Compliance April 12, 2021

Judge Finds in Favor of Principal Life’s Process for Setting GIC Crediting Rate

Principal prevailed in a lawsuit that alleged it set the crediting rate for a guaranteed investment contract (GIC) such that it could “retain unreasonably large and/or excessive profits.”

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Following a six-day trial, Judge John A. Jarvey of the U.S. District Court for the Southern District of Iowa ruled in favor of Principal Life Insurance Co. in a lawsuit alleging it violated the Employee Retirement Income Security Act (ERISA) by setting the crediting rate for a guaranteed investment contract (GIC) such that it could “retain unreasonably large and/or excessive profits.” A GIC is a stable value investment contract issued by an insurance company that usually pays a specified rate of return for a specific period of time, guaranteeing principal and accumulated interest.

The court previously dismissed the suit, finding that Principal is not a fiduciary when it sets the composite crediting rate (CCR) for the GIC and it is also not a party-in-interest engaging in prohibited transactions. However, the 8th U.S. Circuit Court of Appeals reversed that ruling last February.

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The GIC, called the Principal Fixed Income Option (PFIO), was available in the retirement plans of the plaintiff in the lawsuit and the class members he represented. In his opinion, Jarvey noted that Principal calculates the CCR every six months using a formula set forth in the PFIO contract and its related schedules.

“Participants who do not like the CCR can reject the rate by immediately withdrawing their funds from the PFIO at any time and at no cost. A plan sponsor who does not like the CCR, or who otherwise wishes to stop offering the PFIO to its participants, can withdraw all its participants’ funds from the PFIO in one of two ways. First, it can withdraw from the PFIO at no cost after giving 12 months’ notice to Principal (the 12-month put). In the alternative, it can withdraw from the PFIO immediately, without notice, by paying a charge equal to 5% of the plan assets allocated to the PFIO,” the opinion states.

Jarvey said the evidence demonstrated that these restrictions benefit participants by reducing the risk of large, sudden cash outflows from the PFIO. He also said that without these restrictions, Principal could not offer a pooled guaranteed product with a rate as high and as stable as the PFIO.

After reviewing the rate-setting process for the PFIO, Jarvey considered “deducts” from the guaranteed interest rate (GIR), which are intended to reflect Principal’s predictions about certain future costs and risks that it undertakes in connection with offering the PFIO. Jarvey found all contested deducts were reasonable and represented a reasonable expense of administering the PFIO.

Jarvey pointed out that the statute defining the duty of loyalty plainly identifies “the interest of the participants” as including “providing benefits” and “defraying reasonable expenses of administering the plan.” He found that Principal’s determination of the deducts from the GIRs for the PFIO properly served “the interest of the participants” as to payment of benefits in the form of a guaranteed return, defraying reasonable expenses, and providing a sound and stable investment.

The plaintiff contended that undivided and unconflicted loyalty, with no consideration for the fiduciary’s own gain, is required under ERISA, so a fiduciary acting under a conflict of interest breaches its fiduciary duty. However Jarvey agreed with Principal that a conflict of interest is not enough, standing alone, to establish a breach of fiduciary duty.

The plaintiff offered an alternative argument that a fiduciary operating under a conflict of interest must be especially scrupulous, adding that Principal was not scrupulous when setting the CCR, because it took no steps to mitigate the conflict, thus breaching its duty of loyalty. The plaintiff argued that Principal should have mitigated the conflict of interest by stepping aside and allowing independent third parties to set the CCR or, at the very least, that Principal should have consulted with independent third parties when setting the CCR.

But Jarvey found that “the ever-present tension between profit for Principal and the return for the participants did not require Principal to seek advice from independent third parties in setting the CCR or to require Principal to surrender the task of setting the CCR to independent third parties to avoid a breach of fiduciary duty.”

In addition to the lack of a true conflict of interest, Jarvey said the market for products, such as the GIC, adequately protects investors. “When all the components of ‘the interest of the participants’ are considered, there is substantial alignment between ‘the interest of the participants’ and Principal’s interest. It is in both the participants’ and Principal’s interest to establish a CCR that will appropriately account for Principal’s risks and costs in offering the PFIO, not just so that the product can remain competitive in the market, but so that Principal can make good on its guarantees to participants. Participants do not simply want the best rate of return; they want the best rate of return they can get while taking essentially no risk and enjoying the safety and security of a soundly backed investment. Indeed, a guaranteed CCR that is too high threatens the long-term sustainability of the guarantees of the PFIO, which is detrimental to ‘the interest of the participants.’”

Jarvey did agree with the plaintiff’s contention that the focus of a disloyalty claim is on the fiduciary’s motivation. Jarvey found credible the testimony of Principal’s witnesses. They argued that Principal’s actuaries who reviewed the deducts “tried to set the best rate that [they could] for participants” while also appropriately accounting for Principal’s anticipated costs and risks, to ensure Principal could make good on its obligation to pay participants the PFIO’s guaranteed rate regardless of future market conditions. Jarvey said he found the opinions of the plaintiff’s witness “wholly unpersuasive in light of the evidence of the reasonable—indeed, meticulous—process Principal used to determine the deducts.

“That reasonable process provides an inference—here, a strong one—that Principal’s motive was to act in ‘the interest of the participants,’” Jarvey continued.

Using similar reasoning, the court found in favor of Principal on the lawsuit’s self-dealing claims.

Compliance April 12, 2021

The Most Common Retirement Plan Testing Mistakes

By alerting plan sponsors to the issues they see most often, advisers can help their clients navigate IRS testing rules.

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Retirement plan advisers can add value to their relationships with clients by understanding IRS plan testing, experts say. “The rules are incredibly complicated,” says Robyn Credico, defined contribution (DC) consulting leader, North America, at Willis Towers Watson. “Because tests are sometimes only done once every three years, sponsors can pretty easily make a mistake.”

And there are common mistakes sponsors make that advisers can bring their attention to and help them avoid, experts say.

“The most common mistake I see in plan administration testing is following the definition of compensation,” says B. David Joffe of Bradley, chair of the firm’s Employee Benefits and Executive Compensation Practice Group.

“It is helpful if an adviser goes through that definition word for word, in terms of each element of compensation,” Joffe says. “Companies have different ways of defining compensation and coding it. It is also helpful to get a person from the payroll provider involved.

“Next is eligibility and ensuring that those who are eligible to participate in the plan are, in fact, given that access,” Joffe continues. “That can include automatic enrollment, or not automatically enrolling participants when they should be. Enrolling appropriately according to the plan document is very important. Employers need to understand how eligibility terms work.”

Another common error, he says, is applying the IRS required limits on contributions. “Sponsors need to know those limits, particularly as they change annually,” Joffe says.

Sponsors sometimes can find through plan testing that they’re not properly administering hardship withdrawals and loans from the plan, he says, and they should watch out for that.

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Yet another misstep that Carol Buckmann, ERISA attorney and co-founder of Cohen & Buckmann, has found sponsors make is not realizing that they need to include workers from related companies or affiliates in their control group. Sponsors also sometimes mistakenly segregate highly compensated employees (HCEs) into one control group and non-HCEs into another control group, Buckmann says.

While she agrees with Credico that the testing rules are complicated, Buckmann maintains that “advisers don’t need to understand all of the technical tax rules or the testing rules, but, rather, simply make their plan sponsor clients aware of the common mistakes to avoid.”

Plans often fail non-discrimination testing, she notes. “Advisers can help them avoid that by helping them implement automatic enrollment or making the plan a safe harbor plan through company matches, or simply by educating workers on the value of a retirement plan to boost participation,” she says. “These are just some ways advisers can avoid the plan having to return money to HCEs.”

Yet another way plans can avoid failing nondiscrimination testing is by offering HCEs nonqualified deferred compensation plans, says Matt Compton, director of retirement services at Brio Benefit Consulting.

Advisers can also help plan sponsors gather all the necessary data and fill out the recordkeeper’s annual census request, Credico says. Benefits consultants and some ERISA attorneys can also assist their sponsors as they prepare for such tests, she says. Smaller plans are more likely to turn to their third-party administrators (TPAs) for help.

If a mistake is uncovered by IRS plan testing, advisers can help plan sponsors use the IRS’ Employee Plans Compliance Resolution System (EPCRS) to rectify it, Joffe says.

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