James W. Watkins, III, J.D., CFP Emeritus^TM, AWMA®

May It Please the Court:

In the landmark case of Palsgraf v. Long Island R.R.¹, Judge Benjamin Cardozo held that “the risk reasonably to be perceived defines the duty to be obeyed.”² While Palsgraf arose in a tort context, its foundational principle — that liability follows from harms that are reasonably foreseeable to a person in a position of duty — is broadly applicable in fiduciary law. In the context of ERISA fiduciary obligations, this foreseeability principle operates to inform the scope of the fiduciary’s duties of prudence and loyalty.

Just as the court in Palsgraf found no liability where the harm was unforeseeable, the inverse must also apply: where harm is foreseeable, liability should attach.

A. ERISA § 404(a)(1): Duty of Loyalty and Prudence

ERISA § 404(a)(1)(A)-(B)⁵ requires fiduciaries to:

• Act “solely in the interest of the participants and beneficiaries” and
• Act “with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity… would use.”

Inclusion of a Structurally Deficient Annuity was a Foreseeable Harm

The plan sponsor, acting in a fiduciary capacity, could — and should — have reasonably foreseen that the offered annuity would fail to deliver a commensurate return to most participants.

The foreseeability of loss, a core principle of Palsgraf, is relevant and probative in fiduciary litigation. The plan sponsor’s decision to offer an annuity product that actuarially cannot provide a commensurate return — and predictably results in a participant financial loss absent exceptional longevity — is a breach of both the duty of prudence and loyalty. The financial harm to the participant was not a remote or unexpected event, but rather an inherent, foreseeable outcome of the annuity’s structure.

1. HOW FORESEEABILITY ESTABLISHES FIDUCIARY BREACH

A. Imprudence in Design and Selection

In the same way the defendant in Palsgraf should have anticipated a zone of risk caused by negligent conduct, the plan sponsor here should have anticipated that plan participants who selected the annuity would — based on actuarial and present value analysis — be unlikely to even recover their principal. This also violated the plan sponsor’s duty to always act in the beat interests of the plan participant and their beneficiaries. Depletion of estate assets is obviously not in the best interests of a plan participant and their beneficiaries. This renders the product categorically imprudent.

B. Loyalty Breach: Favoring the Issuer over the Investor

The foreseeable erosion of participant value and simultaneous financial benefit to annuity providers constitutes a breach of the loyalty duty. The plan sponsor knew or should have known that the annuity option conferred substantial benefit to the issuer (via fees and retained capital) while imposing foreseeable harm to participants.

C. Failure to Investigate or Disclose Material Facts

Under Tibble v. Edison International⁶, fiduciaries must continuously monitor investments. A product with a known, predictable failure to breakeven violates this duty. The failure to disclose this foreseeable non-breakeven point — especially in relation to participant mortality — strengthens the breach claim.

B. Inclusion of a Structurally Deficient Annuity was a Foreseeable Harm

As mentioned previously, the plan sponsor, acting in a fiduciary capacity, could – and should – have reasonably foreseen that the offered annuity would fail to deliver a commensurate return to plan participants, based upon the consideration of such factors as:

1. Publicly Available Mortality Tables (e.g., Society of Actuaries, IRS 2022 Applicable Mortality Tables);
2. Breakeven Analysis clearly demonstrating that the annuity requires survival to an age well beyond the plan participant’s normal life expectancy or just to recover the initial principal;
3. High Cumulative Costs including income rider fees, administrative expenses, and embedded commissions exceeding 300 basis points annually in some cases;
4. No Estate Value Transfer, making the product inappropriate for participants with legacy or liquidity priorities;
5. Availability of Superior Alternatives, including low-cost bond ladders, TIPS, or deferred income strategies.

HOW FORESEEABILITY ESTABLISHES FIDUCIARY BREACH

A. Imprudence in Design and Selection

In the same way the defendant in Palsgraf should have anticipated a zone of risk caused by negligent conduct, the plan sponsor here should have anticipated that plan participants who selected the annuity option would — based on actuarial and present value analysis — be unlikely to even recover their principal. This renders the product categorically imprudent.

B. Loyalty Breach: Favoring the Issuer over the Investor

The foreseeable erosion of a plan participant’s account value and the simultaneous financial benefit to annuity providers constitutes a breach of the loyalty duty. The plan sponsor knew or should have known that the annuity option conferred substantial benefit to the issuer (via fees and retained capital) while imposing foreseeable harm to participants.

Equity law is a major component of fiduciary law. A basic tenet of equity law is that “equity abhors a windfall.”⁷

C. Failure to Investigate or Disclose Material Facts

Under Tibble, fiduciaries must continuously monitor investments. A product with a known, predictable failure to breakeven violates this duty. The failure to disclose this foreseeable non-breakeven point — especially in relation to participant mortality — strengthens the breach claim.

The plan sponsor, acting in a fiduciary capacity, could — and should — have reasonably foreseen that the offered annuity would fail to deliver a commensurate return to most participants, resulting in an reduction of estate assets, which would constitute yet another fiduciary, breach, in thjs case the duty to always act in the best interest of the plan participants and their beneficiaries.

The long-term underperformance of such annuities was not speculative — it was actuarially predictable and financially foreseeable, as in Palsgraf’s classic formulation.

Just as the court in Palsgraf found no liability where the harm was unforeseeable, the inverse must also apply: where harm is foreseeable, liability should attach. In the case of 401k annuities lacking guaranteed or inflations-adjusted returns, it is eminently foreseeable that participants and the their beneficiaries may suffer erosion of principal and estate asset value. While the annuity industry may point to the availability of riders to address such concerns, such riders add additional costs, which often only serve to exacerbate the costs and financial loss for the annuity owner and their participants. As the Supreme Court pointed out in Hughes v. Northwestern University⁸, the fiduciary prudence of each investment option in a plan must stand alone. The availability of costly add-ons should, therefore, not be considered, especially given their impact on commensurate return. Fiduciaries who approve such offerings without rigorous due diligence fail to meet ERISA’s prudence standard and may be analogized to the negligent actors in Palsgraf – except here, the zone of foreseeable harm includes each plan participant and their beneficiaries.

The foreseeability of loss, a core principle of Palsgraf, is relevant and probative in fiduciary litigation. The plan sponsor’s decision to offer an annuity product that actuarially cannot provide a commensurate return — and predictably results in a financial loss for a plan participant absent exceptional longevity — is a breach of both the duty of prudence and loyalty. The financial harm to the participant was not a remote or unexpected event, but rather an inherent, foreseeable outcome of the annuity’s structure.

Accordingly, the court should apply foreseeability as a lens in evaluating the sponsor’s fiduciary conduct and hold that offering such an annuity was a fiduciary breach under ERISA § 404.

Notes
1. Palsgraf v. Long Island R.R., 248 N.Y. 339. 162 N.E. 99 (1928) (Palsgraf)
2. Palsgraf
3. Palsgraf
4. Palsgraf.
5. 29 U.S.C.A. Section 1104.
6. Tibble v. Edison Int’l, 575 U.S. 523 (2015).
7. U. S. Airways v. McCutchen, 663 F.3d 671(3d. Cir. 2011)
8. Hughes v. Northwestern University, 135 S. Ct. 1823 (2022).

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