Data and Research May 21, 2018

Think Multiemployer Pension Insolvencies Aren’t Your Problem?

Tens of thousands of employers in the U.S. contribute to multiemployer pension funds that are in critical and declining status, collectively facing an unfunded liability well above $100 billion; Society of Actuary researchers warn of potential ripple effects should many of their plans fail at once.

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A new report published by the Society of Actuaries (SOA) throws into sharp detail the challenges faced by the U.S. multiemployer pension system.

Speaking about the report, Lisa Schilling, retirement research actuary for the SOA, quickly pointed out that there are many multiemployer pensions that are healthy and more or less entirely financially fit. In fact, there are more than 1,200 multiemployer pension plans in the United States today, covering about 10 million participants, including roughly 4 million retirees.

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However, while most multiemployer plans are financially stable, a growing number have been identified under federal law as “critical and declining.”

“Our study identifies more than 100 such plans that are meant to be representative of the larger problem, excluding plans receiving Pension Benefit Guaranty Corporation [PBGC] financial assistance or that have received approval for benefit suspensions under the Kline-Miller Multiemployer Pension Reform Act of 2014,” Schilling explains. “These plans cover roughly 1.4 million participants—about 719,000 of them retired and receiving annual benefits totaling more than $7.4 billion.”

As the SOA’s report shows, approximately 11,600 employers contribute to these financially stressed multiemployer pension plans. Broadly speaking, many of these plans are at risk of becoming insolvent within fewer than 10 years, the research warns. Such insolvencies will obviously be harmful to the participants and beneficiaries of the plans in question, but the loss of the significant economic momentum provided by retirees spending their pension plan assets could also harm the wider economy and, by extension, employers that otherwise have little affiliation with the troubled multiemployer pension industry.

“The estimated unfunded liability of these plans is $107.4 billion when measured at a 2.90% discount rate,” Schilling observes. “In our sample, there are 21 plans with approximately 95,000 participants that are projected to become insolvent by 2023, and 48 plans with approximately 545,000 participants are projected to become insolvent by 2028. On average, only about two-thirds of the pension benefits are estimated to be guaranteed by the Pension Benefit Guaranty Corporation.”

Overall, the authors anticipate that some 107 plans will run out of assets over the next 20 years, affecting over 11,000 contributing employers and roughly 875,000 participants.

“These projections assume future annual investment returns of 6%,” Schilling notes. This assumption was developed from several recently published capital market outlook reports and surveys of various investment advisers, and therefore differs from the long-term expected rates of return typically used for minimum funding purposes. Projections that use more detailed plan-specific data may render somewhat different results, although the general outcomes would likely be similar.

SOA’s data suggests the estimated 2018 unfunded liability for these 115 plans, as measured on a minimum funding basis, is $57 billion. (When measured at 2.90%, it is $108 billion. The discount rate of 2.90% represents a liability-weighted average of Treasury rates in April 2018.)

“When Treasury rates are used to discount only the plan’s unreduced benefit obligations after the point of projected plan insolvency, and the minimum funding basis discount rate is used otherwise, these plans’ total unfunded liability is $76 billion,” the report states. “Note that these liabilities reflect full plan benefits without regard to PBGC guarantee limits.”

Some of the conclusions in the report suggest many of these plans are not likely to be able to effect a course correction without outside influence: “Even with extraordinarily optimistic investment returns of 10% per year for 20 years, 68 of the 115 plans would be projected to become insolvent within 20 years.”

“Optimistic investment returns have limited impact on insolvency among these plans primarily because their net cash flow positions tend to be severely negative,” Schilling explains. “In 2018, 81 of the plans have annual negative net cash flow that is 10% or more of their assets. In other words, unless these plans’ assets earn at least 10% per year, the assets will decline. Twenty-seven of the plans have negative net cash flow that is 20% or more of their assets.”

Schilling further warns this set of plans includes a number that are large enough such that, if and when they run out of money, “they could individually end up sinking the PBGC’s multiemployer insurance program outright.”

“What that means is that the PBGC wound no longer be able to pay out even its very modest benefits to the sizable number of multiemployer pension plans that have already gone insolvent in the past,” Schilling explains. “That would represent an even greater economic blow for everyone involved. You could have folks retiring after 30 years of service literally getting a few thousand dollars a year from a pension that should have been worth far, far more. You have to ask, what will happen to food stamps and all the other social programs that are out there to help prop people up when their income falls short? It’s not encouraging.”

Thinking about where these issues may lead, Schilling says it seems clear that Congress must act soon and with gusto, or else no real solution will likely be possible. To this end, she is optimistic that U.S. Senators Orrin Hatch and Sherrod Brown are seeking public and industry input on ways to improve the solvency of multiemployer pension plans and the Pension Benefit Guarantee Corporation. However, like many others, she is skeptical that legislative action will be taken prior to the mid-term election. 

“This is a particular shame because many of these plans are already past the point of no return, and the sooner we can act, the better the outcome is going to be for everyone,” she concludes.

The SOA report was advised and reviewed by a team of researchers, including Christian Benjaminson, James Dexter, Cary Franklin, Eli Greenblum and Ellen Kleinstuber. The full text is available for download here.

Compliance May 21, 2018

Plan Sponsor Interpretation Must Be Given Deference in Lawsuits Challenging Plan Terms

The 6th Circuit noted that Firestone Tire & Rubber Co. v. Bruch, in which an arbitrary-and-capricious standard of review is required by the court if the plan “gives the administrator or fiduciary discretionary authority to determine eligibility for benefits or to construe the terms of the plan,” should have been used by the district court.

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In a lawsuit in which the 6th U.S. Circuit Court of Appeals admitted “This is not an easy case,” the appellate court remanded it back to a district court to redefine the class for “damages” and award damages to the newly defined class.

The case was brought by retirees of the Norton Healthcare defined benefit (DB) retirement plan, accusing the plan of miscalculating lump-sum distributions. The 6th Circuit first denied Norton’s motion to dismiss the case, saying the fact that the parties could not agree on the recalculation of benefits does not make the district court’s judgment less final. “The district court answered all the parties’ merits questions, and found that Norton had misapplied the terms of the Plan. The district court then told the parties exactly how to recalculate those Retirees’ benefits—by using the Retirees’ proposed formula. Thus, there are no unanswered legal or equitable questions in this case. Norton also does not contend it lacks the data necessary to perform the calculations, or that the parties dispute the accuracy or authenticity of the relevant records, so there are no unanswered factual questions either. It is undoubtedly true that the calculations required here are complex and time-consuming… The need for an advanced understanding of applied mathematics to obey an order of the court does not make that judgment any less final for our purposes, the appellate court stated in its opinion.

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However, the 6th Circuit noted that Firestone Tire & Rubber Co. v. Bruch, in which an arbitrary-and-capricious standard of review is required by the court if the plan “gives the administrator or fiduciary discretionary authority to determine eligibility for benefits or to construe the terms of the plan,” should have been used by the district court. The district court had considered the doctrine of contra proferentum—which a standard used to construe ambiguous terms against the drafter of a contract.

The appellate court said, “contra proferentum is inherently incompatible with Firestone deference. Thus, we hold that when Firestone applies, a court may not invoke contra proferentum to “temper” arbitrary-and-capricious review.”

The 6th Circuit found “tension” in the terms of the plan document, but no ambiguity. However, it noted that the Employee Retirement Income Security Act (ERISA) requires that any lump-sum alternative be the “actuarial equivalent” of the basic-form benefit, and because the district court did not address actuarial equivalence, a remand is necessary to answer this question. In addition, since the district court was obligated to consider the evidence in the light most favorable to Norton, the appellate court said this would “naturally” include Norton’s experts’ explanation of how the actuarial conversions work. 

“Because there is a genuine issue of material fact, and because we have altered the district court’s interpretation of the plan, neither party is entitled to summary judgment on this question. We therefore vacate the district court’s grant of summary judgment and remand for further examination of the actuarial-equivalence issue,” the 6th Circuit wrote in its opinion.

Regarding a statute of limitations issue on the retirees’ claims, the appellate court agreed with the retirees that the district court should have applied a longer limitations period to their underpayment claims. The appellate court noted that “ERISA does not explicitly provide a limitations period for Section 1132(a)(1)(B) claims,” so “courts fill the statutory gap using federal common law.”  In previous cases, it has held that “when a plaintiff seeks benefits under the plan and those claims depend on alleged violations of ERISA’s statutory protections, Kentucky’s five-year limitations period applies.”  However, when a claim is based on the contract alone, then Kentucky’s longer statute of limitations—15 years—for contract claims applies. To the extent that the retirees’ claims are based solely on the improper interpretation of the plan terms, the 6th Circuit said the longer contract limitations period must apply.

Regarding the district court’s class certification, the appellate court said it is clear from the record that the amount of any individual class member’s award may vary wildly depending on their circumstances. It said this should have prompted the district court to consider the due-process concerns highlighted by the Supreme Court in Dukes v. Wal-Mart Stores. “On remand, the district court must address this issue prior to certifying a damages class under subrule (b)(2). In sum, to the extent that the district court certified the class for plan-interpretation purposes, that decision is affirmed. To the extent that its certification extended to damages calculations, we vacate the certification and remand for further proceedings consistent with this opinion,” the opinion states.

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