Compliance September 26, 2022

Judge Dismisses ERISA Suit for Not Stating a Claim

A judge dismisses a suit against utility company Exelon, but leaves the door open for future proceedings.

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The U.S. District Court for the Northern District of Illinois has dismissed an ERISA class action against utility company Exelon Corporation and related defendants, including the firm’s investment oversight committee and its board of directors.

The plaintiffs, who are participants and beneficiaries of Exelon’s employee savings plan, initially brought the case in December 2021, alleging that Exelon maintained investment options that charged higher fees and underperformed relative to available alternatives. Exelon had over $1 billion in assets under management, and as such should not have been paying fees comparable to retail prices, plaintiffs claimed. They alleged that they were paying around $99.78 per participant per year, when there were market alternatives as low as $20 per year, and that this cost participants millions of dollars. 

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Exelon moved to dismiss the case in February on the basis that merely offering choices with higher fees is not actionable under ERISA.

Plaintiffs responded in March that Exelon failed to continuously review the investment options’ cost and performance, and that fiduciaries that take an unreasonable amount of time to remove low-performing investments violate their fiduciary duties. The defendants also maintained proprietary actively managed funds, when passive funds tend to outperform actives over time. Plaintiffs claimed that the case should not be dismissed at the pleadings stage because evaluating the investments is a “fact-intensive process” and it is too early in the litigation process for that to have been completed.

Exelon countered in April, arguing that plaintiffs merely claimed that the plan could have been charged lower fees with passive funds, which according to the defendants is not an actionable claim because ERISA neither bans active funds nor requires fiduciaries to “scour the market” to find the cheapest and best-performing investments. Rather, the defendants said, plaintiffs must have specific factual claims to show the investments were “objectively imprudent.”

The defendants also argued that it is not imprudent to maintain lower-performing funds as part of a long-term investment strategy, and that the plaintiffs never established a fair benchmark to which Exelon’s plan could be compared. The higher fees charged were not unreasonable in light of the plan’s needs or the services rendered for those higher fees, argued the defendants, who also noted that merely identifying better funds is not automatic proof of fiduciary imprudence.

The defendants asked the court to take their gatekeeping responsibility seriously, and to dismiss the case without an opportunity to amend the complaint in the future. They accused the plaintiffs of bringing a frivolous suit to impose litigation costs on the defendants and extract a settlement regardless of the suit’s merit.

The U.S. Chamber of Commerce filed an amicus brief on behalf of the defendants. The brief says there has been a surge of ERISA litigation in the past two years, in which plaintiffs cherry-pick data points and time periods. It is always possible to identify bad plans in hindsight, the brief says, but if that were the only requirement for successful legal action, no plan would be immune to ERISA litigation. In the Chamber’s view, lawsuits of this kind only serve to increase litigation and insurance costs to fiduciaries, and therefore incentivize employers to reduce fund choices or not offer retirement plans at all, which would only hurt the people ERISA is designed to protect.

The Chamber’s brief also suggests that litigation concerning higher fees will disincentivize many of the services that higher fees can provide, such as financial literacy education and enhanced customer service.

The Chamber further argued that plaintiffs need direct allegations of wrongdoing, and not circumstantial evidence that is consistent with a prudent process.

The District Court’s dismissal, issued last week, says higher fees are often an indicator of superior services, and the court needs a rationale for believing that the comparators cited by the plaintiffs are similar to the funds offered by Exelon before a fair comparison in fee structure can be made.

The court did keep the door open on management costs, however. The ruling says that while the plaintiffs asserted that there were more affordable comparator funds with “similar investment mixes” and “underlying assets” for “the same or better performance” available, and that therefore higher fees were not justified by higher returns or better services, the plaintiffs need more facts to show that these rival funds are appropriate benchmarks.

The case was dismissed without prejudice, and the plaintiffs were given leave to amend their complaint by October 31.

Exelon has not yet responded to a request for comment about the lawsuit. 

Compliance September 26, 2022

Plan Sponsors Consider PBGC Premium Strategies

As plan sponsors near the deadline for changing how they calculate PBGC premiums, some are considering a change in light of market moves.

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It’s that time again. The deadline for plan sponsors to determine how they plan to calculate Pension Benefit Guaranty Corporation insurance premiums is coming up, and this normally sleepy corner of plan operations is getting interesting. Market dynamics including rising interest rates and inflation could mean it makes sense for some plan sponsors to consider a change to their calculations in order to save money on premium payments. However, it’s not a straightforward process for everyone.

PBGC premium payments are a function of how many participants are in the plan, how underfunded the plan is and what the current interest rate is. The number of participants tends to remain relatively static in frozen plans. Funded status also doesn’t typically change drastically year to year. However, interest rates can change significantly and plan sponsors can lower their premiums by paying close attention to where rates are now and where they are likely to be in the future.

Premium minimums and caps are calculated by the PBGC annually. For this year, the variable rate premium is 4.8% of the plan’s 2022 unfunded vested benefits up to a cap of $598 per participant.

According to the PBGC, defined benefit plan sponsors that have underfunded plans can calculate their premium payments in one of two ways. They can use the spot rate, which uses interest rates from the month prior to the start of the plan year, or they can use the alternative method, which uses the average interest rate over the past 24 months. Once plan sponsors elect a calculation method, they have to keep the same method for five years. Plan sponsors that are able to, and that elect to change before October 15, will be able to start their five-year clock this year.

When interest rates were low for many years in a row, this choice didn’t have much of an impact on premiums. Now that rates are rising, when they rise and by how much can help or hurt the size of premium payments.

“What’s going on is that there’s a decline in assets because of market performance, but there is not a corresponding decline in liabilities,” explains Tonya Manning, chief actuary and wealth practice leader at pension consultancy Buck. “Usually the way the market works if assets go down and interest rates go up, you have a gap between assets and liabilities that holds relatively steady. But, when it comes to calculating premiums right now, the change in assets and interest rates are not moving in the same magnitude.”

Plan sponsors using the spot rate will realize the recent rise in interest rates. Plan sponsors using the alternative method may not fully capture the rise in interest rates because the 24-month average will be brought down by the lower interest rates of 2021. So, each calculation can come away with very different rates and resulting premiums. This difference may become especially acute in 2023, as the most current rate increases will be reflected in the spot rate, whereas the alternative method will only just start catching up. Plans that are locked in to using the alternative method may find themselves paying higher premiums until the 24-month average fully reflects all of the rate increases, or until their five-year window runs out, whichever comes first.

Pension consultant October Three recently issued an alert recommending that plan sponsors that can make a change before the October deadline do so and choose the spot method. The alert says making the change now can benefit plan sponsors for 2023.

“For 2023—which will be based on either a December 2022 spot rate or a 24-month average ending (depending on the elected look-back month) August-December 2022—if the current trend holds, using the standard method produces a significantly higher valuation rate/lower UVBs/lower variable-rate premiums. The movement in rates this year has been the sharpest since 2008, making the PBGC method elected for 2023 the most momentous decision sponsors have faced under current law,” the alert says.

The October Three alert also notes that making the change now means that the five-year lockup period will run from 2022 to 2027, which could have some specific benefits. Plan sponsors already have a pretty good indication that rates will continue to go up in 2022 and 2023. By making the election now, two of the five years are accounted for. If interest rate regimes change significantly in 2024 or beyond, October Three says, then plans will be in their countdown period, which could serve as a good hedge against uncertainty. By waiting until 2023 to make a change, plan sponsors lose one year of knowing what rates are likely to be.

Thinking through total premium cost and plan strategy can be essential for underfunded plans. Severely underfunded plans have to pay the highest PBGC premiums, because from the PBGC’s perspective, there is a greater risk that they may not make good on their plans and have to resort to payouts from the PBGC. Severely underfunded plans have to pay premiums of either 4.8% of unfunded vested benefits or a $598 per participant cap—whichever is lower. The cap will increase in 2023 to more than $600 per participant.

Dan Atkinson, consulting actuary at BCG Pension Risk Consultants, BCG Penbridge, explains it this way: Interest rate calculations have less of an impact for severely underfunded plans because plan sponsors are already paying at or near the cap. But plan sponsors may be further incentivized to consider risk transfer because it can make it more likely that the $598 fee per participant gets charged as a function of the risk transfer, which is often a cheaper outcome.

“Once you get to a point where you are paying almost $600 per person, it makes sense to redo the plan so there are fewer people,” he says.

Buck’s Manning agrees. “There are a lot of factors at play here, especially for underfunded plans,” she says. “Plan sponsors could, of course, make a large payment into a plan to improve the funded status, but there is a lot of uncertainty overall right now. In lieu of a big payment into the plan, plan sponsors should look closely at the various strategies available to them because it is a more meaningful exercise now than it has been in the past few years.”

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