June 27, 2024

DOL Final Rule 4.0 - Correcting the historical record

Adam Cohen, Carol McClarnon, W. Mark Smith

+ Follow Contact

Send

Embed

Eversheds Sutherland (US) LLP

From the 2010 outset of its project to extend ERISA fiduciary status broadly to financial intermediaries, including insurance agents, the US Department of Labor (DOL) has consistently relied on the evolution of the private retirement system to justify its undertaking.

For example, in the April preamble to Final Rule 4.0, DOL argued:

Since 1975, the retirement plan landscape has changed significantly, with a shift from defined benefit plans (in which decisions regarding investment of plan assets are primarily made by professional asset managers) to defined contribution/individual account plans, such as 401(k) plans (in which decisions regarding investment of plan assets are often made by plan participants who lack professional investment expertise). In 1975, individual retirement accounts had only recently been created (by ERISA itself), and 401(k) plans did not yet exist. Retirement assets were principally held in pension funds controlled by large employers or other large plan sponsors and professional money managers. Now, IRAs and plans providing for participant-directed investments, such as 401(k) plans, have become more common retirement vehicles as opposed to traditional pension plans, and rollovers of workplace retirement plan assets to IRAs are commonplace. Individuals, regardless of their financial literacy, have thus become increasingly responsible for their own retirement savings, and have increasingly become direct recipients of investment advice with respect to those savings.

Leaving aside that this defense is fundamentally an argument that Congress should reconsider the statute, the historical record does support DOL’s contention in several respects.

Internal Revenue Code §408, authorizing IRAs, was indeed enacted as part of ERISA, and §401(k) was added to the Code four years later in the Revenue Act of 1978.
According to data published by DOL in September 2023 (cited below) and drawn from Form 5500 filings, in 1975 there were approximately 103,000 defined benefit plans covering 33.0 million participants and 208,000 defined contribution plans covering 11.5 million participants. By 2021, that relationship had indeed flipped, with approximately 46,000 defined benefit plans covering 31.2 million participants (curiously, nearly the same number of participants as in 1975) and 719,000 defined contribution plans covering 114.9 million participants (about ten times the number of participants as in 1975).
The increased number of defined contribution plan participants inarguably increases the number of instances where participants rather than sponsors bear investment and longevity risk and, in participant-directed plans, make investment decisions with respect to their retirement savings.
And since IRAs had just been added to the Code by ERISA, rollovers from plans to IRAs are certainly more commonplace today than they were in 1975.

In one crucial aspect, however, the historical record does not support DOL’s assertion, specifically, that in 1975 “[r]etirement assets were principally held in pension funds controlled by large employers or other large plan sponsors and professional money managers.” The structure of the country’s private retirement system was far more nuanced in 1975 than DOL’s oversimplified generalization suggests.

Based on the same DOL publication, in 1975, defined contribution plans accounted for about 25% of the participant coverage of the private retirement system (11.5 million participants out of a combined participation of 44.5 million) and 28% of total assets (approximately $74 billion out of a total of $260 billion).
The publication also slices the data between plans with more or less than 100 participants. Whatever threshold properly defined a “large plan,” it surely was far greater than 100 participants, but the data shows that, in 1975, the population of defined benefit plans included approximately 83,000 defined benefit plans with fewer than 100 participants, covering 1.5 million participants and with assets of $8.7 billion (about 5% of overall defined benefit plan participation and assets). On average, each such plan covered 18 participants and held about $1 million in assets.

That is, this data suggests that, in 1975, defined benefit plans covering 100 or more participants did hold about 68% of retirement assets.

Assume for present purposes that these plans all count as large plans and widely employed professional money managers.
Against that background, the ERISA fiduciary definition enacted by Congress – in pertinent part, a person who “exercises any authority or control respecting management or disposition of [a plan’s] assets” or “renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan” -- is perfectly designed to capture money managers acting on a discretionary or nondiscretionary basis for large defined benefit plans.

On the other hand, this data also means that, in 1975:

About 80% of all defined benefit plans covered fewer than 100 employees (83,311 out of a total of 103,346 plans) and were not “large” in any sense; and
Between defined contribution plans and these small defined benefit plans, about 32% of all retirement assets were not held in “pension funds controlled by large employers or other large plan sponsors and professional money managers.”

Neither is a trifling fraction of the overall retirement plan landscape that plausibly might have escaped the attention of Congress.

Furthermore, other resources (also cited below) show that, at the time of enactment, the small plan segment of the defined benefit plan universe was served primarily by the insurance industry, which bundled recordkeeping with annuity contracts that paid benefits accrued under the plan at retirement and thus transferred the plan’s actuarial risk from the small plan sponsor to the insurance company. In fact, the ERISA statutory text makes specific provision for, and the legislative record recognizes the presence and incidence of, fully or partially insured pension plans. And the intermediaries for those annuity transactions necessarily were not professional money managers, but rather were insurance agents.

ESsentials: The historical record, considered in its entirety, shows that in 1975, about 80% of all defined benefit plans were small plans where the plan sponsor made the decision where to invest the plan’s assets, most typically through an interaction with an insurance agent. That is, the historical record actually undercuts DOL’s rulemaking, in two critical respects.

For these small defined benefit plans and contrary to DOL’s assertion, that fundamental choice to invest plan assets in an annuity contract was made by small plan sponsors, who are not particularly more experienced or adept in retirement plan financial matters than the general population. Thus, small-scale investment decision-making by persons other than “large employers or other large plan sponsors and professional money managers” was a common occurrence in 1974, just as it is in 2024.
Given the well-understood and (by volume) extensive presence of annuity transactions in the defined benefit plan landscape in 1974, if Congress had intended insurance agents generally to be covered by the fiduciary definition, particularly in a “comprehensive and reticulated statute” like ERISA that in other respects takes specific account of insured plans, it is more than reasonable to think that Congress would have said so affirmatively, rather than inartfully and inarticulately lumping them into the “renders investment advice for a fee” rubric.

_________

^Sources:^{Employee Benefits Security Administration, PRIVATE PENSION PLAN BULLETIN HISTORICAL TABLES AND GRAPHS 1975-2021 (September 2023); PRIVATE PENSION PLAN REFORM, Hearings Before the Subcommittee on Private Pension Plans of the Committee on Finance, United States Senate, 93d Cong., 1st Sess. (May-June 1973); Institute of Life Insurance, LIFE INSURANCE FACT BOOK 1975.}

[View source.]

Send Print Report

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.