New Reporting Requirements for Payments from Insurance Companies

By Fred Reish and Bruce Ashton

The Schedule A to the newly released Form 5500 has changes affecting third party administrators and others who receive payments from insurance companies. The revised Schedule A now requires disclosure of “fees” paid to “other persons,” in addition to the question on prior versions of the Schedule A asking for information on commissions paid to brokers and agents. (The new Schedule A requires disclosure of payments for plan years beginning after 1998.) Because the terms “other persons” and “fees” are not defined in either the instructions to Schedule A (or in Section 103(e) of ERISA, from which this disclosure obligation is derived) and because of the wide variety of arrangements prevalent in the insurance industry for paying service providers who assist in the establishment and administration of the plans, these terms take on special significance.

Identification of the Issue
Section 103(e) of ERISA provides as follows:

“Section 103(e) If some or all of the benefits under the plan are purchased from and guaranteed by an insurance company..., a report under this section shall include a statement from such insurance company... covering the plan year and enumerating... (2)...commissions, and administrative service or other fees or other specific acquisition costs paid by such company... ; ...and the names and addresses of the brokers, agents, or other persons to whom commissions or fees were paid, the amount paid to each, and for what purpose.....” [Emphasis added]

In the preamble to the newly released 5500 package, the DOL noted that several commentators had:

“...questioned the proposed requirement to report fees and commissions paid to “other persons” noting that the current Schedule A requests this information only for “agents and brokers.” Section 103(e) of ERISA includes “other persons” with agents and brokers in defining the requirement to report insurance contract fees and commissions. Further, the current Schedule A instructions provide that fees paid by insurance carriers to persons other than agents and brokers should be reported on the Schedule A as acquisition costs, administrative expenses, etc., as appropriate, and note that for large plan filers these fees paid to “other persons” are subject to separate reporting on the Schedule C. In light of the above, the requirement to report fees and commissions paid to “other persons” has been retained in the Schedule A because the Department believes it serves important enforcement targeting and disclosure purposes to require individual iden4fication of all persons who are paid insurance fees and commissions.” [Emphasis added]

On April 6, the Pension and Welfare Benefits Administration (PWBA) issued its new Strategic Enforcement Plan (StEP). In that Plan, the PWBA lists three national investigative priorities, one of which is service providers to plans. In discussing service provider investigations, the StEP states:

“When investigating plan service providers, PWBA generally focuses on the abusive practices committed by the specific service providers rather than the plans. For example, where a third party administrator has systematically retained an undisclosed fee, generally the focus will be on the third party administrator rather than the plan that contracted for the services.”

Taken literally, “other persons” would include all persons receiving payments from an insurance company, including, for example, the lawyers and actuaries who worked on creating the investment contract. Realistically, this cannot be what is intended by the Schedule A question. Without additional guidance from the DOL, we assume the term is limited to persons who are more directly associated with providing services related to the plan holding the contract and/or the investments purchased from the insurance company. Conversely, the term could be read narrowly to apply only to persons involved in selling the investment to the plan and/or the acquisition of the investment by the plan. Obviously, there are other gradations of interpretation.

Similarly, the term “fees” could be read broadly to be synonymous with all “payments” or narrowly to apply only to fees for services provided to the plan. Again, there are ranges of interpretation in between. It is precisely this range of possible interpretations of both terms that creates the uncertainty in this area.

We understand that the DOL will be publishing guidance — probably informal — on those questions and the other issues raised later on in this article.

Specific Examples
There are two key questions in determining the meaning of the new question. First, are third party administrators “other persons” for purposes of the disclosure requirements of the new Schedule A? Second, what constitutes “fees” for purposes of the Schedule A? Unfortunately, there are no definitive answers to these questions. However, one reasonable interpretation of the Schedule A language would require disclosure of payments in all of the specific fact situations discussed later in this article. For this reason, it would be prudent for service providers to begin disclosing to their clients all payments from insurance companies directly or indirectly related to their plans or the investment contracts held by those plans.

There are a wide variety of approaches used by financial companies that provide investments for plans (including insurance companies) in making payments to third party administrators (who we also refer to as “service providers”) in unbundled arrangements, typically for the administration of 401(k) plans. By “financial company” we mean a company that provides investment products to ERISA-covered qualified plans, including insurance companies, mutual funds and their management and distribution companies, brokerage firms, and banks which provide investment products. In referring to “insurance companies” we include all of the entities covered by Section 103(e) of ERISA, which refers to “insurance company, insurance service, or other similar organization.”

Although the different types of financial companies compete in the same marketplace for the same investment dollars of qualified plans, the disclosure obligations of the providers are different. Only insurance companies are subject to the special disclosure rules of Section 103(e) and Schedule A to the Form 5500, so that only the fees paid to service providers who are associated with plans that invest in insurance contracts (as opposed to mutual funds or products offered by banks and brokerage firms) are required to be separately reported. However, for plans covering 100 or more participants, Schedule C requires reporting of payments from a plan, as opposed to the Schedule A requirement for payments from an insurance company. Schedule C requires reporting of both direct and indirect payments from a plan, even if paid by a financial company providing investments for the plan.

Payments made by a financial company to a service provider are often labeled as fees, expense reimbursements, marketing allowances, general agent overrides or otherwise. However, the payment is typically made in the situation where a third party administrator does one or more of the following: (1) has introduced the broker, agent or other sales representative to the plan sponsor and/or fiduciaries; (2) is the broker or agent on the sale of the investment to the plan and also receives a commission on the sale; (3) has otherwise participated in the process of suggesting, selecting or evaluating the investment; (4) has signed a general agency contract with an insurance company, but may not provide the types of services typically provided by the general agent of an insurance agency or may only provide administrative services to the plans; or (5) is not involved in the sales process and only provides administrative services to a plan which holds the insurance company investment product.

In some situations, the payment may be made from plan assets (that is, there is a direct payment which reduces plan assets or an indirect payment in which the financial institution makes the payment from its general assets, but through its pricing, assesses a corresponding charge against the plan assets). Alternatively, the payment is sometimes made from the general assets of the financial company (e.g., the insurance company or a company controlled by or related to the insurance company), and is not paid by a discrete charge to the assets of the plan. In these latter cases, the financial companies' charges to the plan (e.g., under the group annuity contract) are the same, regardless of whether, for a specific plan, such payments are made to third party administrators.

The following are typical situations currently in practice by various investment providers. In each case, it appears that the payments to the service provider may need to be disclosed under the new Schedule A requirement.

Example 1. An unbundled investment provider pays a third party administrator a percentage (e.g., 20%) of the commissions paid to the broker on the sale of a group annuity contract, where the plan is administered by the third party administrator. In this example, the third party administrator may have signed a “general agency” agreement with the insurance company.

Comment: The instructions to line 2 column (c) of the Schedule A states: “Report all sales commissions regardless of the identity of the recipient. Do not report override commissions, salaries, bonuses, etc., paid to a general agent or manager for managing an agency, or for performing other administrative functions.” [Emphasis added] Presumably, this exception relates only to payments made for activities as a general agent. Therefore, if the third party administrator is not performing the traditional duties of a general agent, substance would prevail over form, and reporting would be required.

Example 2. An unbundled investment provider pays a third party administrator a commission for its services as the broker (which is appropriately disclosed on Schedule A), plus an “expense reimbursement” equal to a percentage of that commission (e.g., 5%) which may or may not be paid on an accountable basis. For this purpose, “not accountable” means that the third party administrator is not required to submit proof that it actually incurred the expenses. The “reimbursement” may be for various types of expenses, but typically involves expenses associated with marketing, sales or finder activities.

Example 3. An unbundled investment provider pays a third party administrator an amount (e.g., 20 basis points) on the aggregate plan assets in all group annuity contracts of the investment provider held by clients of that service provider.

Comment: The instructions state: “For purposes of line 2, commissions and fees include amounts paid by an insurance company on the basis of the aggregate value (e.g., policy amounts, premiums) of contracts or policies (or classes thereof) placed or retained. The amount (or pro rata share of the total) of such commissions or fees attributable to the contract or policy placed with or retained by the plan must be reported Example 4. An unbundled investment provider makes payments to a third party administrator. The payment is based on factors such as the total number of plans the third party administrator has with the investment provider, the aggregate assets in those plans and the total number of participants in those plans. The payments may be labeled as being for marketing, expense reimbursement or otherwise.

Example 5. A bundled investment provider undertakes to provide all investment management, recordkeeping and administration services for the plans that invest in its products. The investment provider receives one fee from the plan and pays, out of that fee, the commissions to the broker who sold the case. The investment provider bears the entire cost of administration and recordkeeping for the plan. In this example, since the investment provider also provides the administration services, there is no direct charge by an unrelated third party administrator for the administration services, and the investment provider subsidizes the administrative costs out of the fees it otherwise receives from the plan on the investment product.

Comment: This example raises some unique issues which do not exist in the other situations. These include whether: (1) the investment provider in the bundled approach needs to report the amount of the subsidized cost on Schedule A; (2) its administrative division or subsidiary is an “other person” for purposes of Schedule A; and (3) the subsidy of the administrative services division or subsidiary is a fee within the meaning of Section 103(e).

The examples discussed in this article only touch the surface of the myriad ways for paying compensation to service providers. However, the new Schedule A requirement for the reporting of the payment of insurance fees to other persons may be sufficiently broad to pick up all of them. As a result, service providers should begin the process of educating their clients about their relationships with financial institutions and the payments they receive from them. Further, we recommend that the disclosure be placed in an engagement agreement which is signed by the plan's ERJSA Administrator — usually the employer or the plan committee. In that way, the service provider will have proof that the payment was disclosed and that the plan fiduciaries knowingly consented to the arrangement.

© 2000 American Society of Pension Actuaries. Article originally appeared in The Pension Actuary, Vol. XXX, Number 3 (May-June 2000). Reprinted with permission.

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