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Will Annuities Be Mandatory in Qualified Plans?

If it happens, the entire process will require careful analysis.

Judith A. Hasenauer, 03/04/2010

It is beginning to appear that at least some people in Washington, DC, are giving serious consideration about the risk that large numbers of people will outlive the funds they have set aside for retirement. Some members of the Obama administration, as well as some elected legislators, have even used the "A" word--annuity--as a possible solution to the longevity problem. What is being considered is some form of a requirement that participants in a qualified pension or profit-sharing plan would have to have some of their assets in an annuity or some other investment that will provide income for life.

It is impossible to predict at the present time what form any such requirement will take, or even if it will ever actually be implemented. The impetus for enacting such a requirement is the huge growth in the popularity of 401(k) plans. Despite the ravages to everyone's investment portfolios caused by the 2008-2009 financial "meltdown," huge numbers of working Americans still have substantial funds in their 401(k) plans. And again, despite the volatility of the stock market, a huge percentage of these funds remain in equity investments--generally in common stocks held in some form of pooled investment entity.

The recent problems of the financial markets notwithstanding, equity investments remain perhaps the best and maybe even the only types of investments that provide working people with some hope of achieving and maintaining their financial goals for retirement. (We love the oft-repeated joke where the guy states that his 401(k) is now a 201(k)!) There seems to us little doubt that much of the motivation for the government to require the inclusion of longevity guarantees for at least some assets held under tax-qualified retirement plans is the recent instability in the financial markets. It is bad enough to worry about the impact of market fluctuations in retirement funds without also having to worry about large numbers of people outliving the funds they have put aside for retirement, regardless of what they may be worth.

The question remains that if some form of longevity guarantee will be required, what form will it take? If we accept the premise that an annuity issued by a legal reserve life insurer provides the simplest method to guarantee against outliving retirement funds, then such a product provides the easiest way to solve the problem Obviously, the life insurance industry is actively supporting this alternative. At the same time, other sectors of the financial services industry are not happy to see life insurers become the only entities that can service this possible new requirement. This is true even though the primary players in providing 401(k) plan services are money managers and such money managers will undoubtedly play a role is managing any assets held under annuities.

Recent years have seen non-insurance company asset management organizations developing arrangements with insurers to "wrap" their asset management capabilities with several different types of insurance guarantees to enable such asset managers to keep funds under management without the need to use insurer issued annuities that require actual funds to be held by the insurer. It would certainly seem that annuity guarantees separated from the actual management of assets by the insurer would accomplish the longevity goals that seem to be the concern of the government. In essence, these annuity guarantees are much like the annuity version of term insurance. The insurer enters into an arrangement with the asset manager (or perhaps even the employer where the pension assets are managed directly by the employer) for some type of "umbrella" coverage whereby the insurer agrees to provide longevity guarantees to all employees covered by the pension plan.

The ability for an employee to continue, after retirement, to participate in the asset management that he or she has enjoyed during the active work years would seem to be appealing--particularly if such asset management could be coupled with longevity guarantees. We would anticipate that such a process will be a welcome addition to the purchase of annuities as a retirement option. Regardless of the method preferred by employers and employees to satisfy any eventual longevity guarantee requirement, such requirement will undoubtedly have complications that will make the choice somewhat complex. After all, that is the usual process when the government mandates something in the Internal Revenue Code. We also question whether insurers will readily accept providing longevity guarantees that are not coupled with asset management by the insurer. Such a process certainly erodes the profit potential for the insurer.

Whatever happens with respect to any requirement for longevity guarantees, the entire process will require careful analysis to ensure that employees are, in fact, afforded meaningful guarantees. This analysis entails not merely the method of providing the longevity guarantee, but also the percentage of retirement assets that must be subjected to such a guarantee. If such a procedure is going to provide meaningful protection against outliving retirement assets, a simplistic approach of merely applying hard and fast percentages to the total funds available will not work. Instead, a more careful financial planning approach should be mandated whereby the needs of the retiree are measured by the funds available for retirement coupled with analysis of other assets, longevity predictions and the like. All too often the government attempts to solve complex problems with a simple "one size fits all" requirement. Such a simplistic approach will not really resolve the longevity risk problem that is endemic to our national retirement system. We have believed for quite some time that longevity risk has not been adequately addressed in defined contribution pension and profit-sharing plans. However, knowledgeable financial analysis is required before longevity risk can have any hope of being reduced for the bulk of retirees.

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