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Guest Article
(From the November 6, 2006 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)
On the day before Halloween cash balance plan sponsors were greeted with a "trick" at the doorstep of the courthouse. Less than two months after the Seventh Circuit Court of Appeals ruled that cash balance plans do not inherently violate federal age discrimination prohibitions, the U.S. District Court for the Southern District of New York - which is part of the Second Circuit - issued a frightening reminder that these age discrimination suits are still viable in the rest of the federal circuits. In re J.P. Morgan Chase Cash Balance Litigation, 06 Civ. 732 (S.D.N.Y., October 30, 2006).
Background
In 2003 the U.S. District Court for the Southern District of Illinois ruled cash balance and other hybrid plan designs violate ERISA § 204(b)(1)(H), which prohibits age-based reductions in the "rate of an employee's benefit accrual." The district court judge reached this conclusion after deciding an employee's "rate of benefit accrual" means "the rate at which an employee accrues a benefit payable in the form of an annuity that commences at age 65." Viewed this way cash balance plans necessarily violate ERISA § 204(b)(1)(H) due to the fact the same pay credit is more valuable to a younger employee than to an otherwise identical older employee because the former has more time to earn interest on the pay credit than the latter. The plan sponsor appealed this ruling to the Seventh Circuit Court of Appeals, which ultimately dismissed the district courtfs conclusion with this pithy observation: "Treating the time value of money as a form of [age] discrimination is not sensible."
Just days before the Seventh Circuit's decision, Congress passed legislation that updates the age discrimination rules for all defined benefit plans, including cash balance and other hybrid plans. However, the new age discrimination rules apply only to periods beginning on or after June 29, 2005, and thus are not relevant to age discrimination claims based on benefit accruals occurring before that date.
Briefly, the Pension Protection Act (PPA) of 2006 (P.L. 109-280) provides that defined benefit plans generally are not age discriminatory if a participant's accrued benefit determined as of any date under the plan's terms would be equal to or greater than that of any similarly situated, younger individual who is or could be a participant. For this purpose, the accrued benefit can be expressed as an annuity payable at normal retirement age, the balance of a hypothetical account, or the current value of the accumulated percentage of the employee's final average compensation. Also, cash balance or other hybrid plans - which the new law calls "applicable defined benefit plans" - must credit interest at or below a market rate of return and provide for three-year vesting of employer contributions in order to satisfy this age discrimination standard.
The cash balance plan case before the U.S. District Court for the Southern District of New York involves periods beginning before June 29, 2005, so the PPA's new age discrimination rules do not apply. Additionally, because the district court is within the Second Circuit (as noted), the Seventh Circuit Court of Appeals' decision is not controlling.
A Different Point of View
Citing the reasoning of the Seventh Circuit Court of Appeals' decision, the plan sponsor asked the U.S. District Court for the Southern District of New York to dismiss the age discrimination claim. The district court denied the plan sponsor's request, and specifically rejected the Seventh Circuit's analysis.
According to the New York district court, the question is not one of policy but rather of statutory construction and interpretation. Specifically, the issue is the meaning of the phrase "rate of an employee's benefit accrual" as used in ERISA § 204(b)(1)(H). The Seventh Circuit ruled that, in the case of cash balance plans, this phrase refers to the employer's contributions to the plan on each employee's behalf. Thus, as long as the cash balance plan's pay and interest credits do not vary because of age, there is no age discrimination problem.
But the New York district court chided the Seventh Circuit for treating "cash balance plans as defined contribution plans." The district court noted ERISA § 204(b)(2)(A) provides a different age discrimination standard for defined contribution plans, based on "the rate at which amounts are allocated to the employee's account" instead of "the rate of an employee's benefit accrual." In the district court's words, "It is difficult to imagine that in this case, where Congress has set forth one standard applicable to defined-benefit plans and another standard applicable to defined-contribution plans, they meant both provisions to mean the same thing." Accordingly, the district court concluded the proper way to measure the rate of benefit accrual is by reference to the change in the present value of the employee's age-65 annuity. As noted, this standard results in cash balance plans being inherently age discriminatory.
Sorting It All Out...
The district court's ruling is important because it sends a clear signal that, even after the Seventh Circuit's decision, there are courts in other circuits still willing to entertain age discrimination claims against cash balance and other hybrid plans for periods beginning before June 29, 2005. And if the plan sponsor pursues an appeal and the Second Circuit Court of Appeals upholds the district court's decision, the circuits will be split on the issue of applying the age discrimination rules to cash balance plans. That might prompt the U.S. Supreme Court to review this issue. Of course, it is still possible the Supreme Court will hear an appeal of the Seventh Circuit's decision even before such a split emerges. Stay tuned.
| The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations.
If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Taina Edlund 202.879.4956, Laura Edwards 202.879.4981, Mike Haberman 202.879.4963, Stephen LaGarde 202.879-5608, Bart Massey 202.220.2104, Laura Morrison 202.879.5653, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5314, Carlisle Toppin 202.220.2067, Tom Veal 312.946.2595, Deborah Walker 202.879.4955. Copyright 2006, Deloitte. |
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