GICs and surrender charges

[eilano]

Co A was bought by Co B. Co A’s 401k plan is being terminated and all participants are allowed to receive a distribution. The plan has GIC contracts with high surrender charges. Co A has been advised by Co B’s financial advisor that the GICs can be liquidated and the charges paid back to the participant’s accounts by the employer so they are whole when the distribution is made. The participants of Co A will then have the right to rollover their account balances to Co B’s retirement plan.

We thought a company could not put the GIC charges back into the plan. Please comment.

[Ron Snyder]

I haven't seen a GIC for years, and never in a 401(k) plan. Are you referring to group annuity contracts?

Why do you believe that the employer would not be able to make the participants whole? I could make the argument that any employer contribution to the plan should be allocated as an employer contribution and not on the basis of surrender charges realized. However, most plan documents permit the employer to pay plan expenses. (When in doubt, check the plan doc.) In addition, in the absence of such authorizing language (could the plan be amended to cover this situation?), I could make a stronger argument that the employer is simply mitigating its damages as a Fiduciary responsible for operation of the plan, including the investment decision to buy a GIC (??) in the first place.

We have avoided this problem in similar situations by merging the two plans and by having the funding provider who is receiving the funds make the participants accounts "whole". Of course they add an offsetting (offputting?) surrender penalty for the privilege, but they're in no worse shape than prior to the merger in such event. With this approach, only those terminating employment have the right to receive their account balance (less income taxes and the 10% premature distribution penalty tax).

[Bird]

I don't think the employer can make up the surrender charges without it being considered a contribution....which may actually work.

I've heard the argument that in certain circumstances, surrender charges could be reimbursed without it being a contribution, but thought that there had to be an actual fiduciary breach, not just a good intention.

I'd think about merging the plans, and trying to keep the old GIC in place until the charges expire. Probably a nuisance at best for someone.

For the record, when a successor investment company "makes up" surrender charges, they don't just have a surrender charge, they tack on an extra annual expense to recover the cost...there's no free lunch.

[namealreadyinuse]

Search for threads on "restorative payments" to get an idea on the IRS requirements for avoiding treatment as a contribution.

[Guest Green92]

"However, most plan documents permit the employer to pay plan expenses"

I just went through this with almost $50,000 plan wide in surrender fees from GIC's in a VA coming to our 401(k). These fees were not deemed plan expenses since they varied for each participant, some had no GIC assets and others had all GIC assets and everything in between. The particippants were willing to pay to get out from under that never ending high fee cycle.

[E as in ERISA]

As Bird alluded to, the issue with the restoration by the employer is that it might be a contribution. And that may be allowed. But it has all the attendant issues of a contribution. Discrimination testing, 415, etc. So if an HC has a large balance in the GIC and gets a large restoration payment, you might fail discriminaition.

I think that this was a good article by Reish that was previously posted on this site:

http://www.reish.com/practice_areas/EmpBen.../doanddonts.cfm

[Guest mjb]

The PLRs confirm the obvious that an employer can make restorative payments to participants account's which will not be counted as contributons if there has been a fiduciary breach. However merely investing plan assets in a GIC that has high(?) surrender charges or incurs a loss is not a breach of fiduciary duty. the answer to the question is that the surrender charges can be paid back to the employees accounts provided that all the applicable requirements for qualified plans are complied with, including the BRF requirements and 415 limits.

[GBurns]

Green92 and eilano,

I have not been actively selling products for quite a while so I only have limited literature. I am curious as to which VA has/had individually selected GICs.

Like vebaguru I do not think that I have never seen this especially in a 401(k).

You might want to PM me if you do not want to use names on the Thread.

[Kirk Maldonado]

Although this ages me considerably, I have seen many section 401(k) plans with GICs. However, I've not seen one for probably 15 or 20 years.

They were the preferred investment vehicle for a while. I remember reading statistics that then that showed that something like 2/3rds or 3/4ths of all section 401(k) contributions were being invested in GICs.

[GBurns]

It wasn't all that long ago, so Seasoned rather than aged might be a better choice.

They were very popular as you noted prior to the Executive Life, Mutual Benefit, First Capital and the other large insurance company failures of the late 1980s and very early 1990s. Cases such as Unisys also helped to drive some plans away.

eilano,

Look up cases like this one to see what happened in some cases when the employer was blamed for making a choice that caused problems including high surrender charges:

http://www.arnoldporter.com/publications_l...d=590&archive=1

(Scroll down to the fourth item Unisys Savings Plan Litigation)

There were some other cases but that one came to mind first.

As for putting the charges back into the plan to make the participants "whole" that should require some competent legal counsel even though some good advice has been posted so far.

[Guest mjb]

GICS were the preferred investment vehicle when 401k plans became available in 1980 because they offered guaranteed rates of up to 12%+ for extended periods of 5+ yrs due to the high inflation of the early eightys (30 yr Mortgage rates were over 14%, mm funds paid 12%.) After inflation subsided in the mid 80 gic providers tried to keep interest rates for future years up up by investing in riskier commercial RE investments until the RE market collapsed in the late 80's taking Equitable Life with it. (Eq LIfe was saved form insolvency by Axa ins of France who invested $1B in return for a contolling interest. This required that Eq. Life switch from a mutual ins co to a stock co. Eq is now called Axa life). Exec life of CA failed because it invested its GICS in junk bonds paying 12% and the under lying bonds defaulted. Exec life of NY was closed by the NY Ins. dept before it defaulted. (NY did not allow investments in risker junk bonds). Then in 1994 Mutual Benefit collapsed after it some of the 30 RE deals its GICs invested failed. After these failures plans turned to stable value funds.

[GBurns]

I thought that that rumor aboutr Equitable life was refuted and had died long ago. There seemed to have been confusion with Equitable Life of the UK which was insolvent and which I think AXA did take over or split with Prudential PLC. The NY Insurance Dept did clarify the issue and did certify that Equitable was solvent enough for demutualization.

I thought that the demutualization took place in 1991 and before the AXA investment and that AXA only became major stockholder through the IPO which took place in 1992 after the demutualization of 1991 without which there could have been no IPO.

Are there any in the audience who paid attention back then and who can comment especially about the potential insolvency whether caused by RE or otherwise ?

[Guest mjb]

GB: Axa made a loan of $1B to Equitable to keep it out of insolvency while NYS state changed the ins law to permit a mutual co to demutualize to a stock co. After the law as changed Axa swapped its loan for a controlling interest in Equitable's equity through demutualization and the policy holders received a minority interest in the co. According to a 2004 press release Equitable Life Assurance Society was renamed Axa Equitable life. I dont understand what you said in the second paragraph of your post.

[Guest msladky]

The Equitable Life Assurance Society of the US should not ever be confused with other insurance firms named Equitable. I worked in the Equitable's pension and investment division 1979-1983. At that time the Equitable was the largest manager of US Tax exempt assets. They were also a great inovator of financial and investment products throught out it's long history.

Short term interest rates in 1980, if memory serves me well, were over 20%, while long term rates were much lower. This caused severe market disintermediation at the Equitable and contributed to it's woes of the mid 1980s.

There are lots of different types of book valued fixed income products that 401(k) plans invest in and some are named GICs. The surrender charges are somteimes confused with a market value adjustment which in today's interest environment would more likely than not cause a fee to liquidate.

[Guest Green92]

The surrender charges are somteimes confused with a market value adjustment which in today's interest environment would more likely than not cause a fee to liquidate.

This is very true, but I would add that most sponsors and participants do not ever make nor do they want to hear about this fine point of distinction.

[GBurns]

Since you find it difficult to understand my timeline, here is the same thing but from AXA:

http://www.axa-equitable.com/pressroom/milestones2.html

http://www.axa-equitable.com/pressroom/milestones3.html

See 1991 in the first and 1992 in the second link.

By the way, What does the name change in 2004 have to do with anything?

[Kirk Maldonado]

Green92:

I would make your statement even more broadly. I don't think most participants or plan sponsors are interested in hearing about 95% of the topics discussed on the Message Boards.

[eilano]

Thanks for the replies. I have reviewed the referenced PLR, which does appear to be on point, and I reviewed it with the provider that was offering to make the "gross-up" / restorative payments to the 401(k) plan. In response, I was pointed to IRS Letter Ruling 200404050 which appears to be more on point - particularly in that it was the new provider/insurance company, rather than the plan sponsor, that was proposing to make whole the participants for losses caused as a result of the contract transfer. This PLR gives me reason to believe that these arrangements pass IRS muster.

[E as in ERISA]

Co A was bought by Co B. Co A’s 401k plan is being terminated and all participants are allowed to receive a distribution. The plan has GIC contracts with high surrender charges. Co A has been advised by Co B’s financial advisor that the GICs can be liquidated and the charges paid back to the participant’s accounts by the employer so they are whole when the distribution is made. The participants of Co A will then have the right to rollover their account balances to Co B’s retirement plan.

We thought a company could not put the GIC charges back into the plan. Please comment.

Sounds like your facts completely changed since you asked the question???

[RCK]

We are terminating a Guaranteed Interest Account effective in the next month and are looking at a negative market value adjustment. Rates have started creeping up enough to create one. We're looking at about 1.25% of the fund.