Guest Article

(From the September 11, 2006 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

Full Seventh Circuit Refuses Request to Review Panel's Decision in Cash Balance Case

The full Seventh Circuit Court of Appeals will not re-hear a case alleging that cash balance plans are inherently age discriminatory. A three-judge panel from the Seventh Circuit early last month ruled cash balance plans do not run afoul of age discrimination prohibitions simply because younger workers have more time to earn interest credits on contributions than their older colleagues. Cooper v. IBM Personal Pension Plan, 05-3588 (7th Cir. August 7, 2006). The plaintiffs will now appeal the three-judge panel's decision to the United States Supreme Court.

Case Background

This legal odyssey started in 2003 when a U.S. District Court judge 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 than the latter. However, the Seventh Circuit Court of Appeals rejected that conclusion with this pithy observation: "Treating the time value of money as a form of discrimination is not sensible."

Legislative Developments

Just days before the Seventh Circuit Court of Appeals' 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.

Additional rules apply to cash balance and other hybrid plans, which the new law calls "applicable defined benefit plans." In addition to satisfying the general age discrimination standard, these plans must credit interest at or below a market rate of return and provide for three-year vesting with respect to employer contributions. In the case of conversions from traditional defined benefit plans to hybrid designs, the PPA prohibits "wear-aways" of accrued benefits. Finally, the PPA corrects the "whipsaw" problem by permitting applicable defined benefit plans to pay lump sums equal to the hypothetical account balance.

What Does it All Mean?

As noted, the PPA's rules relating to cash balance and other hybrid plans generally are effective beginning June 29, 2005. Furthermore, the PPA specifically provides that no inference is to be drawn with respect to applying the pre-PPA age discrimination rules to cash balance and other hybrid plans. Thus, legal challenges to cash balance and other hybrid plans pursuant to pre-PPA rules are still viable.

Now the Supreme Court will have an opportunity to decide whether it wants to take on those pre-PPA claims, or wait to see how other circuits handle these issues. If the Supreme Court decides not to review this case, the Seventh Circuit's decision will stand as the best legal authority to date on applying the pre-PPA age discrimination rules to cash balance plans. Of course, the Seventh Circuit's decision is not binding in any other circuit, so there is still the possibility of other courts reaching different conclusions. So the drama continues.

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, 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.