Defined Benefit Plans’ Actuarial Equivalence Under Attack: Reasonable Becomes Unreasonable (Opinion)

Recent class action lawsuits targeting the reasonability of actuarial equivalence factors used in defined benefit plans have been making news and causing the retirement community to wonder if defined benefit plans, once again, will be exposed to scrutiny and possibly forced to make changes that will be burdensome to plan sponsors and result in increased liabilities.

Defined benefit pension plans are required to define “actuarial equivalence” factors that are used to convert the plan’s normal form of benefit to other forms of benefit payment.  The law indicates that these factors in the plan must be “reasonable”, but it does not define what constitutes “reasonable”. In my opinion, lawmakers put the “reasonable” requirement in place to avoid a plan having factors that are defined arbitrarily (not based on actuarially sound principals), or having factors that are specifically advantageous to a key owner, or other such abusive methodology.

These lawsuits are claiming the plan’s actuarial equivalence factors are not reasonable because the factors haven’t been adjusted to keep pace with the life expectancy or interest rate trends, or a combination thereof.

By law, accrued benefits under a defined benefit pension plan cannot decrease.  Also in compliance with the law, benefits are permitted to be frozen, never to increase.  The law does not require plans to grant cost of living increases on benefits, although some plans provide cost of living increases specifically written into the provisions of the plan. I don’t agree that increased life expectancy should be treated any differently than an increase in the cost of living, and plans should not be required to adjust benefits accordingly. Also, in a plan where benefits have been frozen, they should not be forced to increase benefits due to a change in actuarial equivalence definition.  Furthermore, by the rationale of these lawsuits, if the trend of life expectancy were to turn the other direction and start declining, the adjustment to “reasonable” mortality rates could result in lower benefits.  I’m guessing this is not the desired intent, and if that happened, there would likely be a new set of class action lawsuits.  Finally, if plans were required to change their actuarial equivalence, there could be unintended consequences on the plan’s nondiscrimination compliance.

These lawsuits are questioning actuarial equivalence assumptions with regard to retirees who have already begun receiving benefit payments; thus they are questioning the rates applicable to benefits earned in the past. To go back historically and determine what actuarial equivalence mortality and interest rates should have been used (i.e. considered reasonable) over the history of the plan would be both administratively costly and nearly impossible.  And how would we approach the timing of “reasonable” – annually reasonable, monthly reasonable, daily reasonable?  Because there is not and never has been language in the law to require periodic adjustment to these factors, to bring that burden on now to pension plans that have been around for many years is unreasonable.  Let me define unreasonable: Employers have provided pension benefits to their employees, not because they were required by law, but because they were being generous or they negotiated it with employees.  The plans they set up were done so in compliance with the law.  To argue that the law should change now (or be defined more narrowly) to increase benefits that were provided by the generosity of an employer and earned in the past, is unreasonable.

Blog authored by Cheryl Gabriel, CPC.