INSURANCE CONTRACTS | Pension Plan Funding

Allocated and Unallocated Funding in Insurance Contracts
Insurance companies offer a variety of contracts either designed specifically for qualified plan funding or adaptable to it. In theory, an employer could negotiate a contract with the insurance company with provisions specifically tailored to the employer's needs. In practice, however, insurance contracts tend to fall into specific types, with some but not complete flexibility in their terms. This is partly a result of the fact that an insurance contract—particularly a life insurance contract—cannot be the subject of unfettered negotiation between insurer and contractholder. Often, the terms of the contract require state regulatory approval and, consequently, the insurer is not interested in varying them for each individual contractholder. Also, historical practices and needs in the insurance industry have determined the form of many of the contracts.

Insurance contracts used in funding qualified plans can be divided into allocated and unallocated types. When funding is allocated under an insurance contract, this means that the insurer has assumed the employer's obligation to pay specific benefits to specific participants. The employer is still primarily responsible, but under the terms of the insurance contract, participants and the employer can look to the insurance company for payment of specific amounts. With unallocated funding, the insurance company acts as a holder of the funds, much like a bank trustee. With unallocated funding, the insurance company is, of course, obligated to deal prudently with the funds, but it makes no guarantee that the funds will be adequate to pay any specific benefits under the plan. An insurance contract used in a qualified plan can be either purely allocated or purely unallocated, or can offer a mixture of both.

Insurance contracts can be classified—and will be discussed—in this order:

Allocated Contracts

• Individual life insurance or annuity contracts

  1. Fully insured plans

  2. Combination plans

• Group permanent contracts

• Group deferred annuity contracts

Unallocated Contracts

• Deposit administration contracts

• Immediate participation guarantee contracts

TRUSTS | Pension Plan Funding

The trust is the leading funding agency for qualified plans, in terms of both the number of employees covered and aggregate plan assets. A trust used for qualified plan funding is based on the same general principles of trust law as trusts used for other purposes, such as estate planning and administering the affairs of minors or incompetent persons. A trust is an arrangement involving three parties—the grantor of the trust, the trustee, and the beneficiaries. In qualified plan funding, the grantor is the employer and the beneficiaries are the employees. The trustee is a party holding funds contributed by the employer for the benefit of employees.

Legally speaking, a trustee is a fiduciary. A fiduciary is a person or organization that holds money on behalf of someone else (here the plan participants and beneficiaries) and that must administer that money solely in the interest of those other persons. The trustee's compensation is a fee for services rendered; the trustee is prohibited from personally profiting as a result of investing the trust funds.

The duties of a qualified plan trustee, like those of any other trustee, are set out in a formal trust agreement. Usually, the duties of a plan trustee are to accept employer contributions, invest those contributions, accumulate the earnings, and pay benefits to plan participants and beneficiaries out of the plan fund. The trustee performs these acts only at the direction of the plan administrator and not at the trustee's own discretion. However, in some cases, a trustee is given direct responsibility for choosing plan investments or choosing an investment adviser. The trustee must account periodically to the plan administrator or the employer for all investments, receipts, and disbursements. The trustee does not guarantee the payment of benefits or the adequacy of the trust fund to pay benefits. That remains the obligation of the employer.

A trustee may be an individual or group of individuals or a corporation such as a bank or trust company. Often employers name individual trustees, such as the company president or a major shareholder, to obtain an extra measure of control over plan assets. This is permissible under the law; however, when acting as trustee, such an individual is legally obligated to act solely in the interests of the plan participants and beneficiaries and not in the interests of the employer or shareholders.

Although a qualified plan trust is created and exists under the laws of the state in which it is established, the most significant provisions of trust law affecting qualified plan trusts have been codified in federal statutes that supersede state law whenever they apply.