401(k) Variable Annuities Pitfalls…

Variable Annuities and mortgage fraud… During the months leading up to the financial meltdown of 2008/2009, financial institutions were over-leveraged, especially on owned commercial real estate, and banks were tightening their lending practices.  Principal Global Investors, as part of the Principal Financial Group of companies, was no exception.  Since 1982, the U.S. Property Separate Account (PUSPSA) has been made available to pension and retirement plan clients of the Principal Financial Group by Principal Life Insurance Company, a member company of The Principal.  The Separate Account is a commingled insurance company real estate separate account sponsored by Principal Life and managed by Principal Real Estate Investors, LLC.  In a video produced during a commercial real estate seminar in Chicago in 2008, Principal Real Estate Investors President and Chief Investment Officer Randy Mundt joked how institutions such as theirs were using “creative” methods to obtain more money for their commercial lending and purchasing decisions.

One such creative venture initiated by Principal Real Estate Investors, as sub-advisors of the Principal U.S. Property Separate Account, was to use the 401k separate account as loan guarantees with lending institutions.  Principal called their program a “Forward Commitment” plan, using the account to not only guarantee the borrowed funds, but also to purchase the loan balance should it go into default.  The scam would add no value to the account, and since the investors unit value would be based on the account “market value” at years end, if the loan was purchased, the investor would lose from the beginning since the account would also pay the defaulted interest and other loan costs.  That is exactly what happened with a $13.2 million loan to a developer who was to purchase and build a multi-unit housing development in Henderson, Nevada.

The benefit to Principal would be immediate, but there are no benefits for the 401(k) account.  The loan proceeds would be deposited into Principal’s general fund during a time they needed the cash to liquidate other troubled assets.  They would use the money until the loan defaulted, then pay off the loan and defaulted interest with proceeds from investors contributions in the separate account.  They had access to “free money” until the development either started, or until the loan defaulted.  If the loan defaulted, it is likely that Principal kept the loan proceeds, and used the existing fund cash to pay off the loan.  This system would provide an avenue for laundering the loan proceeds, moving the money into private accounts in Europe.

To fully understand why this happened, you must understand the regulatory system today.  You are led to believe ERISA will protect you, just as that belief prevailed in 2008, but that is not the case.  ERISA clearly defined who a fiduciary is as it relates to your plan, and Principal is NOT a fiduciary!  Principal is free to do whatever they wish with your hard earned dollars.  Each month, when your employer sends 10-15% of your earnings to Principal, you are “gifting” those funds to Principal.

For me to explain the flawed system would be lengthy and dull, and difficult to understand.  Enough to say, if anyone, and that includes your employer, tells you differently, you should send a copy of this post to any EBSA (aka Department of Labor) office in your region, and ask them if my comments are true.  Their answer will be in the affirmative.  The main reason is that virtually all states have the same regulations, and those regulations clearly state that “the insurance company must own all plan assets!”  There is no co-ownership, so instead Principal gives you a piece of paper that states in part, the following…variable annuitiesThere, you have it… from Larry Zimpleman, the former President and CEO of Principal Life Insurance Company.

This commercial investment mirrors many others secured by Principal Real Estate Investors, as a sub-advisor for the PUSPSA, in the past and present.  The 401(k) separate account called the Principal U.S. Property Separate Account listed the purchase and sale in their annual reports, and represented the investment as “Wholly Owned” when purchased in 2006.  That year, Principal describes the account as follows in their 2006 Annual Report:

“The Principal U.S. Property Account is a commingled separate account managed by Principal Real Estate Investors, LLC, and maintained by Principal Life Insurance Company as the Principal U.S. Property Separate Account. It is available through group annuity contracts of Principal Life Insurance Company.”

In 2006, the Principal U.S. Property Account had three primary objectives:

1) to invest in a well-diversified real estate portfolio that reflects the overall performance of the U.S. commercial real estate market;

2) to maintain appropriate liquidity so that clients can make daily contributions or withdrawals subject to certain limits; and

3) to provide clients with private real estate returns that meet or exceed the open-end fund component of the National Council of Real Estate Investment Fiduciaries (NCREIF) Property Index.

A key element in their “Philosophy” was to have a low to moderate risk fund-level operating profile:

“Low to moderate real estate property risk is accomplished by investing primarily in well-leased properties on an unleveraged or low leverage basis. Low to moderate fund-level risk is accomplished by operating with a strong liquidity focus, client diversification, and limited fund-level obligations, such as forward commitments and fund level debt.”

Finally, in 2006 Principal reported a 13.8% leverage ratio, arrived at by dividing total debt (both property and portfolio) by total assets.

By now, you probably think you have a good idea of what the PUSPSA is about, and what kind of investment it is, and exactly what the PUSPSA separate account “owns.”  But you would be mistaken.  Before reading further, examine closely the 2006 Principal U.S. Property Annual Report found on this link.

To begin, the annual report leaves out the word “Separate” in it’s title.  The account mentions that it is “maintained by Principal Life Insurance Company as the Principal U.S. Property Separate Account,” whatever that means.  The truth is, while your gift to Principal of your earnings is used in its entirety to purchase commercial properties, you own only units in the “market value” of the properties, as determined by management!  You do not benefit from realized gains or retained earnings.  If the property loses value, you will pay for those losses through unrealized losses, however, since those losses will become the “estimated” market value at years end!

Ok, by now you are beginning to understand why we have a serious ethics and compliance problem in the financial industry.  Since your money is a gift, it will be used by insurance companies like Principal Life to purchase commercial properties, extract the profits from the retained earnings, and give you a piece of paper that says you own “units” in an account that doesn’t exist!  When choosing a financial partner, consider integrity and ethics a “must see.”

 

 

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Author: Dennis Myhre

Mr. Myhre can be contacted at..... dmyhre@fiduciaryfactor.com