Guest Article

(From the February 5, 2007 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

Another Major Victory for Plan Sponsors in Cash Balance Litigation Saga

The Third Circuit Court of Appeals has joined the Seventh Circuit Court of Appeals in holding that cash balance and other hybrid defined benefit plans are not inherently age discriminatory. The Third Circuit Court of Appeals' decision is another significant step towards clarifying the legal status of cash balance and other hybrid plans under the law in effect prior to changes made by the Pension Protection Act (PPA) of 2006 (P.L. 109-280). However, a recent series of rulings from district courts within the Second Circuit continue to be cause for concern among plan sponsors.

Background and Overview

At issue in all these cases is ERISA § 204(b)(1)(H)(i) (and/or the parallel provision at IRC § 411(b)(1)(H)), which provides a defined benefit plan does not satisfy ERISA's benefit accrual requirements "if, under the plan, an employee's benefit accrual is ceased, or the rate of the employee's benefit accrual is reduced, because of the attainment of any age." The question is whether the rate of an employee's benefit accrual should be measured according to the year-to-year change in the value of the employee's age-65 annuity, or simply as the amount of the employer's pay and interest credits to the employee's hypothetical account. If the former is the answer, then cash balance and other hybrid pension plans are inherently age discriminatory because younger employees have more time to accrue interest credits before reaching retirement age than their older colleagues.

Numerous courts have addressed this question, and most have concluded cash balance and other hybrid pension plans are not inherently age discriminatory. One notable exception had been the U.S. District Court for the Southern District of Illinois, but the Seventh Circuit Court of Appeals overruled the district court's decision last summer. The U.S. Supreme Court recently announced it would not hear an appeal of the Seventh Circuit's ruling.

Since the Seventh Circuit Court of Appeals issued its decision, certain district courts within the Second Circuit's jurisdiction have reached a different conclusion. These courts believe cash balance and other hybrid pension plans are age discriminatory because the rate of benefit accrual in any defined benefit plan means the year-to-year change in the value of the employee's age-65 annuity. Even though at least some of these courts seem to agree this result does not make sense as a policy matter, they believe it is the result that necessarily follows from the language of the statute. The Second Circuit Court of Appeals almost surely will review one or more of these district court rulings.

Third Circuit's Register Decision

Now the Third Circuit Court of Appeals has weighed in on the Seventh Circuit's side. After carefully reviewing the arguments on both sides, the Third Circuit decided Congress did not intend to treat the time value of money as a form of age discrimination.

Briefly, the Third Circuit noted that employer contributions to cash balance plans are identical to employer contributions to defined contribution plans in the sense that younger employees have more time to accrue earnings than older employees. However, this does not raise any age discrimination issues in the defined contribution plan context because the age discrimination rules for these plans focus on the rate of allocations to employees' accounts. As the court put it, "We do not find any support for appellants' argument that Congress wanted to prohibit such a consequence with respect to cash balance plans, but legitimize it for defined contribution plans. Rather, the similarities of the anti-discrimination provisions governing defined benefit and defined contribution plans suggest that Congress was not seeking to prohibit the consequences of the time value of money in either circumstance, and appellants have not offered a reasonable explanation of why Congress would have wanted to do so."

Outlook

Neither the Third Circuit's nor the Seventh Circuit's decision is binding in the Second Circuit or other federal circuits. Thus, the Second Circuit Court of Appeals likely will be called on to decide which interpretation of ERISA's age discrimination rules will prevail in that circuit. The Second Circuit's ultimate decision may prove to be a watershed event in this legal debate. If the Second Circuit sides with its district courts, the resulting split with the Third and Seventh Circuits on these issues may prompt a Supreme Court review. But a decision by the Second Circuit to instead adopt the Third and Seventh Circuits' position might be the proverbial "handwriting on the wall" for those members of the plaintiffs' bar who have been assiduously pursuing these claims.

Of course, whatever happens in the courts relates only to benefit accruals occurring before June 29, 2005 -- the effective date for changes to the age discrimination rules enacted as part of the PPA. The IRS issued initial guidance on those rules in December, and additional guidance is forthcoming.

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, Erinn Madden 202.572.7677, Bart Massey 202.220.2104 , Laura Morrison 202.879-5653, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5314, Tom Veal 312.946.2595, Deborah Walker 202.879.4955. Copyright 2007, Deloitte.