IBM case is reversed on appeal

[Guest mjb]

Yesterday the US ct of appeals for the 7th circuit issued issued a unanimous decision (3-0) reversing the lower ct decision finding that IBMs cash balance discriminated on account of age because the benefit accrual formula included an interest component. The ct's rationale was the opposite of the district ct opinion which held that using interest to determine a benefit accrual formula for each year's benefit was discriminatory (because the compounding of interest would always result in a larger accrued benefit payable at normal retirement age (NRA) for any year 's accrual for a younger person who had a longer time before reaching NRA than an older person.) Age discrimination in pension plans protects employees under 40. The district ct had held that using interest in the annual benefit accrual formula to determine the amount of the accrued benefit paid at NRA was nondiscriminatory only in a DC plan. The 7th circuit held that ERISA does not forbid a benefit accrual formula in a DB plan from using an interest component since benefit accrual (the annual amount which is credited to the participant) cannot be defined to prevent the use of interest in computing the accrued benefit payable at NRA since each employee will receive the same % of pay at the same interest rate for each years accrual even if the accrued benefit at NRA for that benefit accrual will be greater for a younger employee because of the compounding of interest over a longer period.

Stay tuned. This case is nowhere near over. The plaintiffs can appeal to all of the judges of the 7th circuit or directly to the Sup Ct to reverse the decision, although there is no certainty that either ct will agree to hear the case or reverse the decision. The parties could settle for some amount less than the $1.4B exposure that IBM previously agreed to pay if found liable for age discrimination to avoid the risk of a total loss to either side (and save legal fees). There are cases pending in other federal courts on the question of age discrimination in CB plans. The pension reform act passed last week provides a safe harbor for CB plans on a prospective basis only but does not address the question of age disrimination in prior years.

[Guest Harry O]

The coffee and toast for Ellen Schultz and the plaintiffs' lawyers must taste a little bland this morning. Finally some adult supervision arrived on the scene. This whole cash balance controversy has been deeply and permanently damaging to the nation's pension system. As the Seventh Circuit concluded: "It is possible . . . for litigation about pension plans to make everyone worse off." The court then cited Ellen Schultz's January WSJ article announcing that IBM was throwing up its hands and dropping pension plans entirely for new hires. A true Pyrrhic victory for Ellen and the plaintiffs' bar . . .

[SoCalActuary]

It's nice to see some things stay the same, even with big changes.

It still appears that mjb is rooting against cb plans, while Harry O is rooting for them.

[Guest mjb]

I am neutral regarding application of CB plans as a retirement vehicle. I merely note the risk issues for employers that arise from Cb plans (whipsaw effect, age discrimination) just as there are risk issues under traditional DB plans (increasing life expectancy and inability to lock in long term rates of return) which adversely impact on the long term cost of the plan. Xerox did not fare as well as IBM in its CB litigation in 2003 losing in the same circuit over whether freezing interest credits of terminated employees violated the lump sum rules and paid 240M to participants. (I think Xerox has been on the losing end of another court decision recently on a case involving their pension calculations). As any competent attorney knows litigation is always a crap shoot. I have no problem with the codification of CB plan provisions in the new retirement law but I will defer to the actuaries to determine the benefit of the changes to CB plans and enlighten us all.

[Guest Harry O]

All of these attacks on hybrid plans should have been nipped in the bud by the Treasury and IRS. The plans have been around and receiving favorable determination letters since the mid-1980s. Some more formal regulatory guidance would have stopped this nonsense long ago. The age discrimination attack was dismissed in 13 pages by a common sense opinion from the Seventh Circuit (13 pages is the equivalent of a note on the refrigerator as far as ERISA cases go). The whipsaw attack is similarly nutty. The higher the rate of interest paid by the employer to participants, the more of a problem the plan has. How can this make sense? Again, a little leadership by the Treasury and the IRS would have derailed this trial lawyers jihad years ago. Now we are left with a shriveled private pension system as many of the companies that froze FAP DB plans would have happily put in place replacement hybrid plans. But while the plaintiffs lawyers were hard at work attacking those employers still trying to provide retirement benefits to their employees, these other sponsors said the hell with it and got completely out of the DB system. What a waste . . .

[Locust]

It was those darned plaintiffs' lawyers again! They ruined the health system, the tort system, the tobacco, firearms and alcohol and they're cloggin' up the courts with their ridiculous claims. It was only a matter of time before they went after our retirement. What's next - our vacations? Let's move to South America where they know how to keep lawyers in their place.

[SoCalActuary]

I have no problem with the codification of CB plan provisions in the new retirement law but I will defer to the actuaries to determine the benefit of the changes to CB plans and enlighten us all.

As the comedian said, "Sometimes you see it, sometimes you don't."

CB plan or no plan....hmmm, which is better?

Guaranteed accrual in a CB or profit-sensitive accrual in a PS plan....hmmm, which is better?

Guaranteed return or market return on assets....this you could argue. Do you feel lucky?

[Guest mjb]

L: you should have said "Round up the usual suspects. "

Q for the actuaries/quant types- What is the difference between the hybrid plans in section 701 and a money purchase pension plan other than 3yr vesting and a limitation on a rate of return not in excess of a market rate which applies to a hybrid plan? MP plans are exempt from PBGC premiums. In a new plan why set up a hybrid plan with all of the DB plan moving parts other than because the plan can limit the investment risk to no more than the rate of return earned by the plan up to the market rate. Presumably the plan can retain the investment gains in excess of the market rate of return and use the funds for future contributions.

[Blinky the 3-eyed Fish]

That's a fine question from the large plan standpoint. From a small plan standpoint the contribution limits are the reason Dewey, Cheatem and Howe will set up a CB plan.

[david rigby]

Don't we all feel better knowing that the plaintiff attorneys got paid?

I wonder what my next career will be?

[Guest mjb]

But will the funding limits be determined in the same manner as a final average pay plan or will different creiteria be used?

[Blinky the 3-eyed Fish]

Funding is effectively the same in a CB vs. a traditional DB. There are some minor differences, like a CB is most often funded pure unit credit and would rarely incorporate a salary scale.

[Guest Harry O]

I'm afraid the DB plan -- traditional or hybrid -- is dead in all but the small plan market (and it has a limited audience even there). Those employers that froze traditional DB plans haven't seen a mass exodus of employees nor has there been competitive pressure to establish a hybrid plan. The legal controversy served as a convenient excuse not to start a replacement hybrid plan. Other than in the collectively bargained environment, there is simply no reason why any sane employer should continue these plans. DB plans R.I.P.

[Blinky the 3-eyed Fish]

I'm afraid the DB plan -- traditional or hybrid -- is dead in all but the small plan market (and it has a limited audience even there).

Harry, the small plan comment is just not the case at all. EGTRRA and now this new pension bill have made DB plans in the small market very attractive. The interest we are seeing from clients has never been higher in the last 10 years.

[stephen]

And with three eyes you've seen 50% more than most!

[Guest Harry O]

Blink -

Glad to see the corpse isn't dead. <g>

But what type of small employer is *actually* adopting a DB plan these days?

[Blinky the 3-eyed Fish]

It's the standard group: doctors, lawyers, any single person operation like a real estate agent (making big bucks in Phoenix the last few years), financial consultants offices, basically any money-making entity with an older owner(s) and younger or no employees.

Why do you think DB plans are such an issue in the small plan market? The main reason to put in a DB plan has always been the availability of higher deductible contributions. EGTRRA increased those limits dramatically and this new pension bill offers some possible additional increases.

[Belgarath]

For some of you DB people who have my undying admiration because you actually understand numbers...

Maybe this will also largely result in the demise of the (formerly) 412(i) plan now renamed as 412(e)(3)? It would seem to me that perhaps with the new, higher front end cost available under a traditional DB, that the higher deduction formerly available under a 412(i) plan will be largely negated?

Andy, if you aren't home watching the Red Sox, you must have thought of this! What's your opinion?

[AndyH]

Friday wisdom:

A DB plan that needs an actuary costs more to administer

which produces an extra deduction

which makes such a plan much more attractive to the typical 412(i) candidate

which is why 412(i) plans should not exist.

Plato? So-Crates?

[Guest mjb]

Is there any prohibition against funding a CB plan under 412(e)(3) to eliminate the need for an actuary?

[Guest Harry O]

I guess it depends on how you define "small plan market." In my mind the small plan market has two components: what I will call the "PC market" (doctors, lawyers, financial consultants and similar professions that may or may not technically be professional corps) and the "mom and pop market" (small businesses that are not professional corp types and tend to have more employees than the professional corp types). My original post said there was a limited audience in the small plan market for DB plans. What I meant was that this audience was the PC market rather than the mom and pop small business market.

That said, I'm almost exclusively in the super-large plan market so anything I have to say is merely anectodal!