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has an otherwise well understood meaning. If the Sixth Circuit still does not
understand the meaning of the term after all these years, it is unfathomable how it
will be able to correctly adjudicate the meaning of "actuarially equivalent" and
other actuarial terms in the Affordable Care Act.4 See, for example, 42 U.S.C.
18022(d)(1); see also H.H.S. Bulletin, Actuarial Value and Cost-Sharing,5 and
I.R.S. Notice 2012-31.6 It could prove disastrous for people insured under medical
plans for the court to rule that "actuarially equivalent" medical benefits may be
determined using outdated assumptions.
Annualization Error
(II)
The court ruled that the plan administrator has discretion to utilize an
annualization methodology that always produces an incorrect result in favor of the
employer. For the annualization fraction, the administrator uses an 8-hour day in
the numerator and a 9-hour day in the denominator, which clearly skews the result
in the employers favor, as examples infra illustrate.
Inexcusable mistakes on these crucial aspects of the case led the court into
further errors. The case is bound to cause confusion over matters that most ERISA
practitioners would consider to be settled law.
The Putative Guarantee of an Actuarial Equivalent Pension
Under ERISA and the Internal Revenue Code
Section 204(c)(3) of ERISA, 29 U.S.C. 1054(c)(3), requires:
[I]n the case of any defined benefit plan, if an employees accrued benefit is
to be determined as an amount other than an annual benefit commencing at
normal retirement age, the employees accrued benefit shall be the
actuarial equivalent of such benefit .
This requirement is echoed in 411(c)(3) of the Internal Revenue Code and in
Treasury Regulation 411(c)-1(e)(1). As applied to the retirement benefits in
question, noted ERISA scholar Judge Richard Posner stated the requirement
succinctly:
ERISA requires that an early retiree receive the "actuarial equivalent" of the
pension benefits to which he would be entitled at normal retirement age.8
Suppose that two plan participants, A and B, are the same age and have the same
accrued benefit, say $1,000 per month. Thus, if both wait to retire at the normal
retirement age of 65, both will receive the same $1,000 per month for life. Now
suppose that both retire early at the same time, a year before normal retirement
age. Suppose further that A terminated employment when the early retirement
actuarial equivalent factor was .90 and B terminated when it was .93. Under the
Sixth Circuits fallacious reasoning, As monthly early retirement benefit would be
$900, whereas Bs would be $930. These differing amounts cannot both be
actuarially equivalent to $1,000 per month, because their present values are not
equal under a given set of actuarial assumptions.
The actuarial article cited in Stephens explains why actuarial equivalence
factors must be changed from time to time:10
The interest and mortality assumptions play a key role in determining the
magnitude of the actuarial equivalence factor. Periodically, the assumptions
used must be reviewed and modified so as to insure that they continue to
fairly assess the cost of the optional basis of payment.
Assumptions were changed accordingly in Dooley v. American Airlines, Inc.:11
[T]he plan fiduciaries had the authority to change the actuarial assumptions
from time to time in an effort to maintain actuarial equivalence. That is
precisely what they did in this case.
In the subject case, the sponsor changed the plans early retirement actuarial
equivalent factors to fairly reflect changes in interest rates over the 26 years
5
Under Esden, the early retirement benefit should be worth .93 times the accrued
benefit, not the .90 that the plan administrator used.
Further Protections of Accrued Benefits Under ERISA and the Code
In addition to the protections afforded to accrued benefits under (i) ERISA
204(c)(3), I.R.C. 411(c)(3), and Treas. Reg. 411(c)-1(e)(1), minimum standards
for valuing benefits are found in (ii) ERISA 205, I.R.C. 417, and Regulations.
Before examining the Esden Courts analysis of the minimum standards (ii), it is
important to understand that the protections provided by (i) and (ii) are separate
and distinct, so that (i) may be satisfied but not (ii), and vice versa. Different forms
of benefits may be actuarially equivalent within the meaning of a plan document
but may be too small under the minimum standards, possibly because the plan
interest rate is too high. Conversely, different forms of benefits may meet the
minimum standards but may not be actuarially equivalent, possibly because they
are valued using different actuarial assumptions set forth in the plan document.
After the discussing the protections afforded by (i), the Esden Court turned
its attention to the minimum standards (ii):16
Because the Plan is a defined benefit plan, any distribution from the plan
must be the actuarial equivalent of the accrued benefit expressed as an
annual benefit payable at normal retirement age, that isotherwise
expressedthe normal retirement benefit.
7
For the purposes of this rule, the regulations do not leave a plan free to
choose its own methodology for determining the actuarial equivalent of the
accrued benefit expressed as an annuity payable at normal retirement age. If
plans were free to determine their own assumptions and methodology, they
could effectively eviscerate the protections provided by ERISAs
requirement of actuarial equivalence. See, e.g., H.R. Rep. No. 103-632, pt.
2, at 57 (1994) (If plans could use high [discount] rates, plans could lower
the single sum paid to participants.). To comply with ERISA, as well as to
be considered a qualified plan under the Code, a plan must comply with
specified valuation rules and certain consent rules. See Treas. Reg.
1.411(a)-11(a)(1); see also Treas. Reg. 1.417(c)-1(a). By regulation, these
prescribed valuation rules apply to all distributions, regardless of value,
regardless of type of defined benefit plan and regardless of any additional
consent requirement:
Distribution valuation requirements. In determining the present value
of any distribution of any accrued benefit from a defined benefit plan,
the plan must take into account specified valuation rules. For this
purpose, the valuation rules are the same valuation rules for valuing
distributions as set forth in section 417(c); see 1.417(c)-1(d) .
This paragraph also applies whether or not the participants consent is
required under paragraphs (b) and (c) of this section.
Treas. Reg. 1.411(a)-11(d) (emphases added).
The cross-referenced Code section 417(e) requires that the accrued benefit
be discounted back to present value at the applicable interest rate. I.R.C.
417(e)(3)(A); ERISA 205(g)(3); Treas. Reg. 1.417(e)-1(d).13 At the time
Esden received her benefit in the form of a lump sum, the applicable
interest rate (for amounts having a present value less than $25,000) was
defined as the same discount rate that would be used (as of the date of the
distribution) by the Pension Benefit Guaranty Corporation for purposes of
determining the present value of a lump sum distribution on plan
termination. I.R.C. 417(e)(3)(B), 411(a)(11)(B)(ii) (both as in effect in
1991); ERISA 205(g)(3)(B); 203(e)(2)(B) (both as in effect in 1991); see
also Treas. Reg. 1.417(e)-1(d)(2). In general, the regulations promulgated
under section 417(e) further provide that: A plan does not satisfy the
requirements of sections 401(a)(11) and 417 unless it satisfies the
8
Both the statute and the regulation have been subsequently amended. In
1994, the statutory definition of the applicable interest rate was changed to
the annual rate of interest on 30-year Treasury securities for the month
before the date of distribution or such other time as the Secretary may by
regulations prescribe. Retirement Protection Act of 1994, Pub. L. No. 103465, 767(a), 108 Stat. 4809, 5038. Parallel amendments were made to
ERISA 203(g)(3). See Pub. L. No. 103-465, 767(c)(2). These
amendments also added a statutory requirement that the Secretary prescribe
an applicable mortality table for converting annuities into lump-sums. See
I.R.C. 417(e)(3)(A)(ii)(II); ERISA 205(g)(3)(A)(ii)(II). At the same time
I.R.C. 411(a)(11)(B) and ERISA 203(e)(2), which had previously
duplicated the valuation provisions of I.R.C. 417(e)(3) and ERISA 205(g)
respectively were amended to provide that present value shall be calculated
in accordance with those respective sections, thus removing redundancy
from the U.S. Code. See Pub. L. No. 103-465, 767(a)(1), (c)(1).
The pivotal point to be gleaned from the Esden Courts further analysis is
that the interest rate used in the test for the minimum acceptable value of any
distribution is to be determined at or near the date of distribution. That remains the
case today; see Treas. Reg. 1.417(e)-1(d)(4)(i) & (d)(9)(ii)(A):
9
(4) Time for determining interest rate(i) General rule. [T]he applicable
interest rate to be used for a distribution is the rate for the applicable
lookback month. The applicable lookback month for a distribution is the
lookback month for the month that contains the annuity starting date
for the distribution. The time and method for determining the applicable
interest rate for each participant's distribution must be determined in a
consistent manner that is applied uniformly to all participants in the plan.
(ii) Time for determining interest rate. (A) [T]he PBGC interest rate or rates
are determined on either the annuity starting date or the first day of the
plan year that contains the annuity starting date. The plan must provide
which date is applicable. (Bold supplied.)
The interest rate is always closely linked to the annuity starting date. The interest
rate used to determine the early retirement benefit at issue was that used in a 26year-old actuarial factor. That is not the law.
The Codes Proscription Against Cherry Picking Actuarial Assumptions
I.R.C. 401(a)(25) contains a prohibition against picking and choosing
among actuarial factors:
A defined benefit plan shall not be treated as providing definitely
determinable benefits unless, whenever the amount of any benefit is to be
determined on the basis of actuarial assumptions, such assumptions are
specified in the plan in a way which precludes employer discretion.
Without more, this Code provision may not give rise to a cause of action, but the
plan document in the subject case refers to the Code as governing law. Section
401(a)(25) is cited affirmatively in Esden.17 In compliance with this rule, a plan
10
The first thing to be noted about the plan document is that the annualization
formula is defective on its face, an issue that the Sixth Circuit failed to address.
Any employee who works more than 2088 hours in less than a year would have his
compensation reduced instead of converted to a full-time, full-year equivalent, as
required by the plan document. Inasmuch as the employer is a large law firm, this
number of hours hardly would be unusual.
Take, for example, a first-year employee who works 50 hours per week for
46 weeks and is paid $1,000 per week, so that his actual compensation is $46,000
for his 2300 (46 50) hours of work. Under the plain language of the plan
document, his part-year compensation would be "annualized" as only $46,000
(2088/2300) = $46,000 .91 = $41,860, when common sense dictates that the
correct answer is $52,000, so that the putative annualization is more than $10,000
too low. The plan itself is defective, even without any inconsistency between
numerator and denominator.
It is instructive to examine just how innumerate the Sixth Circuit appears to
be. Suppose an employee works n days out of 261 for part of a year and is paid
C dollars. To annualize the part-year compensation, the plan administrator would
credit the employee with 9 hours for each of the n days he worked and use n 9
for his part-year hours. The annualization fraction then would be
12
2088
n9
Now note that the annualization fraction can be broken down into two
components:
2088
261 8
261
8
261
=
=
=
.89
n9
n9
n
9
n
The employees annualized compensation thus would be
C
2088
261
= C
.89
n9
n
It is easy to see that the .89 factor makes the answer 11% too low. Once an 8-hour
day is chosen for use in the numerator, only that same 8-hour day in the
denominator will produce a correct answer.
To see this, return to the example of the employee who works 46 weeks at
$1,000 per week. In that 46-week period, there would be 46 5 = 230 weekdays.
The plan administrator would credit the employee with 9 hours per day for each of
those 230 days, for a total of 2070 hours. The annualization fraction would be
2088/2070 = 1.01. Thus, the administrators annualization methodology would
produce an answer of $46,000 1.01 = $46,460. As before, common sense
produces an answer of $52,000, so that the administrators answer is $5,540 or
11% too low.
13
The obvious flaw in the administrators methodology is the .89 factor that
results from unauthorized use of a 9-hour day in the denominator of the
annualization fraction. Once the plan administrator chose to use an 8-hour day in
the numerator, the only choice for the denominator that would yield the full-time
full-year equivalent mandated by the plan would be the same 8-hour day, which
would eliminate the .89 error.
The correct annualization fraction is simply 261/230 = 1.13, which yields an
annual equivalent of $46,000 1.13 = $51,980, a figure correct within rounding
error from using two digits. This is grade-school math andthe author submits
that anyone who cannot understand it is not competent to administer a pension plan
or adjudicate computational issues. It is unclear why lawyers and judges wish to
number themselves among the innumerate, but many seem to have done so in this
case.
The Sixth Circuits Misreading of the Plan Document
The court was either unable or unwilling to address the elementary
mathematical issues and instead misread the plan document and ignored ERISA
Regulations governing the use of equivalencies for determining service to be
credited to employees.19 The court wrote in pertinent part:20
[The plan administrator] utilized a 45-hour work week . This decision is
based on the terms of the Plan that permit the plan administrator to
14
the document, the administrator may not modify any of the terms of the Plan. As
can be seen from simple mathematical considerations and analysis of the plan
document, the Sixth Circuit erroneously affirmed the administrators rewriting of
the plan language in favor of the employer.
After Sidestepping the Numerical Issues and Misreading the Plan Document
The Sixth Misjudged the Number of Participants Affected
Consistent with the Sixth Circuits misunderstanding of the key term,
"actuarial equivalent", and its aversion to some clearly erroneous grade-school
arithmetic, the Sixth Circuit failed to grasp the size of the group of employees
affected. The court ignored the fact that the annualization language quoted above is
defective on its face and that each new participant who worked a partial year
would have his annualized compensation understated. Later plan amendments call
for an 1820-hour numerator for the annualization fraction (in time further reduced
to 1600), which only compounds the error produced when a 9-hour day is used in
the denominator. Instead of addressing these pertinent issues, the Sixth Circuit
inexplicably focused upon 5 participants and claimed that only a nominal amount
of money is at stake.27
In a defined benefit pension plan, benefits typically depend upon employee
compensation, and employer contributions in turn depend upon benefits. Thus,
mistakes in calculating employee compensation can lead to mistakes in calculating
17
a labyrinth of legal sophistry. Although the Sixth Circuit has rendered its opinion,
[it has] no right morally to decide as a matter of opinion that which can be
determined as a matter of fact.32
2016
19
The author received his Ph.D. in mathematics from the University of Washington and his J.D.
from the University of Michigan. He works as an arbitrator and consultant. Many of his legal and
mathematical publications are posted at https://www.scribd.com/EFrankCornelius.
2
Cornelius v. Dykema Gossett PLLC Retirement Plan, No. 14-1490, February 17, 2015; reh. en
banc den. June 2, 2015; cert. den. October 13, 2015. The courts opinion is posted at
https://www.scribd.com/doc/288965094/Sixth-Circuit-Opinion-Case-No-14-1490-2-17-15 and is
referenced as Opinion.
3
Opinion at 9.
4
Pub. L. 111-148, 124 Stat. 119.
5
Available at http://www.cms.gov/CCIIO/Resources/Files/Downloads/Av-csr-bulletin.pdf.
6
Available at http://www.irs.gov/pub/irs-drop/n-12-31.pdf.
7
Opinion p. 8.
8
Johnson v. Meriter Health Services Employee Retirement Plan, 702 F.3d 364, 367 (7th Cir.
2012).
9
644 F.3d 437, 440 (D.C. Cir. 2011)
10
As cited in Stephens, ACTUARIALLY EQUIVALENT BENEFITS is available at
http://www.soa.org/files/pdf/edu-2009-fall-ea1-02-sn.pdf. The portion quoted is at 11.
11
797 F.2d 1447, 1452 (7th Cir. 1986).
12
ACTUARIALLY EQUIVALENT BENEFITS, supra, at 24; emphasis in original; i represents
interest.
13
ACTUARIALLY EQUIVALENT BENEFITS, supra, at 2.
14
229 F.3d 154 (2d Cir. 2000)
15
229 F.3d at 163.
16
229 F.3d at 164-165; only bold supplied, other emphasis in original.
17
229 F.3d at 159, 166 & n. 16.
18
484 F.3d 395 (6th Cir. 2007).
19
See 29 C.F.R. 2530.200b-3(c)(1) & -3(e)(1).
20
Opinion at 8-9.
21
29 C.F.R. 2530.200b-3(e)(1).
22
681 F.2d 306, 313 (5th Cir. 1982).
23
681 F.2d at 316.
24
229 F.3d at 165 (as a matter of mathematics).
25
Harvard Magazine, January-February 2012, p. 14, Chapter & Verse, author unknown.
26
Dennard, 681 F.2d at 316.
27
Opinion at 9.
28
472 U.S. 559, 571; 105 S.Ct. 2833, 2841; 86 L.Ed.2d 447, 459 (1985).
29
515 F.3d 673, 675 (6th Cir. 2008).
30
517 F.3d 816, 825 (6th Cir. 2007).
31
229 F.3d at 164.
32
Harvard Magazine, January-February 2014, p. 67, Chapter & Verse, quoting H.L. Gantt,
Industrial Leadership, Ch. 4, Results of Task Work.
20