The Defined Benefit (DB) Lawsuits: Why There May Be Widespread Implications

Several lawsuits have been filed recently against plan sponsors of large corporate pension plans at Metropolitan Life Insurance Co., PepsiCo Inc., U.S. Bancorp, and American Airlines Inc. The plaintiffs in these suits claim that lower benefits were paid to participants and/or their beneficiaries due to the defined benefit (DB) plan’s use of outdated mortality tables. The issues raised in these lawsuits are not unique to large pension plans, nor to corporate plan sponsors; and thus, DB plan sponsors should carefully understand the issues and the potential ramifications to their own plans.

The mortality tables used for measuring a plan sponsor’s obligation to fund a DB plan and the minimum lump sum value of a retiree’s benefit from a DB plan (provided the lump sum is an option offered by the plan) are regulated by the IRS and updated on an annual basis. Currently, there are no similar regulations mandating the use of specific mortality tables when converting a DB benefit into certain other actuarial equivalent forms of payments (e.g., Straight Life Annuity, Certain and Life Annuity, or Joint and Survivor Annuity), or when calculating the actuarial equivalent of early retirement benefits. While some plans provide “tabular factors” for converting to optional forms or for early commencement, many others define the mortality tables and the interest rates used for these conversions in their plan documents, with little guidance offered by the IRS as to if, or when, the mortality tables should be updated.

A common feature of qualified corporate DB plans is for optional forms of payments to be actuarially equivalent. For example, the Qualified Joint and Survivor Annuity must have the same actuarial equivalent value as the Single Life Annuity. This means that the cash flows of both payment forms must have the same present value. To convert a Single Life Annuity to an actuarial equivalent optional form, interest and mortality assumptions are used. The only requirements that the IRS has for these mortality tables is that they are reasonable. However, the use of different interest and/or mortality assumptions may yield a different Joint and Survivor Annuity amount, even though the Straight Life Annuity is the same.

The same issue can arise for plans that offer actuarially equivalent early retirement benefits. An individual electing to retire early expects to receive their retirement income over a longer period than someone retiring on time. Therefore, the pension benefit is reduced to provide the same actuarial equivalent value. The use of different interest and/or mortality assumptions may yield a different reduction.

While plan sponsors have not done anything illegal or inappropriate according to IRS regulations as they are today, these lawsuits may open pension plans to scrutiny. If the proceedings rule in favor of the Plaintiffs, adjustments may need to be made to the mortality tables (and possibly interest rates) set within plan documents to avoid the risk of future lawsuits. This may lead to larger benefit payments which, in turn, could cause plans to be underfunded.

Plan sponsors who offer qualified single employer plans should review the plan’s assumptions for measuring actuarially equivalent benefits. It is unknown at this time if the IRS will mandate actuarial equivalent assumptions for all benefit forms or early retirement. However, plan sponsors should consider the impact of any potential changes on their DB plan’s funded status, contribution requirements, and financial reporting obligations.

Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.

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