Hodgson Russ LLP

The Employee Benefits practice is pleased to present the Benefits Developments Newsletter for the month of June 2018.


DOL Issues Final Regulations Expanding Access to Association Health Plans

The U.S. Department of Labor has issued final regulations expanding opportunities for small employers and working owners to band together to form association health plans (“AHPs”). The final regulations are generally consistent with the proposed regulations, which were summarized in our February, 2018 newsletter article.

The final regulations allow an association of employers in the same industry or geographic area to join together for the primary purpose of sponsoring a group health plan. The new rule broadens the formerly restrictive “commonality of interest” standard used to determine when a group of employers may sponsor a single ERISA group health plan. While an association may be formed for the primary purpose of providing group health benefits to its members, the final regulations require that the association must have at least one “substantial business purpose” unrelated to the provision of employee benefits. The business purpose must be substantial enough such that the association would be a viable entity in the absence of its sponsorship of the AHP. Substantial activities of an association might include: convening conferences, offering classes, establishing standards for the industry, or engaging in public relations activities.

Some commenters challenged the loosening of the commonality standard as inconsistent with ERISA, previous DOL advisory opinions, and established case authority. Other commenters challenged the new rule on the basis that loosening the AHP standards allows small employers and individuals to avoid the ACA’s essential health benefits requirements, and undermines the ACA’s consumer health protections.

Other AHP requirements include:

  • The association must have formal organizational structure, governing body, and bylaws or other indicia of formality;
  • The employer members of the association must control both the association and the AHP, but need not manage the day-to-day affairs of the association or AHP;
  • The association may not restrict membership in the AHP on the basis of any health factor (health status, medical condition, claims experience, receipt of health care, medical history, genetic information, evidence of insurability or disability), but may make distinctions based on other factors such as industry, occupation, geography or adherence to a wellness program; and
  • The association must not be a health insurance issuer, or owned or controlled by a health insurance issuer.

AHPs have expanded to include working owners without common law employees. Participation by owner employers is limited to those working at least 20 hours per week, a lower threshold than under the proposed regulations. The final regulations also removed the requirement that working owners must not have access to any other subsidized group health coverage, for example, through a plan sponsored by a spouse’s employer.

AHPs formed under the previous legal standard are grandfathered, and AHPs may be sponsored by an association that complies with either the new rule, or pre-rule guidance.

The regulations become effective for fully insured AHPs as of September 1, 2018, for existing self-insured AHPs under pre-rule guidance as of January 1, 2019, and for new self-insured AHPs formed under the new rule as of April 1, 2019. The new rules can be found at Federal Register, Vol. 83, No. 120, Thursday, June 21, 2018, 29 CFR Part 2510, “Definition of ‘‘Employer’’ Under Section 3(5) of ERISA—Association Health Plans”.


New DOL Guidance: Environmental/Social/Governance Investment Considerations

The Department of Labor (DOL) published new guidance to assist Employee Benefits Security Administration’s (EBSA’s) national and regional offices in interpreting prior guidance regarding the environmental, social or governance (ESG) factors plan fiduciaries may consider when making investment decisions. As plan investments come under greater participant scrutiny in terms of fees and overall prudence, concerns for socially responsible plan investing also continue to be expressed both by participants and fiduciaries. There are previous interpretive bulletins that provide guidance on the concepts of economically targeted investments (ETIs) and consideration of ESG factors in making investment decisions. The most recently issued guidance (Field Assistance Bulletin 2018-01 (the “FAB”)) does not replace the prior guidance, but it expresses a narrower view on the extent to which ESG factors may be considered in making plan investment decisions, while still adhering to fundamental ERISA fiduciary standards of prudence.

The DOL view still is that plan fiduciaries generally “are not permitted to sacrifice investment return or take on additional investment risk as a means of using plan investments to promote collateral social policy goals.” That said, consideration of ESG factors in making plan investment decisions is permissible and, under the proper circumstances, ESG factors can be “more than mere tie-breakers.” However, the FAB cautions that fiduciaries “must not too readily treat ESG factors as economically relevant to the particular investment choices at issue when making a decision,” and reminds fiduciaries that plan fiduciaries “must always put first the economic interests of the plan in providing retirement benefits.”

Where a plan permits participants to choose from a menu of investment fund options, the FAB states that “adding one or more funds to a platform in response to participant requests for an investment alternative that reflects their personal values does not necessarily result in the plan forgoing the placement of one or more other non-ESG themed investment alternatives on the platform.” A “prudently selected, well managed, and properly diversified ESG-themed investment alternative” can be added to the investment fund line-up without requiring the plan to remove or forego adding other non-ESG-themed investment options to the platform. Nonetheless, the FAB notes that a “decision to designate an investment alternative may not be influenced by non-economic factors unless the investment ultimately chosen for the plan, when judged solely on the basis of its economic value, would be equal to or superior to alternative available investments.”

In choosing qualified default investment alternatives (QDIAs), the relevant regulations offer no indication that “fiduciaries should choose QDIAs based on collateral public policy goals.” The FAB, however, cautions that a “decision to favor the fiduciary’s own policy preferences in selecting an ESG-themed investment option for a 401(k)-type plan without regard to possibly different or competing views of plan participants and beneficiaries would raise questions about the fiduciary’s compliance with ERISA’s duty of loyalty.”

The DOL has previously acknowledged that a retirement plan’s investment policy statement (IPS) can include language that speaks to the use of ESG factors in making plan investment decisions. With respect to QDIAs, however, the FAB cautions makes it clear that an IPS is not required to include guidelines on ESG investments. Furthermore, to the extent an IPS includes ESG investment guidelines, the FAB cautions fiduciaries, including ERISA Section 3(38) investment managers, that they must adhere to those guidelines only to the extent the IPS and the ESG guidelines are consistent with ERISA fiduciary standards. Where it is imprudent to comply with aspects of an IPS, the fiduciary must disregard it.

To the extent has an IPS that incorporated ESG investment guidelines or otherwise takes into account ESG factors in selecting specific plan investments, investment fund options, or QDIAs, the FAB represents important new guidance on how fiduciaries should be approaching ESG investment decisions.


AD&D Benefit Denial Reversed

In this case, a plan participant had his leg partially amputated following an automobile accident. The participant’s Accidental Death and Dismemberment claim, however, was denied because the claims administrator determined that the amputation was not the direct and sole cause of the accident, but rather the amputation was contributed to and complicated by the patient’s pre-existing diabetic condition. A district court upheld the claims administrator’s decision, concluding that coverage is barred because the plan provides that no physical illness can “cause or contribute” to the loss, and that the participant’s diabetes contributed to his loss. In reversing the district court’s decision, the Ninth Circuit Court of Appeals found that, although the diabetes was a factor in the injury, the factual record does not support a finding that the disease met the applicable standard of substantially contributing to the participant’s loss. The court notes that in order to be considered a substantial contributing factor for the purpose of restricting coverage, a pre-existing condition must be more than merely a contributing factor. A mere relationship of undetermined degree is not enough. Dowdy v. Metro. Life Ins. Co. (9th Cir. 2018).


Federal District Court Dismisses Breach of Fiduciary Duty Lawsuit Against Northwestern University’s 403(b) Retirement Plans

Participants in two Northwestern University 403(b) retirement plans brought a class action lawsuit in Illinois federal district court against the university, investment committee members and other plan fiduciaries, alleging that the plans’ investments had been mishandled, resulting in excessive fees and other harm to participants. In a massive complaint totaling 165 pages, the plaintiffs alleged that: (i) fiduciaries did not monitor investment options, provided too many investment options, and included poorly performing funds and funds with excessive fees in the fund line up; (ii) fees for recordkeeping were excessive, and were improperly paid through revenue sharing; and (iii) fiduciaries failed to use their bargaining power to negotiate more favorable investment fund expense ratios, including making institutional class funds available, rather than higher cost retail funds.

The defendants moved to dismiss under a procedural rule which required the federal district court to take as true the facts alleged in the compliant, and to draw reasonable inferences in favor of the plaintiffs. Despite the favorable legal standard for plaintiffs, the judge granted defendants’ motion to dismiss all counts and refused plaintiffs’ request to amend their complaint as untimely and futile, because their newly alleged facts would not alter the court’s decision.

Dismissing plaintiffs’ first fiduciary breach claim, the court emphasized that plan participants were not required to invest in the funds plaintiffs alleged were underperforming and charged excessive fees. The court noted that the mere presence of underperforming or more expensive investments, “does not a fiduciary breach make.” Citing the Seventh Circuit decision in Loomis v. Exelon Corp., 658 F.3d 667, 673-4 (7th Cir. 2011), the judge stated that plaintiffs’ theory that participants were incapable of choosing among multiple investment funds was “paternalistic”, and that the plans did not violate ERISA by allowing participants to make their own choices among a variety of investment fund types.

Next, the court addressed the allegation that the plans’ practice of paying recordkeeping expenses through revenue sharing violates ERISA, and that such fees were excessive. Citing the specific holding of another Seventh Circuit decision, Hecker v. Deere & Co., 556 F.3d 575, 585 (7th Cir. 2009), the court held that the use of revenue-sharing to pay plan expenses is permissible, and further held that ERISA’s fiduciary standard does not require the plan fiduciaries to “scour the market” to find the cheapest possible funds. Examining the revenue sharing expense fees under the plans, the court specifically held that the ability of participants to select plan funds with expense ratios of 0.05%, 0.06% and 0.1%, which were “as a matter of law, low”, defeated plaintiffs’ claim that recordkeeping expenses charged were excessive, or constituted a breach of fiduciary duty.

The availability of low-cost index funds led the court to conclude that no fiduciary breach occurred under an amalgamation of similar assertions – e.g., that the range of investment options was too broad, that retail fund fees should not have been charged, and that the plan fiduciaries should have negotiated lower fees. Because the investment fees paid were reasonable as a matter of law and were within the control of participants, the court also dismissed claims that defendants engaged in ERISA prohibited transactions.

The complete vindication of the Northwestern University plans may give hope to other 403(b) plan sponsors defending similar claims of fiduciary breach, particularly in participant-directed plans where low-cost index funds are among the available investment options. Divane v. Northwestern University (N.D. Ill 2018).


Real Estate Development Company Held Not to be a REOC

A person is a fiduciary with respect to an ERISA plan if, among other functions, the person exercises any authority or control with respect to the plan’s assets. In general, a plan’s assets are limited to its direct investments. However, if a plan’s direct investment is an equity interest in a non-publicly offered security, the plan’s assets may include both its direct equity investment and the underlying assets of the entity in which the plan has made its direct equity investment, unless either (i) the entity is an operating company, or (ii) equity participation in the entity by benefit plan investors is less than 25% of the value of any class of equity interest in the entity.

It’s not often that the Department of Labor’s plan asset regulation takes center stage in litigation, but a recent case highlights the potential perils of a plan’s assets including not only its direct equity investment in an entity, but also the entity’s underlying assets. In Hart Interior Design LLC 401(k) Profit Sharing Plan v. Recorp Investments Inc. (D. Ariz.), Paul Maniatis had organized Carinos Properties, LLC (“Carinos”) in June 2000. The plaintiff in the case, Hart Interior Design LLC 401(k) Profit Sharing Plan (the “Plan”), acquired a 28% membership interest in Carinos in August 2000. In September 2000, Carinos purchased more than 1,250 acres of property. Five other entities owned by Mr. Maniatis owned the surrounding 9,750 acres. Carinos was managed by an entity owned by Mr. Maniatis named Recorp Investments, Inc. (“RII”). In 2006, Recorp Inc. (a non-existent entity that was used to refer to all of the Maniatis companies with a stake in the property) acquired interests in deep well groundwater appurtenant to the property. Recorp Inc. subsequently drilled two water wells on the property.

Mr. Maniatis ran into financial difficulties and, in 2012, IMH Financial Corporation (“IMH”), a lender to Mr. Maniatis, obtained a multi-million dollar judgment against him. As part of the judgment, Mr. Maniatis transferred ownership of RII to a wholly owned IMH subsidiary. IMH also obtained a 36% membership interest in Carinos. An IMH subsidiary subsequently sued Carinos and other Recorp entities in New Mexico state court to recover funds on an alleged secured debt executed by Maniatis. IMH also sued Carinos in Arizona state court to recover unpaid management fees Carinos allegedly owned to RII. Since Carinos lacked funds to defend itself, the Plan intervened to defend Carinos. In the state court actions, the Plan challenged the legitimacy and the amounts of the unpaid debts.

The Plan also filed suit in federal district court against RII and IMH, alleging that they were each fiduciaries with respect to the Plan by virtue of their exercising control over the Plan’s assets, and that by attempting to collect suspect debts and withholding certain material information RII and IMH were in breach of their fiduciary duties to the Plan. Since Carinos’ securities were not publicly offered and the Plan owned 28% of the membership interests in Carinos, at issue was whether Carinos was an operating company and, in particular, a real estate operating company (or REOC).

To constitute a REOC during a relevant period, (i) at least 50% of the entity’s assets must be invested in real estate which is managed or developed, (ii) the entity must have the right to substantially participate directly in the management or development activities, and (iii) the entity must, in the ordinary course, be engaged directly in real estate management or development activities. Since the only development performed with respect to the property was the two wells drilled several years before at a time when Mr. Maniatis still owned a membership interest in Carinos, the Court held that Carinos was not actually engaged in real estate management or development in the ordinary course during the relevant period – the court also stated that the mere existence of the two wells would not have qualified Carinos as a REOC anyways. As a result, the district court granted summary judgment in favor of the Plan on the issue of Carinos being a REOC. With respect to the issues of RII and IMH’s status as fiduciaries and whether they had breached their fiduciary duties, the district court held that a triable issue of fact existed.