by Alvin D. Lurie

IBM Singing the Big Blues

We have it on the authority of the woman who started the whole thing that everyone should just stop making such a big production out of the decision that flattened the IBM cash balance plan (Cooper et al. v. IBM, S.D. Ill. 7/31/03). IBM has told its employees that the decision "has thrown into question the long-term viability of the existing U.S. pension system." To which Kathi Cooper, the lead name in the class-action suit, replied, " This wild speculation, whether it’s on the defendants’ part or the class’ part, should stop." I am inclined to agree with her, but because I am convinced that the district court’s decision will be overturned on appeal, if only because it defies logic, legislative history, the purpose of the implicated statute, pension policy, reasonable statutory construction, and common sense. Nothing more than that.

The judge acknowledges that "there may be policy reasons why Congress should specifically authorize (cash balance plans) in the context of defined benefit plans." But he maintains that the narrow question here is whether the (IBM plan) comports with the literal and unambiguous provisions of ERISA section 204(b)(1)(H) [the age discrimination rule], and it does not." Concededly, that could provide a rationale for ignoring policy considerations; although the Supreme Court itself has admitted that it looks "beyond the words to the purpose of the act" when to do otherwise "has led to absurd results", adding that "even when the plain meaning did not produce absurd results but merely an unreasonable one ‘plainly at variance with the policy of the legislation as a whole this Court has followed that purpose, rather than the literal words." United States v. American Trucking Associations, 310 U.S. 534(1940).

But what are these "literal and unambiguous" terms that so convinced the judge? When correctly posing the basic question on which the decision rests – namely "whether §204(b)(1)(H)’s term ‘rate of benefit accrual’ refers to the rate at which an employee accrues a benefit payable in the form of an annuity that commences at age 65 – the judge very properly observes, "ERISA does not explicitly answer this question." It is only by cobbling together several sections that he conflates "accrued benefit" and "rate of benefit accrual", to conclude that the two-part definition of the former in 29 U.S.C. §1002(23)(A) – (1) the "accrued benefit determined under the plan, and (2) "expressed in the form of an annual benefit commencing at normal retirement age"– also governs the undefined term "rate of benefit accrual"; and, because that term "is found in the very next subchapter" (sic – the court obviously meant "subparagraph") to that in which the accrued benefit is implicated, "the best interpretation of this phrase is that it also refers to an employee’s age 65 annual benefit and the rate at which that age 65 annual benefit accrues.

Apart from thereby demonstrating that the critical statutory terms are anything but literal and unambiguous, the court’s interpretive analysis based on the proximity of separate subparagraphs relies upon an unpersuasive non sequitur (and a bizarre example of English usage revolving around the correct way to express the speed of the process of popping corn!), and besides is irrelevant to the central question presented by the cash balance plan design, which is whether the interest credits that are an integral feature of a cash balance benefit formula are required to be taken into account in determining whether the proscribed reduction of the rate of benefit accrual on account of advancing age occurs under the formula. That question is no different irrespective of how the accrued benefit is expressed, whether as a lump sum, or an immediate annual benefit, or an annual benefit commencing at normal retirement age. It is still the same accrued benefit, and all forms of its expression must of course be actuarially equivalent.

The question of the proper treatment of the interest credit is unique to the cash balance design, which consists of an annual compensation credit (e.g., 5% of pay) and an interest credit (e.g. 3% of the compensation credit projected forward to the normal retirement age), i.e., an accretion of interest credits for each year from the time of accruing the compensation credit to the attainment of normal retirement age. Theoretically, one could provide a frontloaded interest credit, where the future year’s interest credits are not conditioned on future service and thus accrue at the same time as the related compensation credit, or a backloaded interest credit under which future interest credits are conditioned on the performance of future services and so do not accrue until subsequently credited to the participant’s account. The IBM plan appears to have been of the former type. A seminal announcement from the IRS, Notice 96-8, advises that the backloaded design "typically will not satisfy any of the accrual rules"(i.e., 3%, 133% and fractional), and so is essentially a non-starter.

It is immediately obvious that the interest credits for A, a 50 year old, will project 15 annual interest elements (assuming an age 65 retirement) while those of B, a 40 year old, will project 25 interest elements; so, though each of them earns the same compensation credit in Year X, B will accrue a much larger benefit in that year because of the greater interest credit. More to the point, each of their respective benefits will decrease in each subsequent year. For that matter, so will the benefit accruals of 25 year olds. This is simply a function of the time value of money; and while there is a direct correlation with aging, it is not age discrimination that brings it about. The alternative would be to assign the identical interest credit to every participant irrespective of age, but that lacks any logical or mathematical foundation. The interest credit in a cash balance plan is really a surrogate for earnings in a defined contribution plan. The longer a participant remains in the plan, the greater his (her) expected earnings. Thus, the younger participant can expect a contribution to his account in Year 1 to become worth more than a contribution to an older participant, as the normal consequence of a longer stream of earnings accumulations. There being no separate accounts for each participant in a cash balance plan, the interest credit is a built-in earnings equivalent. That the earnings equivalent shrinks for each year that the participant adds one year to his age "merely illustrates the time value of money at work", as IBM pointed out to the court to no avail. It is the converse of the fact that when two differently aged participants each receive a dollar of contribution at the samer time, the dollar that the older participant will receive at retirement is worth more than the dollar a younger participant will realize at the later date of his retirement. The opinion even acknowledges that "from an economist’s perspective, Defendants have a good argument." That doesn’t make it legal, the court hastens to add.

The key sentence in the opinion – and the most problematic – is: "Moreover, the interest credits that are projected and valued as an age 65 annuity must also be taken into account in determining whether a cash balance plan complies with the benefit accrual requirements under ERISA §204(b)(1)." The opinion goes on unforgivingly: "At this point in the analysis, the result is inevitable. In terms of an age 65 annuity, the interest credits will always be more valuable for a younger employee as opposed to an older employee." That should not be a disciminatorily-based indictment; rather it is a mathematically-based truism.

The court seems to justify its harsh view of the inevitability of the result by observing that: "These requirements were in effect before IBM considered adopting the CBF (the term used by the company for its cash balance plan). IBM, like many other corporate sponsors, proceeded with open eyes and was fully informed of the consequences of the litigation that was sure to come." What the court doesn’t mention (or even cite) was the thoroughly reasoned opinion in Eaton et al. v. Onan Corporation (No. IP-970814-C-H/G, D.C.S.D. Ind. 9/29/00 (designated "Not Intended For Publication In Print"), which completely supported the position maintained by IBM. Also not mentioned in the opinion are the various pronouncements of the IRS and Treasury going back a number of years that equally support what IBM and other plan sponsors might well have assumed, even with their eyes open, such as this in the preamble to the final 401(a)(4) regulations:

"The fact that interest adjustments through normal retirement age are accrued in the year of the hypothetical allocation will not cause a cash balance plan to fail to satisfy the requirements of section 411(b)(1)(H) [the Code mirror provision to ERISA §204(b)(1)(H)], relating to age-based reductions in the rate at which benefits accrue under a plan." (Note that Reorganization Plan No. 4 assigns to the Treasury authority to write the parallel regulations under ERISA and the IRC.)

So much for the court’s reading of the "literal and unambiguous" provisions of ERISA §204(b)(1)(H).

It was – and still is even after this IBM decision – anything but foregone that the Congress decreed, in a statute enacted before cash balance plans were a known form of matter, that they could not by any means satisfy the age discrimination rules applicable to the defined benefit category of plans, into which cash balance plans fit only most uncomfortably wearing at least as many badges of a money purchase plan. (Sooner or later Congress will have to address the problem of the proliferation of hybrid plans that no longer fit easily into the defined benefit/ defined contribution dichotomy.)

I began this piece by, in effect, predicting that the decision will be reversed on appeal, reciting such grounds as logic, legislative history, purpose, and common sense. I did not acknowledge then that I borrowed most of my criteria from the Onan opinion, that frankly acknowledged the facial ambiguity of the implicated statute, and said, when "dealing with such statutory ambiguities, the courts look for guidance from many sources, including legislative history, the broader purposes of the legislation at issue, including evidence of the limitations and compromises made in Congress, as well as common sense and the practical implications of the alternative interpretations."