When RJR Nabisco decided to terminate an overfunded pension program, it purchased an annuity from an insurance company to cover its obligations to beneficiaries and plan participants. RJR then sold the pension fund’s assets, netting RJR more than $43 million. But the insurance company it chose to issue the annuity, Executive Life Insurance Company of California, collapsed, causing some plan participants to lose benefits. An expensive and lengthy lawsuit ensued.
We’ll look at what the court said the employer did wrong and what is required to fulfill your fiduciary obligations when making financial decisions that affect retirement benefits.
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Employer’s Selection Process
RJR hired an outside consultant from a well-known firm to assist in the process of choosing which insurance company to purchase the annuity from. The consultant compiled a list of potential candidates for consideration. RJR reportedly requested that Executive Life be included solely as a negotiating strategy to force the other companies on the list to reduce their bids.
In the course of the selection process, RJR and its consultant allegedly became aware that Executive Life had more than 50% of its assets in junk bonds. They also reportedly learned that the company had been downgraded by a major insurance rating agency and that it was closely associated with targets of federal investigations. Nevertheless the consultant is said to have considered Executive Life and the other three final candidates to be qualified and competent.
Executive Life’s price was apparently the lowest, and it was ultimately chosen. Almost four years after RJR paid Executive Life $54 million for the annuity, the state of California placed the insurer in conservatorship.
Insurer’s Collapse Spawns Suit Against Employer
Several RJR retirees sued after Executive Life collapsed, charging that the employer failed to exercise due diligence in its choice of an insurer, as required by federal law.
Specifically, they claimed RJR did not conduct a careful investigation, did not diversify its investments to minimize risk and failed to select the safest available annuity.
RJR denied that it had violated any of its duties to the pensioners and initially succeeded in getting the case thrown out. But the suit was reinstated by the federal Fifth Circuit Court of Appeals, which said a trial court could find that RJR placed its own interests ahead of the retired employees. The case was returned to the lower court for trial.
Guidelines For Selecting Insurers Or Making Investments
The appellate court noted that an employer’s termination of an over-funded pension plan and its profiting from a return of plan assets do not necessarily violate federal law. And you don’t have to choose the safest possible annuity or an insurance plan that is guaranteed to be financially successful. But you must always act in the best interests of plan participants and beneficiaries, and avoid conflicts of interest.
The court outlined several points to consider when choosing an insurer to provide an annuity. All of them are equally relevant when you’re making other investment decisions.
- Investigate thoroughly. The court explained that federal law requires your search for an annuity provider to be objective and thorough. So carefully examine such factors as the size of the insurer’s portfolio, its diversification and its risk of exposure to potential losses.
- Evaluate ratings. Review the ratings given by industry agencies, but don’t use them as the sole measure of an insurer’s financial health.
- Don’t put price first. At the outset, evaluate whether the providers you are considering can equally serve the interests of the plan participants. Only then should you pick the insurer that offers the lowest price. The retirees’ interests in full payment of benefits must come before profits.
- Consult an independent expert. To avoid any hint of a conflict of interest, hire an independent expert. But you will not be protected if you blindly follow the expert’s advice without conducting your own thorough investigation.