Fitting a Square Retirement Peg Into a Round Hole

I just don't get it. We knew what they were and honestly, they may have been well defined before then, but in 1974, Congress saw fit to codify defined benefit plans (DB) and defined contribution plans (DC) in ERISA. At the time, there was no Section 401(k) in the Internal Revenue Code.

It was also pretty clear back then. Pension plans were required to offer annuity options. Plans that were not pension plans (mostly profit sharing plans) were not required to offer annuity options. And ERISA said it was good.

In a profit sharing plan, a participant's accrued benefit was his or her account balance, generally. In a pension plan, generally, a participant's accrued benefit was the amount of his or her annuity. And ERISA said it was good.

But, time went by and despite ERISA saying things were good, Congress decided to tinker. And, as a group, Congress has few tools in its bag of tricks that exceed its ability to tinker. It usually works like this. Representative A introduces a bill and she has just enough votes locked up that she can almost get it through the House. And, Representative B comes to her with an idea and says that if you'll just add this one [stupid] provision, I'll vote with you and I can drag C, D, E, F, G, and H along.

That's how the sausage is made in the tinkering factory.

So, once upon a time, we had this round retirement hole (the structure that ERISA gave us) and it was good. It worked pretty well. The evidence of that is that people who spent a good part of their careers under the structure developed in ERISA have generally retired and if they planned at all well, their retirements are not at all bad compared to their working lifetimes.

But, as Congress saw fit to tinker with the rules, it found ways, among others, through bills known as Pension Protection Act[s] to convince employers to get rid of pensions. That's right, Pension Protection Acts killed pensions.

Irony.

So, through Pension Protection Acts, workers were suddenly left with nothing but account balances and through improved awareness of health risks and better medical care, they were also left with longer life spans. Those account balances that were perfectly sufficient to get them to the age 75 or so that was their life expectancy at birth had no chance of getting them to their new life expectancy that was closer to 85.

Now what?

The hue and cry was for annuities. And, thus Congress began to tinker again. How could they possibly fit this square account balance peg into the round annuity hole. So, Congress explored ideas for annuities in DC plans.

But, you see that if you offer actuarially equivalent annuities from a DC plan, then you have gains and losses and that would essentially be a DB plan. If you offer insurance company provided annuities (and recall that insurance companies are in business to make money), then you have too small of an annuity.

Oh the ignominy of the square peg.

We had a perfectly good system. It came with perfectly good benefits and for most plans, perfectly good actuarial assumptions and methods.

And Congress broke it. And after all these years, despite taking file and rasp and hammer to the square peg, the round hole remains empty.

Congress, there are smart people who do not sit in your chambers. Give us your objectives and let us find you a solution. We'll make that peg round and Americans will be able to look forward to their golden years again.

ERISA will once again say it is good.

Is Your Executive Plan Top-Hat?

Most larger companies and some smaller ones provide many of their higher paid employees the opportunity to participate in a nonqualified retirement plan often referred to as a Supplemental Executive Retirement Plan or SERP. The rationale for having such a plan is spelled out in ERISA. The regulations specifically grants "top-hat" status to plans that are limited to a select group of management or highly compensated employees. The plan must also be unfunded (and for those people who say that lots of top-hat plans have assets set aside, that is informal funding in a rabbi trust or through insurance products or some other means).

Before going further, I'd be remiss if I did not mention that my motivation for posting this is a recent series on top-hat plan litigation in Mike Melbinger's blog.

So why should an employer or employee care if their plan is a top-hat plan or not? According to regulations under ERISA Section 104, top-hat plans are exempt from the participation, funding, vesting, and fiduciary rules under ERISA. As we shall see, this can be critically important, especially in the current statutory environment.

Backpedaling just a bit because this will help the less knowledgeable reader to understand why top-hat plans exist, let's consider what it could mean to be in a top-hat group. ERISA was enacted in 1974 to provide certain protections for employees in retirement and certain welfare benefit plans. When a plan is exempt from some of the key provisions of ERISA, it fails to provide those protections. So, being in a top-hat plan could alert a participant that he or she might not need those protections.

As some authors, mostly attorneys, have pointed out, the last year or two has seen more than the usual amount of litigation related to top-hat plans. In the typical situation, either an individual thinks that they were improperly excluded from a top-hat plan (in my completely non-legal view, this would be a tough claim to make) or because they were in a plan that was treated by their employer as being a top-hat plan, but they thought that it did not satisfy the criteria for being top-hat.

Depending on your viewpoint, the latter is either an easy claim or a difficult claim to make. Why is that? It's been more than 40 years since the passage of ERISA and we still don't have formal DOL guidance telling us what a top-hat group is. Some have argued that an individual may properly be in a top-hat group by being either management or highly compensated or both. Despite the current definition of highly compensated (Internal Revenue Code Section 414(q)) not existing until late 1986, some have argued that satisfying that criterion is sufficient. Many years ago, the DOL floated a concept that a person should be eligible for a top-hat group that a person would be eligible if their compensation was at least two times (three times in a separate informally floated concept) the Social Security Wage Base. And, finally, there is the concept that a person may rightfully be in a top-hat group if by the nature of their position, they have the ability to influence the design and amount of their compensation and benefits package.

So, knowing that we currently don't know what a top-hat group actually is, why do we care?

Suppose your company sponsors what it believes to be a top-hat plan and it turns out that it's not top-hat. Then, it's going to be subject to some fairly onerous provisions that could create massive current costs in some cases and unsolvable compliance issues in others.

Consider the following scenario.

Suppose you have a DB SERP with 20 participants. Further suppose that for whatever reason, this plan is found to not be a top-hat plan. Assuming that the company is large enough, then the plan will fail the minimum participation rules and it will necessarily (unless the company has only highly compensated employees) fail the minimum coverage tests. Full vesting must occur generally within 5 years of entry and that entry must occur not later than age 21 with 1 year of service. The plan must be funded according to ERISA's minimum funding rules. And, those plan assets must be invested according to ERISA's fiduciary standards. But, the plan will still not be a qualified plan as it doesn't meet all of the Internal Revenue Code's standards under Section 401(a).

If the plan is not qualified, it must be a nonqualified plan of deferred compensation. That makes the plan subject to Code Section 409A. So, let's throw in one more wrinkle. Let's suppose the company also sponsors a qualified DB plan and let's suppose that the qualified plan is less than 80% funded. Now, you are between a rock and a hard place. Setting aside assets (funding) for the nonqualified plan will violate Code Section 409A which will subject participants to a very large unplanned additional tax liability. (By the way, those participant will likely have to find a way to pay those taxes perhaps without having access to the deferred compensation assets in order to pay them.) Not funding the SERP will cause the plan to fail to meet minimum funding standards which will result in excise taxes under IRC 4971.

Ouch!

What should an employer do?

I've been told by more than one attorney that it is unlikely that you can get a formal legal opinion that your top-hat group is, in fact, a bona fide top hat group.

If you can't get a formal legal opinion, perhaps the best way to get comfort is to get an outsider with expertise in this area to assist with an independent analysis.

Looking at a history of case law and DOL opinion on the topic, one might consider these elements:

• The percentage of the workforce in the top-hat group
• The relative pay of the top-hat group as compared to the pay of those people not in the top-hat group
• Whether the top-hat group was selected by the Board as compared to being, for example, any employee with the title Vice President or higher
• Whether individuals in the top-hat group, especially those among the lower-paid in the group, have significant management responsibilities
• Whether individuals in the group need the protection of ERISA

Nobody really knows. But, having an independent analysis might show that an employer is acting in good faith in determining the group. Given the downside of getting it wrong, it may just be worth it to find out.

Finally, I want to reiterate that I am not an attorney and I have no qualifications to provide legal advice. As such, nothing in this post or anything else that I write should be construed as legal advice or as the practice of law.

Will Fee Litigation Kill the 401(k)?

401(k) litigation is going mad. In two of the most publicized cases, Tibble v Edison and Hecker v Deere, there may have been something legitimate for plaintiffs to complain about. In the latest case, however, this one fashioned as Bell v Anthem, the litigation makes this blogger wonder why a company would offer a 401(k) plan at all.

Essentially, all of this litigation stems from ERISA Section 404(c) which among other things establishes that a retirement committee and its members individually are to act in a fiduciary manner in the best interests of plan participants with respect to the plan. For years, issues under 404(c) were not litigated, and in fact, most of us weren't entirely sure how to apply 404(c).

As plans have gotten bigger and the number of investment options has grown significantly, some attorneys have found this to be particularly fertile ground for litigation. In some cases, the issues have been judged by the courts to be clear.

As an example, suppose that XYZ Investment Company offers a large cap equity fund. Not only does XYZ offer that fund, but it has two share classes -- a retail class to which it charges accounts a fee of 80 basis points and a wholesale or institutional class to which it charges a fee of 40 basis points. This is a large difference and to the extent that a plan sponsor and committee have the leverage to have the institutional class as compared to the retail class in its fund lineup, they should.

You can do the math if you choose. Using something as simple as the Rule of 72 (you can google it if you are not familiar to estimate the results), Ms. W's account balance will double approximately every 15.6 years while Mr. R's will double about every 17.1 years. Or said, differently, at the end of 35 years, Ms. W will have roughly 3 years of excess returns over Mr. R, at least on her initial deferral. Her more recent deferrals will have smaller amounts of excess returns.

Is this material? I don't know; you tell me. Is it significant enough that the plan committee should be held liable if they opted for retail class instead of institutional? That's up to the courts.

Now, we return to Bell v Anthem. The plan in question is large. Its assets total roughly $5 billion. A plan of that size certainly has the leverage to get the least expensive share classes available for its participants, regardless of whose funds they are placing in the plan. Even the big players drool over the prospects of picking up a large mandate in a plan that big.

In the particular case, all but two of the funds offered were Vanguard funds. Vanguard has a reputation, supported by data, in the industry as having one of the lowest fee structures of anyone out there.

Of the funds that were not Vanguard, one was the Touchstone Sands Capital Select Growth Fund (Institutional Class) with a 1.31% expense ratio according to Touchstone's website. The other was the Artisan Midcap Value Fund (Institutional Class) with an expense ratio in the vicinity of 1.15% according to Artisan's website.

None of the Vanguard funds had expense ratios exceeding 0.5%. The Vanguard Target Date Funds had expense ratios of less than 0.2%. Index funds in the plan had expense ratios ranging from 24 basis points down to 4 basis points. Very few knowledgeable observers would consider those expenses to be high, and in fact, most plan advisers that I know would consider them low.

Plaintiffs, however, allege that the 4 basis point fee is too high, as there was an asset class available for the same fund that only charged 2 basis points. I saw that and wondered how material that is.

Going back again to the rule of 72, I compared the two different expense ratios. With an expense ratio of 2 basis points, an initial investment would double with a 5% gross investment return about every 14.46 years. With the 4 basis point expense ratio, it would double about every 14.52 years. That's a difference of less than one month.

Could Anthem have had the less expensive fund? Probably. Are there any complications associated with it? I haven't looked into that? Was the committee and its members guilty of some sort of fiduciary malfeasance by offering the higher cost (4 basis point) fund to its participants? The courts will have to decide that.

The issues in the suit continue. It contends that because of the size of the plan that even the Institutional Class Fund is not good enough. Instead, the suit contends, Anthem could have negotiated separate Anthem accounts at an even lower cost.

Is this practical? I don't know. Does ERISA hold fiduciaries to that standard? I don't know. If it does, would I want to be on a defined contribution plan's investment committee? Absolutely not.

My reading of ERISA suggests to me that a fiduciary is to take reasonable care in acting in the best interests of plan participants. It strikes me that reasonable care includes making good decisions. It does not strike me that reasonable care requires each committee and committee member to spend enough time to make the best decision possible.

Perhaps I am wrong though. It wouldn't be the first time.

But, let's return to the separate accounts. How long would it have taken Anthem to negotiate those separate accounts? How good a deal would they get? Since that negotiation would be on behalf of plan participants, could they charge their time back to those participants? I don't know.

Either way, if this sort of suit becomes the norm, it's time to get rid of employer-sponsored individual account plans. Businesses are in business to provide products and services. When their 401(k) plans change the way they do business, it's time to stop.

You Run a Business -- Why Do You Choose to be in the Benefit Plan Business, Too?

You've been successful in the business world. You've made your way up through the ranks. Suddenly, because your title starts with the word "chief", you find yourself on the company's Benefits (or some other similar name) Committee.

You're an accidental fiduciary. You have no benefits training. You've never studied ERISA. In some cases, you've never heard of ERISA. What are you doing in this role and why?

Perhaps there is not a single person on your committee with a strong grounding in ERISA issues. But, you know that in order to compete for employees, you have to provide your employees with some benefits. It's likely that some or all of those benefit plans are covered by ERISA. And, ERISA coverage brings with it a myriad of rules and requirements.

Oh no, now I have you panicking. What should you do?

Let's consider one of the most common benefit plan offerings in 2015, the 401(k) plan. What is your committee responsible for? Do you know?

While one could argue that the list might be slightly different, here is a pretty decent summary:

• Plan design
• Selection of plan investment options
• Compliance (with laws, regulations, and other requirements)
• Plan administration
• Communication to participants and education of those participants

That's a lot to swallow. Look around your committee. Presumably, since the committee has responsibility for all of those elements, at the very least, you can find people in the room who, between them, have expertise in all of those areas,

You can't? 

Do you really want the responsibility that comes with being a member of that committee when you have just realized that the expertise to handle the committee's roles doesn't reside on the committee?

You have choices, or at least you might. You could resign from the committee. Frankly, that usually doesn't go over well.

You could engage an expert. Suppose you could find an individual who could function in the role that a committee Chair would play in a perfect world. We're likely talking about someone who doesn't work for your company. This person will bring you peace of mind and essentially serve as the quarterback for the committee. He or she won't have a vote, but will guide you through the processes so that 

• Your plan is well-designed for your population and budgets, 
• It has investment options for plan participants that are prudently chosen and monitored according to an Investment Policy Statement (sometimes called an IPS), 
• It gets and stays in compliance with applicable rules, 
• Is administered properly and the firm that administers it is well-monitored, and
• Is communicated to participants in a clear fashion that properly educates those participants as to the benefits of plan participation.

That sounds great, doesn't it?

If you don't currently have such a quarterback for your committee, perhaps you should. I can help you find one.

DOL Weighs in Again on Top-Hat Plans

ERISA contemplated so-called top-hat plans. In fact, it spelled out exactly what was contemplated in providing this opportunity for nonqualified deferred compensation so clearly that the legislative intent could never be misconstrued.

No, it didn't.

As is often the case when bills go from staffer to staffer and then to the floors of the houses of Congress, the bills tend to emerge with run-on sentences often punctuated by a myriad of commas making Congressional intent something upon which otherwise knowing people cannot agree.

Perhaps, some day they will learn.

No they won't, not in my lifetime anyway.

In any event, in a case (Bond v Marriott) concerning top-hat plans in front of the 4th Circuit Court of Appeals, the Department of Labor (DOL) wrote an amicus brief providing its opinion on the statutory wording around top-hat plans.

So, I know that those not familiar are just itching to find out. What does the statute say?

Congress gave us an exception to certain provisions of ERISA for a "[p]lan which is unfunded and is maintained by an employer primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees."

What is the primary purpose of a top-hat plan? Is it to be primarily for providing deferred compensation to a select group that is composed of management or highly compensated employees? Or, is it to be for providing deferred compensation to select group that is composed primarily of management or highly compensated employees?

It's one of those great questions that has confounded us through the ages. No, actually, it's a question that has confounded a select group of us since the passage of ERISA in 1974. To add to that confounding just a bit, everyone who practices in this field knows what a highly compensated employee is. The term is well defined in Code Section 414(q). But wait, Section 414(q), as written, has only been around since 1986 (added by Tax Reform) meaning that perhaps for these purposes, we don't even know what a highly compensated employee really is.

In its amicus brief, the DOL gives us its opinion, one that it claims to have held at least since 1985 and perhaps longer. The DOL tells the court that the primary purpose should be the provision of deferred compensation [for this select group] and that other purposes might include retaining top talent, allowing highly compensated individuals to defer taxation to years with lower marginal tax rates, or avoiding certain limitations applicable to qualified plans in the Internal Revenue Code. DOL further tells us that it does not mean that the select group may be composed primarily [emphasis added] of management or highly compensated employees or that the plan may have some other secondary purpose which is not consistent with its primary purpose.

The brief goes on to give us the judicial history around the provision and of course informs us which case law got it right and which did not. But, the DOL is clear in its claims and steadfastly denies that exceptions should be allowed.

I may be missing something here regarding the DOL. I think that the DOL has regulatory purview over ERISA. While the DOL has ceded that purview most of the time to the IRS where the Internal Revenue Code has a conforming section, that does not seem to be the case here. Could the DOL not have written regulations in 1975 or 1985 or 1995, or 2005 clarifying who, in fact, is eligible for participation in a top-hat plan? Or did they think it so clear that it was not worth their effort, despite being befuddled by decision after decision handed down by federal courts?

I know that when I got into this business, coincidentally in 1985, the more experienced people who taught me instructed that top-hat plans were to be for a group that was primarily management or highly compensated. In fact, it is difficult, in my experience to find practitioners who learned otherwise.

Perhaps that's wishful thinking. Perhaps, on the other hand, it's wishful thinking on the DOL's part. Perhaps the case will go to the US Supreme Court eventually so that nine wise jurists can put their own spin on it and settle this argument once and for all.

Until then, ...

Multiemployer Pension Plan Crisis ... Or Not

Late last week, the New York Times published an article by Floyd Norris, its chief financial correspondent and an economist, on the crisis in multiemployer pension plans. I decided to write about it for a few reasons: 1) it's an interesting topic to me, 2) my strong impression is that the crisis is is not quite as the picture painted in the article, and 3) to go with the article, I think it's important to give some background and education.

I preface by saying that I do not generally work in the area of multiemployer plans, but then neither does Mr. Norris nor most of the people cited in his article.

Multiemployer (ME) pension plans are defined benefit (DB) plans. They meet the general tenet of DB plans in that they promise a benefit to plan participants at retirement rather than simply a pool of money segregated for that participant. But, there are lots of differences between ME plans and what most of us would think of as traditional (single employer) DB plans. Here are some of them.

• ME plans are collectively bargained.
• As the name suggests, these plans are generally maintained by more than one employer, usually in the same or related industries. The rationale is that a worker can be used by multiple businesses while all the time accruing a single pension.
• What is negotiated at the most basic level is the level of contributions that each employer will make. For example, a negotiated contribution might be 20 cents per hour worked or 25 cents per 1,000 miles driven.
• ME plans are managed, so to speak, by their trustees, joint committees having equal representation from labor unions and from management.

The article notes that the Pension Benefit Guaranty Corporation (PBGC), the governmental agency that insures pension benefits, believes that it will run out of money in its ME fund in the very foreseeable future. This could be the case (I have no reason to doubt the PBGC's forecasts) as two of the largest plans (those of the United Mine Workers and Central States Teamsters) are nearing the point where they will have insufficient assets to pay benefits to retirees.

What the article does not point out, however, is that the large majority of ME plans are really pretty well funded. Generally, ME plans have been managed responsibly and as a result, most of those plans do not face similar dangers.

When the Employee Retirement Income Security Act (ERISA) was signed into law in 1974, ME plans were not even covered by the PBGC. It wasn't until 1980 when the Multiemployer Pension Plan Amendments Act (MEPPAA) became law that such a fund was established for ME plans. And, even then, it was thought (I don't know any of the logic which may have been very good at the time for these thoughts) that the likelihood of ME plans needing PBGC coverage was small. So, as PBGC premiums for single-employer plans continued to increase, premiums for ME plans stayed low.

From my viewpoint, the reason for this might have been that it is up to the plan trustees to assure that the level of benefits provided to ME plan participants not be such that plan assets would be insufficient to pay such benefits. However, I have heard it said by people working in the ME arena, that in some of the larger, less funded plans that the strategy used amounted to a death spiral which is now approaching that death.

What happened?

As we know, plan assets have some years where their underlying investments perform well and some where they don't. So, when assets did perform well, and this is oversimplified a bit, the plans appeared to be better funded than they had been and therefore able to support higher levels of benefits for plan participants. In some plans, the trustees granted such increases. But, we all know that not all years provide excellent investment returns. When the plans were suddenly less well funded, benefit levels did not decrease. Further, and the United Mine Workers represent a good case study for this, when the ratio of active workers to retired participants decreases (similar to the US Social Security system), sources of assets may no longer be sufficient to support benefits. [This is a great reason to fully fund benefits for an individual participant on a reasonable actuarial basis by the time that participant leaves employment, but that's for another rant.]

What Mr. Norris does not point out in his article is that most ME plans are not in danger of needing PBGC protection. And, for the two plans in question, one might posit that they dug their own graves, so to speak. That is, they offered levels of benefits that the plans were not able to sustain over the long haul. Some ME actuaries have told me that the trustees who engage them for valuation services and for consulting advice have not necessarily followed that advice. 

The losers in this story are likely the people who have done nothing wrong. Plan participants, as a group, tend to do their jobs and assume that that their pensions will be paid. It is not the fault of a coal miner in the UMW plan that the industry fell on hard times. And, that long haul trucker in the Central States plan probably has no idea how his pension plan works, but he does expect that when he retires that he will get the benefits that he has been guaranteed. 

A joint business and labor group developed a plan designed to rescue the ME system without bailouts and without saving the PBGC. It was controversial in that it violated one of the most sacred tenets of ERISA -- thou shalt not reduce benefits that have already been earned. However, for any plans that go under, benefits in excess of the PBGC maximum guaranteed benefit may be reduced. And, if the PBGC runs out of money, even benefits less than that limit will likely be reduced. 

The situation is more complex than I describe. ME rules are quite complicated. But, I reiterate that the crisis appears to be limited to a relatively small percentage of plans, and according to the joint business and labor group could be solved by reducing benefits only in those plans that promised benefits that it could never have expected to support for the long term. Anything like that, however, would require Congress to pass a bill and the President to sign it.

Oh well ...

Pensions: Are They Just a Toy For Congress to Play With?

In 1963, Studebaker, once a large and proud American auto maker closed its doors in the US for the last time. With that door closing, as legend has it, New York Senator Jacob Javitz had the idea that the retirement income promised to employees needed more security. So was born in his mind the law that in 1974 became the Employee Retirement Income Security Act (ERISA). While it did far more than take steps to make pensions more secure, that was purportedly its primary purpose.

ERISA provided a framework for corporate retirement plans. And, in 1974, before paragraph (k) had been added to Section 401 of the Internal Revenue Code, the predominant employer-provided retirement income came from defined benefit (DB) plans. Unions bargained for them, and what the unions got, management wanted. Also, back in 1974, it was not unusual that if there was a company that an employee worked for in their mid-to-late 20s that that employee would eventually retire from that company. If you, as an employer, promised that employee a pension, you could expect 30 or more years of loyalty from that employee.

So, ERISA set up a minimum funding regime regime for DB plans. If you were using what is known as an immediate gain (or loss) actuarial cost method (if you know what that means, you don't need an explanation and if you don't know what it means, you don't want an explanation), then your minimum funding requirement for the year was the sum of these elements:

• The normal cost or the actuarial present value of benefits accruing during the year
• Amortization over 30 (or 40) years of the unfunded liability remaining from inception of the plan or transition to ERISA
• Amortization over 30 years of the actuarial liability emerging due to changes in plan provisions, the thought likely being that you got 30 years of value from the amendment
• Amortization over 30 years of the actuarial liability emerging due to changes in actuarial assumptions
• Amortization over 15 years of the actuarial liability emerging due to actuarial gains and losses (deviations from the expected)
• A few other elements that rarely came up

By the mid-1980s, DB plans were generally pretty well funded, and most of those that were not yet fully funded were getting much closer than they had been. The exceptions, for the most part, were plans sponsored by companies in dire financial straits that often convinced their actuaries to use fairly aggressive actuarial assumptions, or companies that frequently provided large benefit increases that had not yet been funded.

In 1986, we were graced with the Tax Reform Act (TRA86), a massive and sweeping change to the entire Internal Revenue Code -- so massive, in fact, that the Code was renamed from the Internal Revenue Code of 1954 to the Internal Revenue Code of 1986, a moniker it keeps to this day. A not insignificant portion of TRA86 included changes to pension funding rules. Amortization periods were shortened. For the most part, this increased required contributions for underfunded plans, which in turn increased corporate tax deductions.

Those new rules were revamped quickly. Just a year later, embedded in the Omnibus Budget Reconciliation Act of 1987 (OBRA87) was the Pension Protection Act of 1987. OBRA87 was the annual budget bill. And, has become the trend, each powerful legislator had his own pet spending project. To pay for all that pork, either a revenue generator or a decrease in tax expenditures (a fancy name for deductions) was needed. OBRA87 found a useful tool in DB pension plans. How is that? Just change the funding rules to decrease required contributions and tax deductions will go down which in a backhanded sort of way increases revenue for the government. of course, this was thinly veiled in a complex set of new requirements that applied only to underfunded plans.

A star was born!

Congress needs a revenue raiser? Change the funding rules. Cut the maximum benefit limitations. Change required interest rates. 

With this new toy, Congress looked at changes in pension rules at least every other year. It created uncertainty for employers. Yes, they could plan and budget based on current rules, but they lived in fear that the rules would change. That's a tough way to run a business. Many of those plan sponsors froze their pension plans. Many of them wanted to terminate their plans, but interest rates were so low that the cost of terminating those plans was too high. 

Fast forward to 2006. Coming out of the economic malaise and stock market tumble at the beginning of the decade, many plans were underfunded on an accrued benefit basis using market-based discount rates. It was time to protect pensions yet again. Thus was born the Pension Protection Act of 2006 (PPA), the most sweeping change to corporate pensions since ERISA. It provided a regime that essentially ensured that underfunded plans would be fully funded within 7 years. Employees would get their pensions. 

But, those extra contributions from employers are tax deductible. That's an extra burden on the government. And, it was just one year later (falling from its October 11, 2007 peak) that the markets crashed yet again. Employers couldn't afford these new levels of required contributions. But. Congress had an agenda to help those employers and help themselves. 

Welcome pension smoothing in the form of several laws since then. PPA brought us 7-year funding based on "fair market" conditions and assumptions. Pension smoothing undid that and then undid it again and undid it again as Congress invoked its favorite toy at least 3 times in the period following the signing of PPA. Employers had funding relief. Congress had its decrease in tax expenditures. Employees in pension plans had less funded benefits and the rules got so complex that almost nobody wanted to sponsor a pension plan anymore.

And, the places that pension funding relief gets buried are just amusing. I think the 2014 relief is my favorite -- the Highway and Transportation Funding Act of 2014 (HATFA). That's right. Congress decided it was time to improve our roadway system, but new roads don't come for free. So, to help pay for this, Congress invoked its favorite tax toy, pension funding relief.

Shame on them!

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.

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.

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. 

Life on an Investment Committee

Nevin Adams, editor-in-chief of Plan Sponsor and its News Dash publication writes a great little "IMHO" piece about being on a plan's investment committee. To sum up:

• If you are on an ERISA plan's Investment Committee, you are an ERISA fiduciary
• Once you are an ERISA fiduciary, you have a personal liability
• On the Investment Committee, you are responsible not only for your own decisions, but the decisions of others

You can read Nevin's article here: http://www.plansponsor.com/IMHO__Liability_Driven.aspx

There are several court cases out there right now that rely on this theory. Unfortunately, I am temporarily precluded from writing about the most interesting of the bunch of them.

DOL Proposes Sponsor to Participant Disclosure Regulations

Here's an article http://tinyurl.com/2eubs8w that I wrote on the new regulations that the DOL wrote on ERISA Section 404(a). As I said in the article:

Probably the key takeaway is that sponsors (and their service providers) will have a lot of work to do to bring their plan disclosures into compliance with this new rule. Establishment of websites for non-public funds, developing and formatting participant communications, making sure that necessary information is captured, and the redesign of systems to accomplish all of this, will for many sponsors and service providers involve significant expenditure of management time and expense. The larger issue to consider may be how much of the cost associated with these changes will be passed along to plan sponsors and/or participants by those service providers.

No good checklists currently exist to assist sponsors in ensuring that each requirement is covered. Additionally, in some cases, service providers may not be willing or able to assist plan sponsors in complying with requirements. Perhaps this will be an appropriate time for sponsors to use outside experts who can do this effectively rather than having someone struggle to learn the rules once and rarely, if ever,apply them again.

The compliance burden aside, the information actually provided to participants may or may not be helpful. The DOL has done a lot of work – including focus group testing – to come up with a disclosure scheme that will improve participant choices. Whether, in practice, the new rules have their intended effect only time and experience will tell.

Do You Know if You are a Retirement Plan Fiduciary?

Everyone who works with a retirement plan should act in a fiduciary manner, but many have claimed over time that they are not fiduciaries. Why? They don't want the obligations, they don't want the responsibilities, they don't want the liability.

Until recently, it was fairly easy for outsiders (3rd party providers) to stay outside of the definition of fiduciary under ERISA, but DOL proposed regulations issued on October 21 will pull many under the umbrella of the fiduciary label.

Are you one of the "new fiduciaries" who didn't know you were? http://www.aon.com/attachments/fiduciary_redef_nov2010.pdf