Court says pension plan change didn't violate ADEA or ERISA

10th Circuit says employer appropriately handled transition from traditional pension plan to cash balance plan.

In the past couple decades, many companies have converted their traditional pension plans to cash balance plans in order to make benefits more predictable. But some workers have complained of violations of the Employee Retirement Income Security Act (ERISA) when their benefits are reduced as compared to their former traditional plans. On August 11, the 10th Circuit ruled in Tomlinson et al. vs. El Paso Corporation that employees don’t need to be specifically warned about “wear-away” periods when traditional pension plans are converted to cash balance plans. The court also held that even if older employees are disproportionally subject to frozen benefits, this doesn’t violate the Age Discrimination in Employment Act (ADEA).

A wear-away is the time it takes for a benefit under a new cash balance plan to reach the minimum benefit of the old traditional plan. In Tomlinson, the plaintiffs claimed that the wear-away periods resulting from El Paso’s transition to a new pension plan amounted to unlawful age discrimination, and that El Paso violated the anti-backloading and notice provisions of ERISA (see “Backloading Accusations”). But the 10th Circuit found that El Paso’s transition to the cash balance plan favored, rather than discriminated against, older employees, and that the plan was not backloaded. It further held that “ERISA does not require notification of wear-away periods so long as employees are informed and forewarned of plan changes.”

Picking Plans

“It is no secret that a major issue for many companies is what to do about their pension liabilities,” says Amanda Amert, a partner at Jenner & Block and chair of the firm’s ERISA Litigation Practice. She explains that the conversion to a cash balance plan is an attempt “to maintain much of the value of the pensions for employees while at the same time managing the liabilities that the employer is going to have to bear.”

El Paso converted its traditional pension plan to a cash balance plan in 1997. Under the old plan, employees received retirement benefits equal to a percentage of their final average monthly earnings multiplied by their years of service. The new plan deposited a percentage of each employee’s pay into a hypothetical cash balance account. The percentage of the pay credits increased with an employee’s age and years of service. In addition, four times a year, interest credits were added to the hypothetical account. The interest rate was the same for all employees.

A five-year transition period for eligible El Paso employees began on the first day of 1997. At that point, employees were credited with a cash balance account equal to the amount payable upon retirement under the old plan. During the transition period, employee accounts were calculated under both the old and the new plans. At the end of the transition period, no additions were made to accounts under the old plan, but credits continued to accrue in the new cash balance accounts. The “minimum benefit” was the accrued benefit under the old plan at the end of the transition period. When employees retired, they could choose the greater of the minimum benefit or the cash balance account benefit.

At the end of the transition period, the minimum benefit for many employees was higher than the value of their cash balance account. For some, the benefit they would receive under the new cash balance plan wouldn’t exceed the value of their minimum benefit under the old plan for several years. The court recognized that during this period, “the accrued benefit payable at normal retirement age is effectively frozen,” and older employees were more likely than younger employees to experience long wear-aways.

In January 1996, El Paso distributed a written communication to its employees telling them about the plan change and noted that “employees will earn future benefits at a lower rate.” About 10 months later, El Paso notified its employees that the new plan was “no longer at the top of the range,” and “the hard truth is that those who are not prepared may have to postpone retirement.” Although El Paso did not specifically refer to a wear-away, it did state that after the transition period “the current pension plan formula will be frozen for [some] participants and they will not earn any additional benefits under the current plan.”

A 2002 Summary Plan Description explained how benefits would be calculated under the new plan and described the transition period. It also included details about the choice that retirees would have between the cash balance plan and the minimum benefit.

Although the plaintiffs argued that these notifications had statutory and practical defects, the court disagreed.

Advantageous Option

Littler Mendelson Shareholder Darren Nadel, who represented El Paso, says the 10th Circuit’s opinion “makes it easier for employers to utilize cash balance plans and know how to do so in compliance with the law.” Nadel explains that when an employer’s disclosures are ruled to be inadequate, any plan amendments can be completely undone.

Amert predicts that courts will review the practical effect of changes to defined benefit plans when deciding whether a plan complies with ERISA. “At least in the 10th Circuit, they are not going to be too inclined to penalize employers who are trying to do a good job by narrowly interpreting very specific statutory or regulatory provisions.”

Beverly Caley

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