Employee Benefits

Employee Benefits Developments May 2006

RULINGS, OPINIONS, ETC.

IRS publishes sample Roth 401(k) plan amendment
Internal Revenue Service (IRS) Notice 2006-44, issued April 24, 2006, provides a sample plan amendment for plan sponsors who want to amend their 401(k) plans to provide for designated Roth contributions. A Roth 401(k) plan amendment must be adopted by the end of the plan year in which the amendment is to be effective. The timely adoption of the amendment must be evidenced by a written document that is signed and dated by the employer (including an adopting employer of a pre-approved plan). The new sample amendment will help plan sponsors comply with the amendment requirement. Both individual plan sponsors and sponsors of pre-approved plans may make use of the sample plan amendment in drafting their Roth 401(k) plan amendments, although some tailoring of the model language may be needed to reflect the design of the particular plan being amended. (IRS Notice 2006-44).

Final rules published for terminating abandoned individual account plans
In March 2005, the Department of Labor (DOL) published proposed rules to facilitate a voluntary, safe, and efficient process for winding up the affairs of abandoned individual account plans (e.g., 401(k) plans). (See Hodgson Russ’s Employee Benefits Developments, April 2005.) On April 21, 2006, after considering comments it received on the proposed rules, the DOL published final rules that allow financial institutions to take responsibility for abandoned individual account plans and distribute the plans’ assets to covered workers and their families. With some modifications, the structure and substance of the proposed rules have been retained. The final rules provide standards for determining when a plan is abandoned and establish a process for winding up the affairs of the plan. The rules include a safe harbor mechanism for making distributions from abandoned plans for the benefit of participants or beneficiaries who fail to make benefit elections as well as procedures for filing a terminal report when the wind-up process is completed. In connection with the final rules, the DOL finalized a related prohibited transaction class exemption that permits a “qualified termination administrator” for an abandoned individual account plan to select itself or an affiliate to provide services in connection with the termination of the plan, to pay itself or an affiliate fees for those services, and to pay itself for services provided prior to the plan's deemed termination. The new rules take effect May 22, 2006. (71 Fed. Reg. 20819 (April 21, 2006)).

Massachusetts health insurance mandate adopted
A number of state legislatures have debated the issue of expanding health insurance coverage to the uninsured working population. Broader coverage among the working poor could reduce state Medicaid costs as well as the expense imposed on hospitals and other service providers for health care that is not paid for. A new Massachusetts law is bound to generate further debate and potential litigation asserting that the state action has stepped into the regulation of employer medical plans that is preempted by the Employee Retirement Income Security Act (ERISA). Among other things, it creates a state authority to provide medical insurance coverage to individuals and small businesses, subsidizes insurance costs for lower-income individuals, imposes a mandate on all Massachusetts citizens to obtain medical insurance, levies a fee on employers who do not provide medical insurance for employees, and mandates that employers maintain a cafeteria plan to allow employee medical insurance premiums and day care expenses to be paid on a pre-tax basis. Whether these mandates can withstand a challenge based on ERISA preemption remains to be seen. The mandates go into effect in 2007. If a citizen does not have medical insurance on July 1, 2007, there will be a loss of state income tax exemptions in 2007 and later penalties based on the cost of insurance premiums. The employer fee for not providing a medical plan begins at $295 per year per employee and is imposed on employers with more than 10 employees. The fee is described as reflecting a portion of the cost picked up by the state for free care received by uninsured workers. In addition there is a “Free Rider Surcharge” to be imposed on employers with no medical plan based on the actual free care received by any of its employees over the first $50,000 per employer each year. We will follow the implementation and legal challenges to this law because of its impact on multistate employers and on legislative thinking in other states. (Massachusetts Health Care Access and Affordability Act, enacted April 12, 2006).

CASES

“Implied exception” allows 401(k) plan trustees to delegate investment authority
The Seventh Circuit Court of Appeals recognized that although ERISA § 404(c) provides a safe harbor for delegating authority in participant-directed 401(k) plans, it is not the exclusive means for a plan trustee to avoid fiduciary liability when administering self-directed plans. In Jenkins v. Yager, the court held that the trustee of a participant-directed 401(k) plan did not breach his fiduciary duty by allowing participants to direct their own investments, even though the trustee did not monitor the individual participant’s investment decisions and did not comply with the 404(c) safe harbor.

The court recognized the existence of an “implied exception” under ERISA allowing plan trustees to delegate investment authority to 401(k) plan participants and to avoid fiduciary liability for investment results even though they did not follow the requirements of 404(c). The court also held that monitoring individual participant investment decisions was not necessary to satisfy the trustee’s fiduciary obligations because the trustee appropriately selected a range of investment choices and provided information to participants to help inform their investment decisions. (Jenkins v. Yager, 7th Cir., 2006).

Benefit increase a fraudulent transfer
The Third Circuit has ruled the benefit increases made immediately prior to the bankruptcy filing of Fruehauf Trailer Corp. constituted a fraudulent transfer. At an emergency board of directors meeting preceding the bankruptcy filing, an amendment was made to Fruehauf’s defined benefit pension plan that granted benefit increases under the plan. The source of the funding was a surplus of assets within the plan. Had the amendment not been enacted and the plan terminated, surplus assets would have reverted to Fruehauf. The estimated cost of the benefit increases was $2.4 million.

The Third Circuit affirmed the district court’s finding that the amendment of the plan met the definition of a fraudulent transfer under § 548 of the Bankruptcy Code. Under § 548, a transfer is considered fraudulent and voidable if:

the debtor had an interest in the property,

the interest was transferred within one year of the bankruptcy petition,

the debtor was insolvent or became insolvent as a result, and

the debtor received less than reasonably equivalent value in exchange for the transfer.

Based on the facts of the case, the federal district court and Third Circuit agreed the requirements of a fraudulent transfer were present. Pension Transfer Corp. v. Beneficiaries Under the Third Amendment to Fruehauf Trailer Corporation Retirement Plan No. 003 (In re Fruehauf Trailer Corp.),(3d Cir., 2006).

Another lesson on welfare plan descriptions
In a case coming out of the U.S. District Court for the Western District of New York, the Second Circuit Court of Appeals has ruled in favor of a beneficiary under an employer life insurance plan. Roger Klimbach was an hourly employee of Spherion Corp. and covered by its life insurance plan. Klimbach elected to be covered by a formula providing a death benefit of three times the greater of “current gross salary” or “prior year’s gross earnings.” Klimbach suffered from an illness that resulted in his death. The employer did not dispute his coverage under the plan, but calculated the death benefit based on actual earnings in the year prior to death. Klimbach had reduced hours of service in the prior year and no hours in the year of his death due to his illness. The plan’s summary description used the term “current gross salary” while the plan document used the term “basic annual earnings” as the basis for the death benefit. The ambiguity in the use of the terms and lack of clarity in applying the terms to an hourly paid employee resulted in a decision in favor of the beneficiary. Because of the ambiguity, the court looked to other communications to the employee and the employer’s method of calculating the group insurance premium to conclude that the beneficiary was entitled to a benefit that is three times Klimbach’s annual projected compensation level based on his hourly rate and a full time schedule. Klimbach v. Spherion Corp., (2d Cir. 2006).

“Hidden” clause in SPD unenforceable
Diana Schaum had a disease that rendered her mostly paralyzed and was receiving skilled home nursing care on a 24-hour basis since 1991. The in-home nursing coverage was paid for under a health plan sponsored by Honeywell. In 2004, the plan informed Schaum that it intended to limit the benefits to two hours of skilled in-home nursing care per day. Schaum appealed the plan’s reduction in benefits. During the course of the appeals process, a new agency agreed to provided Schaum with home nursing services. The plan provided the agency with written authorization for 24-hour nursing care, but did not inform the agency of the possible reduction in benefits. The administrator of the Honeywell plan ultimately denied Schaum’s appeal and determined that only two hours of skilled nursing care would be covered.

Schaum had assigned her interest in her claim to the agency, which filed a motion to be a party to the law suit dealing with the claim. The Honeywell plan argued that the assignment of claims to the agency was inappropriate because the plan contained an anti-assignment clause. The District Court for the District of Arizona ruled the anti-assignment clause was invalid because of where it was found in the summary plan description (SPD). The court found that the restriction, which appeared in a section titled “ERISA” in the subsection titled “Plan Administration,” did not satisfy DOL Regulations which require that all restrictive provisions be located near the description of benefits under the plan.

Plan sponsors, therefore, should be careful to not only include provisions such as anti-assignment clauses within their SPD, but should carefully determine where they place them and be certain that they are understandable to plan participants. Schaum v. Honeywell Retiree Medical Plan Number 507 (D. Ariz., 2006).

SPD must disclose evidentiary burden of participants
The U.S. Court of Appeals for the Second Circuit ruled that, while a pension plan may require participants to produce proof that they are entitled to additional benefits, such a burden must be disclosed in the plan’s SPD to be valid. After working in the construction industry for fourteen different employers over the course of four decades, Abraham Wilkins filed an application for pension benefits from the Mason Tenders District Council Pension Fund in 1998. The fund paid him a lump sum benefit of $429, based on pension credits earned over three years. Although the fund had records of covered employment for other years, the earnings in those years were insufficient to qualify for pension credits. Wilkins objected to the calculations and claimed additional benefits based on work not included in the fund’s records, but reflected in his Social Security statement of earnings. The fund denied Wilkins’s claim to additional benefits, on the grounds that the fund could not determine whether those extra earnings represented covered employment. Under such circumstances, it was the practice of the fund to require participants to submit pay stubs to show the additional work was actually performed. Wilkins was unable to locate any records other than his Social Security Statement, and eventually sued the fund.

Wilkins alleged that the fund breached its ERISA fiduciary duties by failing to ensure that his employers submitted accurate records of his earnings, and violated ERISA by requiring participants to prove their entitlement to additional benefits when their employers underreported their hours worked and by failing to include this evidentiary policy in its SPD. The Fourth Circuit upheld a district court finding that the fund did not violate its fiduciary duties when it failed to audit Wilkins’s employers during the specific years in question. The court also upheld the district court ruling that it was not arbitrary and capricious for the fund to require participants to prove their entitlement to additional benefits, but reversed the lower court’s decision that the fund did not violate ERISA by failing to state in its SPD that participants had the burden of producing evidence. According to the court, “it seems to us obvious that the policy, by erecting an additional, mandatory prerequisite to the receipt of promised benefits, may result in disqualification, ineligibility, or a denial or loss of benefits. It must, therefore, be disclosed in the SPD.” The appeals court added that on remand, Wilkins will have the burden of showing that he “was likely to have been harmed as a result of a deficient SPD.” The burden would then shift to the fund to disprove Wilkins’s presumptive entitlement to benefits based on earnings reported to the Social Security Agency, but not to the fund. Wilkins v. Mason Tenders District Council Pension Fund (2d Cir., 2006).

This newsletter is a periodic publication of Hodgson Russ LLP. Its contents are intended for general informational purposes only and should not be construed as legal advice or legal opinion on any specific facts or circumstances. Information contained in the newsletter may be inappropriate to your particular facts or situation. Please consult an attorney for specific advice applicable to your situation. Hodgson Russ is not responsible for inadvertent errors in this publication.