How to Assess Providers of Lifetime Income

Plan sponsors and advisers should consider the steps that go into a prudent process for selecting a provider if they want to include a lifetime income solution in their plans.

Plan sponsors do not have to provide in-plan lifetime income solutions for their plan participants. However, the topic is heating up, as the issue of how participants will manage account balances to provide sustainable lifelong income garners more attention.

Using a prudent process to choose a provider for a lifetime income solution requires several steps, according to “Fiduciary Considerations in Selecting a Lifetime Income Provider for a Defined Contribution Plan,” by Fred Reish and Bruce Ashton, Drinker Biddle & Reath attorneys who specialize in Employee Retirement Income Security Act (ERISA) issues. Steven Kronheim, vice president and associate general counsel at TIAA-CREF is the co-author.

Fiduciaries responsible for selecting annuity providers are not obligated to follow the steps in the safe harbor regulation, the paper notes. But they should consider four main areas—the company’s financial strength; the provider’s evaluation by the rating agencies; commitment and success in the insurance industry; and diversification of business lines—as part of a prudent process.

Of these areas, financial information about a provider is the most important and the section most likely to require the assistance of an outside professional, says Ashton, a partner in Drinker Biddle’s Los Angeles office.

“In my experience, not too many committee members are going to be very knowledgeable about insurance companies,” Ashton tells PLANADVISER. The largest firms are unlikely to have the expertise in-house to really determine the strength of an insurer.

Ashton suggests seeking the assistance of an adviser or consultant with specialized knowledge who is steeped in the industry. “There are some who understand the insurance industry and the strengths of various insurance companies,” he says.

In short, Ashton says, the plan sponsor wants to determine how long the provider has been in business; the size of the business in serving this market specifically; and what its reputation is.

Recently, the Department of Labor (DOL) issued guidance on qualified longevity annuity contracts (QLAC) used in target-date funds (TDFs). Does the guidance at all soothe plan sponsors’ fears about their fiduciary responsibility in choosing a lifetime income provider?

“The short answer is no,” Ashton says. However, he notes that recent guidance from the Internal Revenue Service (IRS) and the Treasury Department—IRS Notice 2014-66 and an accompanying letter from Phyllis Borzi, assistant secretary of the DOL—should give people some comfort that regulators are trying to allay concerns about these types of products.

“The Borzi letter makes it clear that it is certainly permissible that you could engage a 3(38) investment manager to make the determination,” Ashton says.

The plan sponsor and plan committee, Ashton says, can see if the consultant or adviser will take on the role of a 3(38) investment manager and have it make the decision about choosing a provider. “That’s what the structure was in the 2014-66 notice,” he says. “The letter from Borzi pointed out that if you have an investment manager, it’s making the responsible decision, and that’s OK.”

The aspects of an insurance company’s finances are quite detailed, ranging from analysis of the firm’s asset valuation reserve, to diversification of assets, to liquidity, to Fortune 500 ranking. Drinker Biddle’s paper has a sample checklist in the appendix for use in evaluating an insurance company, and specifics on how to access information: Some can be obtained by asking the insurer; some from independent sources, such as ratings agencies or the National Organization of Life and Health Insurance Guaranty Associations.

The following are characteristics that can be used to assess financial strength:

Bond quality: The National Association of Insurance Commissioners bond quality can be found on the insurer’s website or can be requested from the insurer. Investment-grade bonds should be at least 90% of the bond holdings of the company’s general account.

Diversification of invested assets: Bond type and duration; preferred stocks; common stocks; real estate; alternative investments. Questions to ask include: Are the bonds that are owned diversified among bond types? Are the bond maturities diversified according to particular time frames? 

Insurer’s asset liquidity: This can be found on the annual statutory statements. Total bonds, total cash and total mortgages can be found on the assets schedule, while the total reserves can be found on the reserve analysis.

Fortune 500 ranking: Life and health insurance companies are listed either as a stock or a mutual insurance company.

Analysis of insurer’s statutory capital: Data on the capital, surplus and asset-valuation reserve of an insurer can be found in the annual statutory statements (Blue Book) and from the individual rating agencies (Fitch, Moody’s, Standard & Poor’s, and A.M. Best).

Plan sponsors should factor in the quality of the company’s ratings by Fitch, Moody’s, Standard & Poor’s, and A.M. Best. Ratings from each company should be examined to determine the consistency or lack of consistency among the rating agencies. Ratings over a five-year period, or longer, can help determine if the trends have been stable over time or have fluctuated in economic cycles. Read the report that accompanies each rating agency’s rating to see if there are adverse comments that suggest vulnerability to future economic events.

  • Check insurance company annual reports and insurance company websites as well as the individual rating agencies.
  • Acceptable ratings for financially strong companies are considered to be A- or higher by either A.M. Best, Fitch or Standard & Poor’s, and A3 or higher by Moody’s.

Determine the company’s commitment and success. How long has the company been in business? The annuity provider should have enough history to demonstrate the ability to maintain a strong balance sheet through different market cycles. Drinker Biddle recommends that an insurance company have a minimum of 10 years in the annuity industry and annuities with living benefits.

How large is the annuity business? This can be determined by the number of annuity contracts and the amount of annuity assets. A well-established annuity provider would have a minimum of 250,000 contracts and total traditional annuity assets of at least $15 billion, with a minimum $5 billion with living benefits.

  • Make sure that annuities and income guarantees are one of the core business lines—at least 10% of annual revenue—of the insurer.
  • Review the insurance company’s Form 10-K for the company’s regulatory history and litigation history, with particular focus on potential impacts to the annuity business.

Determine the business lines—for example, annuities; life insurance; group insurance; retirement plans; other—from the insurance company’s Form 10-K or annual report. While diversification by itself does not insure that an organization is financially sound, it can help with volatility, as compared with a single line of business. Any insurance company that has a single or limited line of business should be closely scrutinized.

  • Is the company broadly diversified across different lines of business?
  • What is the revenue (in millions) by business line or division for annuities; life insurance; group insurance; retirement plans; other?