
million. The estimate also includes the initial cost to insurers of
preparing the initial disclosure statement to give to employee benefit
plans of $52.7 million and an annual cost for disclosure in subsequent
years of $37 million. The basis for these estimates is provided in the
Paperwork Reduction Act section of this preamble.
Disclosure Provisions
The Department received several comments regarding the disclosure
provisions in the proposed regulation. In response to these comments,
the disclosure provisions have been modified in the final regulation,
thus clarifying the requirements and reducing any potential burdens
associated with these provisions. For example, the Department limited
the disclosure requirements to those items relevant to the
policyholder's ability to withdraw or transfer funds under the policy.
In addition, the Department eliminated the requirement that the insurer
make available upon request of a plan copies of the documents
supporting the actuarial opinion of the insurer's Appointed Actuary.
The Department has determined that these changes have no significant
impact on the costs associated with the regulation.
Termination Provisions
The proposed regulation included two forms of termination payment
that would be available to transition policy holders--a lump sum
payment with a market value adjustment and a book value payout, in
essentially equal installments, over a period of no more than five
years calculated using an interest rate of no less than 1 percent less
than the rate currently crediting on the policy at the time of
termination. The final regulation also includes the two forms of
termination payment but, in response to comments received, lengthens
the period for book value payouts to over no more than ten years and
with a crediting rate of no more than 1 percent less than the current
crediting rate. The Department based this change on a New York state
insurance regulation. The New York regulation serves as the
Department's model because most insurers of group annuity contracts are
licensed to do business in New York. That regulation has applied since
1987 to insurers licensed to do business in New York. The New York
regulation requires that unallocated group annuity contracts issued
after 1987 provide that the policyholder can terminate the contract and
receive either a lump sum payment with a market value adjustment or a
[[Page 634]]
book value payout over no more than 10 years (including a 5 year payout
option) with a crediting rate no less than 1.5 percent less than the
current crediting rate.
For many group annuity contracts, the regulation will liberalize
payout options that were previously available. For other contracts, it
will create new payout options. These changes will have two principal
effects: (1) In situations where contracts did not previously allow for
a positive market value adjustment, they will increase payouts to some
terminating group annuity policyholders, thus transferring value from
insurance companies or their continuing policyholders to pension plans
which terminate their arrangements, and (2) they will tend to change
the investment policies for the assets supporting group annuity
contracts because of the increased likelihood of early terminations of
contracts, in particular shortening the maturity structure and shifting
the asset mix toward a larger portion in marketable securities.
While the transfer of value in situations where contracts did not
previously allow for a positive market value adjustment, may result in
a loss to some insurance companies, at the level of the economy as a
whole that effect will be offset by gains to some pension plans. The
ultimate distributions of the burden and gain are difficult to
determine. The gain may be realized by plan participants or
shareholders of firms sponsoring pension plans and the loss borne by
shareholders of insurance companies or by other purchasers of life
insurance products. While any increase in an insurer's liabilities may
increase the probability of a future insolvency, the Department is
unable to quantify this effect. It believes, however, that those
insurers for whom this regulation has the greatest impact will
aggressively seek to lessen the effects on their financial structures
by appropriate asset/liability matching techniques.
The decrease in insurers' group annuity liability duration is
likely to trigger changes in the way insurers manage the assets
supporting those contracts. That response is likely to take the form of
shifting to assets that are less sensitive to interest rate changes
(i.e., assets with shorter durations). Life insurers will also likely
shift their investments to assets with greater liquidity.
Many of the analyses supplied by the insurance industry in response
to the proposed regulation assumed insurers would shorten their asset
structure to correspond to the interest rate sensitivity of a 5 year
payout of the book value of their Transition Policies. Under the final
regulation, a similar analysis would imply that insurers will shorten
their asset structure to correspond to the interest rate sensitivity of
a 10 year payout of the book value. The 10 year option would imply a
small shortening of insurers' liabilities and thus probably of their
assets. The shortening of the duration of assets would imply, under
most circumstances, a decrease in portfolio rates of return. The 10
year option would require a relatively small reduction in the duration
of the group annuity portfolio for most insurance companies. Because
the yield curve for bonds with respect to maturity is usually fairly
flat in the relevant range of maturities, the difference in the rates
of return associated with such restructuring is fairly small. Thus the
decrease in the portfolio rates of the return would be generally far
smaller than the industry estimates of 50 to 100 basis points that were
derived based on the 5 year book value payout required by the proposed
regulation.
Some commentators have argued that plans will terminate contracts
to take advantage of the upward market adjustments or the difference in
value between the two termination payout options. The Department
believes that few such terminations will occur because other
contractual features, such as guaranteed annuity purchase rates, also
have value. In addition, long-established business relationships are
valuable and Transition Policy contract holders will attempt to
negotiate mutually beneficial agreements for continuing relationships.
Further, as indicated earlier, New York state insurance regulation
requires for recently issued unallocated group annuity contracts issued
by insurers licensed to do business in New York termination provisions
similar to those of this regulation. Most of the major issuers of group
annuity products are licensed to do business in New York. The
Department notes that while there has been more than a decade of
experience with the New York regulation, no written or oral testimony
was submitted to indicate that experience with respect to termination
of such contracts differs from that of other contracts with less
favorable termination provisions.
Cure Provision
As described earlier in this preamble, the Department has added a
cure provision to the final regulation in response to public comment.
This cure provision would allow insurers that have made reasonable and
good faith efforts to comply with the requirements of the regulation up
to 60 days from either the date of the insurers' detection of the
problem or the date of the receipt of written notice of non-compliance
from the plan to comply with the requirements of the regulation. In
addition, interest must be credited on any amounts due the policyholder
on termination or discontinuance of the policy if not paid within 90
days of receipt of notice from the policyholder.
In order for an insurer to make use of the cure, it must have
established written procedures that are reasonably designed to assure
compliance and to detect instances of noncompliance. While the
Department is unable to quantify the benefit of the cure provision, it
is anticipated that the cure provision will allow insurers to avail
themselves of the protections of the regulation with somewhat greater
administrative flexibility. Although there may be certain expenses
associated with the establishment of written compliance procedures, the
Department believes that many insurers would implement such procedures
as part of their usual management practices, and would satisfy the
conditions for use of the cure only if the provision offered a net
benefit to the insurer.
Indirect Costs
The indirect costs associated with the regulation are negative
effects of the regulation on the functioning of capital markets. Some
commentators have argued that the regulation will affect long-term
lending and the availability of capital in the national economy. The
discussion that follows provides details of the indirect costs
associated with the regulation.
Effect on Long-Term Lending and the Availability of Capital in the
National Economy
Several commentators have argued that a shortening of insurers'
portfolios (reducing the investment duration of debt holdings) would
reduce the overall amount and raise the price of long-term lending in
the economy. They further assert that insurers are one of the major
providers of long-term capital, and that if insurers choose in the
future to invest more of their portfolios in shorter term debt
securities, the effect could be a significant reduction in the amount
of capital invested in long-term projects overall.
They support their premise by reporting that the total dollar
figure of insurance industry investment in long-term corporate debt is
$531 billion dollars as of year end 1996 ($885 billion invested in
corporate debt of which 60
[[Page 635]]
percent is long-term). This figure is minimal when considered in terms
of the total long-term debt outstanding in the capital markets.
The Department disagrees with the commentators' above assessment of
the impact of the insurance industry's investment in long-term
securities. According to a recent Federal Reserve statistical release
titled, ``Flow of Funds Accounts of the United States, Flows and
Outstanding, Third Quarter 1998,'' life insurance and other insurance
companies provide a relatively small proportion of total capital
compared to other major participants in the economy. Of the $22.630
trillion Total Credit Market Debt 15 Outstanding at
September 30, 1998, Life insurance and Other insurance companies
holdings represented a total of $2.342 trillion, or 10.35 percent of
the total market. While this report does not specify what percentage of
the $2.3 trillion are in general account assets, nor break out the debt
holdings by maturity, the general information does help to present a
broad and balanced picture of the insurance industry's influence on the
long term debt and private placement markets, when analyzed in
conjunction with statistics available from other sources.
---------------------------------------------------------------------------
\15\ As Defined in Table L.1, Credit Market Debt includes these
federal government securities: mortgage pool securities, U.S.
government loans, and government-sponsored enterprise securities,
and these private financial sector instruments: open market paper,
corporate bonds, bank loans (not elsewhere classified), other loans
and advances, and mortgages.
---------------------------------------------------------------------------
Regarding the potential effects on the availability of financing
for small business entities and on the private placement markets,
further comments are addressed in the Regulatory Flexibility Act
section of this preamble.
Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (PRA 95), 44 U.S.C. 3507(d)(2),
and 5 CFR 1320.11(f) require Federal agencies to publish collections of
information contained in final rules for the public in the Federal
Register. Modifications have been made to the collection of information
that appeared in the Notice of Proposed Rulemaking (NPRM). These
modifications are in response to comments received to the NPRM and
reflect the availability of more recent Form 5500 data. The basis for
these modifications is described in detail in the Economic Analysis
section of this preamble.
The Department of Labor submitted the information collection as
modified to the Office of Management and Budget (OMB) for its review in
accordance with 44 U.S.C. 3507 (d) and OMB has approved the information
collection request included in this final rule under control number
1210-0114.
Estimated Reporting and Recordkeeping Burden: The Department
estimates that there are approximately 123,500 Transition Policies for
private employer pension plans currently in effect. These policies have
been issued by an estimated 104 different insurance companies. While
the burden on the pension plans holding Transition Policies is expected
to be minimal, the final regulation will impose costs in the following
two areas on insurance companies which have issued Transition Policies:
(1) The regulation would require that policies provide that a
policyholder must be able to terminate or discontinue a policy upon 90
days notice to an insurer. The policy must also offer the policyholder
the option to select either a lump sum payment or a series of
installments over a period of no more than ten years. Insurance
companies that have policies not already in compliance with these
requirements will incur costs in preparing riders or amending these
policies and in providing copies of these riders or amendments to
policyholders.
(2) The regulation would require that insurers disclose to each
policyholder certain information, including the methods used by the
insurer to allocate any income and expenses of the insurer's general
account to the policy during the term of the policy and upon its
termination. Disclosure would consist of an initial statement to the
policyholder, either as part of the amended Transition Policy, or as a
separate written document, and an annual statement to the policyholder
as long as the Transition Policy is in effect. The direct cost of
compliance will be borne by the 104 insurance companies estimated to
have Transition Policies and is as follows:
1. Policy Statement
The insurance industry has indicated that the relevant contracts
typically already permit the termination and withdrawal of plan assets.
The final regulation will require they change any policies in which the
language of the provision on the right of the policyholder to terminate
the contract does not meet the minimum requirements of the regulation.
Each insurance company affected is expected to develop a standard
statement to be added to or to replace the existing termination
provision in each contract. The Department estimates that a total of 40
person hours of professional time per insurance company will be
required to review whether existing policy termination provisions meet
the proposed requirements and, if not, to develop a standard
termination statement. Total estimated time for all affected insurers
would be 4,160 hours (104 insurers x 40 hrs.)
The Department assumes that one-half of all policies will require a
statement on termination rights of the policyholder to be added in
place of existing language. Insertion of the statement into each policy
and the mailing to policyholders is estimated to require \1/2\ hour per
policy, or a total of 30,875 hours (61,750 policies x \1/2\ hr.). We
assume that the average of \1/2\ hour per policy would be split evenly
between professional and clerical staff.
For purposes of estimating total costs to insurers of reviewing the
language in current contracts and drafting policy statements, the costs
of professional staff time are estimated to be $75 per hour and the
costs of clerical staff time are estimated to be $12 per hour. Costs
are therefore estimated to be $312,000 (4,160 hrs. x $75) to develop
a standard termination statement and $1.3 million (30,875 hrs. x
$43.50 (average of the $75 per hour professional rate and the $12 per
hour clerical rate)) to insert the statement into each contract and
mail the contracts to policyholders. Mailing costs are estimated at
$.50 per policy, or a total of $30,875 (61,750 policies x $.50).
Total costs to insurers would be approximately $1.7 million.
2. Disclosure Statements
The documentation needed by each insurer for the disclosure
material should currently exist, either as data prepared for other
reporting requirements or as data needed for internal computations by
the insurer to allocate income and expenses. However, the time needed
by each insurer to collect and incorporate the data into disclosure
packages is expected to vary widely among insurers. While only one
standard disclosure statement will likely be needed for prototype
contracts, data for some individualized contracts will have to be
customized on a contract-by-contract basis. Insurers with a large
number of individualized policies will require more time to prepare the
disclosure material than insurers making use of prototype contracts for
all or most of their policies. The time needed and costs to develop the
initial and annual statements are therefore dependent upon both the
total number of policies and the number of individualized policies.
In response to the Department's request for information regarding
the costs and benefits of the proposed
[[Page 636]]
regulation, cost estimates to meet the proposed disclosure requirements
were provided for 6 insurance companies. These cost estimates varied.
Most of the estimates broke out the costs into three components: The
costs of preparing the initial statements; the costs for system changes
to facilitate the development of annual statements; and the ongoing
costs of preparing the annual statements.
The data provided on total insurer costs, together with Department
estimates from Form 5500 reports on the total number of policies for
each of the 6 insurers providing the cost data, were used to estimate
the average costs per policy of the disclosure statement. The estimates
for providing the initial disclosure among the 6 insurers ranged from a
low of $68 per policy to a high of $1,962 per policy. The average cost
per policy was $427. The average of $427 per policy times the estimate
of 123,500 policies yields an estimated total cost for the initial
disclosure statement of $52.7 million. This amounts to .05 percent of
the total asset value of the policies.
Ongoing cost estimates for the annual disclosure statements ranged
from a low of $21 per policy to a high of $1,226 per policy. This
reflects both the direct annual costs estimated for the disclosure
statements and the estimate for the costs of system changes, amortized
over a 10-year period. The average annual cost for the 6 companies was
$283 per policy. Total annual costs would be $35 million. (This annual
cost estimate assumes that no policies are terminated.)
The combined costs for the policy statements and the disclosure
statements are estimated to be $54.4 million in the initial year
following adoption of the regulation and $35 million in each succeeding
year.
The cost data provided by the six insurance companies did not
include any estimates of the hourly burden involved in preparing the
disclosure statements. The Department assumes that the preparation of
the statements will require professional staff time. Based on an
average of $75 per professional staff hour, the total hour estimate for
preparing the initial disclosure statement will be 702,667 hours ($52.7
million/$75 per hour). Total estimated combined hours for the policy
statements and disclosure statement in the initial year will be 737,702
hours (35,035 hours for policy statements plus 702,667 hours for
disclosure statements). Total estimated hours in each subsequent year
for the annual disclosure statement would be 466,667 hours ($35
million/$75).
Representatives of the insurance industry indicated that based on a
survey of 14 member companies, the cost per company of creating the
initial disclosure information would be $7,600,000. However, unlike the
estimates of the six insurance companies, the basis for this estimate
was not disclosed. Therefore the Department was unable to factor this
estimate into its calculations.
The Department appreciates the comment informing us that contracts
may be customized and that our earlier estimates did not take into
account this customization. However, the Department disagrees with
commentators' contention that our estimates did not account for the
costs of preparation and distribution of standardized disclosure forms.
More accurately, the Department's current estimate reflects the fact
that some contracts allow for standardized disclosure and others must
be customized on a contract-by-contract basis. In addition, the current
analysis takes into consideration the Department's modifications to the
disclosure requirements outlined earlier.
Respondents to these new information collection requirements are
not required to respond unless this collection displays a currently
valid OMB control number.
Regulatory Flexibility Act
The Regulatory Flexibility Act (5 U.S.C. 601 et seq.) (RFA),
imposes certain requirements with respect to Federal rules that are
subject to the notice and comment requirements of section 553(b) of the
Administrative Procedure Act (5 U.S.C. 551 et seq.) and likely to have
a significant economic impact on a substantial number of small
entities. If an agency determines that a final rule is likely to have a
significant economic impact on a substantial number of small entities,
section 604 of the RFA requires that the agency present a final
regulatory flexibility analysis at the time of the publication of the
notice of final rulemaking describing the impact of the rule on small
entities. Small entities include small businesses, organizations, and
governmental jurisdictions.
PWBA has conducted a final regulatory flexibility analysis which is
summarized below.
(1) PWBA is promulgating this regulation because it is required to
do so under section 1460 of the Small Business Job Protection Act of
1996 (Pub. L. 104-188).
(2) The objective of the regulation is to provide guidance on the
application of ERISA to policies held in insurance company general
accounts. The legal basis for the regulation is found in ERISA section
401(c); an extensive list of authorities may be found in the Statutory
Authority section, below.
(3) The direct cost of compliance will be borne by insurance
companies. As noted in the proposed regulation, the Department
estimates that no ``small'' insurance companies (as defined by the
Small Business Administration at 61 FR 3280, January 31, 1996) offer
the types of policies regulated here. The Department received no
comments to the proposed regulation disagreeing with this conclusion.
In addition, no small governmental jurisdictions, as defined in 5
U.S.C. section 601, will be affected.
With respect to employee benefit plans, the results of this
analysis remain valid regardless of whether one uses the most
applicable definition found in the regulations issued by the Small
Business Administration (13 CFR section 121.201) or one defines small
entity on the basis of section 104(a)(2) of ERISA as a plan with fewer
than 100 participants. All employee benefit plans that purchased the
regulated policies will receive the benefit of the enhanced disclosure
provided by the regulation. Some of the costs of the disclosure may be
passed on to the plans by the insurers. However, assuming that all
disclosure costs are passed on to plans by the insurers, the Department
estimates that these costs would be on average $441 per policy for
providing initial disclosures (including the cost of amending policies)
and $283 per policy for annual disclosures. This estimate assumes an
equal distribution of the costs to all plans, both large and small.
A few commentators expressed concern that the start-up costs
associated with disclosure requirements can be significant to a small
plan. For example, one commentator indicated that the Department's
original estimate of $100 to $200 per contract ignores the amortization
of costs associated with the initial development of reporting
capabilities. They argued that, for example, their firm services
several plans with general account balances of $10,000 or less. They
argue therefore, that if the annual disclosure cost is $150, this
amounts to 1.5 percent of assets annually for a $10,000 contract;
whereas for a $50,000 contract the cost would be 0.3 percent annually.
The result will be that insurers that are forced to incur these costs
will ultimately pass them on to the plan sponsor, and that for a small
plan these costs are unaffordable. This assumes that insurers will pass
on their aggregate
[[Page 637]]
costs for compliance with the regulation by charging each plan the same
dollar amount per contract, regardless of the size or nature of the
contract or contracts involved, rather than a different method which
may comport with the insurer's business plan.
While insurance companies may pass along costs to plan sponsors,
the Department believes that such costs will be passed on, if at all,
on the basis of the cost of compliance with respect to a particular
contract or type of contract. In this regard, the Department believes
that the cost of compliance will be low for the types of policies most
commonly held by small plans. Compliance cost estimates we received
from insurance companies varied widely. The cost estimates, along with
comments received from industry representatives, indicate a particular
concern about high costs in the case of individualized policies which
may require customized amendments and disclosure statements.
Individualized policies generally appear to be limited to older
contracts which tend to have large dollar values (generally $5 million
or more) and are held by larger, long-established plans. These
contracts are the result of numerous amendments of the original
contract forms which are no longer issued. Except for large value
contracts, more recent contracts are prototypes rather than
individually drafted. These prototype policies are more cost effective
for contracts with smaller dollar values. For example, of the estimated
100,000 policies issued to plans with fewer than 100 participants, the
average value in 1995 was $240,000. The Department understands that
most small plans are likely to hold prototype contracts. This is
because prototype polices are more cost effective than individualized
policies for contracts with small dollar values. For example, of the
123,000 Transition Polices issued to all plans, an estimated 100,000
policies were issued to plans with fewer than 100 participants. The
average value of such policies in 1995 was only $240,000. An estimated
17,000 policies were issued to plans with between 100 and 500
participants. The average value in 1995 was $1.8 million. For the
remaining 6,000 plans, which had more than 500 participants, the
average value was $7.2 million. The average contract value for all
policies is only $800,000. It is evident that only a few (less than 5%)
of plans holding Transition Policies are likely to hold individualized
policies and these are the largest plans.
For each type of prototype policy only a single standard amendment
to bring policies into compliance with the termination requirements of
the regulation (for policies not already in compliance) and a single
standard disclosure statement need be developed. The cost of the
disclosure statement and any needed rider or amendment can be spread
across a large number of contracts, thus minimizing the cost per
contract of compliance. These costs, even if passed on to the plan
sponsors by the insurers, are expected to be a minimal percentage of
the asset value of the contracts.
As noted in the initial regulatory flexibility analysis of the
proposed regulation, no significant alternatives which would minimize
the impact on small entities have been identified. Although the
Department considered whether it would be appropriate to reduce the
costs that might be passed on to small plans by providing fewer
disclosures or termination rights for small plans than is provided by
large plans, such an approach was not adopted. The nature of the
protective provisions is such that it would make little sense to
provide a lower level of protections to contracts held by small plans
in an effort to minimize the cost impact to those plans. The policies
involved, although of lesser total value than policies issued to large
plans, often represent a significant proportion of the assets of the
plans that hold them. They also guarantee all or most of the benefits
of the participants whose pensions they cover. Finally, thee
fiduciaries of small plans may be less knowledgeable of insurance
products and may have less bargaining power in dealing with insurers.
Therefore, the protections in the regulation may be more important to
the participants of small plans than to those of large plans. No
comments received by the Department suggested that the regulation
should provide small plans a lower level of protections than large
plans.
In addition, no alternatives were identified by the commentators or
have otherwise come to the attention of the Department. As discussed
previously, in response to comments received, the Department made
several modifications to the requirements of the proposed regulation.
These modifications include relaxation of the disclosure requirements,
an increase in the book value payout period in the termination
provisions from 5 years to 10 years, and the introduction of the
``cure'' provision. These modifications are designed to minimize the
impact of the regulation on small and large entities alike, consistent
with the objectives of the requirements of the Small Business Job
Protection Act of 1996 and ERISA. It would be inconsistent with these
statutory requirements to create an alternative with lower compliance
criteria, or an exemption from the regulation, for small plans because
these are the entities that have the greatest need for the disclosure
and other protections afforded by the regulation.
(4) The Department received one comment from representatives of the
insurance industry regarding the initial regulatory flexibility
analysis in the proposed regulation. They stated that the regulation
will have collateral and potentially serious adverse effect on small
businesses. In addition, they argue that the regulation, as proposed,
will create a preferred class of policyholders and hurt the
participants and beneficiaries of a large number of small plans that
purchase insurance arrangements backed by insurance company general
accounts. They further state that the termination requirements would
seriously restrict an important source of capital for small businesses.
As described in the Economic Analysis section of this preamble, the
termination requirements may result in transfer of value from some
insurance companies or their continuing policyholders to pension plans
that terminate their arrangements in situations where contracts
otherwise did not previously allow for positive market value
adjustments. However, despite the assertion by insurance industry
representatives that this will adversely affect participants and
beneficiaries in a large number of small plans, no statistical evidence
has been provided to substantiate this claim. The Department finds no
reason to assume, for example, that small plans would be less likely
than large plans to terminate these contracts and thus suffer the
adverse impact (if any) of transfers to the terminating policyholders.
(5) Several commentators have stated, without any supporting
analysis, not only that the insurance industry is an important provider
of long-term capital, but also that small and medium sized businesses
rely heavily on insurance companies as a source of long-term credit.
The Department disagrees with the above statements, based on its
analysis of several prominent sources of data regarding small business
financing 16; its findings are summarized below.
---------------------------------------------------------------------------
\16\ The studies analyzed include the Federal Reserve Board's,
``Report to the Congress of Availability of Credit to Small
Businesses,'' issued in October 1997; ``New Information on Lending
to Small Businesses and Small Farms: the 1996 CAR Data,'' published
in the Federal Reserve Bulletin in January 1998; and ``Bank and
Nonbank Competition for Small Business Credit: Evidence from the
1987 and 1993 National Surveys of Small Business Finances,''
published in the Federal Reserve Bulletin in November 1996.
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[[Page 638]]
The Federal Reserve Board's 1997 ``Report to the Congress on the
Availability of Credit to Small Business,'' indicates that small
business credit needs continue to be met primarily by commercial banks.
The report also documents that business debt growth has risen steadily
since 1993, at an average rate of 5 percent, and that the increasing
credit demands of small companies seem to have been easily accommodated
by financial intermediaries and in the capital markets overall.
Assuming the insurance industry's supply of long-term lending is
somewhat less than their 10 percent participation in the credit market
overall, it appears from these recent debt growth trends that other
financial institutions and suppliers of capital would be able to fill
any gap left by an insurance retrenchment in long-term lending/
investment.
The Federal Reserve Board's 1998 report, ``New Information on
Lending to Small Businesses and Small Farms: the 1996 CAR Data,''
indicates that a vast majority of the reported small business loans
were either originated or purchased by commercial banks or their
affiliates. As of year-end 1996, of the total dollar amount of $146.98
billion loaned, commercial banks originated or purchased 95.6 percent,
or $140.5 billion. Other institutions originated the remaining 4.4
percent.
The Federal Reserve Board's 1996 study, ``Bank and Nonbank
Competition for Small Business Credit: Evidence from the 1987 and 1993
National Surveys of Small Business Finances,'' reported on the
competition for small business credit, and the sources of credit used
by small firms, including credit lines, mortgage loans, equipment
loans, motor vehicle loans, and ``other'' loans.17 The
survey reports that as of 1993, insurance and mortgage companies
together provided a 1.9 percent dollar share of the outstanding credit
lent to small businesses by nonbank institutions (nonbanks provided
38.7 percent of all outstanding credit, versus 61.3 percent provided by
banks).
---------------------------------------------------------------------------
\17\ ``Other'' loans refer to loans not elsewhere classified,
primarily unsecured term loans and loans collateralized by assets
other than real estate, equipment loans, motor vehicles and loans
not taken down under credit lines.
---------------------------------------------------------------------------
In sum, the Department believes that the statistics included in the
above-discussed Federal Reserve reports and surveys point to the
conclusion that commercial banks are the major supplier of credit
financing to small businesses. The reports further show that the
insurance industry's participation is not large in the long-term credit
markets overall, nor is the insurance industry a large provider of
financing for small to medium-sized firms. Therefore, we do not believe
an insurance industry retrenchment from longer term debt investing will
adversely affect capital investments or small business financing.
Several commentators stated that not only are insurers a major
source of long-term lending, but further posited that if insurers
retrenched from the long-term debt market, the results would be a
decrease in the amount of capital allocated to long-term projects,
which in turn could have a detrimental impact on the private placement
markets, which predominantly serve small and medium-sized businesses.
Ultimately, this would have a negative effect on the availability of
financing for small businesses. One commentator in the investment
banking field supported this argument by stating that of the $20
billion total the commentator placed in private securities in 1997,
life insurance companies bought 80 percent, or $16 billion of the
offerings.
This statistic does not present a full picture of the private
placement market, nor does it shed any light about the magnitude,
influence or significance of insurers' participation in the market. It
further does not provide any pertinent information about small
business' dependence on or utilization of this source of capital.
The Department has found significant evidence to refute the
commentators' above concerns. A study conducted specifically on the
private placement markets, published in August, 1998 18
gives an overview of the nature of the private equity and debt markets
19 in which small businesses are financed.
---------------------------------------------------------------------------
\18\ ``The Economics of Small Business Finance: The Roles of
Private Equity and Debt Markets in the Financial Growth Cycle,''
Journal of Banking and Finance, Volume 22.
\19\ Private equity and debt are also referred to as private
placements, and make up the private placement market.
---------------------------------------------------------------------------
This study reports data on the distribution of private financing
for U.S. small businesses. Generally, it shows that within the private
placement markets, small firms depend on both private equity (49.6
percent) and private debt (50.4 percent).
The largest source of private equity financing is the ``principal
owner'' (typically the person who has the largest ownership share and
has the primary authority to make financial decisions) at 31.3 percent
of the total market, which represents 66 percent of total private
equity. The next biggest equity category is ``other equity'' at 12.86
percent, which includes members of the start-up team other than the
owner, family and friends. ``Angel finance'' accounts for an estimated
3.59 percent. (``Angels'' are high net worth individuals who provide
direct funding to early-stage new businesses). Venture capital provides
1.86 percent of small business private equity financing.
There are nine categories of debt which are divided into three
categories of funding that are provided by financial institutions--
commercial banks providing 18.75 percent of total finance, finance
companies 4.91 percent and other financial institutions 20
3.00 percent; the six other categories funded by nonfinancial and
government sources make up the remainder of private debt funding.
---------------------------------------------------------------------------
\20\ ``Other'' financial institutions include thrift
institutions, leasing companies, brokerage firms, mortgage companies
and insurance companies.
---------------------------------------------------------------------------
In summary, insurance companies at most may provide some portion of
the 1.86 percent in small business equity financing funded by the
venture capital sector. Alternatively, they at most may provide some
portion of the 3% funded by ``other'' financial institutions to the
small business private debt market, which includes 4 other types of
institutional investors.
The Department believes that these figures clearly show the
commentators' concerns about the regulation's effect on the private
placement market, and ultimately, small business financing, to be
unfounded.
Small Business Regulatory Enforcement Fairness Act
The final rule being issued here is subject to the provisions of
the Small Business Regulatory Enforcement Act of 1996 (5 U.S.C. 801 et
seq.) (SBREFA) and has been transmitted to the Congress and the
Comptroller General for review.
Unfunded Mandates Reform Act
For purposes of the Unfunded Mandates Reform Act of 1995 (Pub. L.
104-4), as well as Executive Order 12875, this final rule does not
include any Federal mandate that may result in the expenditure by
state, local and tribal governments in the aggregate, or by the private
sector, of $100,000,000 or more in any one year.
Statutory Authority
The regulation set forth herein is issued pursuant to the authority
contained in sections 401(c) and 505 of ERISA (Pub. L. 93-406, Pub. L.
104-188,
[[Page 639]]
88 Stat. 894; 29 U.S.C. 1101(c), 29 U.S.C. 1135) and section 102 of
Reorganization Plan No. 4 of 1978 (43 FR 47713, October 17, 1978),
effective December 31, 1978 (44 FR 1065, January 3, 1979), 3 CFR 1978
Comp. 332, and under Secretary of Labor's Order No. 1-87, 52 FR 13139
(April 21, 1987).
List of Subjects in 29 CFR Part 2550
Employee benefit plans, Employee Retirement Income Security Act,
Employee stock ownership plans, Exemptions, Fiduciaries, Insurance
Companies, Investments, Investment foreign, Party in interest,
Pensions, Pension and Welfare Benefit Programs Office, Prohibited
transactions, Real estate, Securities, Surety bonds, Trusts and
Trustees.
For the reasons discussed in the preamble, 29 CFR Part 2550 is
amended as follows:
PART 2550--[AMENDED]
1. The authority for part 2550 is revised to read as follows:
Authority: 29 U.S.C. 1135. Section 2550.401b-1 also issued under
sec. 102, Reorganization Plan No. 4 of 1978, 3 CFR, 1978 Comp., p.
332. Section 2550.401c-1 also issued under 29 U.S.C. 1101. Section
2550.404c-1 also issued under 29 U.S.C. 1104. Section 2550.407c-3
also issued under 29 U.S.C. 1107. Section 2550.408b-1 also issued
under sec. 102, Reorganization Plan No. 4 of 1978, 3 CFR, 1978
Comp., p. 332, and 29 U.S.C. 1108(b)(1). Section 2550.412-1 also
issued under 29 U.S.C. 1112. Secretary of Labor's Order No. 1-87 (52
FR 13139).
2. New Sec. 2550.401c-1 is added to read as follows:
Sec. 2550.401c-1 Definition of ``plan assets''--insurance company
general accounts.
(a) In general. (1) This section describes, in the case where an
insurer issues one or more policies to or for the benefit of an
employee benefit plan (and such policies are supported by assets of an
insurance company's general account), which assets held by the insurer
(other than plan assets held in its separate accounts) constitute plan
assets for purposes of Subtitle A, and Parts 1 and 4 of Subtitle B, of
Title I of the Employee Retirement Income Security Act of 1974 (ERISA
or the Act) and section 4975 of the Internal Revenue Code (the Code),
and provides guidance with respect to the application of Title I of the
Act and section 4975 of the Code to the general account assets of
insurers.
(2) Generally, when a plan has acquired a Transition Policy (as
defined in paragraph (h)(6) of this section), the plan's assets include
the Transition Policy, but do not include any of the underlying assets
of the insurer's general account if the insurer satisfies the
requirements of paragraphs (c) through (f) of this section or, if the
requirements of paragraphs (c) through (f) were not satisfied, the
insurer cures the non-compliance through satisfaction of the
requirements in paragraph (i)(5) of this section.
(3) For purposes of paragraph (a)(2) of this section, a plan's
assets will not include any of the underlying assets of the insurer's
general account if the insurer fails to satisfy the requirements of
paragraphs (c) through (f) of this section solely because of the
takeover of the insurer's operations from management as a result of the
granting of a petition filed in delinquency proceedings in the State
court where the insurer is domiciled.
(b) Approval by fiduciary independent of the issuer. (1) In
general. An independent plan fiduciary who has the authority to manage
and control the assets of the plan must expressly authorize the
acquisition or purchase of the Transition Policy. For purposes of this
paragraph, a fiduciary is not independent if the fiduciary is an
affiliate of the insurer issuing the policy.
(2) Notwithstanding paragraph (b)(1) of this section, the
authorization by an independent plan fiduciary is not required if:
(i) The insurer is the employer maintaining the plan, or a party in
interest which is wholly owned by the employer maintaining the plan;
and
(ii) The requirements of section 408(b)(5) of the Act are
met.1
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\1\ The Department notes that, because section 401(c)(1)(D) of
the Act and the definition of Transition Policy preclude the
issuance of any additional Transition Policies after December 31,
1998, the requirement for independent fiduciary authorization of the
acquisition or purchase of the Transition Policy in paragraph (b) no
longer has any application.
---------------------------------------------------------------------------
(c) Duty of disclosure. (1) In general. An insurer shall furnish
the information described in paragraphs (c)(3) and (c)(4) of this
section to a plan fiduciary acting on behalf of a plan to which a
Transition Policy has been issued. Paragraph (c)(2) of this section
describes the style and format of such disclosure. Paragraph (c)(3) of
this section describes the content of the initial disclosure. Paragraph
(c)(4) of this section describes the information that must be disclosed
by the insurer at least once per year for as long as the Transition
Policy remains outstanding.
(2) Style and format. The disclosure required by this paragraph
should be clear and concise and written in a manner calculated to be
understood by a plan fiduciary, without relinquishing any of the
substantive detail required by paragraphs (c)(3) and (c)(4) of this
section. The information does not have to be organized in any
particular order but should be presented in a manner which makes it
easy to understand the operation of the Transition Policy.
(3) Initial disclosure. The insurer must provide to the plan,
either as part of an amended policy, or as a separate written document,
the disclosure information set forth in paragraphs (c)(3)(i) through
(iv) of this section. The disclosure must include all of the following
information which is applicable to the Transition Policy:
(i) A description of the method by which any income and any expense
of the insurer's general account are allocated to the policy during the
term of the policy and upon its termination, including:
(A) A description of the method used by the insurer to determine
the fees, charges, expenses or other amounts that are, or may be,
assessed against the policyholder or deducted by the insurer from any
accumulation fund under the policy, including the extent and frequency
with which such fees, charges, expenses or other amounts may be
modified by the insurance company;
(B) A description of the method by which the insurer determines the
return to be credited to any accumulation fund under the policy,
including a description of the method used to allocate income and
expenses to lines of business, business segments, and policies within
such lines of business and business segments, and a description of how
any withdrawals, transfers, or payments will affect the amount of the
return credited;
(C) A description of the rights which the policyholder or plan
participants have to withdraw or transfer all or a portion of any
accumulation fund under the policy, or to apply the amount of a
withdrawal to the purchase of guaranteed benefits or to the payment of
benefits, and the terms on which such withdrawals or other applications
of funds may be made, including a description of any charges, fees,
credits, market value adjustments, or any other charges or adjustments,
both positive and negative;
(D) A statement of the method used to calculate any charges, fees,
credits or market value adjustments described in paragraph (c)(3)(i)(C)
of this section, and, upon the request of a plan fiduciary, the insurer
must provide within 30 days of the request:
(1) The formula actually used to calculate the market value
adjustment, if any, to be applied to the unallocated
[[Page 640]]
amount in the accumulation fund upon distribution of a lump sum payment
to the policyholder, and
(2) The actual calculation, as of a specified date that is no
earlier than the last contract anniversary preceding the date of the
request, of the applicable market value adjustment, including a
description of the specific variables used in the calculation, the
value of each of the variables, and a general description of how the
value of each of those variables was determined.
(3) If the formula is based on interest rate guarantees applicable
to new contracts of the same class or classes, and the duration of the
assets underlying the accumulation fund, the contract must describe the
process by which those components are ascertained or obtained. If the
formula is based on an interest rate implicit in an index of publicly
traded obligations, the identity of the index, the manner in which it
is used, and identification of the source or publication where any data
used in the formula can be found, must be disclosed;
(ii) A statement describing the expense, income and benefit
guarantees under the policy, including a description of the length of
such guarantees, and of the insurer's right, if any, to modify or
eliminate such guarantees;
(iii) A description of the rights of the parties to make or
discontinue contributions under the policy, and of any restrictions
(such as timing, minimum or maximum amounts, and penalties and grace
periods for late payments) on the making of contributions under the
policy, and the consequences of the discontinuance of contributions
under the policy; and
(iv) A statement of how any policyholder or participant-initiated
withdrawals are to be made: first-in, first-out (FIFO) basis, last-in,
first-out (LIFO) basis, pro rata or another basis.
(4) Annual disclosure. At least annually and not later than 90 days
following the period to which it relates, an insurer shall provide the
following information to each plan to which a Transition Policy has
been issued:
(i) The balance of any accumulation fund on the first day and last
day of the period covered by the annual report;
(ii) Any deposits made to the accumulation fund during such annual
period;
(iii) An itemized statement of all income attributed to the policy
or added to the accumulation fund during the period, and a description
of the method used by the insurer to determine the precise amount of
income;
(iv) The actual rate of return credited to the accumulation fund
under the policy during such period, stating whether the rate of return
was calculated before or after deduction of expenses charged to the
accumulation fund;
(v) Any other additions to the accumulation fund during such
period;
(vi) An itemized statement of all fees, charges, expenses or other
amounts assessed against the policy or deducted from the accumulation
fund during the reporting year, and a description of the method used by
the insurer to determine the precise amount of the fees, charges and
other expenses;
(vii) An itemized statement of all benefits paid, including annuity
purchases, to participants and beneficiaries from the accumulation
fund;
(viii) The dates on which the additions or subtractions were
credited to, or deducted from, the accumulation fund during such
period;
(ix) A description, if applicable, of all transactions with
affiliates which exceed 1 percent of group annuity reserves of the
general account for the prior reporting year;
(x) A statement describing any expense, income and benefit
guarantees under the policy, including a description of the length of
such guarantees, and of the insurer's right, if any, to modify or
eliminate such guarantees. However, the information on guarantees does
not have to be provided annually if it was previously disclosed in the
insurance policy and has not been modified since that time;
(xi) A good faith estimate of the amount that would be payable in a
lump sum at the end of such period pursuant to the request of a
policyholder for payment or transfer of amounts in the accumulation
fund under the policy after the insurer deducts any applicable charges
and makes any appropriate market value adjustments, upward or downward,
under the terms of the policy. However, upon the request of a plan
fiduciary, the insurer must provide within 30 days of the request the
information contained in paragraph (c)(3)(i)(D) as of a specified date
that is no earlier than the last contract anniversary preceding the
date of the request; and
(xii) An explanation that the insurer will make available promptly
upon request of a plan, copies of the following publicly available
financial data or other publicly available reports relating to the
financial condition of the insurer:
(A) National Association of Insurance Commissioners Statutory
Annual Statement, with Exhibits, General Interrogatories, and Schedule
D, Part 1A, Sections 1 and 2 and Schedule S--Part 3E;
(B) Rating agency reports on the financial strength and claims-
paying ability of the insurer;
(C) Risk adjusted capital ratio, with a brief description of its
derivation and significance, referring to the risk characteristics of
both the assets and the liabilities of the insurer;
(D) Actuarial opinion of the insurer's Appointed Actuary certifying
the adequacy of the insurer's reserves as required by New York State
Insurance Department Regulation 126 and comparable regulations of other
States; and
(E) The insurer's most recent SEC Form 10K and Form 10Q (stock
companies only).
(d) Alternative separate account arrangements. (1) In general. An
insurer must provide the plan fiduciary with the following additional
information at the same time as the initial disclosure required under
paragraph (c)(3) of this section:
(i) A statement explaining the extent to which alternative contract
arrangements supported by assets of separate accounts of insurers are
available to plans;
(ii) A statement as to whether there is a right under the policy to
transfer funds to a separate account and the terms governing any such
right; and
(iii) A statement explaining the extent to which general account
contracts and separate account contracts of the insurer may pose
differing risks to the plan.
(2) An insurer will be deemed to comply with the requirements of
paragraph (d)(1)(iii) of this section if the disclosure provided to the
plan includes the following statement:
a. Contractual arrangements supported by assets of separate
accounts may pose differing risks to plans from contractual
arrangements supported by assets of general accounts. Under a
general account contract, the plan's contributions or premiums are
placed in the insurer's general account and commingled with the
insurer's corporate funds and assets (excluding separate accounts
and special deposit funds). The insurance company combines in its
general account premiums received from all of its lines of business.
These premiums are pooled and invested by the insurer. General
account assets in the aggregate support the insurer's obligations
under all of its insurance contracts, including (but not limited to)
its individual and group life, health, disability, and annuity
contracts. Experience rated general account policies may share in
the experience of the general account through interest credits,
dividends, or rate adjustments, but assets in the general account
are not segregated for the exclusive benefit of any particular
policy or obligation. General
[[Page 641]]
account assets are also available to the insurer for the conduct of
its routine business activities, such as the payment of salaries,
rent, other ordinary business expenses and dividends.
b. An insurance company separate account is a segregated fund
which is not commingled with the insurer's general assets. Depending
on the particular terms of the separate account contract, income,
expenses, gains and losses associated with the assets allocated to a
separate account may be credited to or charged against the separate
account without regard to other income, expenses, gains, or losses
of the insurance company, and the investment results passed through
directly to the policyholders. While most, if not all, general
account investments are maintained at book value, separate account
investments are normally maintained at market value, which can
fluctuate according to market conditions. In large measure, the
risks associated with a separate account contract depend on the
particular assets in the separate account.
c. The plan's legal rights vary under general and separate
account contracts. In general, an insurer is subject to ERISA's
fiduciary responsibility provisions with respect to the assets of a
separate account (other than a separate account registered under the
Investment Company Act of 1940) to the extent that the investment
performance of such assets is passed directly through to the plan
policyholders. ERISA requires insurers, in administering separate
account assets, to act solely in the interest of the plan's
participants and beneficiaries; prohibits self-dealing and conflicts
of interest; and requires insurers to adhere to a prudent standard
of care. In contrast, ERISA generally imposes less stringent
standards in the administration of general account contracts which
were issued on or before December 31, 1998.
d. On the other hand, State insurance regulation is typically
more restrictive with respect to general accounts than separate
accounts. However, State insurance regulation may not provide the
same level of protection to plan policyholders as ERISA regulation.
In addition, insurance company general account policies often
include various guarantees under which the insurer assumes risks
relating to the funding and distribution of benefits. Insurers do
not usually provide any guarantees with respect to the investment
returns on assets held in separate accounts. Of course, the extent
of any guarantees from any general account or separate account
contract will depend upon the specific policy terms.
e. Finally, separate accounts and general accounts pose
differing risks in the event of the insurer's insolvency. In the
event of insolvency, funds in the general account are available to
meet the claims of the insurer's general creditors, after payment of
amounts due under certain priority claims, including amounts owed to
its policyholders. Funds held in a separate account as reserves for
its policy obligations, however, may be protected from the claims of
creditors other than the policyholders participating in the separate
account. Whether separate account funds will be granted this
protection will depend upon the terms of the applicable policies and
the provisions of any applicable laws in effect at the time of
insolvency.
(e) Termination procedures. Within 90 days of written notice by a
policyholder to an insurer, the insurer must permit the policyholder to
exercise the right to terminate or discontinue the policy and to elect
to receive without penalty either:
(1) A lump sum payment representing all unallocated amounts in the
accumulation fund. For purposes of this paragraph (e)(1), the term
penalty does not include a market value adjustment (as defined in
paragraph (h)(7)of this section) or the recovery of costs actually
incurred which would have been recovered by the insurer but for the
termination or discontinuance of the policy, including any unliquidated
acquisition expenses, to the extent not previously recovered by the
insurer; or
(2) A book value payment of all unallocated amounts in the
accumulation fund under the policy in approximately equal annual
installments, over a period of no longer than 10 years, together with
interest computed at an annual rate which is no less than the annual
rate which was credited to the accumulation fund under the policy as of
the date of the contract termination or discontinuance, minus 1
percentage point. Notwithstanding paragraphs (e)(1) and (e)(2) of this
section, the insurer may defer, for a period not to exceed 180 days,
amounts required to be paid to a policyholder under this paragraph for
any period of time during which regular banking activities are
suspended by State or federal authorities, a national securities
exchange is closed for trading (except for normal holiday closings), or
the Securities and Exchange Commission has determined that a state of
emergency exists which may make such determination and payment
impractical.
(f) Insurer-initiated amendments. In the event the insurer makes an
insurer-initiated amendment (as defined in paragraph (h)(8) of this
section), the insurer must provide written notice to the plan at least
60 days prior to the effective date of the insurer-initiated amendment.
The notice must contain a complete description of the amendment and
must inform the plan of its right to terminate or discontinue the
policy and withdraw all unallocated funds without penalty by sending a
written request within such 60 day period to the name and address
contained in the notice. The plan must be offered the election to
receive either a lump sum or an installment payment as described in
paragraph (e)(1) and (e)(2) of this section. An insurer-initiated
amendment shall not apply to a contract if the plan fiduciary exercises
its right to terminate or discontinue the contract within such 60 day
period and to receive a lump sum or installment payment.
(g) Prudence. An insurer shall manage those assets of the insurer
which are assets of such insurer's general account (irrespective of
whether any such assets are plan assets) with the care, skill, prudence
and diligence under the circumstances then prevailing that a prudent
man acting in a like capacity and familiar with such matters would use
in the conduct of an enterprise of a like character and with like aims,
taking into account all obligations supported by such enterprise. This
prudence standard applies to the conduct of all insurers with respect
to policies issued to plans on or before December 31, 1998, and differs
from the prudence standard set forth in section 404(a)(1)(B) of the
Act. Under the prudence standard provided in this paragraph, prudence
must be determined by reference to all of the obligations supported by
the general account, not just the obligations owed to plan
policyholders. The more stringent standard of prudence set forth in
section 404(a)(1)(B) of the Act continues to apply to any obligations
which insurers may have as fiduciaries which do not arise from the
management of general account assets, as well as to insurers'
management of plan assets maintained in separate accounts. The terms of
this section do not modify or reduce the fiduciary obligations
applicable to insurers in connection with policies issued after
December 31, 1998, which are supported by general account assets,
including the standard of prudence under section 404(a)(1)(B) of the
Act.
(h) Definitions. For purposes of this section:
(1) An affiliate of an insurer means:
(i) Any person, directly or indirectly, through one or more
intermediaries, controlling, controlled by, or under common control
with the insurer,
(ii) Any officer of, director of, 5 percent or more partner in, or
highly compensated employee (earning 5 percent or more of the yearly
wages of the insurer) of, such insurer or of any person described in
paragraph (h)(1)(i) of this section including in the case of an
insurer, an insurance agent or broker thereof (whether or not such
person is a common law employee) if such agent or broker is an employee
described in this paragraph or if the gross income received by such
agent or broker from such insurer exceeds 5 percent of such agent's
gross income from all sources for the year, and
[[Page 642]]
(iii) Any corporation, partnership, or unincorporated enterprise of
which a person described in paragraph (h)(1)(ii) of this section is an
officer, director, or a 5 percent or more partner.
(2) The term control means the power to exercise a controlling
influence over the management or policies of a person other than an
individual.
(3) The term guaranteed benefit policy means a policy described in
section 401(b)(2)(B) of the Act and any regulations promulgated
thereunder.
(4) The term insurer means an insurer as described in section
401(b)(2)(A) of the Act.
(5) The term accumulation fund means the aggregate net
considerations (i.e., gross considerations less all deductions from
such considerations) credited to the Transition Policy plus all
additional amounts, including interest and dividends, credited to such
Transition Policy less partial withdrawals, benefit payments and less
all charges and fees imposed against this accumulated amount under the
Transition Policy other than surrender charges and market value
adjustments.
(6) The term Transition Policy means:
(i) A policy or contract of insurance (other than a guaranteed
benefit policy) that is issued by an insurer to, or on behalf of, an
employee benefit plan on or before December 31, 1998, and which is
supported by the assets of the insurer's general account.
(ii) A policy will not fail to be a Transition Policy merely
because the policy is amended or modified:
(A) To comply with the requirements of section 401(c) of the Act
and this section; or
(B) Pursuant to a merger, acquisition, demutualization, conversion,
or reorganization authorized by applicable State law, provided that the
premiums, policy guarantees, and the other terms and conditions of the
policy remain the same, except that a membership interest in a mutual
insurance company may be eliminated from the policy in exchange for
separate consideration (e.g., shares of stock or policy credits).
(7) For purposes of this section, the term market value adjustment
means an adjustment to the book value of the accumulation fund to
accurately reflect the effect on the value of the accumulation fund of
its liquidation in the prevailing market for fixed income obligations,
taking into account the future cash flows that were anticipated under
the policy. An adjustment is a market value adjustment within the
meaning of this definition only if the insurer has determined the
amount of the adjustment pursuant to a method which was previously
disclosed to the policyholder in accordance with paragraph (c)(3)(i)(D)
of this section, and the method permits both upward and downward
adjustments to the book value of the accumulation fund.
(8) The term insurer-initiated amendment is defined in paragraphs
(h)(8)(i), (ii) and (iii) of this section as:
(i) An amendment to a Transition Policy made by an insurer pursuant
to a unilateral right to amend the policy terms that would have a
material adverse effect on the policyholder; or
(ii) Any of the following unilateral changes in the insurer's
conduct or practices with respect to the policyholder or the
accumulation fund under the policy that result in a material reduction
of existing or future benefits under the policy, a material reduction
in the value of the policy or a material increase in the cost of
financing the plan or plan benefits:
(A) A change in the methodology for assessing fees, expenses, or
other charges against the accumulation fund or the policyholder;
(B) A change in the methodology used for allocating income between
lines of business, or product classes within a line of business;
(C) A change in the methodology used for determining the rate of
return to be credited to the accumulation fund under the policy;
(D) A change in the methodology used for determining the amount of
any fees, charges, expenses, or market value adjustments applicable to
the accumulation fund under the policy in connection with the
termination of the contract or withdrawal from the accumulation fund;
(E) A change in the dividend class to which the policy or contract
is assigned;
(F) A change in the policyholder's rights in connection with the
termination of the policy, withdrawal of funds or the purchase of
annuities for plan participants; and
(G) A change in the annuity purchase rates guaranteed under the
terms of the contract or policy, unless the new rates are more
favorable for the policyholder.
(iii) For purposes of this definition, an insurer-initiated
amendment is material if a prudent fiduciary could reasonably conclude
that the amendment should be considered in determining how or whether
to exercise any rights with respect to the policy, including
termination rights.
(iv) For purposes of this definition, the following amendments or
changes are not insurer-initiated amendments:
(A) Any amendment or change which is made with the affirmative
consent of the policyholder;
(B) Any amendment or change which is made in order to comply with
the requirements of section 401(c) of the Act and this section; or
(C) Any amendment or change which is made pursuant to a merger,
acquisition, demutualization, conversion, or reorganization authorized
by applicable State law, provided that the premiums, policy guarantees,
and the other terms and conditions of the policy remain the same,
except that a membership interest in a mutual insurance company may be
eliminated from the policy in exchange for separate consideration
(e.g., shares of stock or policy credits).
(i) Limitation on liability. (1) No person shall be subject to
liability under Parts 1 and 4 of Title I of the Act or section 4975 of
the Internal Revenue Code of 1986 for conduct which occurred prior to
the applicability dates of the regulation on the basis of a claim that
the assets of an insurer (other than plan assets held in a separate
account) constitute plan assets. Notwithstanding the provisions of this
paragraph (i)(1), this section shall not:
(i) Apply to an action brought by the Secretary of Labor pursuant
to paragraphs (2) or (5) of section 502(a) of ERISA for a breach of
fiduciary responsibility which would also constitute a violation of
Federal or State criminal law;
(ii) Preclude the application of any Federal criminal law; or
(iii) Apply to any civil action commenced before November 7, 1995.
(2) Nothing in this section relieves any person from any State law
regulating insurance which imposes additional obligations or duties
upon insurers to the extent not inconsistent with the provisions of
this section. Therefore, nothing in this section should be construed to
preclude a State from requiring insurers to make additional disclosures
to policyholders, including plans. Nor does this section prohibit a
State from imposing additional substantive requirements with respect to
the management of general accounts or from otherwise regulating the
relationship between the policyholder and the insurer to the extent not
inconsistent with the provisions of this section.
(3) Nothing in this section precludes any claim against an insurer
or other person for violations of the Act which do not require a
finding that the underlying assets of a general account constitute plan
assets, regardless of whether the violation relates to a Transition
Policy.
(4) If the requirements in paragraphs (c) through (f) of this
section are not met
[[Page 643]]
with respect to a plan that has purchased or acquired a Transition
Policy, and the insurer has not cured the non-compliance through
satisfaction of the requirements in paragraph (i)(5) of this section,
the plan's assets include an undivided interest in the underlying
assets of the insurer's general account for that period of time for
which the requirements are not met. However, an insurer's failure to
comply with the requirements of this section with respect to any
particular Transition Policy will not result in the underlying assets
of the general account constituting plan assets with respect to other
Transition Policies if the insurer is otherwise in compliance with the
requirements contained in this section.
(5) Notwithstanding paragraphs (a)(2) and (i)(4) of this section, a
plan's assets will not include an undivided interest in the underlying
assets of the insurer's general account if the insurer made reasonable
and good faith attempts at compliance with each of the requirements of
paragraphs (c) through (f) of this section, and meets each of the
following conditions:
(i) The insurer has in place written procedures that are reasonably
designed to assure compliance with the requirements of paragraphs (c)
through (f) of this section, including procedures reasonably designed
to detect any instances of non-compliance.
(ii) No later than 60 days following the earlier of the insurer's
detection of an instance of non-compliance or the receipt of written
notice of non-compliance from the plan, the insurer complies with the
requirements of paragraphs (c) through (f) of this section. If the
insurer has failed to pay a plan the amounts required under paragraphs
(e) or (f) of this section within 90 days of receiving written notice
of termination or discontinuance of the policy, the insurer must make
all corrections and adjustments necessary to restore to the plan the
full amounts that the plan would have received but for the insurer's
non-compliance within the applicable 60 day period; and
(iii) The insurer makes the plan whole for any losses resulting
from the non-compliance as follows:
(A) If the insurer has failed to comply with the disclosure or
notice requirements set forth in paragraphs (c), (d) and (f) of this
section, then the insurer must make the plan whole for any losses
resulting from its non-compliance within the earlier of 60 days of
detection by the insurer or sixty days following the receipt of written
notice from the plan; and
(B) If the insurer has failed to pay a plan any amounts required
under paragraphs (e) or (f) of this section within 90 days of receiving
written notice of termination or discontinuance of the policy, the
insurer must pay to the plan interest on any amounts restored pursuant
to paragraph (i)(5)(ii) of this section at the ``underpayment rate'' as
set forth in 26 U.S.C. sections 6621 and 6622. Such interest must be
paid within the earlier of 60 days of detection by the insurer or sixty
days following receipt of written notice of non-compliance from the
plan.
(j) Applicability dates. (1) In general. Except as provided in
paragraphs (j)(2) through (4) of this section, this section is
applicable on July 5, 2001.
(2) Paragraph (c) relating to initial disclosures and paragraph (d)
relating to separate account disclosures are applicable on July 5,
2000.
(3) The first annual disclosure required under paragraph(c)(4) of
this section shall be provided to each plan not later than 18 months
following January 5, 2000.
(4) Paragraph (f), relating to insurer-initiated amendments, is
applicable on January 5, 2000.
(k) Effective date. This section is effective January 5, 2000.
Signed at Washington, D.C. this 21st day of December, 1999.
Leslie Kramerich,
Acting Assistant Secretary for Pension and Welfare Benefits
Administration, U.S. Department of Labor.
[FR Doc. 00-32 Filed 01-04-00; 8:45 am]
BILLING CODE 4510-29-P
