One recent line of ERISA litigation involves the actuarial equivalence factors used by defined benefit pension plans. The lawsuits apply both to active defined benefit pension plans and pension plans that have been “frozen” as to future benefit accruals.
In a traditional defined benefit pension plan, a participant’s benefit typically is calculated under a formula that defines the benefit in terms of a monthly life-only annuity commencing with the month following the participant’s sixth-fifth (65th) birthday with no survivor benefit following the participant’s death (the “Life Annuity Benefit”).
Although the pension plan formula defines the Life Annuity Benefit, plan participants may receive payment of their pension benefit in a form other than the age 65 Life Annuity Benefit. Federal pension law generally requires that the benefit payable to a married participant be paid in the form of a joint and surviving spouse annuity (“Joint and Survivor Benefit”) unless the participant has elected payment in an alternate payment form and the participant’s spouse has consented to the participant’s election in the presence of a notary public or authorized plan representative. A Joint and Survivor Benefit provides monthly benefits to the participant for life, and if the participant predeceases the spouse to whom the participant was married on the annuity starting date, a survivor benefit is payable for the remaining life of the spouse. A plan might provide for other alternate payment forms as a matter of plan design.
Converting the Life Annuity Benefit into the Alternate Payment Form
When a participant elects payment in an alternate payment form, the pension plan must convert the participant’s Life Annuity Benefit into an equivalent payment in the applicable alternate payment form. For example, if the benefit will be paid in the form of a Joint and Survivor Benefit, the plan must convert from the Life Annuity Benefit to an actuarially equivalent Joint and Survivor Benefit. The monthly amount payable to the participant under the Joint and Survivor Benefit will be less than the monthly amount that the participant would have received under the Life Annuity Benefit because the Joint and Survivor Benefit includes both a benefit payable over the participant’s lifetime and a potential survivor benefit following the participant’s death. To convert from the Life Annuity Benefit to the Joint and Survivor Benefit, the participant essentially accepts a lower monthly benefit in exchange for the potential survivor benefit.
In actual operation, the defined benefit pension plan specifies actuarial assumptions or factors for converting from the Life Annuity Benefit to the Joint and Survivor Benefit (or to any other alternate payment form). Sometimes, those factors refer to a particular interest rate and mortality table that are used to make the conversion. In other cases, a plan might specify simplified conversion factors, e.g., the participant’s Joint and Survivor Benefit is 93% of the benefit that the participant would have been received under the Life Annuity Benefit.
What do the Lawsuits Challenge?
Basically, the lawsuits allege that the plan, through the use of out-of-date and “unreasonable” actuarial assumptions and conversion factors, has “overcharged” participants when converting from the Life Annuity Benefit to payment in an alternate payment form.
As described above with respect to the conversion from a Life Annuity Benefit to a Joint and Survivor Benefit, the plan expects to incur additional costs in connection with a Joint and Survivor Benefit because of the survivor benefit feature, and as a result, it is logical for the plan to “charge” for this additional expected expense by reducing the participant’s lifetime benefit such that, on average, the Life Annuity Benefit and the Joint and Survivor Benefit have the same expected cost to the plan. The lawsuits do not challenge the plan’s right to “charge” for the additional benefits provided under an alternate payment form. However, the lawsuits allege that the plan has charged too much because the plan has made the conversion from the Life Annuity Benefit to the alternate payment form using actuarial assumptions and factors that are outdated and that over-state the actual expected cost to the plan of providing benefits in an alternate form as compared to the “charge” that would result from updated factors and assumptions.
In many of the cases, the challenge focuses on allegedly outdated mortality tables that do not take improved life expectancy into account. In some situations, the actuarial factors (including mortality table assumption) were established decades ago and have never been updated. In essence, the lawsuits allege that the plan (by not using updated factors and tables) is not paying out the full value of the participant’s benefit when the participant has elected payment in an alternate payment form.
Status of the Lawsuits
Results of the lawsuits to date have been mixed. Some cases have been cleared for discovery and trial, a few have been dismissed (albeit on technical rather than substantive grounds), and a few have produced settlements.
One case, which resulted in a settlement, might be instructive. There, participant benefits would have increased by approximately $150 million if the benefit were recalculated using the actuarial assumptions that the plaintiff class had advanced as “reasonable”. The parties settled for approximately 40% of that figure ($59 million).
The issues involved are complicated. In addition to the core substantive issue about whether ERISA and/or the Internal Revenue Code require that actuarial conversion assumptions, factors and tables be periodically updated, the cases raise issues involving (a) the appropriateness of permitting this type of case to proceed on a class-action basis, and (b) the appropriate statute of limitations applicable to participants who have already commenced retirement benefits, i.e., when it is too late for a participant to complain about his or her benefit calculation.
These issues and more remain to be resolved in the courts. The situation is fluid, as cases continue to be filed and some cases move closer to trial on the merits.