Litigators Put Mortality Assumptions Under the Microscope

In recent years, clear trends have emerged in retirement plan litigation, from the proliferation of stock-drop lawsuits to the rush of litigation focused on the use of retail-priced mutual fund share classes and excessive recordkeeping fees.

Recently, it appears a new theme has emerged: Employees are suing their employers under the Employee Retirement Income Security Act (ERISA) for using what they describe as grossly outdated mortality assumptions and inflated interest rates when calculating the value of certain pension benefits.

The most recent national employer named in such a lawsuit is the United Parcel Service (UPS), but the firm is facing allegations very similar to those filed against MetLife, Pepsi, American Airlines and others. Plaintiffs in these cases are making a somewhat subtle but potentially financially significant argument that seeks to remedy alleged failures by pension plans to pay joint and survivor annuity (JSA) benefits in amounts that are “actuarially equivalent” to a single life annuity (SLA) benefit. Such actuarial equivalence is required by ERISA.

The plaintiffs in such cases suggest that, by not offering JSAs that are actuarially equivalent to the single life annuities that participants earn, the defendants are causing retirees to lose part of their vested retirement benefits in violation of ERISA. They are seeking various remedies from the federal courts, including both monetary damages as well as mandated structural reforms to their pension plans.

The Core of the Issue

It is in the calculation of “actuarial equivalence” that the outdated mortality assumptions and inflated interest rates come into play, according to these lawsuits.

In basic terms, to calculate the payment amounts of a JSA—which is a type of pension annuity that will be passed on to the participant’s spouse or another beneficiary upon death—certain actuarial assumptions are applied to determine a “conversion factor” that can in turn determine the “present value” of the future payments. These assumptions are based on a mortality table (used to predict how long the participant and beneficiary will live) and the current interest rate (used to discount the expected payments based on the expected future earnings on the principle).

Participants in these cases say their employers are knowingly using outdated mortality tables and inflated interest rate assumptions that under-value the JSA benefit relative to the SLA. They say this is the case because mortality rates have generally improved over time with advances in medicine and better collective lifestyle habits. Thus, people who retired recently are expected to live longer than those who retired in previous generations. By the same token, older mortality tables predict that people near (and after) retirement age will die at a faster rate than current mortality tables.

As a result, these cases argue, an employer using an older mortality table to calculate a conversion factor decreases the present value of a JSA and—interest rates being equal—the monthly payment retirees receive. The interest rate also affects the calculation, such that using lower interest rates—mortality rates being equal—decreases the present value of benefits in forms other than an SLA.

Potentially damaging to the defendants in these cases—and thus featured centrally in the text of the complaints filed so far by pension plan participants—is the fact that many of the employers sued for using outdated mortality data to convert SLAs to JSAs are at the same time apparently using updated mortality assumptions for pension plan accounting purposes.

Takeaways from the Litigation

Regardless of how these particular cases turn out, it stands to reason that pension plan sponsors should review their mortality tables and interest rate assumptions used in valuing the standard single life annuity compared with their pension’s JSA option. As has been demonstrated in other ERISA cases about various topics, the federal courts tend to side with plan sponsors whenever there is a demonstrable record of careful and active deliberation about the design elements of a plan. This is to say that ERISA requires fiduciaries to operate diligently and loyally—it does not mandate that one type of mortality table or another is used.

Writing on a similar subject, attorneys with Groom Law Group warn that these lawsuits address “a relatively unexplored area concerning ERISA’s standards for the proper method of calculating joint and survivor annuities and early retirement factors under defined benefit [DB] plans.”

They note that ERISA requires that such annuities must be “the actuarial equivalent of a single annuity for the life of the participant.” At the same time, the attorneys explain, Department of the Treasury regulations provide that actuarial equivalence must be based on “consistently applied reasonable actuarial factors.”

“Given the lack of guidance in this area, the unsettled nature of the ‘reasonableness’ standard and the interplay of fluctuating interest rates with gradual changes in mortality rates, it is difficult to predict how the courts will view these issues,” the attorneys conclude. “For the many remaining corporate sponsors of older pension plans, these cases may present a new area of potential legal exposure.”

Mortality Improvements Continue

Additional context for this discussion comes from comparing current life expectancy figures with those coded into the mortality assumptions used by the employers facing these cases, which date back as far as the early 1970s.

According to the latest figures published by the U.S. Centers for Disease Control and Prevention (CDC), life expectancy for the U.S. population in 2018 was 78.7 years, an increase of 0.1 year from 2017. The age-adjusted death rate decreased by 1.1% from 731.9 deaths per 100,000 standard population in 2017 to 723.6 in 2018. Also notable, age-specific death rates decreased from 2017 to 2018 for age groups 15 to 24; 25 to 34; 45 to 54; 65 to 74; 75 to 84; and 85 and over.

Back in 1970, average life expectancy was closer to 71 years, according to the CDC, or 67.1 for men and 74.7 for women.