The Employee Benefits Practice is pleased to present the Employee Benefits Developments Newsletter for the month of December 2020. Click on the links below for more information on each specific development or case.

New SECURE Act Guidance for Safe Harbor Plans

The IRS published a series of questions and answers in recently issued Notice 2020-86 intended to assist small businesses and other employers that maintain safe harbor 401(k) and 403(b) plans comply with certain rule changes made by the SECURE Act. The Notice has been made available until the IRS is able to develop more comprehensive regulations. The rule changes addressed by the Notice are:

• The increase from 10 percent to 15 percent of the maximum automatic elective deferral under a qualified automatic enrollment safe harbor plan or “QACA”;
• The elimination of certain safe harbor notice requirements for plans that provide safe harbor nonelective contributions;
• The new provisions allowing for retroactive adoption of safe harbor status.

15% Deferral Maximum for Automatic Enrollment Safe Harbor Plans

• QACA safe harbor plans are not required to increase to 15% the maximum qualified percentage of compensation used to determine automatic elective contributions – the increase is optional. The qualified percentage under a QACA safe harbor plan maybe any percentage of compensation determined under the plan, as long as the percentage is applied uniformly, does not exceed 15 percent (or 10 percent during the initial period of automatic elective contributions), and satisfies certain minimum percentage requirements specified in the Internal Revenue Code (the “Code”).
• A QACA safe harbor plan that incorporates the maximum qualified percentage by reference to the Code will not fail to operate in accordance with its terms if it continues to apply the maximum qualified percentage of 10 percent (instead of the new maximum of 15 percent). But a timely SECURE Act amendment that explicitly and retroactively provides that the plan’s maximum qualified percentage is and has been 10 percent must be adopted. The SECURE Act amendment deadline generally is the last day of the 2022 plan year.

Elimination of Certain Safe Harbor Notice Requirements

• The SECURE Act eliminated the safe harbor notice requirement for traditional safe harbor ADP plans that rely on nonelective contributions to satisfy either ADP safe harbor. But the Notice clarifies that the SECURE Act did not eliminate the safe harbor notice requirements for a traditional safe harbor ACP plan that satisfies the safe harbor nonelective contribution requirements. So:
  • If a traditional safe harbor plan satisfies the safe harbor nonelective contribution requirements, but also provides nonsafe harbor matching contributions that are not required to satisfy the actual contribution percentage (ACP) test, then the plan still must satisfy the safe harbor notice requirements. The result, however, is different for a QACA safe harbor plan in this situation – the QACA safe harbor plan would not be required to satisfy the safe harbor notice requirements.
  • And, if a traditional safe harbor plan satisfies the safe harbor nonelective contribution requirements, but also provides nonsafe harbor matching contributions that are required to satisfy the ACP test, then the plan need not satisfy the safe harbor notice requirements.
• The SECURE Act does not change any other requirements that may apply to a plan that satisfies the safe harbor nonelective contribution requirements applicable to a traditional or QACA safe harbor plan.
• Mid-Year Amendment/Suspension Rules
  • If a plan does not provide a safe harbor notice for a plan year beginning after 2019 because safe harbor notice requirements no longer apply to the plan, but the employer nevertheless provides a notice that (i) includes a statement that the plan may be amended mid-year to reduce or suspend safe harbor nonelective contributions, and (ii) otherwise satisfies the requirements for a safe harbor notice, the plan will not fail to satisfy the requirement that the statement regarding the possible mid-year reduction or suspension of safe harbor nonelective contributions be included in a safe harbor notice. Solely for the first plan year beginning after 2020, the notice is considered timely if given to each eligible employee by the later of 30 days before the beginning of the plan year or January 31, 2021.
  • If an employer amends a traditional or QACA safe harbor plan to reduce or suspend the plan’s safe harbor nonelective contributions during a plan year, but later amends the plan to readopt the safe harbor nonelective contributions for the entirety of the plan year, then as long as the subsequent amendment is adopted at least 30 days before the plan year closes the plan will not be required to satisfy the ADP or ACP test (as applicable) for the plan year or be subject to the top-heavy rules for the plan year.

Retroactive Adoption of Safe Harbor Status

• Effective for plan years beginning after 2019, a plan generally may be amended during a plan year to adopt a safe harbor design for the plan year using safe harbor nonelective contributions if the plan is retroactively amended at least 30 days before the plan year closes – notably, the guidance was published after the 30-day deadline for the calendar year 2020 plan year has passed which limits a calendar year plan’s options in 2020. However, a retroactive amendment may be adopted as late as the last day for distributing excess contributions for the plan year, but only if the amount of the nonelective contribution the employer is required to make under the arrangement for the plan year with respect to any eligible employee is an amount equal to at least four percent of the employee’s compensation.
• Note that because the SECURE Act did not eliminate the safe harbor notice requirements for a traditional ACP safe harbor plan that satisfies the safe harbor nonelective contribution requirements (see discussion above), the new retroactive adoption rules, in that case, do not supersede the current regulations – that safe harbor plan remains subject to the pre-SECURE Act safe harbor notice requirements.
• If a plan is retroactively amended to adopt safe harbor nonelective contributions of at least four percent of compensation for a plan year, and if the safe harbor nonelective contributions are contributed to the plan after the tax filing deadline for the prior taxable year (including extensions) but before the deadline for distributing excess contributions for the plan year, the safe harbor nonelective contributions will not be deductible for the prior taxable year – they still must be contributed by the tax filing deadline to be deductible.

Notice 2020-86 applies on similar terms to 403(b) plans that apply the ACP safe harbor rules.

The Treasury Department and the IRS have invited comments on the guidance in Notice 2020-86 – those comments must be submitted in writing on or before February 8, 2021.

While Notice 2020-86 does not make for particularly light reading, for employers with plans that might be looking to retroactively adopt or readopt safe harbor features for the 2020 plan year, or might looking to implement safe harbor features for the upcoming 2021 plan year, it provides valuable guidance on the notice requirements and amendment deadlines.

DOL Issues Final Rule Restricting ESG Investments in Retirement Plans

On October 30, 2020, the U.S. Department of Labor issued its final rule on Financial Factors in Selecting Plan Investments (“Final Rule”). The Final Rule amends the investment regulations under ERISA, requiring retirement plan fiduciaries to satisfy their duties of prudence and loyalty by selecting investments based solely on pecuniary considerations.

Consistent with the Proposed Regulations issued in June (see our article here), the Final Rule restricts retirement plan fiduciaries from considering non-pecuniary environmental, social and governance (“ESG”) factors when selecting the investments to be offered to plan participants. Non-pecuniary factors may only be taken into account in “tiebreaker” situations where two investment alternatives are indistinguishable in terms of pecuniary factors.

The Final Rule departs from the Proposed Regulations in the following respects:

• Replaces all references to ESG with “non-pecuniary” because of the lack of a precise, consistent definition of ESG;
• Removes specific language regarding which investment characteristics might constitute pecuniary ESG considerations;
• Separates regulatory provisions related to the duties of prudence and loyalty, and clarifies that the duty of prudence provisions continue to provide a safe harbor, whereas the duty of loyalty provisions are minimum standards;
• Incorporates new language regarding the investment analysis and documentation requirements that must be satisfied for plan fiduciaries to consider non-pecuniary factors in “tiebreaker” situations; and
• Adds language indicating that fiduciaries must consider “reasonably available alternatives” to indicate that fiduciaries need not “scour the market” or evaluate every possible investment alternative to satisfy the Final Rule.

The Final Rule sets forth the following fiduciary principles:

1. ERISA fiduciaries must satisfy the duties of prudence and loyalty by evaluating and selecting investments based solely on pecuniary factors – e.g., financial considerations that have a material effect on risk and/or return based on appropriate investment horizons;
2. Compliance with the duty of loyalty prohibits fiduciaries from subordinating the interests of participants to unrelated objectives, from sacrificing investment returns, or taking on additional investment risk to promote non-pecuniary goals;
3. Fiduciaries must consider reasonably available alternatives to satisfy the duties of prudence and loyalty;
4. Fiduciaries must satisfy investment analysis and documentation requirements if non-pecuniary factors are used in “tiebreaker” situations where investment alternatives are indistinguishable based on pecuniary factors, including demonstrating;
   1. Why pecuniary factors were not sufficient to select the investment;
   2. How the selected investment compares to alternative investments with regard to liquidity, diversity, and returns; and
   3. How the non-pecuniary factor(s) are consistent with the interests of participants in their retirement income or financial benefits under the plan; and
5. ERISA fiduciaries of participant-directed retirement plans are not outright prohibited from including an investment fund that promotes non-pecuniary goals so long as a fiduciary’s evaluation of the investment is based solely on pecuniary factors.

The Final Rule becomes effective January 12, 2021. Because the Final Rule is prospective in effect, plan fiduciaries are not required to immediately divest their ESG investment offerings. However, the DOL stated in preambles to the Final Rule that fiduciaries nonetheless have an ongoing duty to monitor ESG investment offerings, and to consider whether investments featuring non-pecuniary factors continue to be viable under the fiduciary standards of the Final Rule, sufficient to be retained. In contrast, plan administrators have until April 30, 2022 to implement the obligation to divest QDIAs that are not compliant with the Final Rule.

Department of Labor, Employee Benefits Security Administration, 29 CFR Parts 2509 and 2550, Financial Factors in Selecting Plan Investments, 88 Fed. Red. 72846 (November 13, 2020).

Employer Held Liable For Service Provider's Error

Usually court cases involving proper remedies under ERISA are largely of interest only to ERISA attorneys and litigators. However, a recent Second Circuit Court of Appeals case is one that should be of interest to employers who sponsor plans. The case involves a retiree group term life insurance plan. The plaintiff’s mother in this case was employed for a number of years and her annual income was $16,800. Under the terms of the plan, the mother was eligible for life insurance coverage equal to one times annual pay. However, the third party administrator incorrectly coded the mother’s income as being $16,800 per week. The administrator sent various communications to the plaintiff’s mother informing her of the level of coverage. The plaintiff’s mother contacted the administrator and indicated that she was surprised by the level of coverage, but she was told the level was correct. The administrator’s record showed that an employee asked a supervisor to look at the level of benefit and the supervisor told the subordinate employee that the level of coverage was correct. The daughter, relying on this level of life insurance coverage for her mother, quit her job and allowed her mother to live with her rent free, covered her mother’s living expense, paid off the mother’s debt, and the daughter took an unpaid leave of absence.

As you may suppose, the mother died and the daughter expected to receive $679,000 as a death benefit. At the time the claim was filed, the administrator recognized the error in their records and informed the daughter/plaintiff that the benefit was only $16,800. A lawsuit occurred.

The Second Circuit, overturning the district court, made two findings. First, the employer’s appointment of the third party administrator was a fiduciary act and therefore, errors made by the third party administrator are imputed to the employer/fiduciary. Therefore, the statements informing mother of the higher level of coverage are to be upheld as a statement made by a fiduciary to a plan participant. Second, the court found that the employer is liable because the daughter detrimentally relied on the statements made by the third party administrator and therefore, it was an appropriate remedy under ERISA for this fiduciary breach to provide for monetary damages.

As this case highlights, employers should be aware that they may be held liable for mistakes made by third party administrators that they hire. Employers may want to review service contracts with their third party administrators regarding the third party administrator’s liability. Employers may also want to require third party administrators to inform the employer when any questions are raised about the proper calculation of benefits so that the employer may review the situation before a tragic situation happens and a large lawsuit occurs. Sullivan-Mestecky v. Verizon Communications Inc., (2d Cir. 2020).

State Law Regulating PBMs Not Pre-Empted by ERISA

The Supreme Court recently held that the Employee Retirement Income Security Act (“ERISA”) does not preempt an Arkansas law regulating Pharmacy Benefit Managers (“PBMs”). PBMs generally act as intermediaries between health plans and pharmacies, providing services such as claims processing, negotiating rebates from drug manufacturers, and setting pharmacy reimbursement rates. Arkansas passed a law regulating the PBMs’ pharmacy reimbursement rates. Under this state law, a PBM could not set a reimbursement rate lower than the pharmacy’s acquisition cost. The intent of the legislation is to protect smaller, independent pharmacies that would often incur a loss when filling a prescription where their acquisition cost was higher than the reimbursement rate set by a PBM. The Pharmaceutical Care Management Association sued, claiming in part that the Arkansas state law regulated employee benefit plans and therefore should be preempted by ERISA. ERISA is a federal law that preempts any state law that interferes with nationally uniform employee benefit plan administration. The Court held, however, that the state law did not preempt ERISA because the law “merely increased costs or altered incentive plans.” The law was a form of cost regulation and did not force plans to “adopt any particular scheme of substantive coverage.” This ruling is significant because it highlights the limitations of ERISA preemption and will likely mean greater state regulation of PBMs. (Rutledge v. Pharm. Care Mgmt. Ass’n, (U.S. 2020).

Circuit Court Holds Plan Entitled to Recoupment of Overpayment

In 2016, the Supreme Court held, in Montanile v. Board of Trustees of the National Elevator Industry Health Benefit Plan, that Section 502(a)(3) of the Employee Retirement Income Security Act allows a plan to recover an overpayment of benefits where the funds remain in the payee’s possession or can be traced to property acquired with the funds. A recent decision by the Sixth Circuit Court of Appeals applies the Montanile decision to an overpayment of benefits from a pension plan.

In Zirbel v. Ford Motor Co., an alternate payee under a qualified domestic relations order received an overpayment of $243,000 from a pension plan sponsored by Ford Motor Company. After taxes were withheld from the distribution, the remaining proceeds were ultimately placed in a retirement account, invested in mutual funds, gifted to the alternate payee’s children, and used to pay more taxes. After discovering the overpayment, the plan committee invoked a plan provision providing “In the event of an error that results in an overpayment of benefits to a Member, the amount of the overpayment shall be returned to the Retirement Fund, without limitation, except the Committee shall have discretionary authority to reduce any repayment amount from a Member” and sought to recover the $243,000 overpayment amount. The alternate payee appealed the decision through the plan’s administrative claims procedure, which was ultimately denied by the plan committee. As part of the administrative claims process, the alternate payee was provided the opportunity to apply for a hardship waiver, but she failed to do so.

Applying an arbitrary and capricious standard of review, the Appeals Court held that the plan committee’s decision to seek recoupment was permissible. As to the issue of tracing the overpaid funds, the Appeals Court rejected the argument that commingling the overpayment with other investments defeated the equitable lien running in favor of the plan. Regarding the portion of the overpayment used to pay taxes and to make gifts to the alternate payee’s children, it appears the alternate payee failed to argue that these portions of the overpayment were no longer traceable at the district court level and, therefore, the Appeals Court held that the argument had been waived.

The decision in Zirbel demonstrates the importance in having a full and fair administrative claims process and following that process in seeking to recover overpayments. Although the Zirbel decision provides additional favorable precedent for plans seeking to recover overpayments, we expect that recouping overpayments will nevertheless remain challenging in many cases due to the fact-intensive process of tracing any overpayment.