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Fiduciary Update | February 2015

Drew McCorkle
CAPTRUST Vice President | Financial Advisor

Pension Plan’s “All Equity” Investment Allocation Challenged  

Pension plan participants challenged the plan fiduciaries’ decision to invest the plan assets entirely in equities. The asset allocation decision was made in 2004 and, as may be expected, the impact of the market turmoil in 2008 and 2009 was significant. The plan was alleged to have lost more than $1 billion as a result of the allocation decision. A key part of the court’s analysis was whether the participants had been harmed, as no participants had failed to receive their benefits when due. The court concluded that an argument could be made that the losses incurred could impact the plan’s eventual ability to pay benefits. (If the plan had been overfunded after the alleged losses, the claim would have been dismissed.) However, the claim was dismissed because the asset allocation decision was made more than six years prior to the claim’s filing and, as a result, was barred by ERISA’s six-year statute of limitations. Adedipe v. U.S. Bank, National Association (D. Minn. 2014)

The court rejected a “continuing violation” theory that a new decision to remain in the all-equity strategy was made from time to time as the strategy was maintained, which would restart the statute of limitations clock. The court noted, “To be sure, significant changes in market conditions can trigger an obligation for fiduciaries to investigate whether altering an investment strategy previously decided upon would be in the best interests of the plan. But even so, it is elemental that ERISA requires [fiduciaries] to have acted prudently and loyally in investing the plan’s assets, not to have predicted and avoided the consequences of the financial crisis.” The pendency of Tibble v. Edison, in which the Supreme Court is expected to address ERISA’s statute of limitations provision, was noted by the court.

IRS and DOL: Deferred Annuities are Permitted in Target Date Funds

Continuing a series of announcements and actions in recent years supporting the use of annuities in defined contribution plans, the Internal Revenue Service (IRS) and Department of Labor (DOL) have indicated that using deferred annuities in target date funds is permitted under their respective legal frameworks. As described in a recent IRS Notice, deferred annuities could take the place of the fixed income component of target date fund asset allocations in increasing proportion, beginning when the fund is within 10 years of its retirement target date. From the IRS’s perspective, using deferred annuities only in target date funds for participants within 10 years of retirement would limit the availability of the annuities to older participants and could result in nondiscrimination issues. For this purpose, if its requirements are met, the IRS will consider the entire target date fund series to be a single investment, eliminating the nondiscrimination issue. Interestingly, to receive this treatment, the IRS requires that particular target date fund “vintages” be available only to those who will retire within narrow ranges around their target date, so the annuity feature fits the age of investors in the strategy. In our experience, access to the various target date vintages is not controlled in this way. (IRS Notice 2014-66, 10-24-14)

In conjunction with the IRS notice, the DOL issued guidance indicating that the inclusion of deferred annuities in target date funds would not affect their suitability as a plan’s qualified default investment alternative (QDIA). The DOL also noted that plan fiduciaries have a duty to prudently select and appropriately monitor the target date fund investment manager, and that it is the target date funds’ investment manager who will have responsibility to select the provider of any deferred annuity included in its target date funds. It is anticipated that the target date fund investment manager would use the DOL’s “annuity selection safe harbor” guidance. (Phyllis Borzi, DOL, Letter to Mark Iwry, U.S. Department of the Treasury, 10-23-14)

Important Cases to Watch

Fiduciary Duty to Reevaluate Fund Selections

Claims alleging that plan fiduciaries used overpriced mutual funds were dismissed because the funds were selected more than six years before the lawsuit was filed—and {the claims were} barred by ERISA’s six-year statute of limitations. The Supreme Court will decide this term whether fiduciaries have a duty to reevaluate decisions like this, or whether they are “safe” if a decision ages past the six-year mark. Tibble v. Edison (S. Ct. argument set for 2-24-15)

Healthcare Plan: Fiduciary Breach in Fee Overcharge

The United States Supreme Court has left undisturbed a $6 million judgment in favor of a health plan that paid fees for administrative services that were not disclosed by its provider. Hi-Lex Controls maintained a self-funded health plan for its employees and retained the services of Blue Cross Blue Shield of Michigan (BCBS-MI) to administer the plan. BCBS-MI began charging an undisclosed administrative surcharge on some covered services, increasing Hi-Lex’s costs—along with BCBS-MI’s revenue. BCBS-MI was found to be a fiduciary and to have breached its duty to the plan. Unlike in the retirement plan arena, health plan providers are not obligated to disclose their fees under Section 408(b)(2) of ERISA. Following lower court decisions in this case, some plan sponsors are now periodically requesting fee disclosures from their health care providers for all fees they are receiving both directly and indirectly. Hi-Lex Controls, Inc. v. Blue Cross Blue Shield of Michigan (6th Cir. 2014) (S. Ct. Cert. Denied 10-20-14)

Fiduciary Committee Decision to Map Investments from Balanced to Target Date Investments Stands

In the widely reported case of Tussey v. ABB, Inc. (8th Cir. 2014), plan fiduciaries were found to be liable for using more than $13 million of 401(k) recordkeeping fees to pay for non-401(k) plan services such as payroll and healthcare processing. The court of appeals reversed an additional judgment of $21.8 million that was based on the plan fiduciaries not strictly following the 401(k) plan’s investment policy statement when a balanced fund was eliminated and its assets were mapped to target date funds. The district court had substituted its own judgment for the fiduciary committee’s and arrived at a different conclusion. The court of appeals found that the proper starting point is to assume that the committee’s decision was prudent. From that starting point, the court of appeals did not find a basis for overturning the committee’s decision. The Supreme Court was asked to decide whether courts should defer to fiduciary committees or substitute their own judgment. It declined to do so, and the decision stands. This case underscores the importance of having a thoughtful process and basis for making and documenting fiduciary committee decisions. (S. Ct. Cert. Denied 11-10-14) 

Delay in Disability Insurance Payment Requires Disgorgement of Insurance Company Profits

In a ground-breaking decision, the U.S. Court of Appeals for the Sixth Circuit required an insurance company to pay a beneficiary the profits it earned on wrongly withheld disability insurance benefits. An executive was disabled and denied benefits until the conclusion of protracted litigation to establish his entitlement. The accumulated disability payment was more than $900,000. The profits earned on that amount, based on the insurance company’s internal rate of return, was $2.8 million, which the insurance company was required to pay. In an uncommon step, the decision of the three-judge appeals panel was vacated, and the case was reheard en banc by the 15 judges in the Sixth Circuit Court of Appeals last summer. A decision is pending. Rochow v. Life Insurance Company of North America (6th Cir. 2013)

Casting a Wider Net for Retirement Participants

Last year, President Obama introduced the myRA program and, as we go to print, new bipartisan bills have emerged in both the U.S. House of Representatives and Senate focused on encouraging small employers to offer retirement savings plans. Expanding American workers’ access to retirement savings is a major legislative theme and a top priority for the Obama administration. Here are a few developments to watch:

myRAs Now Available to Small Employers. In his State of the Union speech last year, President Obama announced the establishment of My Retirement Accounts or myRAs.  Through the myRA program, employees can accumulate a maximum account of $15,000 on an after-tax basis if their employers participate in the program. Currently, deferrals can be made only by payroll deduction. Deferrals are invested exclusively in myRA Treasury retirement savings bonds, with current yields expected in the low single digits. At the request of the Treasury Department, which is running the myRA program, the DOL has provided its view that an employer’s participation in the myRA program would not be considered to create a retirement plan covered by ERISA. Availability of myRAs is limited to those who do not have an employer-sponsored retirement plan available. (John Canary, DOL, letter to Mark Iwry, U.S. Department of the Treasury, 12-15-14)  

Illinois Adopts Mandatory Auto-enrollment IRAs. Under a new state law, all employers with 25 or more employees in the state of Illinois who do not have a retirement plan in place will be required to enroll their employees in a state-run individual retirement account (IRA) program with a 3 percent after-tax deferral. Employees will have the opportunity to opt out of the program, change their deferral amounts, and change their investments. Investments will be facilitated by the Illinois Secure Choice Savings Board. The program, which will also establish Roth IRAs, is intended to be in place within 24 months, pending guidance from the IRS  and the DOL. The Illinois Secure Choice Savings Program provides for a $250-per-employee penalty in the first year of noncompliance and a $500-per-employee penalty in subsequent years. (Ill SB2758 Signed into law 1-5-15)

In addition to Illinois, a number of other states are pursuing this type of arrangement. We expect to see more states seek solutions that expand access to retirement saving programs via small employers.

White House Proposals. In this year’s State of the Union address, President Obama offered two new proposals to bring more employees into the retirement system, and renewed his call for an upper limit on tax-preferred retirement savings:

- All employers with more than 10 employees, who do not already offer a retirement plan, would be required to automatically enroll employees in an IRA, at an as-yet-undisclosed minimum salary deferral. Employees would have the opportunity to opt out of the program.

- Current retirement plan eligibility minimums would be reduced to allow the participation of employees who have worked at least 500 hours per year for three years. (Many plans exclude those working fewer than 1,000 hours per year from participating, as is currently permitted.)

- First proposed last year, Obama renewed his call to limit the maximum annual tax-preferred retirement benefit to $210,000. At today’s interest rates, that would translate to a maximum savings of approximately $3.4 million.

Supreme Court Approval of “Equitable Relief” under ERISA: Closing the Loop

In 2011, the Supreme Court decided CIGNA Corp. v. Amara, issuing a landmark decision that has changed the types of relief courts can give to plaintiffs in ERISA cases. Before this decision, courts believed they were restricted to providing only what plan documents specifically permitted. The Supreme Court’s 2011 decision sent the case back to the district court with directions that other “equitable” relief can also be awarded. In this particular case, pension plan amendments were made and communicated to participants in a misleading way. Following the plan amendments, many participants believed that they would be entitled to a larger benefit than they would actually get. Upon reconsideration, the district court “reformed” the plan document to provide that participants get the better of what the plan provided or what the communications indicated they would get. This decision was recently affirmed by the U.S. Court of Appeals for the Second Circuit. Amara v. CIGNA Corp. (2nd Cir. 2014)

Reduction of Previously Earned Pension Benefits Now Allowed in Union Plans

Late last year Congress passed legislation that in extreme circumstances permits previously earned benefits in multiemployer pension plans to be reduced—including for participants in pay status. (Note:  “multiemployer” plans cover collectively bargained employees and are usually governed by joint boards of trustees representing management and labor, while “multiple employer” plans are single employer plans that share a plan document.) The impetus for this legislation is the severely underfunded state of some multiemployer plans and the Pension Benefit Guaranty Corporation’s significant deficit in the fund to cover these plans. The PBGC’s 2014 annual report reflected that the deficit in the fund to pay benefits for multiemployer plans has increased to $42.4 billion from $8.1 billion since last year’s report. In an effort to stanch the increase in liability from failing multiemployer plans, the new law will permit the benefits of plans in “critical and declining status” to be reduced. To use this provision, plan sponsors will have to show that with a suspension of benefits the plan can remain solvent and provide benefits of at least 110% of the PBGC’s guarantee for multiemployer plans (currently $12,870 per year). This is the first instance in which ERISA covered benefits in pay status have been subject to reduction; however, those older than 80 will be exempt from reductions. Applications for a reduction in benefits must be made to the Department of the Treasury and are subject to a significant regulatory process. This law does not affect single employer pension plans.

Beneficiary Issues: What’s a Plan Fiduciary to Do?

From time to time plan fiduciaries are confronted with beneficiary issues. Two recent cases illustrate different resolutions. In one situation the fiduciaries did not have to act because the potential beneficiaries actively pursued the matter. A decedent-participant and his wife separated after being married for 16 years, but they did not formally divorce.  Fifteen years after the separation, the participant changed the beneficiary of his 401(k) plan to be his son. Six years later the participant died and a dispute ensued between the son and his mother—the decedent’s wife. The son sued his mother for a judgment that he was entitled to the benefits. (Guess who’s NOT coming to dinner…) The Court conclude that because there had been no divorce the surviving—if estranged—wife was entitled to benefits under the provisions of the Retirement Equity Act, which amended ERISA to protect spousal rights. Gallagher v. Gallagher (D. MA 2013) 

Another situation left the matter in the fiduciaries’ hands. A decedent-participant had submitted a number of beneficiary designation forms over a period of 30 years variously identifying five different wives as his beneficiary.  The final form on file indicated that he was “widowed.” The plan administrator could not determine the proper beneficiary, and filed an “interpleader” action in court.  With this process the possible claimants (in this case all five wives) are named and the Plan Administrator steps back from the proceedings while the named parties plead their cases and a judge decides who wins. In the end, there was not a divorce from wife number five—who was not actually dead—and she was determined to be the beneficiary. Trustees v. Coates