Compliance February 26, 2021

Principal Life Insurance Co. Named In Self-Dealing ERISA Suit

Related self-dealing claims made against other national financial services providers by participants in their own retirement plans have met varying degrees of success.

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A new Employee Retirement Income Security Act (ERISA) lawsuit filed in the U.S. District Court for the Southern District of Iowa accuses the Principal Life Insurance Co. of committing various fiduciary breaches in the operation of two retirement plans open to its own employees.

Also named as a defendant in the case are the retirement plans’ investment and administrative committees. The allegations against the defendants fit into the mold of similar self-dealing suits that have been filed against national financial services providers in recent years.

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“Principal affiliates act as the primary investment adviser for the pooled separate accounts in which the plans invest,” the lawsuit states. “Principal affiliates charge a high investment adviser fee for that service. But Principal’s affiliates hire sub-advisers to do the essential work of portfolio management. Principal does, however, keep much of the investment management fees. The plans could go straight to the sub-adviser for the same service, cutting out Principal as a middleman, and pay less than what they pay now for the same service, with millions of dollars of annual savings.”

The lawsuit suggests the defendants “chose and maintained Principal investment products and plan administration services because Principal, its subsidiaries and its officers benefited financially from the fees.

“Defendants also breached their fiduciary duties by causing the plans to maintain a vendor relationship with Principal for administrative services whereby the plans paid, directly or indirectly, higher than reasonable fees to Principal for such services,” the complaint continues.

Later on, the complaint notes that, with the notional exception of a brokerage window plaintiffs say was built into the plans as a condition of an ERISA class action settlement the plans entered into in 2015, the plans invested exclusively in Principal investment options during the class period.

Responding to a request for comment, Principal shared the following statement: “We disagree with the allegations in this lawsuit and will vigorously contest them. Principal has always been committed to offering meaningful benefit programs to employees and is one of many companies in the industry that have had lawsuits filed against them making these kinds of claims.”

A significant portion of the text of the lawsuit is dedicated to analyzing the way the investment committee hired and monitored various sub-advisers. The complaint suggests that “every one of the sub-advisers for the Principal investment options (or underlying Principal mutual fund as the case may be) offers portfolio management services directly to institutional investors as a separately managed account (not to be confused with a pooled separate account, which is a commingled fund offered by an insurance company multiple investors)—in other words, a single client account.

“This means that the plans’ fiduciaries could have negotiated directly with the sub-adviser to a given Principal fund held by the plans for investment management matters rather than paying a Principal affiliate, Principal Global Investors,” the complaint suggests. “But the investment committee did not do so.”

The upshot of this line of argument is ultimately that the sub-advisers “would readily have agreed” to include the plans in their aggregated assets to acquire and keep Principal’s sizable plan business.

“Thus,” the complaint suggests, “the plans could have obtained the best fee terms available to Principal had defendants used the plans’ assets and bargaining power to the plans’ advantage. Defendants chose not to do so.”

In similar cases, defendants have often argued that such allegations as those recounted above do not sufficiently state a claim that fiduciary breaches occurred. Their central point is that the simple fact that a plan is paying higher fees than its peers or a given benchmark does not in itself imply that any disloyalty or imprudence occurred.

Such defendants also often point to meeting minutes, governing plan documents and other records in an attempt to demonstrate that an internal review processes was in place and was followed diligently by the fiduciaries. Indeed, the complaint in this latest case acknowledges directly that Principal maintains a due diligence team that evaluates sub-advisers for its pooled funds quarterly, based on investment guidelines when each sub-adviser is hired. The monitoring process involves quantitative and qualitative assessments, the complaint acknowledges.

The full text of the complaint is available here. 

The Markets February 26, 2021

Why Annuities Are So Helpful in Today’s Market Environment

Thanks to increases in longevity and lower expected returns from stocks and bonds in the foreseeable future, annuities are now seen as a big part of the solution.

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“It is a real challenge for retirees today that people are living longer, with retirements now lasting 20 to 30 years and interest rates being so low,” said Jonathan Barth, registered investment adviser (RIA) consultant with DPL Financial Partners, speaking during a webinar the company sponsored, titled, “Practical Market Assumptions for Today’s Retirement Realities: Why Adhering to Traditional Income Strategies No Longer Works.”

“Some bonds are returning as little as 1%, and some are even negative,” Barth said. “This is making advisers look at different solutions to secure retirement income.”

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Michael Finke, a professor of wealth management at The American College, said that, historically, bonds have returned 5%. “Depending on their maturity, Treasurys are delivering about 1%, and corporate bonds, 1.5% to 2%,” he said, explaining that all-in it now costs about $150,000 to buy annual income of $1,000 from bonds. “Investing more heavily in equities seems to be the only answer, but they are becoming quite expensive. Valuations today are as high as they have ever been. This is depressing for new retirees.” Annuities, Finke added, can provide comparable income at a much lower cost

David Blanchett, head of retirement research, Morningstar, said it is imperative for advisers to lower return assumptions in their models. In the next 10 years, Morningstar forecasts that cash will return 0.6%, bonds 1.2%, equities 5.7%, international bonds 1.5% and international equities 6.3%, he said. Morningstar’s forecast beyond the next 10 years for bonds is 4.8%, for U.S. equities is 9.0%, for international bonds is 4.4% and for international equities is 7.6%, he added. “This is bad news for investors, but you have to give them a realistic assumption,” Blanchett said.

Barth said: “How are advisers adapting to low bond returns, high uncertainty, increasing life expectancy and fee compression? We surveyed 200 practices and found they are increasing risk in retirement plans, and are increasingly interested in annuities to deliver a secure retirement for their clients.”

The survey also revealed that 43% of advisers said their clients are delaying retirement, 59% said their clients are saving more, 46% are taking more risk in their portfolio and 50% are spending less, Barth noted.

Finke said it has become important for advisers to consider “the advantages of annuitization in a low interest rate environment. You just can’t get as much from your safe investments as you used to. You can get 40% more income in retirement through annuitization than through bonds, and you are free from the risk that you are going run out of money. This enables retirees to spend their money on things that can make them happy in retirement.”

DPL’s survey asked advisers how they are adjusting portfolios to address low yields for clients nearing retirement, Barth said. Nearly one-third (30%) said they are delaying the transition from equities to bonds, 18% are actually increasing equity allocations, 26% are increasing their clients’ savings—but only 7% are turning to annuities, he noted.

Finke said there is a “tremendous disconnect between academics and practitioners when it comes to annuities. We all know that annuities are the best tool to safely fund a retirement. Advisers must consider using this tool if they are to do their job properly.”

Barth said that even though so few advisers are currently using annuities, 68% said they would consider using them—and not just to produce income. They also like their principal protection, tax-efficient legacy planning and wealth accumulation properties, Barth said.

Finke said it is time for advisers to be honest about return projections and the value of annuities. “If you run your Monte Carlo with realistic expectations about asset returns, you are going to come up with very different conclusions about the safety of your investment portfolio,” he said. “I’m not being pessimistic. I’m just being realistic. All of a sudden, insurance products become more attractive.”

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