New 401(k) and 401(m) Regulations Released. Nearly ten years have passed since the Internal Revenue Service (“IRS”) last issued regulations regarding nondiscrimination and other requirements for cash or deferred arrangements under Internal Revenue Code (“Code”) § 401(k) and for matching and employee contributions under Code § 401(m). In the intervening period, the law in this area has changed significantly—so much so that, on July 17 the IRS published a proposed set of new, comprehensive 401(k) and 401(m) regulations. Though the proposed regulations are unlikely to top Harry Potter and the Order of the Phoenix on anyone’s summer reading list, this 220-page tome is not to be ignored, because the IRS has reconsidered and proposed changes to many existing rules, including:

an express prohibition against prefunding elective and matching contributions;
elimination of the mandatory disaggregation of the ESOP (employee stock ownership plan) and non-ESOP portions of a single plan; and
a new requirement designed to limit the use of targeted QNECs (qualified non-elective contributions), also known as bottom-up QNECs.

The regulations would take effect no sooner than one year after they are finalized. (68 Fed. Reg. 42,476 (July 17, 2003).)

IRS Issues Final Regulations Regarding Retroactive Annuity Starting Date in Defined Benefit Plans. The Code permits a qualified plan to furnish the requisite qualified joint and survivor annuity explanation after the annuity starting date, as long as the election period is extended at least 30 days beyond the date on which the explanation is furnished. On July 16 the IRS issued final regulations describing how, and under what circumstances, payments may be made for a retroactive annuity starting date in a defined benefit plan. The regulations first apply to plan years beginning after 2003. (68 Fed. Reg. 41,906 (July 16, 2003).)

Ten or More Employer Welfare Benefit Plan Regulations Released. The Code has special rules limiting the deduction of employer contributions to a welfare benefit fund. These rules do not apply to a welfare benefit fund that: (1) is part of a 10 or more employer plan, and (2) does not maintain experience-rating arrangements with respect to individual employers. On July 17 the IRS issued final regulations explaining this exception. The regulations are effective for contributions paid or incurred in employer tax years beginning on or after July 11, 2002. A requirement that plan documents reflect certain compliance information and a record maintenance requirement for plan administrators are first effective for benefit fund taxable years beginning after July 17, 2003. (68 Fed. Reg. 42254 (July 17, 2003).)

IRS Limits Use of Life Insurance and Annuity Contracts to Avoid Current Tax on Investment Earnings. Treasury has recognized for some time that insurance companies have been developing insurance and annuity contract products that “wrap” around other investments (e.g., partnership investments) as a mechanism to avoid current taxation. To curb the proliferation of these products, Treasury issued two revenue rulings that help identify when the purchasers of variable life insurance contracts and variable annuity contracts are considered owners of the assets that fund the contracts. To the extent purchasers of the contracts are owners of the underlying assets, any interest, dividends or other items of income earned on the assets that fund the variable contracts would be included in the purchasers’ income when the income was earned. (Rev. Ruls. 2003-91 and 2003-92, 2003-33 IRB ____ (Aug. 18, 2003).)

EEOC Proposes to Exempt Retiree Health Benefits From ADEA. Three years ago, many felt the now infamous Erie County decision sounded the death knell for retiree health benefits. But today the patient may have a new lease on life. In August 2000, under a framework fashioned by the Third Circuit Court of Appeals, a federal district court held Erie County, Pennsylvania, violated the Age Discrimination in Employment Act of 1967 (the “ADEA”) in not providing its retirees equal benefits because

age 65 retirees were required to pay a greater portion of the total cost of their health insurance premiums than younger retirees;
the health plan offered to older retirees did not allow participants to alternate between different forms of coverage, while the plan offered to younger retirees did; and
the health plan for younger retirees did not restrict participants to a prescription drug formulary, while the plan for older retirees had that restriction.

On July 14, 2003, so as not to discourage employers from providing health benefits to retirees, the U.S. Equal Employment Opportunity Commission (the “EEOC”) proposed to amend its regulations to exempt from the prohibitions of the ADEA the practice of altering, reducing or eliminating employer-sponsored retiree health benefits when retirees become eligible for Medicare or a state-sponsored retiree health benefits program. The proposed exemption, covering both existing as well as newly-created retiree health plans, would become effective on the date of publication of a final rule in the Federal Register. (68 Fed. Reg. 41,542 (July 14, 2003).)

CASES

False Statements Not Allowed, Even if Plan Changes Are Not Under Serious Consideration. The Fifth Circuit has become the latest federal appeals court to weigh in on the question of whether the Employee Retirement Income Security Act of 1974 (“ERISA”) imposes on a company a duty to truthfully disclose, on inquiry from participants, whether changes to a particular benefit plan are under consideration. Prior to their early retirements from Schlumberger Ltd. and Schlumberger Technology Corp. (collectively “Schlumberger”), three long-time employees were told by personnel representatives that the company had made no decision to implement an enhanced retirement incentive program in the near future. The three left Schlumberger, and, less than a month later, the company announced a new voluntary early retirement plan for which they were now ineligible; so they sued. On appeal of a summary judgment motion granted in favor of Schlumberger, the court held an employer has a fiduciary duty to refrain from misrepresentations if it chooses to communicate about the future of a participant’s plan benefits. The court rejected the view (as has the Second Circuit) that the duty to speak truthfully arises only once the employer begins seriously considering a plan, noting the “lack of serious consideration does not equate to a free zone for lying.” At the same time, the court held an employer has no obligation affirmatively to disclose a benefit plan amendment is under consideration. In this instance, no material misrepresentations were found, and the lower court decision was affirmed. (Martinez v. Schlumberger, Ltd., 2003 WL 21557397 (5th Cir. 2003).)

COBRA Notice Insufficient for Failure to Present Readily Comprehensible Statement of Continuation Rights. Employers not only must be certain they give timely COBRA notices following the occurrence of qualifying events, but they also must be certain the COBRA notices they deliver give accurate and understandable information on the right of qualified beneficiaries to pay for and receive continuation of their medical coverage. The Third Circuit Court of Appeals recently considered the adequacy of the COBRA notice used by an employer, and determined the employer failed to discharge its statutory duty to provide notice of continuation rights when the notice used did not define key terms it used. Failure properly to discharge the COBRA notice requirement in this type of circumstance could leave the employer liable for the employee’s medical expenses. (Emilien v. Stull Technologies Corp., 2003 WL 21675343 (3d Cir. 2003).)

Failure to Disclose Plan Remedies Constitutes ERISA Violation. Hubert Back worked for Danka Corporation and its corporate predecessors, Eastman Kodak Company and IBM, for 27 years. In 1997, Back suffered a work-related injury—no, not to his back, but to his shoulder—and ultimately was discharged. Alleging wrongful withholding of severance pay (among other claims), Back sued. The district court noted Back never had filed a written claim for severance benefits and therefore dismissed Back’s claim under the doctrine of exhaustion of remedies. On July 14, the Eighth Circuit Court of Appeals reversed and remanded, holding Danka’s failure to inform Back of the available and required internal remedy (i.e., by providing him a copy of a summary plan description or the severance plan itself) was a violation of ERISA. (Back v. Danka Corp., 2003 WL 21637950 (8th Cir. 2003).)

Words Mean Something. Lawyers often are accused of niggling over words, but in two recent federal appellate court cases word choice was crucial to benefit determinations.

In the first case, Kenneth Burke participated in Kodak’s Survivor Income Benefits plan (the “Plan”), which provided payments to spouses, domestic partners, and dependents on the death of a participant. Mr. Burke died in fall 1999, and his wife, Sally, was denied benefits on February 21, 2000, because she and Kenneth had been married for less than one year at the time of his death. Five months later, Sally Burke appealed the denial, but the Plan administrator rejected it as untimely because it was submitted outside the 90-day appeals period described in the handbook. In its review of the facts and circumstances, the Second Circuit Court of Appeals stated Kodak’s initial denial notice was inadequate, because it did not expressly provide Mrs. Burke had only 90 days to appeal. Rather, the handbook simply stated an aggrieved beneficiary “should” appeal within 90 days. Noting Kodak easily could have used unambiguous mandatory language” (i.e., “must”), the court concluded Mrs. Burke was denied the opportunity for a full and fair review of her claim. (Burke v. Kodak Retirement Income Plan, 2003 WL 21666136 (2d Cir. 2003).)

In the second case, George and Susan Michael were denied life insurance benefits when Philip Khan, Susan’s father, died on October 24, 2000, before receiving notice of his right to convert his group life insurance policy into an individual policy. The Michaels sued the plan and the plan administrator, First Commercial Bank (“First Commercial”), for breach of fiduciary duty. Mr. Khan terminated employment on August 31, 2000, and First Commercial failed to “complete” a conversion notice within 10 days as clearly required by the group insurance policy. However, the Seventh Circuit Court of Appeals upheld the denial of the Michaels’ claim in finding the policy did not similarly require First Commercial to “give” or “mail” the notice in question to Mr. Khan within the same 10 days, and, hence, the failure to “complete” the form within the required period was of no consequence. (Michael v. First Commercial Bank, 2003 WL 21580277 (7th Cir. 2003).)