Insurance Company General Accounts

SUMMARY: This document contains a proposed regulation which clarifies

the application of the Employee Retirement Income Security Act of 1974

as amended (ERISA or the Act) to insurance company general accounts.

Pursuant to section 1460 of the Small Business Job Protection Act of

1996 (Pub. L. 104-188), section 401 of ERISA has been amended. Section

401 now provides that the Department must issue proposed regulations

to: Provide guidance for the purpose of determining, where an insurer

issues one or more policies to or for the benefit of an employee

benefit plan (and such policies are supported by assets of the

insurer's general account), which assets held by the insurer (other

than plan assets held in its separate accounts) constitute assets of

the plan for purposes of part 4 of Title I of ERISA and section 4975 of

the Internal Revenue Code of 1986 (the Code); and provide guidance with

respect to the application of Title I to the general account assets of

insurers. If adopted, the regulation will affect participants and

beneficiaries of employee benefit plans, plan fiduciaries and insurance

company general accounts.

DATES: Written comments and requests for a hearing (preferably at least

three copies) concerning the proposed regulation must be received by

March 23, 1998.

ADDRESSES: Interested persons are invited to submit written comments

(preferably, at least three copies) concerning the proposed rule to:

Pension and Welfare Benefits Administration, Office of Exemption

Determinations, Room N-5649, 200 Constitution Ave., N.W., Washington,

DC 20210. Attention: ``General Account Contracts''. Written comments

may also be sent by the Internet to the following address:

[email protected].

FOR FURTHER INFORMATION CONTACT: Lyssa E. Hall, Office of Exemption

Determinations, Pension and Welfare Benefits Administration, U.S.

Department of Labor, Room N-5649, 200 Constitution Avenue, N.W.,

Washington, D.C. 20210, (202) 219-8194, or Timothy Hauser, Plan

Benefits Security Division, Office of the Solicitor, (202) 219-8637.

These are not toll-free numbers.

SUPPLEMENTARY INFORMATION:

A. Background

Life insurance companies issue a variety of group contracts for use

in connection with employee pension benefit plans, some of which

provide benefits the amount of which is guaranteed, some of which

provide benefits that may fluctuate with the investment performance of

the insurance company, and some of which offer elements of both. Under

section 401(b)(2) of ERISA, if an insurance company issues a

``guaranteed benefit policy'' to a plan, the assets of the plan are

deemed to include the policy, but do not, solely by reason of the

issuance of the policy, include any of the assets of the insurance

company. Section 401(b)(2)(B) defines the term ``guaranteed benefit

policy'' to mean an insurance policy or contract to the extent that

such policy or contract provides for benefits the amount of which is

guaranteed by the insurer. In addition, in paragraph (b) of ERISA

Interpretive Bulletin 75-2, 29 CFR 2509.75-2 (1975), the Department

stated that if an insurance company issues a contract or policy of

insurance to a plan and places the consideration for such contract or

policy in its general asset account, the assets in such account shall

not be considered to be plan assets.1

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\1\ Paragraph (b) of 29 CFR 2509.75-2 was removed effective July

1, 1996, 61 FR 33847, 33849 (July 1, 1996).

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On December 13, 1993, the Supreme Court rendered its decision in

John Hancock Mutual Life Insurance Co. v. Harris Trust & Savings Bank,

510 U.S. 86 (1993) (Harris Trust) which interpreted the meaning of

``guaranteed benefit policy''. In its decision, the Court held that a

contract qualifies as a guaranteed benefit policy only to the extent it

allocates investment risk to the insurer:

[w]e hold that to determine whether a contract qualifies as a

guaranteed benefit policy, each component of the contract bears

examination. A component fits within the guaranteed benefit policy

exclusion only if it allocates investment risk to the insurer. Such

an allocation is present when the insurer provides a genuine

guarantee of an aggregate amount of benefits payable to retirement

plan participants and their beneficiaries.

Therefore, under the Supreme Court's decision, an insurer's general

account includes plan assets to the extent it contains funds which are

attributable to any nonguaranteed components of contracts with employee

benefit plans. Because John Hancock's contract provided for a return

that varied with the insurer's investment performance, the Court

concluded that John Hancock held plan assets, and was, therefore, a

fiduciary with respect to the management and disposition of those

assets. Under the Court's reasoning, a broad range of activities

involving insurance company general accounts are subject to ERISA's

fiduciary standards.

Because of the retroactive effect of the Supreme Court decision,

numerous transactions engaged in by insurance company general accounts

may have violated ERISA's prohibited transaction and general fiduciary

responsibility provisions. If the underlying assets of a general

account include plan assets, persons who have engaged in transactions

with such general account may be viewed as parties in interest under

section 3(14) of ERISA and disqualified persons under section 4975 of

the Code, including fiduciaries with respect to plans which have

interests as policyholders in the general account. For example,

insurance companies are a source of loans for smaller and mid-sized

companies. Many of these companies have party in interest relationships

with plans that have purchased general account contracts. Application

of the prohibited transaction rules to the general account of an

insurance company as a result of the Harris Trust decision could call

such loans into question under ERISA. Lastly, the underlying assets of

an entity in which a general account acquired an equity interest may

include plan assets as a result of the Harris Trust decision.

The insurance industry believed that, absent legislative or

administrative action, it would be subject to significant additional

litigation and potential liability with respect to the operation of its

general accounts. On March 25, 1994, the American Council of Life

Insurance (ACLI) submitted an application for a class exemption from

certain of the restrictions of sections 406 and 407 of ERISA and from

certain excise taxes imposed by section 4975(a) and (b) of the Code.

The ACLI requested broad exemptive relief for transactions which

included the following: all internal operations of general accounts,

all investment transactions involving general account assets, including

transactions with parties in interest with respect to plans that have

purchased general account contracts, and the purchase by the general

account of securities issued by, and real property leased to, employers

of employees

[[Page 66909]]

covered by plans that have purchased general account contracts.

On August 22, 1994, the Department published a notice of proposed

Class Exemption for Certain Transactions Involving Insurance Company

General Accounts. (59 FR 43134). Although the ACLI requested exemptive

relief for activities in connection with the internal operation of

general accounts, the Department determined that it did not have

sufficient information regarding the operation of such accounts to make

the findings required by section 408(a) of ERISA. Accordingly, the

proposed class exemption did not provide relief for transactions

involving the internal operation of an insurance company general

account. The final exemption (Prohibited Transaction Exemption (PTE)

95-60, 60 FR 35925), was published in the Federal Register on July 12,

1995.

B. Public Law 104-188

In response to the Supreme Court decision in Harris Trust, Congress

amended section 401 of ERISA by adding a new subsection 401(c) which

clarifies the application of ERISA to insurance company general

accounts. Pub. L. 104-188, Sec. 1460. This statutory provision provides

that the Secretary shall issue proposed regulations to provide guidance

for the purpose of determining, in cases where an insurer issues one or

more policies to or for the benefit of an employee benefit plan (and

such policies are supported by the assets of such insurer's general

account), which assets held by the insurer (other than plan assets held

in its separate accounts) constitute assets of the plan for purposes of

part 4 of Title I and section 4975 of the Code and to provide guidance

with respect to the application of Title I to an insurer's general

account assets. The final regulations shall be issued not later than

December 31, 1997.

The regulations will only apply to those general account policies

which are issued by an insurer on or before December 31, 1998. In the

case of such policies, the regulations will take effect at the end of

the 18 month period following the date on which the regulations become

final. Pub. L. 104-188, however, authorizes the Secretary to issue

additional regulations designed to prevent avoidance of the regulations

described above. These additional regulations, if issued, may have an

earlier effective date.

The Department must ensure that the regulations issued under Pub.

L. 104-188 are administratively feasible, and protect the interests and

rights of the plan and of its participants and beneficiaries. In

addition, the regulations must require, in connection with any policy

(other than a guaranteed benefit policy) issued by an insurer to or for

the benefit of an employee benefit plan, that: (1) An independent plan

fiduciary authorize the purchase of the policy (unless the purchase is

exempt under ERISA section 408(b)(5)); (2) the insurer provide

information in policies issued and on an annual basis to policyholders

(as prescribed in such regulations) disclosing the methods by which any

income and expenses of the insurer's general account are allocated to

the policy and the actual return to the plan under the policy and such

other financial information as the Department determines is

appropriate; (3) the insurer disclose to the plan fiduciary the extent

to which alternative arrangements supported by the assets of the

insurer's separate accounts are available, whether there is a right

under the policy to transfer funds to a separate account and the terms

governing any such right, and the extent to which support by assets of

the insurer's general account and support by assets of the insurer's

separate accounts might pose differing risks to the plan; and (4) the

insurer manage general account assets prudently, taking into account

all obligations supported by such general account.

Compliance with the regulations issued by the Department will be

deemed compliance by such insurer with sections 404, 406 and 407 of

ERISA. In addition, under this statutory provision, no person will be

liable under part 4 of Title I or Code section 4975 for conduct which

occurred before the date which is 18 months following the issuance of

the final regulation on the basis of a claim that the assets of an

insurer (other than plan assets held in a separate account) constitute

plan assets. The limitation on liability is subject to three

exceptions: (1) The Department may circumscribe this limitation on

liability in regulations intended to prevent avoidance of the

regulations which it is required to issue under the statutory

amendment; (2) the Department may bring actions pursuant to paragraph

(2) or (5) of section 502(a) of ERISA for breaches of fiduciary

responsibility which also constitute violations of Federal or State

criminal law; and (3) civil actions commenced before November 7, 1995

are exempt from the amendment's coverage.

On November 25, 1996, the Department published a Request for

Information (RFI) to solicit information and comments from the public

to be considered by the Department in developing the regulations

mandated by Pub. L. 104-188. The RFI contained a list of questions

designed to elicit information that would be helpful to the Department

in developing this notice of proposed rulemaking.

Discussion of the Comments

The questions asked by the Department in the RFI requested

information regarding disclosures to contractholders, market value

adjustments, unilateral contract amendments, state regulatory

requirements and guaranteed benefit policies.

A total of eight substantive responses to the RFI were received:

one was from the ACLI itself; the remaining comments were from a law

firm representing a group of major life insurance companies, an

organization representing insurance regulators, two law firms

representing plans which have invested in insurance company general

account contracts, an insurance company, an association representing

senior financial executives and an advocacy organization representing

senior citizens.

Disclosures

Many of the comments addressed the need for insurance companies to

provide adequate and meaningful disclosure regarding the financial

soundness of the insurance company, the nature of the insurer's general

account assets, transactions with affiliates and the investment

policies/objectives of the insurer as well as contract specific

information regarding fees, commissions, expenses, termination

requirements, and allocation methodologies.

Several of the commenters stressed that such information must be

presented in ``plain English'' using a format which would be understood

by lay persons. Two commenters suggested that the Department require

that information be supplied in standardized form. Another commenter

stated that the information in the Statutory Annual Statement could be

adapted to provide appropriate disclosures.

A commenter noted that, in order for a plan fiduciary to make a

prudent decision regarding the investment of plan assets in an

insurance company general account contract, the insurance company must

provide the fiduciary with sufficient information. In this regard,

another commenter stated that many general account investments are

tantamount to an illiquid investment in a corporate bond; thus, the

general level of disclosure required should be comparable to that made

available to investors of other illiquid investments. A number of

commenters agreed that

[[Page 66910]]

the items of information identified in the RFI should be disclosed to

plan investors on an annual basis. In addition to those items, a

commenter suggested that the disclosure requirements should recognize

the fact that the general account supports products not covered by

ERISA. Another stated that information regarding the current value of

the investment compared to the purchase price of the contract should be

provided annually. Finally, a commenter noted that gross and net

returns on the contract before and after adjustments should be

reported.

With respect to the effective date of the disclosure provisions in

the regulation, one commenter stated that the disclosure provisions

should become effective prior to the end of the 18th month following

publication of the final regulation.

Market Value Adjustments (MVAs)

Two commenters expressed concern that MVAs may operate as penalties

imposed on plans which terminate or withdraw funds from general account

contracts. They represent that MVAs should not be used to enrich the

insurer, but should be fair to terminating contractholders as well as

remaining contractholders. One commenter suggested that MVAs should

``cut both ways,'' i.e., if market value is above book value, the

terminating policyholders should receive the difference between book

and market value as the adjustment. This commenter stated that MVAs

should be based on regularly published indices that reflect the

categories of investments in the insurer's general account. To the

extent that such adjustments represent lost opportunity costs, the

insurer should be required to articulate a justification for its

estimate of the lost opportunity.

Finally, one commenter stated that MVAs should not be circumscribed

by the Department since they protect remaining contractholders.

Unilateral Contract Amendments

Three commenters either opposed an insurer's ability to

unilaterally amend contract terms or believed that the Department

should impose limits on such amendments. In the alternative, two

commenters suggested that if unilateral amendments are made and the

parties cannot agree on such changes, the matter should be referred to

binding arbitration. Another commenter suggested that the account

holder be permitted to exit the arrangement if the unilateral change

was not satisfactory.

State Regulatory Requirements

Two commenters stated that the Department should not take state

insurance requirements into account in drafting the regulation either

because ERISA should govern employee benefit plans or consideration of

state regulatory requirements would dilute the strength of ERISA.

Another commenter noted that state regulatory requirements either

overlap or address each of the requirements imposed by section 1460 of

Pub. L. 104-188.

Guaranteed Benefit Policies

Two commenters urged the Department to issue a regulation defining

guaranteed benefit policy under section 401(b)(2) of the Act

concurrently with the regulations the Department is required to issue

under section 401(c).2

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\2\ The Department notes that the statute requires the

promulgation of regulations under section 401(c) but does not

require the Department to promulgate regulations defining guaranteed

benefit policies. At this time, the Department has not made a

decision regarding whether to initiate a regulatory project on this

matter. Therefore, this proposed regulation does not address the

definition of guaranteed benefit policy.

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Description of Proposal

The proposal amends 29 CFR Part 2550 by adding a new section,

2550.401c-1. This new section is divided into ten major parts.

Paragraph (a) of the proposal describes the scope of the regulation and

the general rule. Proposed paragraphs (b) through (f) contain

conditions which must be met in order for the general rule to apply.

Specifically, paragraph (b) addresses the requirement that an

independent fiduciary expressly authorize the acquisition or purchase

of a Transition Policy. Paragraph (c) describes the disclosures that an

insurer must make both prior to the issuance of a Transition Policy to

a plan and on an annual basis. Paragraph (d) provides for additional

disclosures regarding separate account contracts. Paragraph (e)

contains the procedures that apply to the termination or discontinuance

of a Transition Policy by a policyholder. Paragraph (f) contains notice

provisions regarding contract terminations and withdrawals in

connection with insurer-initiated amendments. Proposed paragraph (g)

sets forth a prudence standard for the management of general account

assets by insurers. The definitions of certain terms used in the

proposed regulation are contained in paragraph (h). Proposed paragraph

(i) describes the effect of compliance with the regulation and proposed

paragraph (j) contains the effective dates of the regulation.

1. Scope and General Rule

Proposed Sec. 2550.401c-1(a) and (b) essentially follow the

language of section 401(c) of ERISA. Paragraph (a) describes, in cases

where an insurer issues one or more policies to or for the benefit of

an employee benefit plan (and such policies are supported by assets of

an insurance company's general account), which assets held by the

insurer (other than plan assets held in its separate accounts)

constitute plan assets for purposes of Subtitle A, and Parts 1 and 4 of

Subtitle B, of Title I of the Act and section 4975 of the Internal

Revenue Code, and provides guidance with respect to the application of

Title I and section 4975 of the Code to the general account assets of

insurers.

Proposed paragraph (a)(2) states the general rule that when a plan

acquires a policy issued by an insurer on or before December 31, 1998

(Transition Policy), which is supported by assets of the insurer's

general account, the plan's assets include the policy, but do not

include any of the underlying assets of the insurer's general account

if the insurer satisfies the requirements of paragraphs (b) through (f)

of the regulation. The term Transition Policy is defined in paragraph

(h)(6) as a policy or contract of insurance (other than a guaranteed

benefit policy) that is issued by an insurer to, or on behalf of, an

employee benefit plan on or before December 31, 1998, and which is

supported by the assets of the insurer's general account. A policy will

not fail to be a Transition Policy if it is amended solely for the

purposes of complying with the provisions of this regulation.

2. Authorization by an Independent Fiduciary

Proposed paragraph (b)(1) states the general requirement that an

independent fiduciary who has the authority to manage and control the

assets of the plan must expressly authorize the acquisition or purchase

of the Transition Policy. In order to be independent, the fiduciary may

not be an affiliate of the insurer issuing the policy.

Paragraph (b)(2) of the proposed regulation contains an exception

to the requirement of independent plan fiduciary authorization if the

insurer is the employer maintaining the plan, or a party in interest

which is wholly-owned by the employer maintaining the plan,

[[Page 66911]]

and the requirements of section 408(b)(5) of ERISA are met.3

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\3\ This exception for in-house plans of the insurer under

section 401(c)(3) of ERISA is similar to the statutory exemption

contained in section 408(b)(5) of ERISA which provides relief from

the prohibitions of section 406 for purchases of life insurance,

health insurance or annuities from an insurer if the plan pays no

more than adequate consideration and if the insurer is the employer

maintaining the plan.

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3. Disclosure

Section 401(c)(3)(B) of the Act, as added by Pub. L. 104-188,

provides that the regulations prescribed by the Secretary shall require

in connection with any policy issued by an insurer to or for the

benefit of an employee benefit plan to the extent the policy is not a

guaranteed benefit policy * * * (B) that the insurer describe (in such

form and manner as shall be prescribed in such regulations), in annual

reports and in policies issued to the policyholder after the date on

which such regulations are issued in final form * * * (i) a description

of the method by which any income and expenses of the insurer's general

account are allocated to the policy during the term of the policy and

upon termination of the policy, and (ii) for each report, the actual

return to the plan under the policy and such other financial

information as the Secretary may deem appropriate for the period

covered by each such annual report.

Proposed paragraph (c)(1) similarly imposes a duty on the insurer

to disclose specific information to plan fiduciaries prior to the

issuance of a Transition Policy and at least annually for as long as

the policy is outstanding. Proposed paragraph (c)(2) requires that the

disclosures be clear and concise and written in a manner calculated to

be understood by a plan fiduciary. Although the Department has not

mandated a specific format, the information should be presented in a

manner which facilitates the fiduciary's understanding of the operation

of the policy. The Department expects that, following disclosure of the

required information and any other information requested by the

fiduciary pursuant to paragraph (c)(4)(xii), the plan fiduciary, with

independent professional assistance, if necessary, will be able to

ascertain how various values or amounts relevant to the plan's policy

such as, the actual return to be credited to any accumulation fund

under the policy, will be determined.

Paragraph (c)(3) sets forth the content requirement for the

information which must be provided to the plan either as part of the

Transition Policy, or as a separate written document which accompanies

the Transition Policy. For Transition Policies issued before the date

which is 90 days after the date of publication of the final regulation,

the insurer must provide the information identified in paragraph

(c)(3)(i) through (iv) no later than 90 days after publication of the

final regulation. For Transition Policies issued 90 days after the date

of publication of the final regulation, the insurer must provide the

information to a plan before the plan makes a binding commitment to

acquire the policy.

Under paragraph (c)(3), an insurer must provide a description of

the method by which any income and expenses of the insurer's general

account are allocated to the policy during the term of the policy and

upon its termination. The initial disclosure under this paragraph must

include, among other things, a statement of the method used to

determine ongoing fees and expenses that may be assessed against the

policy or deducted from any accumulation fund under the policy. The

term ``accumulation fund'' is defined in paragraph (h)(5) as the

aggregate net consideration (i.e., gross considerations less all

deductions from such considerations) credited to the Transition Policy

plus all additional amounts, including interest and dividends, credited

to the contract, less partial withdrawals and benefit payments and less

charges and fees imposed against this accumulated amount under the

Transition Policy other than surrender charges and market value

adjustments. 4

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\4\ This definition is substantially similar to the definition

contained in New York insurance regulations. In this regard, see 11

NYCRR 40.2 (1996).

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The insurer must also include, in its description of the method

used to allocate income and expenses to the Transition Policy, an

explanation of the method used to determine the return to be credited

to any accumulation fund under the policy, a description of the

policyholder's rights to transfer or withdraw all or a portion of any

fund under the policy, or to apply such amounts to the purchase of

benefits, and a statement of the precise method used to calculate the

charges, fees or market value adjustments that may be imposed in

connection with the policyholder's right to withdraw or transfer

amounts under any accumulation fund. Upon request, the insurer must

provide the information necessary to independently calculate the exact

dollar amounts of charges, fees or market value adjustments.

In developing the proposed regulation, the Department reviewed the

disclosure requirements imposed by New York insurance regulations, and

incorporated several provisions which we believe would be helpful to

plan fiduciaries prior to their commitment to purchase a Transition

Policy. The information disclosed pursuant to this paragraph will

address many of the concerns expressed by the commenters in response to

the RFI regarding the lack of contract-level disclosure by insurers.

The information disclosed pursuant to this paragraph should enable plan

fiduciaries to adequately evaluate the suitability of a particular

policy for a plan.

Proposed paragraph (c)(4) describes the information which must be

provided at least annually to each plan to which a Transition Policy

has been issued. In general, the information is intended to provide the

policyholder with an overview of all the activity that has occurred in

the accumulation fund during the applicable period. These disclosures

should enable the policyholder to evaluate the insurer's performance

under the policy. In this regard, the insurer must provide the

following information to each plan regarding the applicable reporting

period: the balance in the accumulation fund on the first and last day

of the period; any deposits made to the accumulation fund; all income

attributed to the policy or added to the accumulation fund; the actual

rate of return credited to the accumulation fund; any other additions

to the accumulation fund; a statement of all fees, charges or expenses

assessed against the policy or deducted from the accumulation fund; and

the dates on which the additions or subtractions were credited to, or

deleted from, the accumulation fund.

In addition, insurers must annually disclose all transactions with

affiliates which exceed 1 percent of group annuity reserves of the

general account for the prior reporting year. The annual disclosure

must also include a description of any guarantees under the policy and

the amount that would be payable in a lump sum pursuant to the request

of a policyholder for payment of amounts in the accumulation fund under

the policy after deduction of any charges and any deductions or

additions resulting from market value adjustments.

As part of the annual disclosure, an insurer must inform

policyholders that it will make available upon request certain

publicly-available financial information relating to the financial

condition of the insurer. Such

[[Page 66912]]

information would include rating agency reports on the insurer's

financial strength, the risk adjusted capital ratio, an actuarial

opinion certifying to the adequacy of the insurer's reserves and the

insurer's most recent SEC Form 10K and Form 10Q (if a stock company).

The Department believes that the annual disclosures required under

paragraph (c)(4) will provide sufficient information to the plan

fiduciaries to enable them to assess the appropriateness of continuing

the plan's investment in the Transition Policy. The Department's

primary intent in mandating the disclosures under paragraphs (c)(3) and

(4) is to ensure that plan fiduciaries are provided with relevant

information, including the financial strength of the insurer, in an

understandable form in order to make a meaningful, informed decision

regarding both the initial investment in a Transition Policy, and the

advisability of leaving the accumulation fund with the insurer. Lastly,

the information provided by the insurance company with respect to its

allocation methodologies must be in sufficient detail to enable the

policyholder to calculate the expenses charged against the Transition

Policy as well as the income credited to the policy. This information

will allow plan fiduciaries to monitor the actions of the insurer with

respect to the Transition Policy.

The Department solicits comments on the proposed disclosure

requirements and procedures, both as to their usefulness for plans and

the impact on plans and insurers.

It was Congressional intent under section 401(c) of ERISA to

require substantive disclosure from insurance companies in order to

enable plans to effectively monitor the performance of insurance

company general account contracts. In this regard, the Department does

not intend to promulgate regulations which require the disclosure of

proprietary information if Congressional intent for meaningful

disclosure can otherwise be effectuated. Accordingly, the Department

requests comments from interested persons on whether any of the items

of disclosure specified in the proposed regulation would place an

insurer at a competitive disadvantage by giving other insurance

companies access to their proprietary information. In responding to

this request, please specify which items of information would be

considered proprietary and the rationale for that conclusion.

Proposed paragraph (d)(1) contains an additional disclosure

requirement regarding the availability of separate account contracts.

Under this paragraph, the insurer must explain the extent to which

alternative contract arrangements supported by assets of separate

accounts of the insurer are available to plans; whether there is a

right under the policy to transfer funds to a separate account; and the

terms governing any such right. An insurer also must disclose the

extent to which general account contracts and separate account

contracts pose differing risks to the plan. Proposed paragraph (d)(2)

contains a standardized statement describing the relative risks of

separate accounts and general account contracts which, if provided to

policyholders, will be deemed to comply with paragraph (d)(1)(iii) of

the regulation.

4. Termination Procedures

Paragraph (e)(1) of the proposed regulation provides that a

policyholder must be able to terminate or discontinue a policy upon 90

days notice to an insurer. The policyholder must have the option to

select one of two payout alternatives, both of which must be made

available by the insurer.

Under the first alternative, an insurer must permit the

policyholder to receive, without penalty, a lump sum payment

representing all unallocated amounts in the accumulation fund after

deduction of unrecovered expenses and adjustment of the book value of

the policy to its market value equivalency. The Department notes that

for purposes of paragraph (e), the term penalty does not include a

market value adjustment (as defined in proposed paragraph (h)(7)) or

the recovery of costs actually incurred including unliquidated

acquisition expenses, to the extent not previously recovered by the

insurer.

In response to the concerns expressed by some commenters regarding

an insurer's use of market value adjustments as a penalty to a

withdrawing policyholder, the Department has defined the term market

value adjustment to reflect the economic effect on a Transition Policy

of an early termination or withdrawal in the current market. Since the

purpose of the adjustment is to protect the remaining policyholders, it

should represent the economic effect on the policy of a termination

under current economic conditions and not penalize the withdrawing

policyholder.

Under the second alternative, proposed paragraph (e)(2), an insurer

must permit the policyholder to receive a book value payment of all

unallocated amounts in the accumulation fund under the policy in

approximately equal annual installments, over a period of no longer

than five years, with interest.

These termination provisions are designed, in part, ``to protect

the interests and rights of plan[s] * * *'' (See ERISA

Sec. 401(c)(2)(B)) by ensuring that plans are not locked into

economically disadvantageous relationships.5 Under the terms

of the proposed regulation, plan fiduciaries will receive full

disclosure of the general account contract's investment performance,

and have the ability to transfer plan assets from the general account

to other investments. In this manner, the regulation enables plans to

rationally protect their own economic interests without imposing

detailed federal regulations on the day-to-day operation of general

accounts.

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\5\ The proposal is similar to the Department's rule governing

contracts between plans and service providers. See 29 CFR

Sec. 2550.408b-2(c) (providing that ``[n]o contract or arrangement

is reasonable within the meaning of section 408(b)(2) of the Act * *

* if it does not permit termination by the plan without penalty to

the plan on reasonably short notice under the circumstances to

prevent the plan from becoming locked into an arrangement that has

become disadvantageous'').

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The Department recognizes, however, that insurers have a legitimate

interest in avoiding adverse selection and excessive liquidity demands

by plan contractholders. Accordingly, the regulation permits insurers

to impose a market value adjustment on lump sum withdrawals, and

authorizes insurers to spread book value withdrawals over a five-year

period at a rate of interest as much as one percentage point below the

rate credited to the contract's accumulation fund on the date of

termination. Many general account contracts already permit a ten-year

book value withdrawal in accordance with provisions of state law. See,

e.g., 11 NYCRR Sec. 40.5 (1997) (giving contractholders the right to a

ten-year book value withdrawal under specified contracts with interest

at a rate not less than 1.5 percent below the rate credited at the time

of termination). In proposing a five-year period and a one percent

interest adjustment for book value withdrawals, the Department has

sought to balance plans' interest in a meaningful right to book value

withdrawals with insurers' interest in maintaining balanced and stable

portfolios of investments with varying maturities. Neither the book

value option nor the market value option should require any fundamental

changes in current investment practices or strain the cash flows of

well-managed insurers.

The Department solicits comments from interested persons on: (1)

The effect on insurers and non-terminating plan policyholders of

allowing terminating plans to choose either a

[[Page 66913]]

book value payment or market value adjustment on termination of the

contract; (2) the benefit to plans of the proposed termination option

and; (3) the accuracy and burden of the proposed market value

adjustment.

5. Insurer Initiated Amendments

Paragraph (f) describes the notice requirements and payout

provisions governing insurer-initiated amendments. Under paragraph (f),

if an insurer makes an insurer-initiated amendment, the insurer must

provide written notice to the plan at least 60 days prior to the

effective date of the amendment. The notice must contain a complete

description of the amendment and must inform the policyholder of its

right to terminate or discontinue the policy and withdraw all

unallocated funds in accordance with paragraph (e)(1) or (e)(2) by

sending a written request to the name and address contained in the

notice. Proposed paragraph (f), unlike the more general termination

provisions set forth in paragraph (e), is effective upon publication of

the final regulation in the Federal Register.

An insurer-initiated amendment is defined in paragraph (h)(8) as:

(1) An amendment to a policy made by an insurer pursuant to a

unilateral right to amend the policy terms that would have a material

adverse effect on the policyholder; or (2) certain unilateral

enumerated changes that result in a reduction of existing or future

benefits under the policy, a reduction in the value of the policy or an

increase in the cost of financing the plan or plan benefits, if such

change has more than a de minimis effect.

It is the Department's view that section 401(c) is similar to a

statutory exemption to the general fiduciary responsibility provisions

of ERISA and, accordingly, an insurer will have the burden of proving

that such changes will not have more than a de minimis effect on the

policy. The regulation's insurer-initiated amendment provisions ensure

that a plan fiduciary can terminate or discontinue a contract that has

become disadvantageous as a result of unilateral action on the part of

the insurer.

The Department solicits comments on the effect of the insurer-

initiated amendment provisions in the proposed regulation.

6. Prudence

Proposed paragraph (g) sets forth the prudence standard applicable

to insurance company general accounts. Unlike the prudence standard

provided in section 404(a)(1)(B) of ERISA, prudence for purposes of

section 401(c)(3)(D) of ERISA is determined by reference to all of the

obligations supported by the general account, not just the obligations

owed to plan policyholders. In this regard, the Department notes that

nothing contained in the proposal modifies the application of the more

stringent standard of prudence set forth in section 404(a)(1)(B) of

ERISA as applicable to fiduciaries, including insurers, who manage plan

assets maintained in separate accounts, as well as to assets of the

general account which support policies issued after December 31, 1998.

7. Definitions

Proposed paragraph (h) contains definitions of certain terms used

in the proposed regulation.

8. Limitation on Liability

Proposed paragraph (i)(1) provides that no person shall be liable

under parts 1 and 4 of Title I of the Act or section 4975 of the Code

for conduct which occurred prior to the effective dates of the

regulation on the basis of a claim that the assets of an insurer (other

than plan assets held in a separate account) constitute plan assets.

Paragraph (i)(1) further provides that the above limitation on

liability does not apply in the following three circumstances: (1) An

action brought by the Secretary of Labor pursuant to paragraph (2) or

(5) of section 502(a) of the Act for a breach of fiduciary

responsibility which would also constitute a violation of Federal or

State criminal law; (2) the application of any Federal criminal law; or

(3) any civil action commenced before November 7, 1995.

Proposed paragraph (i)(2) states that the regulation does not

relieve any person from any State law regulating insurance which

imposes additional obligations upon insurers to the extent not

inconsistent with this regulation. Thus, for example, nothing in this

regulation would preclude a state from requiring an insurer to make

additional disclosures to policyholders, including plans.

Proposed paragraph (i)(3) of the regulation makes clear that

neither ERISA nor the regulations promulgated thereunder precludes a

claim against an insurer or others for a violation of the Act which is

not contingent upon the assertion that the insurer's general account

assets are plan assets, regardless of whether the violation relates to

a Transition Policy. Thus, for example, a Transition Policy may give

rise to fiduciary status on the part of the insurer based upon the

insurer's discretionary authority over the administration or management

of the plan, rather than its authority over the management of general

account assets. See section 3(21) of the Act. Nothing in ERISA or this

regulation would preclude a finding that an insurer is liable under

ERISA for breaches of its fiduciary responsibility in connection with

plan management or administration prior to the effective dates of the

regulation. Similarly, neither ERISA nor the regulation precludes a

finding that an insurer is a fiduciary by reason of its discretionary

authority or control over plan assets other than the insurer's general

account assets. If the insurer breaches its fiduciary responsibility

with respect to plan assets, it may be liable under ERISA regardless of

whether the insurer has issued a Transition Policy to a plan or

ultimately placed the plan's assets in its general account.

Paragraph (i)(4) of the proposed regulation provides that if an

insurer fails to meet the requirements of paragraphs (b) through (f) of

the regulation with respect to a specific plan policyholder the result

of such failure would be that the general account would be subject to

ERISA's fiduciary responsibility provisions with respect to the

specific plan for that period of time during which the requirement of

the regulation was not met. Once back in compliance with the

regulation, the insurer would no longer be subject to ERISA or have

potential liability for subsequent periods of time when the

requirements of the regulation are met. In addition, the regulation

makes clear that the underlying assets of the general account would not

constitute plan assets for other Transition Policies to the extent that

the insurer was in compliance with the requirements of the regulation.

9. Effective Date

Proposed paragraph (j)(1) states the general rule that the

regulation is effective 18 months after its publication in the Federal

Register.

Paragraph (j)(2), (3) and (4) of the proposed regulation provide

earlier effective dates for paragraph (b) relating to independent

fiduciary approval, paragraphs (c) and (d) relating to disclosures, and

paragraph (f) relating to insurer initiated amendments.

Paragraph (j)(2) of the proposed regulation states that if a

Transition Policy is issued before the date which is 90 days after the

date of publication of the final regulation, the disclosure provisions

in paragraphs (c) and (d) shall take effect 90 days after the

publication of the final regulation.

[[Page 66914]]

Paragraph (j)(3) of the proposed regulation provides that paragraphs

(c) and (d) are effective 90 days after the date of publication of the

regulation for a Transition Policy issued after such date. In this

regard, the Department believes that the earlier effective dates are

consistent with section 401(c)(3)(B) of the Act, as added by Pub. L.

104-188, which states that the disclosures required by the regulation

be provided after the date that the regulations are issued in final

form.

Proposed paragraph (j)(4) provides that the effective date for

paragraphs (b) and (f) of the proposed regulation is the date of

publication of the final regulation in the Federal Register. In

addition, this paragraph provides special rules for insurer-initiated

amendments which become effective during the period between the dates

of publication of the proposed and final regulations. For example,

assume that an insurer makes an insurer-initiated amendment to a

Transition Policy after publication of the proposed regulations in the

Federal Register but prior to the issuance of the final regulations. If

adopted as proposed, the insurer would have 30 days to notify the plan

of the amendment. The notice must contain a complete description of the

amendment and must inform the plan of its right to terminate the

contract and withdraw all unallocated funds. If the plan elects to

receive a lump sum payment, the insurer must calculate such amount

using the more favorable (to the plan) of the market value adjustments

determined as of: (1) The effective date of the amendment; or (2) the

date upon which the insurer received written notice from the plan

requesting a lump sum payment. Specifically, the insurer must provide

notice of the amendment to the plan within 30 days of publication of

the final regulation. The notice must contain, among other things, a

complete description of the amendment and must inform the plan of its

right to terminate or discontinue the policy and withdraw all

unallocated funds in accordance with the requirements of paragraph (e)

and this paragraph. If the policyholder elects to receive a lump sum

payment on termination or discontinuance of the policy, the insurer

must use the more favorable (to the plan) of the market value

adjustments determined on either the effective date of the amendment or

determined upon receipt of the written request from the plan.

Section 401(c)(5)(B)(i) of the Act, as added by Pub. L. 104-188,

provides an exception to the general 18-month effective date for

regulations intended to prevent the avoidance of the regulations set

forth herein. The Department is proposing an earlier effective date for

the provisions relating to the independent fiduciary approval,

disclosures and insurer-initiated amendments. The Department believes

that the earlier effective dates protect the interests and rights of a

plan and its participants and beneficiaries by minimizing the potential

for insurers to change their conduct in ways which are disadvantageous

to plan policyholders without compliance with the terms and conditions

of the regulation. The Department notes that compliance with the

specific requirements of the regulation must occur as of the date that

such requirement becomes effective. Failure to comply with any of the

requirements listed in paragraphs (b) through (f) of this regulation

after the effective date of such paragraphs will result in the general

account of the insurer holding plan assets as provided in paragraph

(i)(4).

Economic Analysis Under Executive Order 12866

Under Executive Order 12866 (58 FR 51735, Oct. 4, 1993), the

Department must determine whether the regulatory action is

``significant'' and therefore subject to review by the Office of

Management and Budget (OMB) under the requirements of the Executive

Order. Under section 3(f), the order defines a ``significant regulatory

action'' as an action that is likely to result in, among other things,

a rule raising novel policy issues arising out of the President's

priorities. Pursuant to the terms of the Executive Order, the

Department has determined that this regulatory action is a

``significant regulatory action'' as that term is used in Executive

Order 12866 because the action would raise novel policy issues arising

out of the President's priorities. Thus, the Department believes this

notice is ``significant,'' and subject to OMB review on that basis.

The Office of Management and Budget has determined that this

regulatory action is economically significant because it may adversely

effect in a material way a sector of the economy. The Department

therefore solicits additional information from the interested public

regarding the economic impact of the proposed regulation. Specifically,

the Department requests current data on the number and characteristics

of potentially affected insurance contracts that would provide the

basis for a more extensive analysis of the costs and benefits of the

proposed regulation.

These regulations mitigate the constraints imposed by ERISA on the

operation of insurance company general accounts. The Department

believes that insurers are likely in nearly all circumstances to avail

themselves of the relief provided under the proposed regulation. The

consequences for an insurer, of not complying with the safe harbor

afforded by the regulation, would subject the insurer's general account

to potential liability under part 4 of Title I of ERISA. Because the

statute simply directs the Department to issue a regulation and

specifies much of the regulation's content, its costs and benefits may

be estimated simply by analyzing the regulation. The Department is not

aware of any published analysis of the nature or level of the costs the

statute will not impose.

The Department has endeavored to control the compliance costs

associated with the regulation by providing model language, by

requiring disclosures at the outset of the contract or no more than

annually, and by allowing disclosure materials to be based on materials

prepared for other reasons. The Department's analysis of the impact of

the regulation has concluded that it will provide greater protections

for 130,000 pension plans holding contracts with 110 insurers. The net

cost of these protections is estimated to be no more than $2 to $5

million per year. This estimate of the potential impact of the proposed

regulation is based on the Department's estimates of assets held in

life insurers' general accounts and the proportion of these that might

be deemed to be holding ERISA plan assets. The total of all assets held

by life insurers in their general accounts amounts to approximately

$1.7 trillion. Based on data reported on Schedule A available from Form

5500 series reports, the Department estimates that the assets of

contracts potentially directly affected by the regulation have a

current value of approximately $40 billion or slightly less than 3

percent of general account assets. This estimate of $40 billion

represents the amount reported by plans to be held in contracts

categorized as unallocated general account contracts whose performance

is linked with that of the general accounts in the annual financial

reports filed by plans. As such it represents an upper bound of the

value of the contracts potentially affected by the regulation because

some portion of these contracts may in fact already meet the conditions

specified in the regulation. The Department solicits additional data

which would permit a further delineation of the affected assets.

It is estimated that the costs of this regulation will primarily

arise from the cost of compliance with its disclosure requirements. The

benefits to plans,

[[Page 66915]]

participants and beneficiaries arise from the improved understanding of

their investment that comes from the disclosure, and from the limits on

the calculation of the market value adjustment by the insurer at the

time of termination of the contract.

The insurance contracts affected by this regulation have a wide

range of characteristics that cannot in a comprehensive way be

precisely defined. They may differ widely, in particular with respect

to the conditions associated with their termination provisions.

However, the regulation's disclosure and termination provisions

establish minimum standards, which may be more favorable to plans than

their terms absent the regulation. As a result, some plans that have

been unable to terminate, or might not have terminated, their

contractual arrangements may now terminate those arrangements. The

Department does not believe, however, that the regulation will have a

significant adverse financial impact on other general account

policyholders or insurers. As the American Council of Life Insurance

has noted in various submissions, the relevant contracts typically

already permit the termination and withdrawal of plan assets in a lump

sum (subject to a market value adjustment) or in installments over a

period of years at book value with interest. Although the regulation

protects plans by permitting them to withdraw plan assets in a lump sum

without penalty, it also protects the legitimate interests of insurers

by permitting them to recover incurred costs and to impose a market

value adjustment designed to ``accurately reflect the effect on the

value of the accumulation fund of its liquidation in the prevailing

market for fixed income obligations.'' Similarly, the regulation

mitigates any adverse economic impact by permitting insurers to spread

book value withdrawals over a five-year period at a reduced rate of

interest (assuming the relevant contract does not give the plan more

favorable termination and withdrawal rights). The Department believes

that these provisions adequately protect the insurers from the risks of

``adverse selection'' or disintermediation, while providing significant

protection to plan policyholders. In many respects, the regulation

simply parallels the pre-existing rule under ERISA that a contract

between a plan and party in interest is impermissible unless it permits

termination without penalty so as to ``prevent the plan from becoming

locked into an arrangement that has become disadvantageous.'' 29 CFR

2550.408b-2(c).

A portion of the estimated costs of the regulation is attributed to

the termination of some contracts which, absent the regulation, would

have remained in force. Some of the costs that the insurers may incur

are offset, however, by commensurate benefits to plans. The only net

costs of the regulation therefore, are the cost of supplying the

disclosure information and transaction costs for plans terminating

their insurance contracts. In the view of the Department, these costs

must be weighed against the benefits that accrue to plans and the

economy in general from the enhanced transparency of general account

products, and the resulting increased ability plans will have to

rationally manage their portfolios and allocate assets more

efficiently. The regulation is designed to ensure that a plan fiduciary

will have access to all the information necessary to assess the

potential and actual performance of a general account contract both

before and after entering into the initial agreement with the insurer.

The regulation's termination and withdrawal provisions additionally

ensure that the plan fiduciary can act on the information disclosed by

withdrawing the plan's assets in favor of other investment vehicles or

expenditures if it is prudent or economically advantageous to do so.

The net result is to safeguard plans' ability to allocate their

resources in the most economically rational manner possible.

The analysis of the impact of the regulation does not attribute any

cost to the possible effect of the regulation on the management or

composition of insurers' general account portfolios. This is because

the total value of the contracts potentially affected represent less

than 3 percent of general account assets. According to data published

by the American Council of Life Insurance, general account reserves are

primarily invested in fixed income securities of relatively short

maturities. The maximum liquidity requirement imposed by the regulation

in the highly unlikely event that all of the affected plans chose to

terminate the contracts would be less than 6-tenths percent of the

general accounts (this reflects the distribution of 3 percent of

general assets over 5 years). This should be readily available from the

cash flow derived from the current distribution of investments. The

Department therefore has not assigned any cost of the regulation to

other general account policyholders.

The insurance industry has not provided the Department with any

information regarding the magnitude of their costs. Accordingly, the

Department solicits additional information from the interested public

regarding the economic analysis in the proposed regulation.

Specifically, the Department requests comments and supporting data on

the costs and benefits of the proposed regulation, as well as

information on whether more frequent contract terminations which may

result from enhanced opportunities provided by the proposed regulation

will result in an increase in brokerage, appraisal and/or other

transactions costs.

Regulatory Flexibility Act

The Regulatory Flexibility Act of 1980 requires each Federal agency

to perform an Initial Regulatory Flexibility Analysis for all rules

that are likely to have a significant economic impact on a substantial

number of small entities. Small entities include small businesses,

organizations, and governmental jurisdictions. The Pension and Welfare

Benefits Administration has determined that this rule will not have a

significant economic impact on a substantial number of small entities.

A summary for the basis of that conclusion follows:

(1) PWBA is promulgating this regulation because it is required to

do so under section 1460 of the Small Business Job Protection Act of

1996 (Pub. L. 104-188).

(2) The objective of the proposed regulation is to provide guidance

on the application of ERISA to policies held in insurance company

general accounts. The legal basis for the proposed regulation is found

in new ERISA section 401(c); an extensive list of authorities may be

found in the Statutory Authority section, below.

(3) The direct cost of compliance will be born by insurance

companies; the Department estimates that no ``small'' insurance

companies (as defined by the Small Business Administration at 61 FR

3280, Jan 31, 1996) offer the type of policies regulated here. No small

governmental jurisdictions will be affected. It is estimated that

121,000 small employee benefit plans (those with fewer than 100

participants) purchase the regulated policies, and will therefore

receive the benefit of the enhanced disclosure provided by the

regulation. Some of the costs of disclosure may be passed on to the

plans by the insurers.

(4) No federal reporting is required under the proposed rule. It is

anticipated that the majority of the disclosure requirements may be

handled by clerical staff; however, there will be

[[Page 66916]]

a need for professional staff involvement.

(5) No federal rules have been identified that duplicate, overlap

or conflict with the proposed rule. To the extent possible, the overlap

in disclosures between this rule and state and SEC reporting

requirements have been designed to allow the same materials to meet

both requirements while providing the necessary protections for

employee benefit plans.

(6) No significant alternatives which would minimize the impact on

small entities have been identified. It would be inappropriate to

create an alternative with lower compliance criteria, or an exemption

under the proposed regulation, for small plans because those are the

entities that have the greatest need for the disclosures and other

protections offered by the regulation.

Paperwork Reduction Act

The proposed regulation contains information collections which are

subject to review by the Office of Management and Budget (OMB) under

the Paperwork Reduction Act of 1995. The title, summary, description of

need, respondents description, and estimated reporting and

recordkeeping burden are shown below.

Title: Disclosure Regarding Plan Assets in Insurance Company

General Accounts.

Summary/Description of Need: Section 1460 of the Small Business Job

Protection Act of 1996 (Pub. L. 104-188) amended ERISA by adding new

Section 401(c), which requires that certain steps be taken by insurance

companies which offer and maintain policies for private sector employee

benefit plans where the assets are held in the insurer's general

account. Pursuant to the authority given to the Secretary under the

statute, the regulation requires certain disclosures be provided at the

outset of the contract and annually, and other disclosures be provided

upon request.

Respondents Description: Individuals or households; Business or

other for-profit institutions; Not-for-profit institutions.

Estimated Reporting and Recordkeeping Burden: Based upon Form 5500

filing data, an estimated 134,000 plans, primarily pension plans, have

invested in 138,000 policies offered by approximately 110 insurance

companies. Because insurers must already assemble much of the

information to be disclosed for purposes of state disclosure

requirements and their own administration of the contracts, the

Department does not believe the additional disclosure obligations

imposed by the regulation will be unduly burdensome. The additional

costs can be divided into start-up expenses incurred immediately after

the regulation takes effect, and a yearly expense thereafter. Initially

insurers will be required to modify disclosure forms and computer

programs to comply with the new obligations imposed by the regulation.

In total, the Department estimates that this initial expense will cost

no more than $2 to $5 million. Thereafter, the Department estimates

that insurers will generally incur disclosure and reproduction expenses

of between $100 and $200 for each contract to which the regulation

applies.

The Department of Labor has submitted a copy of the proposed

information collection to the Office of Management and Budget in

accordance with 44 U.S.C. Sec. 3507(d) of the Paperwork Reduction Act

of 1995 for its review of its information collections. Interested

persons are invited to submit comments regarding this proposed new

collection of information.

The Department of Labor is particularly interested in comments

which:

Evaluate whether the proposed collection of information is

necessary for the proper performance of the functions of the agency,

including whether the information will have practical utility;

Evaluate the accuracy of the agency's estimate of the

burden of the proposed collection of information, including the

validity of the methodology and assumptions used;

Enhance the quality, utility and clarity of the

information to be collected; and

Minimize the burden of the collection of information on

those who are to respond, including through the use of appropriate

automated, electronic, mechanical, or other technological collection

techniques or other forms of information technology, e.g., permitting

electronic submission of responses.

Comments should be sent to the Office of Information and Regulatory

Affairs (OIRA), Office of Management and Budget (OMB), Room 10235, New

Executive Office Building, Washington, D.C. 20503; Attention: Desk

Officer for the Pension and Welfare Benefits Administration. OMB

requests that comments be received within 30 days of publication of the

Notice of Proposed Rulemaking.

Statutory Authority

The proposed regulation set forth herein is issued pursuant to the

authority contained in sections 401(c) and 505 of ERISA (Pub. L. 93-

406, Pub. L. 104-188, 88 Stat. 894; 29 U.S.C. 1101(c), 29 U.S.C. 1135)

and section 102 of Reorganization Plan No. 4 of 1978 (43 FR 47713,

October 17, 1978), effective December 31, 1978 (44 FR 1065, January 3,

1979), 3 CFR 1978 Comp. 332, and under Secretary of Labor's Order No.

1-87, 52 FR 13139 (April 21, 1987).

List of Subjects in 29 CFR Part 2550

Employee benefit plans, Employee Retirement Income Security Act,

Employee stock ownership plans, Exemptions, Fiduciaries, Insurance

Companies, Investments, Investment foreign, Party in interest,

Pensions, Pension and Welfare Benefit Programs Office, Prohibited

transactions, Real estate, Securities, Surety bonds, Trusts and

trustees.

For the reasons discussed in the preamble, it is proposed to amend

29 CFR part 2550 as follows:

PART 2550--[AMENDED]

1. The authority for Part 2550 is revised to read as follows:

Authority: 29 U.S.C. 1135. Section 2550.401b-1 also issued under

sec. 102, Reorganization Plan No. 4 of 1978, 43 FR 47713, 3 CFR,

1978 Comp., p. 332. Section 2550.401c-1 also issued under 29 U.S.C.

1101. Section 2550.404c-1 also issued under 29 U.S.C. 1104. Section

2550.407c-3 also issued under 29 U.S.C. 1107. Section 2550.408b-1

also issued under sec. 102, Reorganization Plan No. 4 of 1978, 43 FR

47713, 3 CFR, 1978 Comp., p. 332, and 29 U.S.C. 1108(b)(1). Section

2550.412-1 also issued under 29 U.S.C. 1112. Secretary of Labor's

Order No. 1-87 (52 FR 13139).

2. New section 2550.401c-1 is added to read as follows:

Sec. 2550.401c-1 Definition of ``plan assets''--insurance company

general accounts.

(a) In general. (1) This section describes, in the case where an

insurer issues one or more policies to or for the benefit of an

employee benefit plan (and such policies are supported by assets of an

insurance company's general account), which assets held by the insurer

(other than plan assets held in its separate accounts) constitute plan

assets for purposes of Subtitle A, and Parts 1 and 4 of Subtitle B, of

Title I of the Employee Retirement Income Security Act of 1974 (ERISA

or the Act) and section 4975 of the Internal Revenue Code (the Code),

and provides guidance with respect to the application of Title I of the

Act and section 4975 of the Code to the general account assets of

insurers.

(2) Generally, when a plan acquires a policy issued by an insurer

on or before

[[Page 66917]]

December 31, 1998 (Transition Policy), which is supported by assets of

the insurer's general account, the plan's assets include the policy,

but do not include any of the underlying assets of the insurer's

general account if the insurer satisfies the requirements of paragraphs

(b) through (f) of this section.

(b) Approval by fiduciary independent of the issuer.--(1) In

general. An independent plan fiduciary who has the authority to manage

and control the assets of the plan must expressly authorize the

acquisition or purchase of the Transition Policy. For purposes of this

subparagraph, a fiduciary is not independent if the fiduciary is an

affiliate of the insurer issuing the policy.

(2) Notwithstanding paragraph (b)(1) of this section, the

authorization by an independent plan fiduciary is not required if:

(i) The insurer is the employer maintaining the plan, or a party in

interest which is wholly owned by the employer maintaining the plan;

and

(ii) The requirements of section 408(b)(5) of the Act are met.

(c) Duty of Disclosure.--(1) In general. An insurer shall furnish

the following information to a plan fiduciary acting on behalf of a

plan to which a Transition Policy has been issued. Paragraph (c)(2) of

this section describes the style and format of such disclosure.

Paragraph (c)(3) of this section describes the content of the initial

disclosure. Paragraph (c)(4) of this section describes the information

that must be disclosed by the insurer at least once per year for as

long as the

Transition Policy remains outstanding.

(2) Style and format. The disclosure required by this paragraph

should be clear and concise and written in a manner calculated to be

understood by a plan fiduciary, without relinquishing any of the

substantive detail required by paragraphs (c)(3) and (c)(4) of this

section. The information does not have to be organized in any

particular order but should be presented in a manner which makes it

easy to understand the operation of the policy. To the extent

paragraphs (c)(3) and (c)(4) of this section require the disclosure of

the insurer's methods or methodologies for determining various values

or amounts relevant to the plan's policy, the disclosure must be made

in sufficient detail and with such clarity that the plan fiduciary,

with relevant data from the insurer and appropriate professional

assistance, can determine the values or amounts applicable to the

plan's policy. The insurer must disclose any data necessary for

application of the methods or methodologies without unreasonable delay

upon the request of the plan fiduciary.

(3) Initial Disclosure. Prior to obtaining a binding commitment

from a plan to acquire a Transition Policy, the insurer must provide to

the plan, either as part of the policy, or as a separate written

document which accompanies the policy, the disclosure information set

forth in paragraph (c)(3)(i) through (iv) of this section. In the case

of a Transition Policy that has been issued before the date which is 90

days after the date of publication of the final regulation, the insurer

must provide the disclosure information no later than 90 days after

publication. The disclosure must include all of the following

information which is applicable to the Transition Policy:

(i) A description of the method by which any income and expenses of

the insurer's general account are allocated to the policy during the

term of the policy and upon its termination, including:

(A) A statement of the method used by the insurer to determine the

fees, charges, expenses or other amounts that are or may be assessed

against the policyholder or deducted by the insurer from any

accumulation fund under the policy, including the extent and frequency

with which such fees, charges, expenses or other amounts may be

modified by the insurance company;

(B) A statement of the method by which the insurer determines the

return to be credited to any accumulation fund under the policy,

including a statement of the method used to allocate income and

expenses to lines of business, business segments, and policies within

such lines of business and business segments, and a description of how

any withdrawals, transfers, or payments will affect the amount of the

return credited;

(C) A description of the rights which the policyholder or plan

participant has to withdraw or transfer all or a portion of any fund

under the policy, or to apply the amount of a withdrawal to the

purchase of or payment of benefits, and the terms on which such

withdrawals or other use of funds may be made, including a description

of any expense charges, fees, experience rating charges or credits,

market value adjustments, or any other charges or adjustments, both

positive and negative;

(D) A statement of the method used to calculate the charges, fees,

credits or market value adjustments described in paragraph (i)(C) of

this section, and, upon the request of a plan fiduciary, the

information necessary to independently calculate the exact dollar

amounts of the charges, fees or adjustments. The initial disclosure

provided to the plan must set forth and describe each of the provisions

and elements of the formula for making the market value adjustment in

sufficient detail and with such clarity that the plan fiduciary, with

relevant data from the insurer and with professional assistance, if

necessary, can replicate any adjustment proposed by the insurer. If the

formula is based on interest rate guarantees applicable to new

contracts of the same class or classes, and the duration of the assets

underlying the accumulation fund, the contract must describe the

process by which those components are ascertained or obtained. If the

formula is based on an interest rate implicit in an index of publicly

traded obligations, the identity of the index, the manner in which it

is used, and identification of the source or publication where any data

used in the formula can be found, must be disclosed;

(ii) A statement describing the expense, income and benefit

guarantees under the policy, including a description of the length of

such guarantees, and of the insurer's right, if any, to modify or

eliminate such guarantees; and

(iii) A description of the rights of the parties to make or

discontinue contributions under the policy, and of any restrictions

(such as timing, minimum or maximum amounts, and penalties and grace

periods for late payments) on the making of contributions under the

policy, and the consequences of the discontinuance of contributions

under the policy.

(iv) A statement of how any policyholder or participant-initiated

withdrawals are to be made: first-in, first-out (FIFO) basis, last-in,

first-out (LIFO) basis, pro rata or another basis.

(4) Annual disclosure. At least annually and not later than 90 days

following the period to which it relates, an insurer shall provide the

following information to each plan to which a Transition Policy has

been issued:

(i) The balance of any accumulation fund on the first day and last

day of the period covered by the annual report;

(ii) Any deposits made to the accumulation fund during such annual

period;

(iii) An itemized statement of all income attributed to the policy

or added to the accumulation fund during the period, and a description

of the method used by the insurer to determine the precise amount of

income;

(iv) The actual rate of return credited to the accumulation fund

under the policy during such period, stating whether the rate of return

was calculated before or after deduction of

[[Page 66918]]

expenses charged to the accumulation fund;

(v) Any other additions to the accumulation fund during such

period;

(vi) An itemized statement of all fees, charges, expenses or other

amounts assessed against the policy or deducted from the accumulation

fund during the reporting year, and a description of the method used by

the insurer to determine the precise amount of the fees, charges and

other expenses;

(vii) An itemized statement of all benefits paid, including annuity

purchases, to participants and beneficiaries from the accumulation

fund;

(viii) The dates on which the additions or subtractions were

credited to, or deleted from, the accumulation fund during such period;

(ix) A description, if applicable, of all transactions with

affiliates which exceed 1 percent of group annuity reserves of the

general account for the prior reporting year;

(x) A statement describing any expense, income and benefit

guarantees under the policy, including a description of the length of

such guarantees, and of the insurer's right, if any, to modify or

eliminate such guarantees;

(xi) The amount that would be payable in a lump sum at the end of

such period pursuant to the request of a policyholder for payment or

transfer of amounts in the accumulation fund under the policy after the

insurer deducts any applicable charges and makes any appropriate market

value adjustments, upward or downward, under the terms of the policy;

and

(xii) An explanation that the insurer promptly will make available

upon request of a plan, copies of the following publicly-available

financial data or other publicly available reports relating to the

financial condition of the insurer:

(A) National Association of Insurance Commissioners (NAIC)

Statutory Annual Statement, with Exhibits, General Interrogatories, and

Schedule D, Part 1A, Secs 1 and 2 and Schedule S-Part 3E;

(B) Rating agency reports on the financial strength and claims-

paying ability of the insurer;

(C) Risk adjusted capital ratio, with a brief description of its

derivation and significance, referring to the risk characteristics of

both the assets and the liabilities of the insurer;

(D) Actuarial opinion (with supporting documents) of the insurer's

Appointed Actuary certifying the adequacy of the insurer's reserves as

required by New York State Insurance Department Regulation 126 and

comparable regulations of other states; and

(E) The insurer's most recent SEC Form 10K and Form 10Q (stock

companies only).

(d) Alternative separate account arrangements.--(1) In general. An

insurer must provide the plan fiduciary with the following additional

information at the same time as the disclosure required under paragraph

(c) of this section:

(i) A statement explaining the extent to which alternative contract

arrangements supported by assets of separate accounts of insurers are

available to plans;

(ii) A statement as to whether there is a right under the policy to

transfer funds to a separate account and the terms governing any such

right; and

(iii) A statement explaining the extent to which general account

contracts and separate account contracts of the insurer may pose

differing risks to the plan.

(2) An insurer will be deemed to comply with the requirements of

paragraph (d)(1)(iii) of this section if the disclosure provided to the

plan includes the following statement:

a. Contractual arrangements supported by assets of separate

accounts may pose differing risks to plans from contractual

arrangements supported by assets of general accounts. Under a

general account contract, the plan's contributions or premiums are

placed in the insurer's general account and commingled with the

insurer's corporate funds and assets (excluding separate accounts

and special deposit funds). The insurance company combines in its

general account premiums received from all its lines of business.

These premiums are pooled and invested by the insurer. General

account assets in the aggregate support the insurer's obligations

under all of its insurance contracts, including (but not limited to)

its individual and group life, health, disability, and annuity

contracts. Experience rated general account policies may share in

the experience of the general account through interest credits,

dividends, or rate adjustments, but assets in the general account

are not segregated for the exclusive benefit of any particular

policy or obligation. General account assets are also available to

the insurer for the conduct of its routine business activities, such

as the payment of salaries, rent, other ordinary business expenses

and dividends.

b. An insurance company separate account is a segregated fund

which is not commingled with the insurer's general assets. Depending

on the particular terms of the separate account contract, income,

expenses, gains and losses associated with the assets allocated to a

separate account may be credited to or charged against the separate

account without regard to other income, expenses, gains, or losses

of the insurance company, and the investment results passed through

directly to the policyholders. While most, if not all, general

account investments are maintained at book value, separate account

investments are normally maintained at market value, which can

fluctuate according to market conditions. In large measure, the

risks associated with a separate account contract depend on the

particular assets in the separate account.

c. The plan's legal rights vary under general and separate

account contracts. In general, an insurer is subject to ERISA's

fiduciary responsibility provisions with respect to the assets of a

separate account (other than a separate account registered under the

Investment Company Act of 1940) to the extent that the investment

performance of such assets is passed directly through to the plan

policyholders. ERISA requires insurers, in administering separate

account assets, to act solely in the interest of the plan's

participants and beneficiaries; precludes self-dealing and conflicts

of interest; and requires insurers to adhere to a prudent standard

of care. In contrast, ERISA generally imposes less stringent

standards in the administration of general account contracts which

were issued on or before December 31, 1998.

d. On the other hand, state insurance regulation is typically

more restrictive with respect to general accounts than separate

accounts. In addition, insurance company general account policies

often include various guarantees under which the insurer assumes

risks relating to the funding and distribution of benefits. Insurers

do not usually provide any guarantees with respect to the investment

returns on assets held in separate accounts. Of course, the extent

of any guarantees from any general account or separate account

contract will depend upon the specific policy terms.

e. Finally, separate accounts and general accounts pose

differing risks in the event of the insurer's insolvency. In the

event of insolvency, funds in the general account are available to

meet the claims of the insurer's general creditors, after payment of

amounts due under certain priority claims, including amounts owed to

its policyholders. Funds held in a separate account as reserves for

its policy obligations, however, may be protected from the claims of

creditors other than the policyholders participating in the separate

account. Whether separate account funds will be granted this

protection will depend upon the terms of the applicable policies and

the provisions of any applicable laws in effect at the time of

insolvency.

(e) Termination procedures. Within 90 days of written notice by a

policyholder to an insurer, the insurer must permit the policyholder to

exercise the right to terminate or discontinue the policy and to

receive without penalty either:

(1) a lump sum payment representing all unallocated amounts in the

accumulation fund. For purposes of this paragraph (e), the term penalty

does not include a market value adjustment (as defined in paragraph

(h)(7) of this section) or the recovery of costs actually incurred

which would have been

[[Page 66919]]

recovered by the insurer but for the termination or discontinuance of

the policy, including any unliquidated acquisition expenses, to the

extent not previously recovered by the insurer; or

(2) a book value payment of all unallocated amounts in the

accumulation fund under the policy in approximately equal annual

installments, over a period of no longer than five years, together with

interest computed at an annual rate which is no less than the annual

rate which was credited to the accumulation fund under the policy as of

the date of the contract termination or discontinuance, minus 1

percentage point.

(f) Insurer-initiated amendments. In the event the insurer makes an

insurer-initiated amendment (as defined in paragraph (h)(8) of this

section), the insurer must provide written notice to the plan at least

sixty days prior to the effective date of the insurer-initiated

amendment. The notice must contain a complete description of the

amendment and must inform the plan of its right to terminate or

discontinue the policy and withdraw all unallocated funds without

penalty by sending a written request within such sixty day period to

the name and address contained in the notice. The plan must be offered

the right to receive a lump sum or installment payment described in

paragraph (e)(1) or (e)(2) of this section. An insurer-initiated

amendment shall not apply to a contract if the plan fiduciary exercises

its right to terminate or discontinue the contract within such sixty

day period and to receive a lump sum or installment payment.

(g) Prudence. An insurer shall manage those assets of the insurer

which are assets of such insurer's general account (irrespective of

whether any such assets are plan assets) with the care, skill, prudence

and diligence under the circumstances then prevailing that a prudent

man acting in a like capacity and familiar with such matters would use

in the conduct of an enterprise of a like character and with like aims,

taking into account all obligations supported by such enterprise. This

prudence standard applies to the conduct of all insurers with respect

to policies issued to plans on or before December 31, 1998, and differs

from the prudence standard set forth in section 404(a)(1)(B) of ERISA.

Under the prudence standard provided in this paragraph, prudence must

be determined by reference to all of the obligations supported by the

general account, not just the obligations owed to plan policyholders.

The more stringent standard of prudence set forth in section

404(a)(1)(B) of ERISA continues to apply to any obligations which

insurers may have as fiduciaries which do not arise from the management

of general account assets, as well as to insurers' management of plan

assets maintained in separate accounts. The terms of the regulation do

not modify or reduce the fiduciary obligations applicable to insurers

in connection with policies issued after December 31, 1998, which are

supported by general account assets, including the standard of prudence

under section 404(a)(1)(B) of the Act.

(h) Definitions. For purposes of this section:

(1) an affiliate of an insurer means:

(i) Any person, directly or indirectly, through one or more

intermediaries, controlling, controlled by, or under common control

with the insurer,

(ii) Any officer, director, partner or employee of such insurer or

of a person described in paragraph (i) of this definition including in

the case of an insurer, an insurance agent or broker thereof, whether

or not such person is a common law employee, and

(iii) Any corporation, partnership, or unincorporated enterprise of

which a person described in paragraph (ii) of this definition is an

officer, director, partner or employee.

(2) The term control means the power to exercise a controlling

influence over the management or policies of a person other than an

individual.

(3) The term guaranteed benefit policy means a policy described in

section 401(b)(2)(B) of the Act and any regulations promulgated

thereunder.

(4) The term insurer means an insurer as described in section

401(b)(2)(A) of the Act.

(5) The term accumulation fund means the aggregate net

consideration (i.e., gross considerations less all deductions from such

considerations) credited to the Transition Policy plus all additional

amounts, including interest and dividends, credited to such Transition

Policy less partial withdrawals, benefit payments and less all charges

and fees imposed against this accumulated amount under the Transition

Policy other than surrender charges and market value adjustments.

(6) The term Transition Policy means:

(i) a policy or contract of insurance (other than a guaranteed

benefit policy) that is issued by an insurer to, or on behalf of, an

employee benefit plan on or before December 31, 1998, and which is

supported by the assets of the insurer's general account.

(ii) A policy will not fail to be a Transition Policy merely

because the policy is amended or modified to comply with the

requirements of section 401(c) of the Act and this section.

(7) For purposes of this regulation, the term market value

adjustment means an adjustment to the book value of the accumulation

fund to accurately reflect the effect on the value of the accumulation

fund of its liquidation in the prevailing market for fixed income

obligations, taking into account the future cash flows that were

anticipated under the policy. An adjustment is a market value

adjustment within the meaning of this definition only if the insurer

has determined the amount of the adjustment pursuant to a method which

was previously disclosed to the policyholder in accordance with

paragraph (c)(3)(i)(D) of this section, and the method permits both

upward and downward adjustments to the book value of the accumulation

fund.

(8) The term insurer-initiated amendment is defined in paragraphs

(h)(8) (i) and (ii) of this section:

(i) An amendment to a policy made by an insurer pursuant to a

unilateral right to amend the policy terms that would have a material

adverse effect on the policyholder; or

(ii) Any of the following unilateral changes in the insurer's

conduct or practices with respect to the policyholder or the

accumulation fund under the policy that result in a reduction of

existing or future benefits under the policy, a reduction in the value

of the policy or an increase in the cost of financing the plan or plan

benefits, if such changes have more than a de minimis effect on the

policy:

(A) A change in the methodology for assessing fees, expenses, or

other charges against the accumulation fund or the policyholder;

(B) A change in the methodology used for allocating income between

lines of business, or product classes within a line of business;

(C) A change in the methodology used for determining the rate of

return to be credited to the accumulation fund under the policy;

(D) A change in the methodology used for determining the amount of

any fees, charges, or market value adjustments applicable to the

accumulation fund under the policy in connection with the termination

of the contract or withdrawal from the accumulation fund;

(E) A change in the dividend class to which the policy or contract

is assigned;

(F) A change in the policyholder's rights in connection with the

termination of the contract, withdrawal of funds or the purchase of

annuities for plan participants; and

(G) A change in the annuity purchase rates.

[[Page 66920]]

(iii) For purposes of this definition, any amendment or change

which is made with the affirmative consent of the policyholder is not

an insurer-initiated amendment.

(i) Limitation on liability. (1) No person shall be subject to

liability under Parts 1 and 4 of Title I of the Act or section 4975 of

the Code for conduct which occurred prior to the effective dates of the

regulation on the basis of a claim that the assets of an insurer (other

than plan assets held in a separate account) constitute plan assets.

Notwithstanding the foregoing, this section shall not:

(i) Apply to an action brought by the Secretary of Labor pursuant

to paragraphs (2) or (5) of section 502(a) of ERISA for a breach of

fiduciary responsibility which would also constitute a violation of

Federal or State criminal law;

(ii) Preclude the application of any Federal criminal law; or

(iii) Apply to any civil action commenced before November 7, 1995.

(2) Nothing in this section relieves any person from any State law

regulating insurance which imposes additional obligations or duties

upon insurers to the extent not inconsistent with the provisions of

this section. Therefore, nothing in this section should be construed to

preclude a State from requiring insurers to make additional disclosures

to policyholders, including plans. Nor does this section prohibit a

State from imposing additional substantive requirements with respect to

the management of general accounts or from otherwise regulating the

relationship between the policyholder and the insurer to the extent not

inconsistent with the provisions of this section;

(3) Nothing in this section precludes any claim against an insurer

or other person for violations of the Act which do not require a

finding that the underlying assets of a general account constitute plan

assets, regardless of whether the violation relates to a Transition

Policy; and

(4) If the requirements in paragraphs (b) through (f) of this

section of the regulation are not met with respect to a plan that has

purchased or acquired a Transition Policy, the plan's assets include an

undivided interest in the underlying assets of the insurer's general

account for that period of time for which the requirements are not met.

However, an insurer's failure to comply with the requirements of this

section with respect to any particular Transition Policy will not

result in the underlying assets of the general account constituting

plan assets with respect to other Transition Policies if the insurer is

otherwise in compliance with the requirements contained in the section.

(j) Effective date. (1) In general. Except as provided below, this

section is effective from the date which is 18 months after its

publication in the Federal Register.

(2) With respect to a Transition Policy issued before the date

which is 90 days after the date of publication of the final regulation,

paragraphs (c) and (d) of this section shall apply to the policy 90

days after the date of such publication.

(3) With respect to a Transition Policy issued 90 days after the

date of publication of the final regulation, paragraphs (c) and (d) of

this section shall apply to the policy as of the date of such

publication.

(4) Paragraph (b) of this section, relating to independent

fiduciary approval, and paragraph (f) of this section, relating to

insurer-initiated amendments, are effective on the date of publication

of the final regulation in the Federal Register. In the event an

insurer makes an insurer-initiated amendment to a Transition Policy

during the period between the dates of publication of the proposed and

final regulations, the insurer must provide written notice to the plan

within 30 days of publication of the final regulation. The document

must contain a complete description of the amendment; inform the plan

of its right to terminate or discontinue the policy and withdraw all

unallocated funds without penalty in accordance with the requirements

of paragraph (e) of this section and this paragraph; and provide that

the plan may exercise its right by sending a written request to the

name and address contained in the notice within sixty days of its

receipt of the notice from the insurer. In the event that the plan

exercises its right to terminate or discontinue the policy, the insurer

must disregard the effect of any insurer-initiated amendment which

would have the effect of decreasing the amount distributed to the plan.

In the case of a plan electing a lump sum payment, the insurer must use

the more favorable (to the plan) of the market value adjustments

determined on either the effective date of the amendment or determined

upon receipt of the written request from the plan in calculating the

lump sum representing the unallocated funds in the accumulation fund.

Signed at Washington, DC this 15th day of December, 1997.

Olena Berg,

Assistant Secretary, Pension and Welfare Benefits Administration, U.S.

Department of Labor.

[FR Doc. 97-33088 Filed 12-19-97; 8:45 am]

BILLING CODE 4510-29-P