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QDIA Rule Allows VAs, Excludes Stable-Value Funds

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The U.S. Labor Department has decided to include variable annuities on the basic list of 401(k) plan qualified default investment alternatives but to shut out stable-value funds.

The Labor Department will be publishing a final rule Wednesday that will create a QDIA provision classifying diversified variable annuities, lifecycle funds, balanced funds and other diversified funds that include stock as the only investment products that can be used as default investment options without extra justification.

A provision of the Pension Protection Act of 2006 created the QDIA option to encourage 401(k) plan fiduciaries to make suitable default investment decisions for participants who do not say what they want plan administrators to do with their accounts. The provision provides protection for plan fiduciaries who make prudent, carefully considered decisions to put participant money in investments that turn out to perform poorly.

The PPA QDIA provision protects fiduciaries of plans that put the assets of plan participants who make no allocation requests into professionally managed accounts; “lifecycle” funds, or funds aimed at individuals with specific target retirement dates; and “lifestyle” funds, or funds aimed at individuals with specific levels of risk tolerance.

Insurers, the biggest sellers of stable-value funds, typically invest the fund assets in high-grade bonds, guaranteed investment contracts issued by insurance companies, and other highly rated interest-bearing securities that offer a relatively low yield.

In comments about a proposed QDIA regulation, insurers had asked the Labor Department to include stable-value funds on the QDIA list, but mutual fund companies and some consumer groups said Congress created the PPA QDIA provision in an effort to encourage fiduciaries to choose default investments that include some exposure to stocks.

The Labor Department “considered market trends, generally accepted investment theories, mainstream financial planning practices, and actual investor behavior, as well as the estimated effect of qualified default investment alternatives on retirement savings,” department officials write in a preamble to the final rule.

“All of these criteria suggest that it is desirable to invest retirement savings in vehicles that provide for the possibility of capital appreciation in addition to capital preservation.”

Under the terms of the final rule, employers that still want to offer stable-value funds as default investment options can do so, but they will have to be prepared to show that the funds are prudent options, retirement plan experts say.

The QDIA final rule includes a grandfather provision for plan money already invested by default in stable-value funds. Plans can keep any money invested in stable-value funds by default before the effective date of the final rule in the stable-value funds.

In addition, the new final rule will allow 401(k) money to be invested in stable-value accounts on a default basis for the first 120 days after a contribution is made, Labor Department officials say.

Today, 401(k) plan participants have invested about $400 billion of their $2.7 trillion in total plan assets in stable-value funds, according to the Employee Benefit Research Institute, Washington.

It is not clear what percentage of plan money is in stable-value funds by default, and Labor Department officials predict in the preamble to the new QDIA final rule that plan administrators will be responsible for investing only about 1.2% to 1.5% of 401(k) plan assets in QDIAs in 2034.

The QDIA final rule probably will cut default 401(k) plan investments in stable-value funds and other “capital preservation” products by the inflation-adjusted equivalent of about $10 billion per year by 2034, Labor Department officials predict.

The final rule might increase total 401(k) plan stable-value fund investments over the years, by promoting automatic enrollment and other measures that should increase actively invested account balances, officials write.

Variable annuities are, technically, not on the list of QDIAs. But variable annuities can be used as the funding vehicles for the stock-based default investments.

Some insurance company executives and others who commented on the proposed version of the QDIA rule said they did not believe the proposed version was clear about whether variable annuities incorporating lifecycle or lifestyle funds could be used as QDIAs in the same fashion as lifecycle or lifestyle mutual funds.

“Consistent with providing flexibility and encouraging innovation in the development and offering of retirement products, model portfolios or services, the [Labor] Department intends that the definition of ‘qualified default investment alternative’ be construed to include products and portfolios offered through variable annuity and similar contracts, as well as through common and collective trust funds or other pooled investment funds, where the qualified default investment alternative satisfies all of the conditions of the regulation,” department officials write in the preamble to final rule.

“For purposes of identifying the entity responsible for the management of the qualified default investment alternative in such arrangements … it is the view of the department that such a determination is made by reference to the entity (e.g., separate account, subaccount, or similar entity) that is responsible for carrying out the day-today investment management/asset allocation responsibilities,” officials write.

“It is the view of the department that the availability of annuity purchase rights, death benefit guarantees, investment guarantees or other features common to variable annuity contracts will not themselves affect the status of a fund, product or portfolio as a qualified default investment alternative when the conditions of the regulation are satisfied,” officials write.

Colin Devine, a life insurance analyst at a unit of Citigroup Inc., New York, writes in a comment on the controversy that the QDIA final rule is a “huge victory for the mutual fund industry.”

Fidelity Investments, Boston, predicts that more than $100 billion of assets that insurers now manage in defined contribution plans could shift to mutual funds within the first year that the change is in effect, Devine writes.

But GICs “are a relatively small piece of 401(k) assets,” and “we do not forecast [the change] will meaningfully shrink life insurer earnings,” Devine writes.

The American Council of Life Insurers, Washington, is emphasizing the fact that 401(k) plan participants who actively manage their accounts still can invest in stable-value funds.

“The story about stable-value funds is the same: They provide capital preservation,” ACLI spokesman Jack Dolan says. “Participants under a variety of circumstances need a stable-value fund.”

Stable-value fund advocates at the Stable Value Investment Association, Washington, say a plan still can use a stable-value fund as its default investment, even if a stable-value fund is not a QDIA.

The law requires plan fiduciaries to make prudent decisions about default investments, and, in some cases, stable-value funds may be more prudent than the products on the QDIA list, SVIA officials write in an analysis of the final rule.

A stable-value fund might be an appropriate default investment if a high percentage of a plan’s participants are close to retirement or the participants are especially risk-averse, SVIA officials write.

A copy of the QDIA final rule is available

Allison Bell contributed information to this report.