The life insurance industry has lost its battle to retain stable value funds as qualified default investments in 401(k) plans.
Specifically, the final regulation published in The Federal Register by the Department of Labor says the appropriate default investments will be investment products that include equities, including mutual fund products such as lifecycle funds.
Stable value funds, also known as Guaranteed Investment Contracts, or “GICs,” can be used for new participants in 401(k) plans, but only for their first 120 days of participation.
However, for a variety of reasons, including the addition of a liberal transition rule to the final regulation, the impact on the industry’s competitiveness in the defined contribution market is likely to be limited, according to industry officials and a highly rated securities analyst.
In fact, the overall positives of the law that prompted the rule, the Pension Protection Act of 2006, are favorable for the industry, these sources say. These include automatic enrollment of plan participants in defined contribution plans, many of them administered by insurance companies, allowing qualified default investment alternatives (QDIAs) to be offered through variable annuities, and the fact that the industry has gradually added mutual funds to its investment options.
And, as noted by Chris Bowman, vice president of retirement and investors services at Principal Financial, based in Des Moines, the final rule provides certainty to plan sponsors as to what investment options carry with them a safe harbor.
The final regulation was published by the DOL on Oct. 24. According to Bowman, that in itself poses one of the greatest challenges because that means the rule will go into effect Dec. 24, providing little time for companies to inform plan sponsors and transition them to qualified default investment alternatives.
In a conference call Oct. 23 with reporters, Bradford Campbell, assistant Secretary of Labor in charge of the Employment Benefits Security Administration, the administrator of ERISA, noted in response to a question that no one had brought the issue of the rapid transition timetable to the agency’s attention previously.
At the same time, a grandfather rule allows money invested in these funds prior to the effective date of the final rule to remain in those conservative investments.
That will protect the approximately $90 billion held by insurers in these stable value funds, which are funded by high-quality bonds and other highly-rated, interest-bearing securities.
Moreover, the new regulation allows variable annuities or other pooled investment funds to be used as a funding vehicle for any of the qualified default investment vehicles for 401(k)s.
“That is definitely a positive,” said Mike DeGeorge, general counsel of NAVA, Inc. “The industry pushed mightily to have the regulation clarify that VAs can be used as a funding vehicle for any of the qualified default investment vehicles,” he said.
Colin Devine, a managing partner and life insurance analyst for Citigroup Global Markets Research, made two comments on the regulation. In a note to investors the previous week, he called the rule a “huge victory for the mutual fund industry.” He said Fidelity had predicted that more than $100 billion of assets insurers manage in defined contribution plans could switch to mutual funds within the first year of the change.
But, Devine cautioned in his investment note that GICs “are a relatively small piece of 401(k) assets,” and that while the default option change could cause the GIC market to shrink, “we do not forecast it will meaningfully shrink life insurer earnings.”
He said GIC and stable value funds represent about 11% of 401(k) account values. “By comparison, 49% of plan assets are invested in equities; 13% in balanced funds and 9% in bond funds.
“Even with their exclusion, we still predict good demand for GICs as their guaranteed returns appeal to older, more conservative employees,” Devine said.
And, in comments at a seminar held in conjunction with the annual meeting of the American Council of Life Insurers as the details of the regulation became public, Devine said the PPA, of which the default option regulation is a component, is an overall positive for the insurance industry.
Commenting at the seminar on annuities in general, Devine said, the “growth [for life insurance companies] will be unequaled. This is our time. If you don’t succeed, you can’t blame the banks or the brokers.”
In his note to investors, Devine said that annuities could emerge as the big money maker in 401(k)s. “In our view, the biggest beneficiary of the PPA still remains the emerging post-retirement income market.”
He said, “Large, well-branded life insurers appear poised to dominate this segment as variable annuities with living benefits offer a very efficient way to insure lifetime income risk.
“Income-oriented annuities can provide a source of earnings for over 30 years, thereby representing a tremendous source of potential embedded value creation,” he said.
Commenting on the decision, Jack Dolan, a spokesman for the ACLI, said, “We have been expecting this.”
He added that an important point is that plan participants actively managing their 401(k) plans still will have access to stable value funds.
“The story about stable value funds is the same: They provide capital preservation,” he said. “Participants under a variety of circumstances need stable value funds.
“And, in fact, plan sponsors still could offer stable value funds as a default funds,” he said. “What the regulation says is that they don’t receive a safe harbor from ERISA fiduciary liability standards. They would have to make clear that a stable value fund is a prudent choice.”
Specifically, the final regulation provides for four types of QDIAs:
–A product with a mix of investments that takes into account the individual’s age or retirement date (an example of such a product could be a life-cycle or targeted-retirement-date fund.)
–An investment service that allocates contributions among existing plan options to provide an asset mix that takes into account the individual’s age or retirement date (an example of such a service could be a professionally-managed account.)
–A product with a mix of investments that takes into account the characteristics of the group of employees as a whole, rather than each individual (an example of such a product could be a balanced fund.)
–A capital preservation product for only the first 120 days of participation (an option for plan sponsors wishing to simplify administration if workers opt-out of participation before incurring an additional tax).
The final rule says that a QDIA must either be managed by an investment manager, plan trustee or plan sponsor who is a named fiduciary, or be an investment company registered under the Investment Company Act of 1940.
The DOL estimated that because the new law facilitates the adoption of automatic enrollment plans, between $70 billion and $134 billion in additional retirement savings will be generated by 2034.
“The new default options will be an essential element in the success of automatic enrollment plans to help workers achieve retirement security,” Campbell said.
“This regulation will ensure that workers in qualified default alternatives are automatically invested in a mix of fixed income, equity and other assets appropriate for long-term retirement savings,” he added.