Lawsuit Questions Differing Investment Terms for 401(k) and DB Plan

The lawsuit accuses Nationwide 401(k) plan fiduciaries of not negotiating terms for a fixed-income contract comparable to that for its DB plan for the purpose of increasing its subsidiary's profits.

A lawsuit has been filed alleging that Nationwide Mutual Insurance Co. and the investment committee for its 401(k) plan failed to prudently manage the plan and used it as an opportunity to promote their business interests at the expense of the plan and its participants in violation of the Employee Retirement Income Security Act (ERISA).

Specifically, the complaint says the defendants failed to negotiate contractual terms for the 401(k) plan’s Guaranteed Investment Fund (GIF) that were comparable to the terms they negotiated on behalf of the company’s defined benefit (DB) plan. As a result, it says, the 401(k) plan’s GIF paid a much lower interest rate than was paid by the otherwise-identical investment held within the pension plan. The lawsuit says this failure led to participants losing more than $142 million in benefits during the proposed class period.

Nationwide says, “We are aware of the litigation and are reviewing the allegations.”

The complaint explains that the GIF is a fixed-interest insurance contract that guarantees the investor’s principal and pays a fixed interest rate to investors over a specified period. The interest rate paid is ultimately set by Nationwide’s wholly-owned subsidiary, Nationwide Life Insurance Co. and periodically adjusted, typically quarterly. The interest rate is set either at the insurance company’s discretion or pursuant to contractual terms negotiated with the contract owner (the retirement plan in the instance of the lawsuit) or a party acting on the owner’s behalf (the defendants), or a combination of both, depending on the contract’s terms.

The plaintiffs allege that, pertaining to the 401(k) plan, this process is “tainted by an inherent conflict of interest.” They note that funds invested in the GIF are deposited into Nationwide’s General Account, which in turn invests in securities that generate a much higher rate of return than the guaranteed rate that Nationwide pays to GIF investors. Nationwide retains the difference between General Account earnings and the interest rate paid to GIF investors as profit, “giving Nationwide a powerful financial incentive to pay GIF investors the lowest possible interest rate in order to maximize Nationwide’s profit margin,” the plaintiffs claim.

They argue that the incentive is different in the context of the DB plan. The complaint explains that the participants in the pension plan are entitled to a specific benefit amount—rather than the earnings on investments—with Nationwide bearing the responsibility to make up any shortfall between pension plan investment returns and benefits payments. “Thus, there is no financial incentive for Nationwide to ‘shortchange’ the pension plan because it would be shortchanging itself, rather than participants. … As a result, the fact that the pension plan’s fixed-interest investment earns a much higher interest rate than the GIF—despite the fact that both accounts’ assets are invested in the exact same pool of investments within Nationwide’s General Account—demonstrates that defendants succumbed to Nationwide’s self-interest rather than prudently and loyally dealing with 401(k) plan investments in the sole interests of plan participants and beneficiaries,” the complaint states.

The plaintiffs mention two other insurance companies that, the plaintiffs say, hold fixed-interest investments like the GIF in both their 401(k) and traditional pension plans that were able to negotiate comparable contractual terms for both plans. The lawsuit says, “This contrast demonstrates that defendants’ failure to negotiate contractual terms comparable to those negotiated on behalf of the pension plan was not due to any differences between defined contribution and defined benefit plans, but instead to defendants’ failure to adhere to the high standards of prudence and loyalty required under ERISA.”