Lincoln Secured Retirement Income(SM) Solution: Fiduciary Process In Evaluating In-Plan Guarantees

Lincoln Financial Group believes that plan sponsors considering a guaranteed withdrawal benefit solution should have a full understanding of the product and other alternatives, including the Lincoln Secured Retirement IncomeSM solution. In particular, Lincoln Financial Group believes it would be especially helpful for the plan sponsor to receive this information from an independent and experienced source. Accordingly, Lincoln Financial Group has commissioned Drinker, Biddle & Reath, LLP to prepare this white paper entitled, "Lincoln Secured Retirement IncomeSM Solution: Fiduciary Process in Evaluating In-Plan Guarantees."

INTRODUCTION

This White Paper discusses the fiduciary process for selecting in-plan lifetime income guarantees. In a companion White Paper, entitled "Lincoln Secured Retirement IncomeSM Solution: Addressing Participant Retirement Income Risks," we examine the risks confronting retirees in managing their retirement savings and review available solutions - some of which are guaranteed and some not - including, in particular, the Lincoln Secured Retirement IncomeSM solution. (For a copy of the companion White Paper, go to http://www.drinkerbiddle.com/resources/publications/2013/Lincoln-Secured-Retirement-Income-Solution-Addressing-Participant-Retirement-Income-Risks). In this paper, we discuss the steps for a prudent process for selecting a guaranteed lifetime income solution under the Employee Retirement Income Security Act of 1974 (ERISA) and similar state laws applicable to government plans, and offer a proposed fiduciary checklist to assist in that process.

At the outset, it is important to acknowledge that neither ERISA nor comparable state laws require defined contribution plans (including 401(k), 403(b) and 457 plans) to provide an in-plan lifetime income solution for participants. Nevertheless, the issue of how participants will manage their accounts and IRAs to provide sustainable lifelong income is gaining increasing attention. As a result, plan sponsors are concerned about the risks confronting their participants, and are considering services and products to help them obtain sustainable income in retirement. The selection of such products and their providers requires a prudent process, which is the subject of this White Paper. In addition to discussing the process for the selection and monitoring of these products generally, we provide a specific analysis of The Lincoln National Life Insurance Company (hereafter referred to as Lincoln Financial) and the Lincoln Secured Retirement IncomeSM solution.

Retiree Risks

Our companion White Paper points out that participants face a variety of risks, including the following:

The amount of replacement income a retiree needs to pay his bills, both monthly and unanticipated. Studies suggest that the amount is between 75% and 85% of final pre-retirement pay. How long a retiree (and perhaps the retiree's spouse) will live following retirement. The statistical probability is that, for married participants, either the retiree or the spouse may live 30 or more years after retirement. The sequence of returns risk, that is, the risk and impact of market downturns after a retiree begins to withdraw from his investments. Losses due to stock market volatility soon after retirement will likely never be recouped. The "safe" rate at which a retiree can withdraw money out of his retirement savings each month and continue to do so for at least 30 years: Financial models suggest that withdrawal rates of between 3% and 5% of a 65-year old retiree's initial account balance are "safe" (depending on the assumptions used in the model). The impact of inflation. "Cognitive impairment," that is, the degradation of the ability to make sound financial decisions as a retiree gets older. For a more complete discussion, including a discussion of how few participants understand or are prepared to face them and an assessment of how the Lincoln Secured Retirement IncomeSM solution addresses these risks, please refer to the companion White Paper.

This paper focuses on lifetime income solutions that are guaranteed by insurance companies. "Lifetime income" refers to a product or service designed to provide a retiree with a sustainable stream of income over his projected post-employment lifetime. A product is "guaranteed" if the amount of the income and the obligation to pay that amount is backed by an insurance company. As explained in the companion White Paper, these primarily consist of guaranteed withdrawal benefit (GWB) features, such as those available in the Lincoln Secured Retirement IncomeSM investment option, and traditional annuities.

Conclusions

Selection of a lifetime income guaranteed solution is a fiduciary decision. Even though the selection, in part, involves an assessment of the ability of the insurance company to meet its financial commitments in the future, this does not require fiduciaries to guarantee the future. They must engage in a prudent process to reach an informed and reasoned decision. In this sense, the selection is no different from any other decision that fiduciaries are required to make - except in the details of the information the fiduciaries must collect and analyze about the insurance company and the GWB.

The Department of Labor (DOL) has adopted a safe harbor regulation describing the process for selecting the issuer of annuities for defined contribution plans. Using this as a framework, Martin Schmidt1 of HS2 Solutions2, an independent financial advisor (with input from representatives of Lincoln Financial) has developed a checklist of the type of information that fiduciaries should consider. While not intended to be an exclusive list, the checklist includes the following items:

There are four main areas that fiduciaries should consider when evaluating an insurance company:

Financial strength of the company Evaluation by the rating agencies Commitment and success in the insurance industry Diversification of the business lines For each of these major categories, the checklist indicates the information to be assessed, how to obtain the information, and, where relevant, how to compare the information gathered on different providers. These areas are more fully developed in the checklist.

The complete checklist and our commentary are included in Appendix A to this White Paper.

In Appendix B, we include an analysis, based on a report prepared by Martin Schmidt of HS2 Solutions, that assesses Lincoln Financial and its Secured Retirement IncomeSM solution using the criteria set forth in the checklist. Mr. Schmidt's conclusion is that a fiduciary would be considered to act prudently if it selects the Lincoln Secured Retirement IncomeSM solution for its plan.

In his analysis, Mr. Schmidt concludes:

At the date of this White Paper, based on the reported information and how it is measured against the standards established in the checklist, a fiduciary may reasonably conclude that The Lincoln National Life Insurance Company is financially able to make future payments on the Lincoln Secured Retirement IncomeSM solution and would be a prudent choice for a fiduciary when evaluating an insurance company. From an objective measure, the company has a strong financial structure and is rated highly by each of the rating agencies. The company also has sufficient size when compared to other insurance companies in the industry. From a subjective measure, the company has a long history in the annuity...