<nobr>Sep 27, 2005</nobr>
ERIC Urges the Senate to Protect Hybrid Pension Plans
As Senators seek common ground regarding pension reforms, we urge that you ensure that the final Senate bill protects hybrid pension plans.
According to the most recent Form 5500 data, approximately 9 million individuals rely on hybrid pension plans such as cash balance and pension equity plans for their retirement security. Until thrown into uncertainty by recent litigation, hybrid plans had been the favored option for employers who wanted to establish or maintain responsive and secure defined benefit pensions for their employees. Hybrid plans address retirement security in a dynamic economy and are specifically responsive to the 21st century needs of employees, including many older employees, short-service employees, and employees, many of whom are women, who interrupt their careers to raise a family or assist an aging parent.
Hybrid plans provide portable defined benefit pension benefits that employees earn automatically without having to make contributions and protect employees against investment risk. Importantly, hybrid plans offer the option of receiving benefits as an annuity that protects the retiree against the threat of outliving his or her retirement benefits. These plans have become increasingly popular with participating employees.
Recently, however, a single district court adopted a line of argument that hybrid plan designs are inherently unlawful because they credit interest and younger employees will accumulate more interest by age 65 than older employees. In essence, the court concluded that the time value of money is age-discriminatory. This argument has been rejected by every other district court that has considered the issue both before and after this particular ruling, and with good reason. If this court’s logic were allowed to stand many well-established traditional defined benefit plans would be illegal because they, too, credit interest or otherwise index benefits. Furthermore, if the same reasoning were applied more broadly, any indexed benefit such as social security benefits, any plan (such as a 401(k) plan) that provides benefits that grow with investment earnings, and even an interest-bearing savings account could be considered age-discriminatory. The court’s argument is not credible, and legislation concerning the lawfulness of hybrid plans – both existing and future plans – is entirely appropriate and desirable.
It is important to understand that two very separate issues are involved in the current debate. One is whether the basic design of hybrid plans is lawful under age discrimination statutes. The other is concerns that have been raised regarding conversions from traditional defined benefit plans to hybrid plan designs.
Many hybrid pension plans have received determination letters from the Internal Revenue Service confirming that their design complies with applicable law, include the age discrimination rules. The Treasury Department has published several statements confirming that cash balance plans do not violate the age discrimination rules solely because interest credits accrue when the employee earns the related pay credit.
Plan sponsors are seeking validation of the basic plan design in order to remove the current uncertainty concerning the status of these plans. This issue arises whether or not a conversion has occurred. In other words, it also applies where a hybrid plan was established without a conversion.
It is critical to the health and vitality of the defined benefit system to validate the design of both existing and future hybrid plans. If Congress enacts legislation that confirms the lawfulness of hybrid plans designs on a prospective-only basis, there is significant risk that – regardless of any “no inference” language that might be included – a court will infer from the prospective effective date that the law was different (and less hospitable to hybrid plans) in the past. The liability exposure is significant. For example, in order to comply with such a ruling, instead of crediting 5% of pay for each employee regardless of age, a plan that credits 5% of pay for a 25-year-old could be required to credit 100% of pay for a 65-year-old to offset the effect of the time value of money. This is irrational. No plan can exist under such rules. Even if employers ultimately win their cases, they would still have to endure years of expensive and unwarranted litigation. For many, the prudent course, absent Congressional action that protects existing as well as future plans, will be to suspend or terminate their plans. This would be an unnecessary and tragic result that benefits no one.
Congress’s validation of the hybrid plan design should be without reservation. There should be no litigation “carve out.” Hybrid plans are, and always have been, lawful, and there is no reason to treat one company differently from another just because one has been sued and the other has not. In addition, Congress should not impose mandates on plan designs, such as requirements for specific types of interest credits, that serve merely to stifle creativity and flexibility.
Finally, regarding conversions, Congress faces two issues – whether to act regarding prior conversions and whether to act regarding future conversions.
Congress should not impose retroactive mandates on conversions. It is not right for Congress to say that it has changed its mind regarding actions taken in good faith and in accordance with the law as much as a decade or so ago. Employee benefits are offered by employers on a voluntary basis. Any such action by Congress will undermine employer confidence in offering any form of employee benefit.
Likewise, Congress must exercise extreme care regarding any future requirements, including prescribed conversion methodologies, regarding hybrid plans. If hurdles enacted are too high, employers simply will not choose that route, relying instead on benefits where the employee bears the investment risk. If Congress enacts rules that seek to mandate the continuation of current benefits into the future, employer confidence in offering any form of employee benefit again will be severely undermined.
Studies have repeatedly shown that, in conversions, employees have not lost benefits that they had already accrued. Moreover, these studies indicate that, responding to the marketplace, employers converting to hybrid designs have taken strong steps to offer attractive compensation to all their employees – including older employees.
We strongly urge Congress to affirm the design of hybrid plans so that employers will be able to maintain existing plans and offer new ones that provide valuable and secure benefits to their employees.
Janice M. Gregory
Senior Vice President
The ERISA Industry Committee
Back to Previous Page