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Employee Benefits Developments October 2006

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RULINGS, OPINIONS, ETC.

2007 benefit limits announced
The Internal Revenue Service and Social Security Administration have announced the cost-of-living adjusted dollar limits applicable to benefit plans for 2007. A listing of key limits is set out below:

Proposed rule on default investments
The Pension Protection Act of 2006 provides relief to fiduciaries who invest in certain types of default investments in the absence of participant investment direction. On September 27, the Department of Labor (DOL) issued guidance regarding permissible default investment options for participant-directed defined contribution plans. This relief applies, but is not limited, to plans with automatic enrollment features.

The DOL guidance provides a safe harbor for fiduciaries investing assets in a qualified default investment alternative (QDIA). A QDIA must be one of three types of investments:

Life-cycle or target-retirement date fund, which determines the appropriate proportion of equity and fixed income investments using a participant’s age, life expectancy, or retirement date.

Balanced fund, which uses the demographics of the plan participant population as a whole to determine the appropriate investment selection.

Professionally managed account, which utilizes investment management services to allocate assets in a participant’s individual account.

It is important to note that stable value or money market investment vehicles are not considered QDIAs and therefore fiduciaries who use them as default investments will not be protected from liability under this proposed regulation.

In addition to investing in a QDIA, certain other conditions must be met for fiduciaries to receive liability protection, such as:

The plan must allow for participant-directed investment.

On at least a quarterly basis, participants must be given the opportunity to shift investments from QDIAs, without financial penalty, to a wide range of investment options.

The plan must provide an annual notice to participants at least 30 days before the start of the plan year. The notice must describe the circumstances under which assets will be invested in QDIAs, the characteristics of the QDIAs, participant rights, and sources of additional information.

Any material (i.e., proxy voting material, prospectuses, and account statements) provided to the plan relating to investments in a QDIA must be given to participants.

A QDIA cannot hold employer securities except if they are held as part of certain regulated pooled investments or are acquired as a matching contribution.

Liability protection is not comprehensive
Plan fiduciaries are still liable for prudently selecting and monitoring funds, including the QDIAs, offered by the plan. The DOL specifically notes that consideration must be given to investment fees and expenses when choosing investment alternatives. The proposed effective date will be 60 days after publication of the final regulations. (Fed. Reg. Vol. 71, No. 187, 2550)

New pension financial disclosure guidance
The Financial Accounting Standards Board (FASB) issued a new Statement of Financial Accounting Standards No. 158 (standard) regarding recognition of obligations associated with single employer defined benefit pension plans. Pursuant to the new standard, an employer is required to recognize in its statement of financial position (balance sheet) an asset for a plan’s overfunded status or a liability for a plan’s underfunded status; previously, employers could disclose the funding status of a plan in the footnotes to the financial statements. Additionally, the standard requires recognition of changes in the funded status of defined benefit plans in the year in which the change occurs, whereas previous standards allowed for delayed recognition of certain changes. The new standard is effective for fiscal years ending after December 15, 2006 for publicly traded companies and for fiscal years ending after June 15, 2007 for private companies and non-governmental nonprofit organizations. Statement No. 158 is the first step in FASB’s comprehensive project determining new accounting standards for defined benefit pension and post-retirement benefit plans. (www.fasb.org/st/index.shtml)

CASES

Self-insured long term disability plan can be exempt from ERISA and subject to claims under state law
Xerox maintained a self-insured long-term disability (LTD) plan that paid a benefit equal to 60 percent of a disabled employee’s salary for up to 24 months following five months of short-term disability benefits. When a Xerox employee was terminated while receiving benefits under the LTD plan, the employee sued Xerox and alleged that Xerox wrongfully terminated his LTD benefits. Xerox sought to have the employee’s claims for relief under state law dismissed on the basis that the Employee Retirement Income Security Act (ERISA) preempts state law. A federal district court ruled that the Xerox LTD plan is an employee welfare benefit plan subject to ERISA, and that decision was appealed to the Ninth Circuit Court of Appeals. Specifically, the Ninth Circuit was asked to decide whether the Xerox LTD plan qualified as a “payroll practice” that exempts the plan from ERISA.

The Ninth Circuit ruled in favor of the employee by holding that the Xerox LTD plan may indeed qualify as an exempt payroll practice and remanded the case for further consideration by the district court. A payroll practice that pays an employee’s normal compensation from the employer’s general assets during periods that the employee is physically unable to perform his or her duties can be exempt from ERISA. The key issue the Ninth Circuit considered is whether an LTD plan that pays only 60 precent of an employee’s regular salary could constitute payment of normal compensation. In reaching its decision, the Ninth Circuit considered and gave great deference to several DOL opinion letters in which the DOL found programs offering payments of less than full salary can qualify as exempt payroll practices. (Bassiri v. Xerox (9th Cir. 2006))

Hopelessly inadequate letter is not a faulty SPD
Former department store employees who believed they were entitled to benefits under the terms of a letter promising them severance pay in the event of a change in control are out of luck in the wake of a recent decision by the United States Court of Appeals for the Eight Circuit. Following rumors that Saks, Incorporated (Saks) and its various department store groups were likely takeover targets, Saks sought to reassure its employees and improve morale in the fall of 2000 by rolling out a new change of control severance plan (COC plan). The COC plan promised severance pay and other benefits for any participants who were terminated or relocated within two years of a change in control. A change in control was defined under the plan as applying only to external takeovers and sales of major business units. At a meeting of employees in 2000, a company executive read a letter promising the employees 26 weeks of salary under the new COC plan if there was a change of control that caused their termination. Employees were not provided with summary plan descriptions (SPDs) or copies of the plan document.

Two years later, Saks consolidated home offices, resulting in the termination of some employees. The employees were paid severance benefits, but those benefits were substantially less than what the employees would have received had they qualified for severance under the COC plan. The employees sued, claiming the 2000 severance letter had led them to believe they would receive benefits under the COC plan under such a consolidation. The lower court agreed, ruling the letter was a faulty SPD that contradicted the COC plan by promising benefits in the event of the internal consolidation of operating divisions. The former employees were awarded over $1.6 million in severance pay. On appeal, the Eighth Circuit reversed. The federal appellate court acknowledged that an SPD provision may prevail if it conflicts with a plan provision, even if the SPD is “faulty,” that is, does not contain all the information required by ERISA. The court noted, however, that the rule does not apply if the conflicting document is “hopelessly inadequate” as an SPD. In this case, the Eighth Circuit found the letter promising the benefits was merely an informal description of the COC plan and was not intended to satisfy requirements of an SPD. The court left open the issue of whether attorneys’ fees might be awarded to the employees as a result of Saks’s “deceptive behavior and flagrant disregard of its ERISA disclosure duties” by failing to provide an SPD. (Antolik v. Saks, Inc. (8th Cir. 2006)

Inaccurate benefit estimate does not violate fiduciary duty
No plan administrator or other fiduciary would be happy with making a mistake—especially one where a participant is given an estimated retirement benefit of $1,700 per month and subsequently it is found that the correct benefit is $1,400. That’s essentially what happened under the Qwest Pension Plan when the plan’s automated benefit estimating system came up with an incorrect benefit amount for one retiree. The mistake, acknowledged by the participant, arose because a change in employment status wasn’t properly recognized by the system, which was operated by a third-party provider. The participant sued anyway, alleging that the erroneous estimates amounted to a breach of fiduciary duty by the plan and its administrator and that the plan should pay him the difference. The court found that the plan administrator met the ERISA fiduciary standards because (1) the plan clearly disclosed that the final benefit calculation may differ from initial estimates, (2) the estimates were generally accurate, (3) the estimates were provided by a non-fiduciary, and (4) there was no knowing or deliberate error. While the plan made a mistake in the estimates, the court concluded its general operation met the required duty of care and that the plan could not be held to pay the inaccurate estimate. The plan demonstrated that it generally did a good job. Keeping up a good day-to day standard saved the plan from an unfortunate liability. (Christensen v. The Qwest Pension Plan (8th Cir. 2006))

Special needs trustee must reimburse plan for benefits paid
The defendant in this case was a Wal-Mart medical plan participant who incurred significant medical expenses after sustaining injuries in an automobile accident. The medical plan maintained by Wal-Mart paid in excess of $469,000 for the injured participant’s medical care. The participant sued the parties who allegedly caused her injuries and settled her claims for $700,000. After payment of attorney fees and costs, the participant received $417,477, which was placed in a special needs trust created for her benefit. Under a third-party reimbursement provision in the plan’s SPD (which was found to be a part of the plan document), an injured participant who is compensated for his or her injuries by a third party is required to reimburse the plan for benefits paid on account of the injury. Although the plan administrator advised the participant and her attorneys of the plan’s reimbursement rights and of her obligation to notify the plan of any settlement, the plan was not notified of the settlement until well after the settlement had been completed and the proceeds placed in the special needs trust. The plan then sued the trustee of the special needs trust requesting, among other things, that the court direct the trustee to turn over to the plan the proceeds held in trust as reimbursement for medical expenses paid on the participant’s behalf. The court ruled in the plan’s favor, finding that a lien against the settlement proceeds arose as a result of the plan’s third-party reimbursement provision and that the lien had been asserted before the settlement proceeds were paid to the trust. This case points out of the importance of having a well-conceived and administered third-party recovery program that results in early identification of possible third-party claims and early notification to a putative plantiff-participant (and his or her attorney) of a plan’s reimbursement rights. (Admin. Comm. of the Wal-Mart Stores, Inc. Associates’ Health and Welfare Plan v. Shank (E.D. Mo. 2006))

Voluntary disability plan was subject to ERISA
Under DOL regulations, certain “voluntary” insurance arrangements are exempt from ERISA. This means, among other things, that ERISA’s fiduciary provisions do not apply and that SPDs, ERISA claims procedures, and 5500 filings are not required.

To fall within this exemption, four requirements must be met:

Participation in the program must be completely voluntary.

No contributions can be made by the employer (i.e., the employee must pay the entire premium).

The employer cannot endorse the program and cannot become involved its management or administration except to permit the insurer to publicize the program to employees and to collect premiums through payroll deduction.

The employer must not receive any compensation in connection with the program (other than a reasonable compensation for administrative services rendered in connection with the administration of payroll deduction contributions).

Most so-called voluntary arrangements meet the first, second, and fourth criteria (participation is voluntary, there are no employer contributions, and the employer receives no direct or indirect compensation from the insurer). There has been much litigation, however, with respect to whether an employer has endorsed the program or performed management and administrative functions that extend beyond the functions that are specifically permitted (i.e., permitting the insured to publicize the program and collecting and remitting payroll deduction contributions). This was the issue in Moorman v. UNUMProvident Corp. (11th Cir. 2006).

In Moorman, the court found the “voluntary” disability insurance plan offered through Southeastern Steam, Inc. (Southeastern) was subject to ERISA because Southeastern had endorsed it and had participated in its management and administration. The court found the employer had selected the waiting period, referred to the plan in its employee handbook and as part of the company’s employee benefits, and assisted (through its human resources staff) in the processing of at least one or two claims. Accordingly, the court held the employer had gone well beyond the limited functions permitted by the regulation, thereby rendering the exemption inapplicable. The court went on to find that the plan was subject to ERISA because of the level of employer involvement. The court reasoned that by applying for coverage on behalf of its employees, deciding on key terms (e.g., the waiting period), assisting with claims, and referring to the plan as part of the employer’s benefit package, the employer, in the eyes of the employees, had closely tied the disability insurance plan to the employee/employer relationship.
Employers wishing to avoid ERISA coverage of voluntary arrangements must not endorse the program or become involved in plan management or administrative functions beyond the limited functions referenced in the regulations. In addition, any plan descriptions describing voluntary non-ERISA benefits should clearly state the voluntary benefits offered are not a part of the employer’s ERISA-covered welfare benefit plan. (Moorman v. UNUMProvident Corp. (11th Cir. 2006))