I have been receiving a number of requests to perform forensic analyses on ERISA plans that include one or more variable annuities as investment options within the plan. Most of these plans are ERISA 403(b) plans due to the fact that the entities are private entities, as opposed to public/government entities that are exempted from ERISA coverage.
While there are many prudence and cost-efficiency related issues relating to variable annuities overall, an emerging issue involves the plan sponsor’s ability to carry out its fiduciary duties under ERISA. As SCOTUS noted in the Tibble decision
In determining the contours of an ERISA fiduciary’s duty, courts often must look to the law of trusts….Under trust law, a trustee has a continuing duty to monitor trust investments and remove imprudent ones.
Variable annuities usually include numerous sub-accounts as investment options. This increases the odds of finding sub-accounts that are not prudent and need to be removed.
The issue – I am not aware of any variable annuities that permit owners, or plan sponsors, to actually remove an imprudent sub-account from a variable annuity that is part of the annuity’s investment menu. Based upon my experience as a compliance director and ERISA/ securities attorney, the typical response from the variable annuity issuer would be that the overall menu of options is fine, just do not invest in the imprudent sub-accounts.
And there it is, the old “menu of investment options” defense so often misunderstood and misapplied by attorneys and judges. Judges and attorneys have often cited the Hecker v. Deere I decision in support of the “menu of options” argument.
For some reason, the court’s subsequent decision in Hecker v. Deere II is often conveniently overlooked by judges and attorneys, even though most of the legal community agrees that the court’s second decision effectively reversed the court’s first decision. Enlightened courts have quickly pointed out the practical impact of both cases and have consistently rejected the “menu of options” defense.
In footnote 8 of the DiFelice v. U. S. Airways decision, the court explained why “each individual investment” must be the applicable standard in defined contribution cases. With DC plans, a plan participant carries the financial risk of imprudent investments, although the plan has the exclusive power to choose the plan’s available investment options.
Drinker Biddle issued an excellent white paper that sets out the definitive standard, stating that
The obligation of fiduciaries under ERISA is to prudently select, monitor, and remove individual investments, as well as to consider the performance of the portfolio as a whole. It is not an “either-or” scenario; both requirements must be satisfied.
Which brings us back to the original question. Unless and until a variable annuity allows a plan sponsor to remove an imprudent investment sub-account offered within a variable annuity offered as an investment option within an ERISA plan, how does a plan sponsor avoid a breach of their fiduciary duty to make such changes in compliance with ERISA?
As a plaintiff’s attorney, thjs would seem to be a perfect example of the proverbial “low hanging fruit,” with no viable option for the plan’s failure to meet its fiduciary duties. It has been suggested to me that any attempt to correct the problem by totally replacing the variable annuity could have potentially significant tax implications as well, even given the fact that the plan is given favorable tax treatment. Since I am not a tax attorney, I will leave that issue to the tax attorneys.
Is the plan sponsor’s inability to remove imprudent investment sub-accounts from variable annuities within an ERISA plan a breach of their fiduciary duties? The elements certainly seem to be there to make a valid argument in favor of finding a breach, to make the variable annuity issue potentially ERISA litigation’s “next big thing.” Time will tell.
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This article is for informational purposes only, and is not designed or intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances. If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought.