Frommert Redux Again

ERISA is a funny law. I guess there are other funny laws as well, but I haven't worked with most of them as often as I have worked with ERISA. Consider the somewhat curious ERISA litigation patterned as Frommert v Conkright (you can read the most recent verdict here.

I'm not quite certain when the original case was brought, but I am certain that I was not yet eligible to make 401(k) catch-up contributions and I started making them in 2007. Since then, the 2nd Circuit Court of Appeals has heard the case three times (well, it hasn't always been exactly the same case). If it follows the pattern that it has thus far, it may even make it to the Supreme Court for a second time. Frankly, I don't know how often that happens, but it doesn't feel like it happens a lot.

So, why is ERISA a funny law? Much like lots of other American laws (and the Constitution for that matter), it was written in a somewhat different era. You know how that goes. As time moves on and creative minds are brought to bear, stuff happens. Not everything that happens could have been contemplated when the law was written.

You need an example? There are a lot of people out there in legal land who refer to the US Constitution as a nearly perfect document (I have heard it referred to that way virtually ever since I knew it existed). In fact, it's only been amended 17 times since the Bill of Rights and one of those amendments was passed to repeal an earlier amendment. So, one could argue that with an average of one amendment being passed and left in roughly every 15 years, it was pretty good.

Okay, what did the Constitution say about the internet? I was pretty sure it was silent on the matter, but I checked (ctrl-F lets you do that pretty quickly). It's not in there. So, how do courts rule on matters related to the internet. They use this legal mumbo-jumbo known as a precedent and then they often construe a relationship from one case to another. And, at the end of the day, it seems to this non-attorney that a judge or panel of judges will determine what they think is the correct answer and then leave it up to a smart, young law clerk to find them a rationale.

At its core, Frommert is about something known to retirement plan experts as a floor-offset plan. Essentially, a participant is entitled to a minimum benefit (the floor) and company defined contributions represent an offset. Since one piece of the benefit (DB) is expressed as an annual annuity and the other an account balance, performing the offset calculation requires that an administrator convert one piece of the calculation to be parallel with the other. This is done using a concept known as actuarial equivalence.

The concept of actuarial equivalence allows us to convert an account balance to an annuity or conversely. So, there's only one way to do this, right? Wrong!

The actual conversion depends on a set of actuarial assumptions, in this case the discount rate and the rate of mortality. Said differently, an account balance will pay you a different amount of money annually for the rest of your life depending upon how long you live and what interest rate is earned on the money.

The math in a floor-offset arrangement is funny, in much the same vein as ERISA is funny. Calculations, even when performed in the fairest sense possible produce unexpected results. One thing about them is certain, however, they tend to provide, relatively speaking, much larger benefits for the higher paid employees than for the lower ones. And, there is nothing in ERISA that specifically tells an administrator how to address every possible situation.

How funny are they? In Frommert (III), the court found a situation where it considered two virtually identical employees. Each retired in 2005 with the same final average earnings. Each had been hired in 1980. Employee A, however, was a rehired employee, having also worked for the company from 1960 to 1970. Employee B was a new hire in 1980. Solely because of that earlier period of employment, Employee A had a smaller benefit than Employee B. That is, Employee A was essentially penalized for his earlier period of employment.

Among other things, the court found that if this was a result of the offset calculation methodology that the method of offset was unreasonable and violated ERISA. Further, it found that the notices provided by the employer (Xerox) to employees about this plan were insufficient. So, the case is remanded (yet again) to the District Court where it will be re-heard, undoubtedly re-appealed regardless of the verdict and will very possibly once again wind up at the Supreme Court. I wonder how many of the plaintiffs will still be alive by the time this case is finally put to rest.

If You Like Your Plan, You Can Have Something

Perhaps my mind is easily boggled, but it boggles the mind. The Department of Health and Human Services has once again, this time by Bulletin, reinvented the Affordable Care Act (ACA, PPACA, ObamaCare). This time, Health and Human Services (HHS) Secretary Kathleen Sebelius disclosed through a letter to six senators that HHS had issued a Bulletin modifying enforcement.

According to the Bulletin and letter, "If you have been notified that your individual market policy will not be renewed, you will be eligible for a hardship exemption and will be able to enroll in catastrophic coverage."

Call me a cynic. You wouldn't be the first person to do so. But, here is the way I view the last three-plus years in the evolution of the ACA. First, the bill was getting very close to having enough support to pass. Then, Scott Brown (R-MA) was elected to fill the senate seat vacated by the death of Ted Kennedy (D-MA). This gave the Republicans 41 seats, enough to stop the Democrats from invoking cloture. The Democrats outmaneuvered the Republicans in working around the rules of the Senate and the bill was passed and signed into law. It was trumpeted as we all know quite famously that it would expand coverage, reduce the cost of coverage for most, and if you like your health plan, you can keep your health plan, PERIOD. Then came a website rollout so atrocious that even many of the most ardent supporters of the Obama Administration criticized it. Enrollment deadlines were delayed and insurers were told to reinstate policies for which they had already provided cancellation notices.

Somebody never worked in the insurance industry. Reinstatement is not that easy. And, there is also state insurance law to deal with here. So, many who wanted insurance were left without it. Yes, some number of previously uninsured had found their way to "get covered" as the Administration likes to say, but many who had been covered were left out in the cold.

Now, according to the HHS Bulletin, these same people can go on to the exchange and buy catastrophic coverage. This is the type of coverage that has been labeled as a substandard policy by some in the Administration.

Yes, my mind is boggled.

I was not one of those people who had said that health care did not need reforming. I always thought that it did and I still do. But, this is a perfect example of what happens when debate is cut off and 535 people who between them have little cumulative expertise on a subject (yes, I know there are some physicians in the Senate and the House) and who don't read the bill go ahead and vote on it anyway. Agencies are then left the unenviable task of regulating it and it always seems that, at the very least, a sizable minority of the people don't like the regulations.

So, enforcement apparently will be done as the HHS Secretary, presumably speaking for the President (this is entirely my guess), sees fit.

Silly me, I thought it was a law.

Future Shock Meets 1984

I remember reading both of the books. Everyone seems to have read or be familiar with George Orwell's "1984." Fewer recall Alvin Toffler's "Future Shock." While Toffler's was more about the psychological aspects of reacting to rapid change, I am using my blog-owner's license to use it hear.

So, this is a blog usually devoted to benefits and compensation. What does this have to do with these two books by these two authors?

I'm going to take you into a future world. Perhaps it will never occur, perhaps it will occur sooner than you think. As Orwell suggested, Big Brother knows more about you than you would care to believe. Today, Big Brother is not just the government or the Thought Police, it's Google, Amazon, your credit card company, your favorite place to buy groceries, Netflix, and the like.

There are two approaches that you can take. You can hate it. Many people do not like the intrusion. Many people do not like the lack of privacy. But, you know what? This is going to happen to you whether you like it or not. It is virtually impossible in today's world to avoid this intrusion and lack of privacy. So, the second approach is to embrace it.

When Future Shock meets 1984, your identity will live on a chip. As far as my vision can take me, that chip currently lives in your smartphone, but perhaps it will be somewhere else by the time we get there. Perhaps it won't be a chip at all, but that's not the point here.

By this time, Congress has gotten its act together (wow, that seems like it must be far, far in the future) and reformed or eliminated the Tax Code as we know it. This will be important because this new model will require much more flexibility and customization.

So, you start your new job and instead of negotiating your pay, you negotiate your total worth to your new employer, The Third Wave, Inc. (TTWI). [Those who get the reference are pretty literate, by the way.] On your first day with TTWI, you go into a meeting with Winston Smith, the head of all things people. At TTWI, Winston is not even a person, but a drone leading up the people function.

As you walk into the meeting room, your chip activates and based on all the data on your chip, Winston instantly produces a recommended benefits and compensation package for you. Winston knows that you have a mortgage to pay monthly, he knows how much your spouse earns, and he knows about your family. He also knows that you have a proclivity for collecting autographed original vinyl 45s of one-hit wonders and that you need additional cash to cover that.

You look at the flexible design that Winston has provided you, make one small change because Winston didn't know that you plan to accelerate your mortgage payments starting in two months, and you are on your way.

So, what do you think? Are you bothered? Did you like how smoothly the process went? Did you like not having to read hundreds of pages of legalese? Did you like getting recommendations that were customized to you?

It's coming -- maybe not in my lifetime, but it's coming.

IRS Gives Limited Pension Nondiscrimination Relief

Just 10 days ago, I wrote about the request to the IRS and Treasury from Senators Portman and Cardin to provide pension nondiscrimination testing relief to sponsors who have soft frozen their defined benefit (DB) plans. In Notice 2014-5, the IRS has done that, albeit on a temporary basis.

For background, a DB plan is soft frozen typically when a grandfathered group of participants are allowed to continue accruing benefits, but no new entrants are allowed into the plan. From a testing standpoint under Code Sections 401(a)(4) and 410(b), the plan will typically pass in the early years as the group benefiting under the plan will look a lot like the group that was benefiting immediately before the soft freeze. Eventually, however, as turnover tends to be higher among nonhighly compensated employees (NHCEs) than among highly compensated employees (HCEs) and because more participants will 'graduate' from NHCE status to HCE status than conversely, testing results get worse.

The typical alternative then is to aggregate the soft frozen DB plan with one or more DC plans for testing purposes. The aggregated plan is then referred to as a DB/DC plan, a name that does not quite roll off the tongue, but is descriptive nonetheless. DB/DC plans may be tested on a benefits basis (usually will pass) or on a contributions basis (usually will fail), but in order to be tested on a benefits basis, the DB/DC plan must jump through one of a number of hoops. Without going into detail, this is usually easy in the early years and gets more and more difficult with each passing year. Add to that that the DC plan being aggregated with the DB plan cannot be a plan subject to Code Section 401(k) or 401(m) (or a part of a larger plan subject to one of those sections) or be an ESOP and the process gets a little bit more difficult to deal with.

According to the Notice, if a sponsor soft froze its DB plan before December 13, 2013 and its DB/DC plan met one of the requirements to be cross-tested on a benefits basis for the 2013 plan year, then for any plan year that begins before 2016, the sponsor generally may continue to test this DB/DC plan on a benefits basis. In the meantime, IRS has requested comments on this notice and will continue to evaluate how such situations should be handled.

This relief is only short-term in nature and there are many situations that will not be helped by this relief, but if you are one of the lucky sponsors, this may give you the help you were looking for.

When You Know a New Tax is Bad

It seems that every year, there is a new tax that I or someone that I know has to pay or a new tax credit or both. Oftentimes, it can be taken care of on Form 1040 or some form that I already file in one line item, even if it feels like a random number generator fills in the amount that I get to send to my good friends at the Treasury Department.

As all my readers know, the Affordable Care Act (ACA, PPACA, ObamaCare) wasn't just any old law. And, since even the most optimistic of all proponents of the law knew that it would cost a lot of money, new taxes were needed to pay for it. These aren't just any old taxes. I'm talking about two in particular -- the 3.8% Medicare surtax on investment income for those individuals earning over $200,000 and for couples filing jointly earning over $250,000, and the 0.9% additional Medicare tax on earned income in excess of those same thresholds. (By the way, just like perhaps the worst structured tax in history -- the Alternative Minimum Tax -- those thresholds are not indexed.)

I looked at many of the personal taxes in the Internal Revenue Code. Almost without exception, when taxes apply to individuals or to couples filing jointly, the dual threshold is either twice the individual threshold, or at least meaningfully (50% or more) higher.

But, these are not your ordinary taxes.

All you lucky people (maybe you are just hard-working and it's not just luck) who will be subject to these taxes get to fill out not just one new form, but two new forms. That's right, you have to fill out Form 8959 to determine if you (and your employer) paid enough Medicare tax for you [and your spouse]. And, you need to fill out Form 8960 to determine if you were both a lucky earner and a lucky investor for the year.

I'd link you to the forms, but they are only available as drafts right now. And, I'm sure you don't really want to see them anyway.

Suffice it to say that as of now, Form 8960 looks like an easy one, but Form 8959 must have been jointly produced by the makers of Tylenol, Advil, and Aleve. You will have to have your Form W-2(s) in front of you while you suffer through the calculations and the eventual answer. Then if you are really lucky, you get to attach these two forms to your Form 1040 and send more money.

My conclusion? A tax (I know, it's really two taxes, but it looks like one to me) that requires two new forms can't be a good tax. Let's just get rid of it. I want to go back to the original income tax provisions -- pay 1% of your income in excess of $3,000. I'll even accept that the $3,000 is not indexed.

The Curious Tale of Prescription Drugs and The Affordable Care Act

Much has been written about the Affordable Care Act (ACA, PPACA, ObamaCare) with regard to keeping your plan and keeping your doctor. For many enrollees, one of the most critical and little-known elements in choosing your ACA plan may be the prescription drugs they take.

Consider this. If you enroll in a Bronze plan (the cheapest alternative considering only premium costs), you will have the highest deductible and highest out-of-pocket limits. On the other hand, if you enroll in a Platinum plan (highest premiums), you will have the lowest deductible and the lowest out-of-pocket limits.

Simple enough so far, isn't it?

So, as a plan member, you would assume that you can continue to take your standard medications. And, since it's all part of a government-mandated benefit program, you would also assume that the same prescription drugs would be available under each plan.

You would be wrong.

An ACA plan's treatment of a particular drug is a function of whether or not that drug is in the plan's formulary. For people who prefer simpler terminology, each plan's formulary is the listing of drugs that are covered by the plan. If a drug is covered by your plan, you will get discounted (think in-network) rates and your payment for that prescription will count against your deductible and out-of-pocket maximum. If it's not covered, however, then your payments will be full retail (not discounted) and will not count against your deductible or out-of-pocket maximum.

If prescription drugs are a significant part of your annual health care costs, then that leaves you with an easy solution in choosing a plan, doesn't it? You will simply look at the plan's drug formulary, compare it to what you are taking and consider how that will affect your annual cost.

Not so fast.

I actually know something about this law. My online search capabilities are as good as the next person's. I've been to the websites of several plans that can be found on the "marketplace" and in only one case thus far have I been able to find the formulary.

Suppose I find the formulary for every plan for which I am eligible. Then, of course, I can make an intelligent buying decision, can't I?

Think again. Even if you know the formulary, there is no data that I could find telling me what the discounts are under the various plans. But, I heard from someone who said he spoke with a pharmacy benefit manager (PBM) on this topic. He said he was told that pricing may vary wildly under ACA marketplace plans..

So, you tell me. Do you now know how to make your ACA buying decisions? I don't.

There's More to Risk than Just Risk

Risk is a four-letter word. There is even a book with that title (I've never read it and I'm neither recommending it nor panning it). Every CFO will tell you that they hate risk. Most large companies in today's world have large departments whose sole function is to deal with risk. They are tasked with identifying risk, measuring risk, and mitigating risk.

So, John, you're telling me there is more?

I'm afraid there is. When you have fairly constant risk, you can develop a plan to measure it and often to control it. On the other hand, when your risk is volatile, that feels worse.

Consider a hypothetical element of risk related to some sort of performance. Let's say that the mean performance is denoted by 0 and that good performance is denoted by a positive number and poor performance is denoted by a negative number.

Which series of outcomes would you rather have?

• 1, -1, 1, -1, 1, -1, 1, -1, 1, -1
• 0, 7, -4, -8, 6, -3, -11, 5, 8, 0

I suspect that 100% of my readers like the first scenario better. Why? Each has mean and thus expected cumulative outcome 0. But, in the first scenario, the expected downside is (negative) 0.5. In the second scenario, it's (negative) 6.5. 

I developed those results by determining the probability (based on each data set separately) of achieving a sub-par performance and multiplying that by the average negative score in all years in which the score was negative. 

Suppose I want to insure or hedge against this risk. In the first case, it seems like I would be safe insuring against a risk of 1. Suppose I can afford to actually lose (and cover out of assets) 0.5, then I need to purchase insurance or a hedge to cover the other 0.5 each year. 

In the second case, however, it's not so easy. If I know that my loss could be 11, does that mean that I need to insure or hedge 10.5? At the very least, I need to be able to cover my expected downside (for years in which I have sub-par performance. So, in no event can I consider hedging or insuring less than 6.0. 

While the relationship may not be linear, it is probably not a bad approximation. So, in this case, depending upon my view of the situation, I need to insure or hedge somewhere between 13 (this possibly is a linear model and is 6.5/0.5) times as much and 21 (costs less than 21 times as much and developed as 10.5/0.5) times as much. 

That additional cost and it is likely very significant in this case is the cost of volatility. And, that's just the financial cost. There is also the headache cost, the reputational cost, and lots of other associated costs. 

So, when somebody tells you that some riskier strategy is better because it has more upside potential, look at it the other way. Nobody ever lost sleep over an upside. 

Think about it a different way. Consider yourself a golfer. On the 18th green, you have a 5 foot putt that affects a bet you have made. If you are a millionaire and the bet is for $1, you probably don't care all that much (other than for ego and pride) whether you make it or not. You can afford to lose or not win $1. On the other hand, suppose you have $50 to your name and the putt is for $5,000. If you're like most people I know, you will be petrified. You can't stand that kind of risk.

Business works the same way.

Think about it.

Senators Portman and Cardin Appeal to Treasury for Retirement Nondiscrimination Help

We don't see it much in Washington these days, but Senators Rob Portman (R-OH) and Ben Cardin (D-MD) are teaming up once again. That's right, senators from opposing parties are finding common ground to do something together. And, they have a worthy goal. The key question, in my mind, is whether or not they have found a good way to achieve that goal.

A little more than a week ago, the dynamic duo penned a letter to Treasury Secretary Jack Lew asking that the Treasury Department review pension nondiscrimination regulations, specifically with regard to so-called soft frozen plans. They did this under the guise of retirement security for working Americans.

I have mixed feelings about what they write and I will come back to that later. First, however, it is necessary to give some background on pension nondiscrimination and soft freezes.

ERISA, signed into law on Labor Day, 1974, generally prohibited companies from providing nondiscriminatory pension benefits. While the rules perhaps had more teeth than I am going to see, this was generally achieved by showing three things about the pension benefits that were offered:

• That they were properly integrated (with Social Security) under Revenue Ruling 71-446
• That they covered a reasonable cross-section of employees (this was difficult to not satisfy in my experience)
• That they were comparable within the meaning of Revenue Ruling 81-202

Along came the Tax Reform Act of 1986 (TRA). It added some more specific rules to the Internal Revenue Code (Code) among them sections 410(b) and 401(a)(4). Together with a few related provisions, this suite of rules became known generally as the nondiscrimination rules. Regulations were long and cumbersome. But, unlike previous rules, they prescribed objective tests to determine whether the retirement benefits offered by a company were nondiscriminatory.

Objective tests are good and they are bad. From a practitioner's standpoint, they give us a set of bright line rules to follow. Exceed the thresholds and you pass. Fall short and you fail. It's pretty simple.

These sections of the Code were regulated fairly early in my career and I became somewhat expert at dealing with them. What I learned, somewhat oversimplified, is that it is quite rare that a tester, highly knowledgeable with respect to the rules, cannot force a company's plans through the tests to prove them nondiscriminatory. In fact, I worked with some situations that on their faces were very discriminatory in favor of highly compensated employees (HCEs) and proved that they were not.

There is one situation, however, that has always proven to be troublesome -- that of soft frozen plans. Generally, a defined benefit (DB) plan is soft frozen when participation (and benefit accrual) continues for employees who were in the plan on the soft freeze date and never happens for those who were not. In a variation on the theme, future participation is sometimes limited to those who have met some age and service threshold with the company as of the soft freeze date. 

What frequently happens is that over time, the population that remains in the DB plan becomes more predominantly composed of HCEs. And, as this happens, the DB plan on its own is not nondiscriminatory. What companies would like to do is to look at the total retirement program and show that it is nondiscriminatory. But, as many of these companies have only a 401(k) plan going forward (401(k) plans cannot be aggregated with DB plans for most testing purposes), the math just doesn't work.

So, companies wind up taking the only alternative that they can see and eventually totally (hard) freeze the DB plan. When they do so, the grandfathered employees, as a group, are often just at the point in their careers that their pension accruals are largest. These are the years that were going to allow them to retire securely.

This is the problem that Portman and Cardin seek to address. They tell us that the nondiscrimination rules were meant to enhance retirement security, not to detract from it. To me, this is where the difference in views that often occurs between legislators and businesspeople comes to the fore. 

Legislators, when developing retirement rules have often preached that if we force companies to provide similar benefits to nonhighly compensated employees (NHCEs) as to HCEs that the companies would increase NHCE benefits to meet that bogey. To paraphrase President Kennedy (who used the slogan of the New England Council (Chamber of Commerce)), they assume that a rising tide will lift all boats.

Historically, it hasn't worked that way. Faced with that situation, companies have opted to provide smaller benefits across the board, thereby lessening retirement security for most, and have found other ways to provide for their key employees.

Senators Portman and Cardin have a worthy goal. They seek to find a way to allow companies to continue to provide meaningful benefits to those people who have an expectation of those benefits. But, even if they do, they cannot solve the whole problem.

For years, Congress has passed bills designed to enhance retirement security only to see that each one in turn has caused more and more companies to get out of the business of providing retirement benefits to their employees. Oftentimes, these rules, such as the Pension Protection Act of 2006, have been poorly thought through, and actually decrease retirement security for workers. In fact, during my career, each time a major piece of pension legislation has become law, a swath of companies seek ways to get out of the business of providing pensions. But, no law over that period has caused companies to start up new plans.

If we want to restore a sense of retirement security for typical working Americans, we need to start anew from the beginning, not simply apply another band-aid to the problem. That said, I applaud the senators for making far more of a constructive effort than any of their colleagues.

In Network or Out of Network -- Courts Decide

It's been the same with every health plan that I can remember being in. There is always a communication to me that I am responsible for determining whether the provider that I choose to see is in network or not. Frankly, it's never seemed fair.

Consider that health care payers don't always update their websites with changes immediately. Doctor's offices don't want to be responsible for telling their patients in which networks they are participating providers. So, the easy way out is to put the burden on the insured who really has no good way to divine the answer.

Enter Killian v Concert Health Plan. This case was eventually argued en banc (for the lay people among us including me, that means that it was heard by all the judges of the Court) before the 7th Circuit Court of Appeals (housed in Chicago). The Court, as I read it, ruled for the plaintiffs. For plan participants, this is good news. For insurers and perhaps for plan sponsors, it's not as good.

The most important (to me) facts were as follows:

• Susan Killian was a cancer patient.
• She suffered from lung cancer which spread to her brain.
• The first hospital that she went to (in network) said they could not operate, but sought a second opinion.
• The second opinion was provided at Rush University Medical Center that thought they could successfully operate.
• She was admitted for successful brain surgery, but died a few months later.
• The Killians (Susan Killian was married to James) received only out of network reimbursement for services at Rush.

This seems fairly normal, doesn't it? Well, it would be, if not for this fact pattern:

• Mrs. Killian's insurance card had on it several toll-free numbers that insureds could call to ask questions about their coverage.
• Mr. Killian called one before Mrs. Killian's surgery.
• The representative said there was no information on the hospital (Rush), but to "go ahead with whatever had to be done."

The Court cited five points in combination in coming to its decision:

1. Mr. Killian did appear concerned/interested in whether the providers were in or out of network.
2. Mr. Killian did follow the instructions on Mrs. Killian's insurance card by calling one of the toll-free numbers and inquiring about the in versus out of network status
3. Mr. Killian informed a representative (at the toll-free number) that he was looking to determine whether the surgery would be paid for as in network
4. Mr. Killian was told by the representative at the toll-free number to "go ahead with whatever had to be done."
5. Mr. Killian acted as a reasonable person would in extrapolating from that that the services would be covered as in network.

What the Court decided was that Mr. Killian may now pursue a claim against his deceased wife's health plan for breach of fiduciary duty. What Mr. Killian will actually do and how a court will rule on that matter is not clear, but this is the first case that I am personally aware of where the burden of determining in versus out of network status has been shifted somewhat by the Courts.

I'm not an attorney, so I'll leave the rest of the analysis to those with formal legal training. That said, as a health plan participant who has at times during his own lifetime been frustrated by the same determination, this feels like a step toward protection of plan participants who do act diligently.

Politics Doesn't Fix Health Care

It doesn't matter which party is making the decision. Politics doesn't fix health care.

It seemed clear to me that President Obama's November 14 decision to allow insurers to renew certain cancelled policies for 2014 was done entirely for political expediency. I have not yet found anyone who disagrees with me. So, now everything is fixed and everyone who had a policy that they liked in 2013 can keep that for 2014, right?

Wrong!

First, state regulators have to grant approval for this to happen. In a number of states, regulators have already said that they will not allow these sub-standard, non-compliant policies to be renewed.

Second, there have been increases in health care costs over the last year. The natural extension of this is that premiums must increase. This requires actuarial calculations to determine the correct increase. Actuarial work takes time. And, the actuaries who would do this may have other priorities right now. That some politicians(s) thought something was a good idea does not create more hours in the day, more days in the week, or more weeks in the year for any actuaries that I know, and I know a lot of actuaries.

Third, health insurance plans require administration. In the 21st century, plan administration requires software. Software requires time to be created or updated. And, it needs to be checked for glitches (see, for example, healthcare.gov). That some politicians(s) thought something was a good idea does not create more hours in the day, more days in the week, or more weeks in the year for any programmers that I know.

And, then there is the business decision that insurers must make. Despite a general public hatred of insurance companies, people tend to be somewhat loyal to their policies if not their insurers. Suppose you have a policy with, for example, Aetna and they decide to not reinstate it, but your friend who has a policy with, say, Kaiser, gets theirs reinstated, how will that make you feel about Aetna? On the other hand, if you find out that the Kaiser policy got reinstated with a large increase in premiums, you might feel even worse about Kaiser. It creates a frankly unhealthy guessing game.

But, wait, there's more.

According to the guidance we have received, these reinstated policies are simply a one-year fix. They will not be grandfathered, or so it seems. So, even if your policy is reinstated, come this time or thereabout, in 2014, you will be facing the same dilemma of trying to work out your health insurance arrangement for 2015. Well, at least healthcare.gov may be working properly by then.

Flaws of Common -- How About Choice Instead

I read a lot these days about "common." There's Common Core on the education side of things (in the US). I read this morning in a Harvard Business Review article about common goals for a health care system. We are supposed to do things for the common good.

This is all well and good, but when we look about any of these common elements, who determines what it is commonly best? In my experience, it is neither the end users nor the people in the trenches. More typically, it is one of the government, the bureaucrats (they may be government), the administrators who will never have to implement the common things they prescribe, or people from think tanks who often have never spent a day in the real world.

Here are a couple of facts. I am different than you. You are different from the person who is currently sitting or standing nearest to you. Even if that person is your identical (maternal) twin, you've had different experiences and while you may be far more alike than any two random people, you are not the same as each other. In fact, you are different.

So, what is commonly best? I don't know. Neither do you. And, neither do the people developing common programs. Perhaps (and perhaps not), they are more informed about the subject matter to which they are applying commonality than are you and I. But, generally, they have not walked a mile in your shoes or mine.

I'm much more a fan of choice. Suppose we consider employee rewards. For these purposes, I am going to define an individual's rewards value (or cost) to be the sum of (the value or cost) these elements:

• Compensation -- base pay plus bonus plus overtime plus long-term incentives plus equity compensation to the extent that any of these apply
• Retirement benefits -- this includes 401(k), profit sharing, pension, ESOP, or anything else that is targeted to help an individual to generate retirement income or retirement wealth [I separate this from the next element because retirement benefits are typically pay related while many other benefits either are not or are less pay related]
• Other benefits -- this includes health care as its largest component
• Softer stuff -- consider here things like training and development, and work/life benefits

Suppose for any given year, each employee was offered a formula (we're getting very hypothetical here, so ignore current tax law) whereby they would be allocated some number of dollars based on a percentage of what we would typically view as base pay plus some flat dollar amount. This is essentially what people are given today, except that they are largely told how to take those dollars. 

Suppose further that each employee could allocate those dollars any way that he or she wanted. Consider a health care option. Much like under the Affordable Care Act, a person would have an option of a somewhat minimal bare-bones plan (think Bronze missing some of the essential benefit coverage) right up through a plan that subjects the employee [and family] to extremely little risk (think Platinum plan). The difference here is that I am going to let each individual annually design their own program to meet their needs. In order to avoid complete anti-selection, however, there will be certain components that someone can only opt in and out of periodically (for example, once you opt in to maternity health benefits, I am going to make you stay in that program for at least 10 years to avoid people opting in only in the year in which they expect to have a baby).

What we would get from such a program is that each person would take the dollars allocated to them and design an UNcommon program that meets their individual needs. Pretty cool, huh?

Now, let's move back to education. In the programs that produce the most successful people (success here isn't measured by income, but by achievement and no, I don't know how to measure achievement either, but you know what I mean), teachers don't teach to tests. They teach to students. They let the creative juices flow whether that creativity is geared toward math for a mathematically inclined student or art for an artistically inclined student. The teachers seek to bring out the best in students. 

Yes, we all need exposure to different areas of education. And, while it does come up in conversation occasionally, that I learned in four different grades that Vasco Da Gama was a Portuguese explorer who sailed around the Cape of Good Hope in the very late 15th century, that knowledge has certainly not added to my probability of success. Perhaps that time in school could have been more useful to my future had it been spent on developing my social skills or on my writing (I hated writing when I was in school). I had classmates, however, who were so naturally social butterflies, but who thought that basic arithmetic was the most challenging thing they would ever encounter.

It goes back to my them. We are all different. If you are in your teens, even though you think that you and your best friend have so much in common (there's that word again), your lives will likely move down different paths.

Why then does everything have to be common?

Gamifying Benefits Programs or Top That!

Admit it. You probably like playing games. They may or may not be the same games that I like to play or that your neighbor likes to play, but you like playing games. And, one of the reasons that you like playing games is for the challenge of achievements.

You're part of the Facebook generations. Whether that means you are 14 years old and barely old enough without exaggerating your age to get a Facebook account or you're 40 years old and claim that you originally got on Facebook to watch what your kids were doing or you're 84 years old and you really like the idea of sharing pictures and tales of your grandchildren and great-grandchildren, there's a good chance that you spend more time on Facebook than you are willing to admit.

No, this is not an endorsement for Facebook. Some days I love it, some days I hate it. This is more of a look yourself in the mirror moment. When you first got on Facebook, it was probably either a curiosity or just a social thing. But, then you looked at your news feed and you saw that one of your friends had earned a new level in Farmville, or that another friend had passed three people in Candy Crush Saga,or that yet one more friend had played a 100 point word in Words With Friends, and you got that feeling in your brain -- hey, I can do that, too.

So, you started playing one game or another, and admit it, you became a little bit obsessed. Even though I know you won't admit it, you really want all of your friends to see it when your game of choice posts to your wall about your latest success. You puff up with pride and that wry little smile that says, "Top that!"

Before I move forward, I need to apologize to my readers. Many of you know that I would prefer that the English language remain sacrosanct and that we as writers and speakers should use actual words. Yesterday, I came across the words gamification and gamifying and I really doubted that they were words. So, I looked them up, and sure enough, much to my chagrin, they are words that can be found in English language dictionaries. Sad, but true. So, that explains my use of one of them in the title of this post and in other places within the post.

OK, welcome back to the real world.

Corporate HR struggles mightily with ways to make its benefits programs more effective. With large amounts of responsibility being placed on HR to make benefits programs both effective and cost-effective, it takes some creativity to move to the top of the classs.

Bring on gamification!

We're going to have to make participation in programs like this optional due to various privacy laws such as HIPAA (the Health Insurance Portability and Accountability Act of 1996, if you really want to know what HIPAA stands for), but I have a suspicion that because we all love games that many of your employees will, with no coercion at all, choose to share their game progress with friends, neighbors, co-workers, and even their dreaded second and third level connections. They'll get that sense of pride and be thinking, "Top that!"

Let's consider an example. Modern Cool Company (MCC) has been concerned about its employees' eventual ability to retire. MCC's Director of Benefits Oil Derrick Zoolander (he goes by Derrick) knows that most of MCC's employees don't save any money outside of their 401(k) plan and the data that Derrick gets from the plan's third party administrator (TrustWorthy) suggests that most are not saving much inside their 401(k). Derrick had no idea what to do, and frustrated, he hung out on Facebook.

Eureka, he found it. As he looked at his news feed, dozens of his friends were either posting or allowing their games to post about their accomplishments. Rachel Greene Slime killed her one-millionth enemy in Mafia Wars. Richie Cunningpork leveled up in Pet Saga. Chrissy Snow Flake passed her friend Jonas Grumpy (perhaps a more obscure reference, but Jonas Grumby was the Skipper on Gilligan's Island) and Greg Brainy was heard to be screaming "Marcia, Marcia, Marcia", after being passed by his sister in Vampire Wars.

Derrick went to his graphics people and had them start to develop 401(k) badges. When an employee of MCC named Don Draperies got a financial checkup through the TrustWorthy Adviser System (TWAS), he got a badge. He could toss it in the garbage (no self-respecting game player would ever do that), proudly display it in his cube, or bring it home to show his wife and kids (frankly his kids would be more impressed if he had a similar achievement in World at Warcraft), and perhaps more importantly for his ego, MCC's intranet allows him to collect his badge on there and post it to social media both internally and externally. Don was so excited that he posted it to his Facebook wall with the message, "Top that!"

Seeing the success and excitement of his first badge winner, Derrick went back to his graphics people and created more and more badges. There was the "Increased My Deferrals" badge, the "I Got My Full Match" badge, the "I Paid Off My Loan" badge, the "402(g) Limit" badge and the list goes on.

It only took a little over a year, but Derrick's 401(k) plan was the envy of his peer group, Levels of participation had gone from a measly 41% to 98% during 2014. Other than the one in the first week of January, the MCC 401(k) plan didn't have a single request for a hardship withdrawal the entire year, and Derrick learned right after Christmas that MCC had been named the winner of the Plan Sponsor of the Year Award for 2014 and that he would get to accept the award for the company. And, you know of course what he was going to do with that knowledge -- he posted it to Facebook with the status, "Top that!"

I know it sounds stupid and I know there may be legal hurdles and I know that you probably don't think gamification is a word, but consider it. Give it a try. Thank me later.

The Hidden Side of Health Care Costs

I'm not always a fan of Employee Benefit Research Institute (EBRI) reports, but this one resonated with me. 61% of workers report an increase in health care costs. But, the bigger story is that most of them say that this increase is affecting them in other ways. In these days of half the political world touting self-reliance and the other half touting the government providing for all, this survey through my lens says that neither works on an island. We need a bit of both.

So, what does the report say? It tells us that among the 61% whose health care costs are increasing (I am reading that health care costs for this purpose are the sum of premiums and out-of-pocket costs), as a result of this:

• 32% have had to decrease the amount they are saving for retirement
• 57% have decreased the amount they are saving for other purposes
• 22% are having trouble paying for necessities such as food, heat, and housing
• 38% are struggling to pay other bills
• 1/3 have seen increases in credit card debt
• 27% have essentially drained their savings
• 16% have had to borrow money

If I were on one side of the aisle (in Congress) or the other, I would say (you know which side comes down where on this one):

• This is exactly why we need the Affordable Care Act (ACA, PPACA, ObamaCare)
• Forcing people to have what the government deems the proper health insurance cannot work

Let's consider what is happening though. When I was in my teens, oh so many years ago, most of the adults around me were retiring in their late 50s or early 60s. They looked forward to their golden years. They had defined benefit pension plans. Now, unless they are among the particularly fortunate group, their means of saving for retirement is a combination of a 401(k) plan and whatever they can save on their own. Ask these people when they plan to retire and most will laugh at you. They cannot see that on the horizon.

Also, back in my teens, by the time people retired, they owned their homes free and clear. Now? A recent survey that I read (sorry, I can't find the link) informed me that at age 65, more than half of homeowners still have a mortgage and for many of them, it has a very substantial balance.

Whatever the reason, and that's for a different day and a different post, we need some real changes. In the credit card era, people lose track of what they owe. And, much like the federal government, it's tough to make a dent in that when so much of your income is used for debt service. Unlike the federal government, however, the average guy on the street just can't borrow money at interest rates from 0% to 4%. No, your credit card company probably charges you some amount in excess of 10%.

Do I have the answer? No, I don't. If I did, you would hear me screaming it far and wide. But, in a day when take-home pay for many Americans is decreasing (higher taxes, higher employee cost of benefits) and the cost of goods, services and debt service is not, it gets really difficult for the economy to grow.

To me, this is the ultimate hidden side of health care costs. Because of the increases in personal costs of health care, the non-health care side of the economy is stifled.

We need change, but I don't see that kind of change-a-coming.

IRS and Treasury Provide Carryover Flexibility in Health Care FSAs

This came as surprise to me. In Notice 2013-71, the IRS and Treasury provided another softer version of the Health Care Flexible Spending Account (FSA) use-it-or-lose-it (UIOLI) rule, allowing certain plans to be amended to allow for limited carryovers from year to year.

As people who deal with health care FSAs on a regular basis know, back in 2005, IRS and Treasury modified the then existing rules to allow a health care FSA to be amended to provide a "grace period" for UIOLI, extending 2 months and 15 days beyond the end of the plan year. So, in English, calendar year plans could allow participants in 2013, for example, to use their HSA deferrals up until March 15, 2014, without losing them. This was done to be consistent with the short-term deferral rules under Code Section 409A (although I'm not sure what the inherent connection should be between Sections 125 and 409A).

Now this. Under the new UIOLI rule, plan sponsors have a choice. Those that have never adopted the grace period rule (most have in my experience) may amend their plans to add the new $500 provision. Those that have the grace period provision may amend their plans to eliminate the grace period provision for a year and add the $500 rule.

What are the implications of this? While the Notice is effective immediately so that calendar year plans could be amended for the 2013 plan year, this blogger thinks that is generally not a good idea if the plan uses the grace period rule.

Why? Consider your employee Betty Badeyes. Betty, like the rest of us who stare at a computer screen more than we should, has long since not had 20/20 vision. She wears corrective lenses. And, she knows that she has an appointment in late January 2014 to have her eyes examined and probably get a new prescription. These are bona fide expenses for reimbursement under a health care FSA, and they are in excess of $500. Betty knows this. So, when she made her health care FSA election back in late 2012 for the 2013 plan year, she took into account that she would be spending about $1,000 in early 2014 that she could use under the grace period role.

If the plan sponsor, amends the plan to eliminate the grace period and implement the carryover rule for 2013, then Ms. Badeyes may have to change her name to Betty Badtemper as she will only be able to pay for about half of her eye care expenses with flex dollars. What's more is that unless she can find some other qualified medical expenses before the end of the plan year, Betty may be losing $500 under the UIOLI rule.

In summary, I think this is a good option that most plan sponsors should consider adopting. But, they should communicate the change before the beginning of the plan year that it will affect.

2014 IRS Limits -- Better Late than Never

As all those of you who weren't hiding away from your computer, smartphone, tablet, television, radio, and friends know, we had a little shutdown in Washington DC in the first part of last month. Non-essential employees not only weren't being paid to work, they weren't allowed to work.

Of course for many of us who are benefits professionals, knowing the 2014 limitations under various Code sections is pretty darn essential. But, the powers that be, who by the way wield far more power than your sometimes faithful blogger, decided that this was not among the essential functions.

Well, your government is back at work and therefore, we have our 2014 limits. Drum roll please ...

High-deductible health plans (HDHPs) 

• The annual limitation on deductions for an individual with self-only coverage increased from $3,250 to $3,300.
• For an individual with family coverage, that limitation increased from $6,450 to $6,550.
• A plan is high deductible the annual deductible is at least $1,250 (unchanged) for single coverage or $2,500 for family coverage and the annual out-of-pocket limits do not exceed $6,350 (up from $6,250) for single coverage or $12,700 (up from $12,500) for family coverage.

IRAs

• The IRA contribution limit remains at $5,500
• The IRA catch-up limit remains at $1,000
• The Adjusted Gross Income (AGI) phase-out starts at $96,000 (up from $95,000) for joint filers and $60,000 (up from $59,000) for individual filers

SEPs

• SEP minimum compensation remains at $550
• SEP maximum compensation increased to $260,000 from $255,000

SIMPLE Plans

• SIMPLE maximum contributions remain at $12,000
• SIMPLE catch-up contribution limits remain at $2,500

Other Limits

• 401(a)(17) pay cap up to $260,000 from $255,000
• 402(g) limit on elective deferrals to a 401(k) or 403(b) plan remains at $17,500
• The catch-up contribution limit remains at $5,500
• The 415(c) limit for annual additions to defined contribution plans has increased to $52,000 from $51,000
• The maximum account balance in an ESOP subject to a 5-year distribution period increased to $1,050,000 from $1,035,000
• The dollar amount used to determine the lengthening of the 5-year distribution period in an ESOP increased from $205,000 to $210,000
• The HCE threshold remained steady at $115,000
• The maximum benefit limitation for defined benefit plans under Code Section 415(b) increased from $205,000 to $210,000
• The compensation threshold for being a key employee (Section 416) increased to 170,000 from $165,000
• The Section 457 limit on elective deferrals remained unchanged at $17,500
• The taxable wage base increased from $113,700 to $117,000

ObamaCare Economics -- You Shouldn't Be Surprised

This may look like it's going to be a highly political post, but it's not. Instead, it's more of a primer for the ordinary consumer of health care and health insurance.

We're hearing these days about those people who have made it far enough through the Affordable Care Act enrollment website to learn their options. Remember, if you are going to enroll in an ACA exchange health insurance program, you have the choice of a Bronze, Silver, Gold or Platinum plan. They are designed to provide the consumer some choice in the matter. That's a good thing.

The big difference among the plans is the percentage of costs that they are expected to cover. While designs will vary from state to state, Bronze plans are expected to cover 60% of health care costs, Silver plans 70%, Gold plans 80% and Platinum plans 90%. Among the ways that Platinum plans will get to that threshold are by having lower deductibles, lower out-of-pocket maximums and lower co-pays. In other words, the Platinum is a more generous (and more expensive) plan.

Each plan, regardless of its associated metal must cover essential health benefits. If you get really excited by reading this kind of stuff, you can go to Section 1302 of the Affordable Care Act. But, most of my readers have better things to do with their time. So, you can find a summary here:

• Ambulatory patient services (generally outpatient services such as routine doctor visits)
• Emergency services
• Hospitalization
• Maternity and newborn care
• Mental health services
• Substance use disorder services 
• Prescription drug coverage
• Rehabilitative and habilitative services and devices (in plainer English, these are things like relearning a physical skill, e.g. walking, or learning a physical skill, e.g., speaking if you were born with a speech impediment)
• Lab tests and services
• Preventive and wellness services including chronic disease management
• Pediatric services including oral and vision care

Thus far, I have heard lots of complaints that the Affordable Care Act is not affordable. This should have been obvious to anyone who bothered to think about it. 

Why?

Suppose you as a consumer went out to buy private health insurance coverage pre-2014. Let's further suppose that you are a healthy late 20s single male who does not engage in any particularly dangerous activities (think skydiving, mixed martial arts, motorcycle racing, etc.). You don't require any prescription drugs. You are not a substance abuser and you are fortunate to have not been born with or gotten any severe disabilities.

Now, suppose you went out and bought a health insurance plan for yourself. You wouldn't pay for lots of these required coverages. Certainly, you wouldn't get maternity coverage. You would likely leave out prescription drug coverage and rehabilitative and habilitative coverage. You wouldn't get substance abuse coverage. 

And, you wouldn't pay for them. 

But, under the ACA, you have to have them. You don't get a choice. 

Further, under the various metal-type plans, the design is such that the "average" (not really an average, but perhaps typical) person will pay 60%, 70%, 80%, or 90% of their health care costs. 

Here are two more facts. 1) All of these coverages cost money. 2) Insurance companies are in business to make money (contrary to popular belief, they do not exist for the sole purpose of losing money so that you, dear reader, can have great and inexpensive health care coverage).

What this means is that healthier people who are less likely to require health services need to subsidize coverage for those more likely to require health services. Further, since people should make intelligent choices, heavy users of these benefits should opt into plans that provide more (and better) coverages and light users should elect the plans that are least expensive. This phenomenon is an example of antiselection and antiselection increases costs.

Don't get me wrong. I think it's great that children under the age of 26 should be able to covered by their parents' plans. I have kids who have made use of it. I think it's great pre-existing conditions cannot be excluded from coverage by insurers. But, you know what? One of the ways that insurers have kept premiums down is by excluding pre-existing conditions.

Think about it. If an insurer is required to provide you with chemotherapy, it is unlikely that they can be charging you enough to make up for the cost of your treatments. Therefore, they have to spread the costs among others who are not receiving chemotherapy.

It's just math.

I also think it's great that there are no lifetime maximums under the Affordable Care Act. If you don't know, many health plans have historically had lifetime maximums of $1 million or $2 million. This means that once the plan has paid out that much on your behalf, they stop paying. Why do they have these provisions? They have them to that the insurer can limit its downside risk. It's good business practice. But they can't do it anymore. Since they are in business to make money (there's that nasty word again), they will spread the costs of not being able to impose lifetime maximums across all their customers. 

Again, it's just math.

Anyone who thought that the government could provide more and better insurance coverage for less money was either 1) delusional, 2) dreaming, or 3) not very smart. 

It's just math, and you, dear reader, should not be surprised.

John's Adventures at Healthcare.Gov

Chapter 1 -- Down the Sign-Up Hole

It all started on an October afternoon. I wanted to see for myself what all the ruckus was about. Surely, finding out what it would cost to sign my family up for the Affordable Care Act (ACA, PPACA, ObamaCare) could not be too hard. After all, I am reasonably computer savvy. I understand health care and health insurance better than the average person. My IQ tests to which I was subjected in childhood and early adulthood suggest that I am at least as intelligent as the average American.

My first task was to select a username and password. That I recall, each was required to be between 6 and 70 characters -- quite a range, I would say. I chose a pretty unique username of 20 characters containing an assortment of letters, numbers, and the dreaded special characters. The system told me that this username was already taken. I tried another one of 21 characters. The system told me that one was already taken. I tried one of 34 characters created randomly by banging on the keyboard of my laptop with my eyes closed until I was satisfied. This one, too, was already taken.

At this point, I screamed that word that one screams when one does not believe what has happened. You know the word. It starts with a B and ends with a T and has a total of 8 letters. Assuming that my characters were chosen fairly well at random, the odds of this username being a duplicate were approximately 1 in 36 raised to the 34th power. Excel tells me that this is a 53 digit number.

A few minutes passed and my e-mail inbox greeted me. The Health Insurance Marketplace informed me that my username and password had been accepted. The key question was which one.

Chapter 2 -- My Own Pool of Tears

I wanted to cry. I'm not sure if they were tears of joy or frustration. Finally, I decided they were tears of laughter. I clicked on the verification link and there it was: healthcare.gov was instructing me to log in. And, believe it or not, one of my log-ins was working.

I began to enter data. I chose Georgia, this having been my state of residence for more than 25 years now. I told the system some stuff about me.

I'm curious. Why does it ask if I am of Hispanic, Latino, or Spanish heritage? The question after that asks me for my race. Why not save a question and just ask my race? Obviously, I am missing something. And, in order to insure me, why does healthcare.gov need to know my race anyway?

Chapter 3 -- Chasing My Tale

The system asked me for my Social Security Number and for the name on my Social Security card. I typed it in.

Wrong, you idiot.

The system said there is no such person.

Well, I was looking at my Social Security Card while doing this. I held one next to the other and I was not wrong. So I tried again. Failure. Alas, the third time was a charm. I guess whoever said it was correct. Try, try, and try again.

Then I had to do the same things for my other family members. Just out of curiosity, what happens if you don't have some of this information handy?

Finally, all of the required information was entered for all of my family members. As you must after each tidbit of information that you enter, I clicked on "Save and Continue."

Success?

No, of course not. I clicked again ... and again ... and again. No luck.

So, I logged out and logged back in. And, I had the same problem. And, I tried it another day. And, again I had the same problem. So, I cannot tell you yet what will happen in Chapter 4 -- Obamacare Sends a Bill.

Public Plans, Beware What Your Actuary Can and Cannot Do

Thick laws create strange results. Consider for example the relatively new final SEC rule on registration of municipal advisers. As well as I can tell, the intent of this provision (Section 975) of the Dodd-Frank law was to ensure that those who are advising municipalities on things like bond offerings and investments. It never looked to me that actuaries were the target.

I don't know how it looked to the SEC. What I do know is that the final rule specifically exempted "retirement board" members from SEC registration. What I also know is that it did not exempt actuaries.

Why do I care and why might you care? It looks as if there are two situations where actuaries will be subject to registration as municipal advisers and if they are, they will be subject to all the attendant SEC rules:

• If your actuary performs an actuarial study in which the actuary sets any of the investment return assumptions or
• Makes any recommendation about how the governmental entity might address an unfunded liability including advice about the issuance of a municipal financial (debt) product,

 the actuary must register with the SEC.

It seems strange to me that municipal officials serving on retirement boards would be exempted, but actuaries may not be.

I guess it's not the first time that a government agency has confused me.

A Quick Word From Me

I love that people read my blog. If you like a post, please consider sharing it or +1ing it or both. Also, please feel free to comment. I read all the comments posted.

But, that brings me to another point. A number of people leave comments that are nothing more than links to their websites. Do you know what happens to them, they get marked as spam.

A Service to Go with a Sad Story

I am going to pitch a service here that all employers should consider. If you are spending money to provide additional benefits for your executives, that money should go to them and not to the government.

Sometimes a good idea comes out of a sad story. And, I'm happy to report that in this case, it's sad because a company wasted money providing a generous benefit for its executives and then didn't tell the executives the pitfalls, but it's not sad in the context of someone going bankrupt or suffering a tragedy.

I got a call yesterday afternoon from someone who found me on the internet, probably through this blog. His wife is a participant in a SERP. Her employment with the company ended in July (I don't know how or why, I just know that it ended).

In early 2007, the wife received a communication from her employer. It told her that her SERP was being split into two pieces -- a 409A-grandfathered piece and a non-grandfathered piece. This was a not uncommon strategy. In addition, the non-grandfathered piece had a default payment of a lump sum of the present value of the accrued benefit payable six months after termination. A participant could elect a different form and or timing of payment (within limits defined in the plan). All of this is very normal in the world of SERPs post-409A.

Apparently, that is all the communication told her. It didn't explain the complexities of 409A. From what I could gather, her employer didn't want to give too much information because they were worried about potential litigation. So, they probably figured that giving no guidance at all meant that they gave no incorrect guidance.

When I answered the phone, the unhappy husband told me that he and his wife assumed that she could change her option when she terminated. So, she accepted the default and went on her merry way. Now, she will be receiving a lump sum that they don't really need right now and paying about half of it to various governments in the form of taxes.

Here's the idea. An employer could choose to go all the way or just do part of this.

Get an outsider like me who understands executive rewards and the 409A and other tax implications to help communicate to your executive group. In what I would term a perfect world (assuming that the employer chooses to not do the communication themselves), here is what would be entailed:

• Provide the outside consultant with the plan provisions and data for all the parts of the rewards package that you would like covered (SERP, deferred compensation plan, equity compensation, cash compensation, severance, change in control, etc.)
• Invite your executive group to a meeting. In that meeting, the outside consultant presents to the group generically on those elements of the rewards package. In that meeting, each executive, will get a summary/informal statement of their rewards package showing values and costs. The executives will place greater value on their rewards packages when they know how much they are worth and how much you are spending on them.
• With signed waivers (consulting, not legal, tax or accounting advice), allow executives to have individual meetings with the outside consultant after the group meeting. Let them ask questions about what they can change and when, what are their options, and what are their restrictions?
• These meetings can cover as much or as little of the executive rewards package as you would like, but the idea is to use the money that you are spending on executives for executives, not for the government.

Consider it. Let me help.

Pay Ratio Rule Explained ... In Plain Pithy English

Yesterday, the Securities and Exchange Commission (SEC) approved by a 3-2 vote along party lines a proposed rule implementing the pay ratio rule of Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Only here are you likely to see an explanation of the rule in words that you can understand and use. And, be forewarned, there is nothing in the rule that either serves to reform Wall Street or to protect consumers. In case you missed that, let me repeat in different words: the rule serves no useful purpose.

That said, I commend the commissioners and their staff for their efforts in crafting a rule that seems to well follow the statute while removing significant burden on companies in complying. I do not believe that the two dissenting votes object so much to the way the rule was crafted as they do that the rule was crafted at all.

Some of you will need some background on the rule. For those who don't, to refresh, 953(b) requires an issuer [of proxies] to disclose the ratio of the compensation as defined in Item 402(c)(2)(x) of Regulation S-K for the median-compensated employee in the company to that same definition of compensation for the CEO.

So, what does the proposal say? And, why, John, do you of all people, since you have clearly been anti-953(b) commend the commissioners and their staff?

The rule allows for significant simplification in the process. That said, multinational companies with decentralized payrolls may still spend millions of dollars complying with 953(b), but that still pales when compared with what they might have spent.

Disclosure Items

The rule requires the disclosure of three specific items:

1. Compensation for the median-compensated employee in the company
2. Compensation for the CEO (or PEO if you like the SEC vernacular better)
3. The ratio of 1 to 2, expressed as 1 to some integer, e.g., 1 to 377

Where a company uses sampling techniques, simplifying processes, or other estimation techniques (to be discussed later), the company is to describe these techniques, processes, assumptions, and methods in enough detail to be understandable to an investor, but not necessarily to satisfy an economist or statistician.

The issuer, at its discretion, may include other disclosures with it to assist an investor or potential investor in understanding the ratio. Such disclosures should be provided on a reasonably consistent basis. In other words, if in year 1, the issuer uses wiggle words to explain why the pay ratio is 1 to 999, then in year 2, the issuer should use similar verbiage to explain why the pay ratio is now 1 to 17.

Calculation of Compensation

As for other purposes in the proxy such as the Summary Compensation Table, compensation is to be calculated using the methods in 402(c)(2)(x). Without confusing the reader, this includes cash as well as the value of certain equity compensation and the increase in the present value of accumulated pension benefits, among other things. While the issuer (company) will already have calculated this for the CEO, the calculation for the median employee, hereafter referred to as Jane Doe, will also use the same methodology. So, to the extent that Jane is granted stock options and participates in one or more employer-sponsored pension plans (government-mandated plans are generally excludible), that must be included as part of compensation. 

Additionally, all disclosures are to be done in US dollars. Therefore, to the extent that (and I pity the poor company) Jane is paid in foreign currency, the value of such currency must be converted to US dollars. No adjustments may be made for cost-of-living differences in foreign geographies.

Who Gets Counted and How

All employees of the employer on the last day of the fiscal year are to be counted (leased employees and temporary employees of contractors may be excluded). Permanent full-time employees who worked less than the full fiscal year may have their compensation annualized. Part-time, seasonal, and temporary employees may not have their compensation annualized. And, as should now be clear unless you have slept through my first few paragraphs, foreign employees must be counted.

Simplifying the Process

This is where the SEC made us proud (hey, I was proud of them for this, but I guess I shouldn't put words in your mouth). Frequent readers will recall that I described 953(b) as a legislated disaster. (Actually, I need to thank Mary Hughes, my editor at Bloomberg/BNA for coming up with that description.) I am going to get a bit technical for a moment as I explain why to those people who have been hiding behind the rock in my blog.

Section 953(b) requires that companies disclose compensation for their median-compensated employee. Suppose a company has 999 employees. Then, the median-compensated employee (you remember her, Jane Doe) is the 500th highest-compensated. In order to determine who that is, the company would have to determine the compensation (402(c)(2)(x)) for each employee in the company. Currently, that is a by-hand process for the five employees usually disclosed in the Summary Compensation Table of the proxy. Doing it for another 1,000 or so would not be a worthwhile operation. Remember, for many companies, many employees will have many elements of compensation that take many hours to determine and that is way to many manys to be justified in the spirit of reforming Wall Street or protecting consumers.

The proposed rule allows companies to use sampling methods and and alternative forms of compensation in determining the median employee. For example, a company with only US employees, but having 250,000 of them might sample by selecting only those employees whose Social Security Numbers end in 22, 55, or 88. This seems unbiased and would still tend to produce a group of 7,500 people or so. I could go through the math for you (but, you're very welcome, I will refrain) to show you that the compensation of the median-compensated employee of the 7,500 will not vary significantly from that of Jane Doe. Further, in then determining the median of the 7,500, the company may (if it is appropriate for that company) use a convenient measure such as W-2 compensation specifically to determine which employee is the median-compensated one. Then, the company must determine 402(c)(2)(x) compensation for the CEO and that one other person.

Effective Date

I am used to reading IRS regulations. They usually tell you when you must comply with a regulation and they tell you using words (it may the only place they use such words) that you and I can understand. The SEC has chosen to do otherwise. In fact, after reading through their description three or four times, I am still not convinced that the actual rule says what their description of their own rule says. In other words, it is really confusing.

That said, I will use the SEC's own example. If the final rule were to become effective in 2014 and the issuing company had a fiscal year ending on December 31, then such issuer would need to comply for the 2015 fiscal year meaning that the pay ratio disclosure would need to be provide by 120 days after the end of 2015.

Request for Comments

Again, I praise the SEC. They actually want to get this right. They asked 69 questions requesting comments. While I don't entirely agree with their choice of questions, their willingness to ask them and to seek good answers is laudable. 

I will be commenting. I would encourage other interested parties to comment as well.

How Should Issuers Prepare?

The good news is that issuers have lots of time to prepare. It sounds to me as if you won't have to be disclosing pay ratios for another 30 months or so. That's a lot of time. It gives you time to get your ObamaCare ducks in a row before you think about this.

But, pay ratio disclosure will come. Here is a non-exhaustive list of things I think you should do.

• Figure out all the payrolls that you have company-wide
• Determine a measure of compensation that is (or something comparable is) reasonably and readily available such as W-2 or the foreign equivalent(s)
• Understand all the places and to whom equity compensation is issued
• Understand all the defined benefit (including cash balance) plans out there as well as nonqualified deferred compensation
• Prepare your foreign payroll administrators for the eventual need
• Develop a sampling method that is appropriate for your company (need help?)

You Have Questions?

The regulation and explanation combined are 162 pages. It's not exciting reading and in fact, does not have a good plot. I tried to present a readable and understandable summary here, but there's obviously much more. 

If you do have questions, you can ask me.

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Pay Ratio Here, I Fear

The did it. By an overwhelming 3-2 vote, strictly along party lines (tsk, tsk), the Securities and Exchange Commission approved a proposed rule under Dodd-Frank Section 953(b). The two dissenters, Commissioners Gallagher and Piwowar, both issued scathing condemnations of both the statute and the proposed rule while the other commissioners praised it for the assistance that it will provide to investors and potential investors.

The rule has not been published yet, or at least, I can't find a copy, but I did take some good notes, so my readers get an early summary with surprisingly enough, some cynicism from your faithful blogger.

Issuers will need to provide three numbers:

1. Compensation (Rule 402(c)(2)(10)) for the median-paid employee
2. Compensation of the CEO
3. The ratio of 1 to 2

Despite this being what the law calls for, #3 is stupid. For those who are not sure what I just said, #3 is stupid. Suppose I told you that the ratio of compensation of the median employee to the CEO is .0073. What would that number mean to you unless you are mathematically facile? Is that a good number or a bad number? Should you be happy?

I repeat, #3 is stupid. The ratio should have CEO pay in the numerator and be an integer.

Haters of the statute did get a few breaks:

• Companies may determine the median employee via statistical sampling. After doing this, they must determine the 402(c)(2)(10) compensation of that median employee rigorously. Despite commentary from Commisioner Piwowar to the contrary, this is a huge concession to issuers.
• Compensation of permanent full-time employees may be annualized.

On the other side, there are these provision:

• Part-time, temporary, and seasonal employees pay may not be annualized.
• Compensation of global employees must be currency converted.

And, on the I'm not sure until I see the actual regulation side,

• There is no rule to say how statistical sampling must be done, but it must be reasonable and consistent.
• The dispersion of pay should be a significant contributing factor in determining the sample size for statistical sampling.

I understand that the novel which shall be heretofore known as the Dodd-Frank pay ratio rule is quite voluminous. Stay tuned here to get the most easily readable and entertaining reports on what it says.

Populating Your Web Site

So, you're in a business related to benefits and or compensation. You have this really nice website. It's pretty glossy and glitzy, but you don't have enough substance on it. You need some technical or opinion articles, but either you don't have the time or you just don't like to write.

Have you ever considered specifying what you want on there and have someone else write it for you? You're here reading my blog. You know that I write on a wide variety of topics.

So, have me do it for you.  Contact me and we'll work out the details.

Pension Miseducation

Like many benefits and compensation professionals, I receive daily my fair share of e-mail blasts from consolidators -- those services that scour the web for tidbits to provide to their readers. Because they have tens of thousands of free subscribers, they are able to sell advertising. That's their business model, as I understand it.

This morning, I opened one of those e-mails and found this article that looked like it was worth a read. In fact, there was some interesting material in there. And then there was this:

That aphorism also suits one frustration of today's pension plan sponsors. Somehow, they have to attain lofty actuarial return goals of 7% to 8%, but the expected returns they have to draw from, for both equities and fixed income, are stuck at ground level.

Hold on a second. Lofty actuarial return goals, you say? This implies somehow that the actuaries set the target and that based on that, plan sponsors and their associated investment committees then struggle to meet that target.

This is backwards. The selection of actuarial assumptions is different for accounting and for funding. In either case, however, the actuary does not just willy-nilly pick a target return on assets assumption. For ERISA funding purposes, the law mandates the selection. For FASB (ASC) purposes, the plan sponsor selects the return on assets assumption with the advice of experts including the actuary and investment adviser for approval by auditors. To the extent that the actuary finds the assumption to fail to meet Actuarial Standards of Practice (ASOPs), the actuary is to disclose such and to provide calculations representing what the amounts would have been had the assumption met the ASOPs.

Those who do not seem to understand this take a different position. The typical process for those sponsors looks like this:

• Look at the expected return on assets assumption.
• Go to the investment adviser and tell them that they need an investment portfolio that will meet or exceed that expected return on assets assumption.

But, the sponsor owns that assumption (if it is for accounting purposes). If it's for government plan funding, usually (state and local laws differ) the sponsoring government has input into the assumption. 

If an actuary has some (or all) purview over the return on assets assumption and (s)he is doing his or her job properly, the actuary will look at the investment lineup together with a capital market model and develop a return on assets assumption commensurate with that lineup. It is not the other way around. If plan sponsors do not think that their investment lineup can return 7% to 8%, then they should lower their assumption for expected return on plan assets. Yes, this will increase their financial accounting costs (and their funding costs for governmental plans). Ultimately, the cost of a plan is what it is. The cost of paying $1 per month for the rest of an individual's life is the same, no matter the actuary.

In my personal experience, for years, many plan sponsors pressured their actuaries to use more aggressive actuarial assumptions in an effort to influence P&L and, back in the days when it mattered for funding costs, to keep required contributions down. Some actuaries agreed to do that, some did not. 

But, when a plan sponsor, including a state or local government, chooses a high expected return on assets assumption, usually to manage short-term costs, that they are unable to find a suite of investments to generate that expected return is not the actuary's fault. Place blame where it belongs.

IRS HDHP Notice that Had to Be

Yesterday, the IRS published Notice 2013-57 confirming that a High Deductible Health Plan (HDHP) can, in fact, still be an HDHP if it offers preventive health care without being subject to the deductible. The IRS got this one very right, despite Congress having missed a few technical details.

Here's the rub. The Affordable Care Act (ACA, PPACA, or ObamaCare) clearly contemplates HDHPs and health savings accounts (HSAs). The law tells us all of the following:

• For an individual to make (or for the individual's employer to make on the individual's behalf) tax-favored contributions to an HSA, the individual must participate in an HDHP.
• Further, the HDHP must not pay any benefits to the individual until the [high] deductible is satisfied.
• The ACA requires that a health plan must provide first dollar coverage for certain preventive care services.

Thankfully, the IRS made a completely reasonable decision. It determined that those benefits that must be provided should not preclude the use of an HSA. IRS went further by saying that anything that is preventive care under Notices 2004-23 or 2004-50 is preventive care for this purpose whether or not it is specified as preventive care under the ACA.

Phew! And, you were worried that this little glitch was going to blow up ObamaCare.

Federal Court On the Money in Pension Case

I am stunned. Defined benefit pension plans and their funding measures and funding rules are a very complicated topic. In fact, federal judges (for private plans, they must be federal as ERISA preempts state law) often struggle to understand the intricacies of defined benefit plans.

I can't blame them. Congress has written statute that is so twisted as to make it extremely difficult for experts at the IRS to provide regulations and for trained actuaries to them implement. These are people who spend much of their working lives worrying about the rules underlying pension plans. For a judge with little or no formal pension training to see through the fog is a really nice change.

So, what's it all about, [Alfie]?

In Palmason v Weyerhauser, as I understand it, plaintiffs brought suit because Weyerhauser invested too large a portion of its qualified pension assets in risky asset classes, primarily alternatives (while the opinion doesn't specify, generally pension assets are considered invested in alternative assets when those assets are classified as none of cash, fixed income, or equity, e.g., real estate or infrastructure). At some point, the plan became underfunded.

It's time for an explanation. And, the Court got this one right. Measures of the funded status of a pension plan can be on many different bases. For accounting purposes, we have two different measures of the obligations (often referred to as plan liabilities) of a plan each based on a discount rate which is determined based on yields of fixed income instruments on the last day of the fiscal year. The Pension Benefit Guaranty Corporation (PBGC) looks at the plan's liabilities based on the rates at which PBGC thinks those obligations could be settled in the event of plan termination (this tends to produce a particularly high liability). IRS (and ERISA) funding rules are theoretically similar to accounting rules, but due to smoothing techniques and a constant stream of funding relief rules, a plan's funding liability (sometimes referred to As AFTAP) may be far less than these other liabilities.

In the Court's opinion, it points out that plaintiff must have standing to sue when the claim is filed. Attorneys could give you chapter and verse as to why this is the case and what generates standing, but I'll keep it simple. Under ERISA, generally, to sue for monetary damages, one must be able to show monetary harm.

In a US qualified defined benefit pension plan, a participant (except in the case of certain plan terminations) is entitled to a payment from a pool of assets. Those assets are used to pay the benefits of all plan participants. So, unlike a defined contribution plan, a diminution in plan assets may not affect the ability of the plan to pay benefits to a particular participant.

In any event, plaintiff's expert pointed out that the plan was funded 76% or 85.5% at the time the suit was filed. These were apparently accounting and PBGC measures, but not funding measures.

How can a participant be harmed by the funding level in a defined benefit plan if the plan is not being terminated? Essentially, there are two ways:

• If a plan's AFTAP is less than 80%, a participant's ability to receive a lump sum payment may be eliminated in part or in full.
• If a plan's AFTAP is less than 60%, a participant's future accruals will cease [perhaps temporarily].

The plan was not close to either of these conditions. Near the date that the suit was filed, the AFTAP was likely in the vicinity of 100% or more.

While I do not have access to the report or testimony of plaintiff's expert, it would appear that he focused on the measures that he did because they helped his client's case. Perhaps he did this because he realized that participant had no case otherwise. 

Would you as an expert take a case where the only testimony that you could provide would be that which only purpose would be to obfuscate the real point?

Judge Lasnik was not pleased. Rarely, if ever, have I seen a pension case where the judge calls out an expert by name and essentially criticizes his testimony for ignoring the real facts of the case. I hate to criticize my actuarial brethren as oftentimes, judges have not understood really relevant testimony from actuaries and made, shall we say, interesting rulings, but in this case, the judge saw the smoke and mirrors and appropriately, in my opinion, shot down the expert. 

The Need For Honest Debate

It's that time again, it's time for a rant. But, I hope that it will be instructional as well. I'm going to talk about our need for honest debate in our legislative process. And, because this is a blog that, at least in theory, deals with benefits and compensation, I'll use benefits and compensation issues to illustrate my point.

For those who are wondering, the antagonists here are the large part of the 535 (that's the usual number) elected officials who in combination are the voting members of Congress. The protagonists, if there are any are the other 315 million or so of us who get to live by what the 535 come up with.

Let's start with nearly everyone's favorite whipping boy, the Affordable Care Act (PPACA, ACA, or ObamaCare). We all know what happened. President Obama really wanted to reform the US health care system. At various times, he indicated that he wanted to move toward a single payer system. Many of his fellow Democrats among the 535 also wanted a single payer system, but knowing that was unlikely to get enough support to become law, they settled for a bill that eventually became PPACA. The Republicans banded together to vote against it, unanimously. My distinct impression is that most didn't care what was in it. It was to be a landmark piece of Democrat-sponsored legislation and Republicans were voting against it. My distinct impression was also that most Democrats didn't care what was in it either. It was going to be a win against Republicans, so Democrats voted for it. As Nancy Pelosi (D-CA) famously said (and I am going to include the whole quote so that it is not taken out of context):

You've heard about the controversies within the bill, the process about the bill, one or the other. But I don't know if you have heard that it is legislation for the future, not just about health care for America, but about a healthier America, where preventive care is not something you have to pay a deductible for or out of pocket. Prevention, prevention, prevention -- it's about diet, not diabetes. It's going to be very, very exciting. But we have to pass the bill so that you can find out what is in it, away from the fog of the controversy.

Did Ms. Pelosi know what was in the bill when she voted for it? She probably had a general idea, but didn't know the specifics. How about the other 534? I'd wager that most of them had neither read more than a page or two, at most, of the legislation and had not been briefed on it by anyone who had read it.

Where was the debate? Where was the opportunity for individual members of Congress to discuss the good parts and the bad? Even among the most ardent Republicans who voted against the bill, I suspect it would be difficult to find many who think that mandatory preventive coverage and coverage of kids up to age 26 are bad things. On the other hand, the medical device tax that was inserted deep in the bill's bowels as a revenue raiser would probably not get support today from more than a few Democrats who voted for the bill.

Suppose the bill had truly been debated. Suppose the good parts had been picked out as the foundation for a bill that might have gotten some bipartisan support. Suppose the parts that virtually all of us can agree don't make sense had been left out. What would debate have taught us? It would have confirmed that our health care system needed some reform. It would have confirmed that providing health care coverage to millions of uninsured costs money. It's not budget neutral. It's certainly not helpful to the budget. But, we didn't have good, honest debate and we eventually have learned what was in the bill.

Dodd-Frank was another bill that was passed without a whole lot of what I might refer to as crossover voting. That is, a few Republicans voted in favor and a few Democrats voted against. But, to call it bipartisan is a bit of a stretch. The bill was massive. Many who voted for or against had a pet little provision in there that triggered their votes.

The bill was supposed to clean up Wall Street and protect consumers. I know this to be true because of the full name: The Dodd-Frank Wall Street Reform and Consumer Protection Act. Names of laws don't lie, do they? Say it ain't so.

Somehow, it became important to get Title IX in there -- the part on executive compensation. And, Senator Robert Melendez (D-NJ) managed to sneak in what regular readers know to be my personal favorite, the pay ratio provisions in Section 953(b).

I've communicated with a few people who follow Capitol Hill closely, Congressional reporters. None of them are sure how this provision actually got into the bill. They all agree that it was not debated. What happened?

Implementation of Section 953(b) will require some simple mathematics, or arithmetic if you prefer. Senator Menendez, the purported author of the section was a political science major before attending law school He was also a member of a Latin fraternity. He first entered politics at the ripe old age of 20.

I looked hard. I cannot find any evidence of Senator Menendez' mathematical prowess or of his knowledge of executive compensation. Perhaps that is why Section 953(b) is so incredibly messed up -- bad enough that I have written about it enough times to finally learn how to type the word ratio without placing an n at the end of it even though my fingers seem to prefer to type ration.

To the credit of the 535, Dodd-Frank was debated ... as a bill. But, it's tough when you have a bill that, at least in one printing, contains about 3200 pages to debate every provision. Section 953(b) escaped debate. It became part of the law.

It is bad law. Despite what the AFL-CIO says, Section 953(b) is bad law. There, I said it. Perhaps it should have been debated. Perhaps Ms. Pelosi should have said that [we] have to debate the bill so that we can put useful provisions in it. Perhaps I am dreaming.