Benefits Products & Services

Reviving income guarantees in the post-DB plan era

LFG travels the long and promising road to in-plan annuity acceptance

By Thomas A. McCoy, CLU

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Ever since defined contribution plans supplanted defined benefit plans as the predominant employee benefits retirement plan vehicle, no one seems to expect DB plans to return to their former prominence in the market. What has happened, though, is that the idea of a guaranteed level of lifetime income in retirement—which DB plans provide, and traditional DC plans cannot—is too good to go away.

In the past few years some leading writers of individual annuities have developed hybrid products for retirement plans that provide the security blanket effect of a defined benefit plan within the flexible delivery vehicle of a DC plan. (See "A Measure of Certainty"—August 2011 issue—for a discussion of Prudential's approach.) These in-plan annuities combine a guaranteed level of lifetime income with upside growth potential based on the performance of a variable annuity.

Annuity writers aren't the only ones interested in the in-plan market. In 2010 the Departments of Labor and Treasury invited annuity providers to hearings on worker retirement funding readiness. At the hearings, annuity company representatives made their case for including in-plan annuities in the retirement product mix. In 2011 the Senate Committee on Aging asked retirement plan providers for details about guaranteed income features in defined contribution plans.

Eric Levy, senior vice president and head of products and solutions management for Lincoln Financial Group's Retirement Plan Services business, testified at the Departments of Labor and Treasury hearings. Since that time, he says, "We've been out talking to plan sponsors and doing research which indicates a strong need for in-plan annuities. What's really encouraging is that among plan participants, it isn't only the near-retirees who see the need for the income guarantee. We're seeing strong interest among participants age 45 and up.

"The challenge for plan sponsors has been identifying what their fiduciary responsibilities are in offering them," says Levy.

To deal with this challenge, the industry has urged the Department of Labor to provide a new "safe harbor" for plan sponsors that are considering offering in-plan annuities—one that is clearer than the "safe harbor" language currently in place. Unfortunately, that regulatory guidance has been slow in coming.

"We as an industry, and we as a company, have said we can't wait," says Levy. So the product introductions continue, as insurers hope to build momentum for further acceptance. LFG, one of the nation's top 10 writers of individual annuities, will introduce an in-plan annuity in the fourth quarter of this year.

To allay some of the concerns plan sponsors may have about their fiduciary duties, LFG has partnered with Drinker Biddle & Reath LLP, a Los Angeles-based law firm specializing in fiduciary responsibility and compliance issues for retirement plans. The law firm has partnered with Lincoln to help plan sponsors gain a better understanding of the fiduciary responsibilities associated with evaluating in-plan guarantee products. Levy says one of the advantages of purchasing a guaranteed income product within a 401(k) or other defined contribution retirement plan is that the participant is "dollar cost averaging" in the same way that he does with the traditional investment products of the plan.

"We are working on a solution that will include a balanced fund wrapped by the guaranteed income rider. That vehicle will be allocated into a participant's portfolio over time. At age 55 we'll allocate 10% of the participant's assets toward the income guarantee. At age 56 we would transfer another 10% and so forth so that within 10 years the assets would be 100% into the guaranteed fund."

Once the guarantee kicks in, the person can retire with the guaranteed lifetime income floor. The investments that are used within the participant's account—even after the account is fully annuitized—have the potential for further growth beyond the guarantee (using an index-based balanced fund), but the guaranteed floor will always be there in retirement. The retiree can't outlive this income amount.

LFG has used its experience in the individual annuity market and proceeded cautiously but steadily toward the development of its in-plan annuity. "One way we see guaranteed income products gaining acceptance within defined contribution plans is through collaboration among diverse financial institutions—asset managers, insurers and recordkeepers," Levy states.

LFG joined in a collaborative venture in mid-2012 to produce a guaranteed income product as a default option for employees of United Technologies Corporation (UTC). Nationwide Life Insurance Company and Prudential Retirement Insurance and Annuity Company are the other participating annuity providers for the "Lifetime Income Strategy" offered to UTC's defined contribution plan participants. AllianceBernstein provides asset management services for the plan, and Aon Hewitt is the plan's record keeper.

"As the plan sponsor, we wanted a multi-insurer solution to promote price competitiveness and greater capacity," said Robin Diamonte, UTC's chief investment officer, at the time the feature was introduced.

Levy sees the UTC model as a possible prototype for other employers that want to bring greater retirement income certainty to their DC plan participants. "UTC has thousands of employees, and large companies often are the first to adopt changes in retirement plans. When a concept works there, it is more likely to be adopted by middle-sized and smaller employers."

Lincoln Financial Group and other major retirement plan specialists know that a long road lies ahead to convince key constituencies—regulators, plan sponsors and participants—that guaranteed income products can be an effective cornerstone product for DC plan participants. "We may only be in the top of the third inning of the game in terms of our education efforts," says Levy.

Plan participants will ultimately influence their plan sponsors and regulators in determining the worth of in-plan annuities. So as the product does its job of providing the peace of mind that comes with a lifetime income guarantee, momentum for further growth is likely to follow.

Employee benefits brokers can look forward to playing a vital role in that process.