Relying heavily on decisions issued by the Third Circuit in 2007 and the Seventh Circuit in 2006, on August 27, 2007, the Court of Appeals for the Sixth Circuit held that defined benefit plans employing a cash balance formula do not violate ERISA’s anti age-discrimination provision, ERISA § 204(b)(1)(H), 29 U.S.C. § 1054(b)(1)(H). Drutis v. Rand McNally & Co., ___ F.3d ___, 2007 WL 2409762 (6th Cir. Aug. 27, 2007). The opinion, authored by Judge John M. Rogers, rejected plaintiffs’ argument that cash balance plans are “necessarily age discriminatory,” reasoning that “any disparity in the benefits that employees of different ages receive from cash balance plans is merely the result of the time value of money.” Id. at *3.
Drutis v. Rand McNally & Co.
In Drutis, plaintiffs argued that cash balance plans violate per se the provisions of ERISA, and thus their claims “turned on the nature of cash balance plans in general.” 2007 WL 2409762, *3. The court’s analysis began with a description of the features of cash balance plans. Quoting at length the Third Circuit’s decision in Register v. PNC Fin. Servs. Group, Inc., 477 F.3d 56 (3d Cir. 2007), the Sixth Circuit explained that:
A cash balance plan is, by statutory definition, a defined benefit plan. However, cash [balance] plans are structured to function like a defined contribution plan. A cash balance plan is classified as a defined benefit plan because cash balance plans . . . are required to offer payment of an employee’s benefit in the form of a series of payments for life. . . . Nevertheless, a cash balance plan differs from a traditional defined benefit plan in that traditional defined benefit plans define an employee’s benefit as a series of monthly payments for life to begin at retirement, but cash balance plans define the benefit in terms of a stated account balance, albeit a “hypothetical” account. Thus, cash balance plans are like defined contribution plans in that both define the employee’s benefit in terms of a stated balance.
Drutis, 2007 WL 2409762, at *4 (quoting Register, 477 F.3d at 62). Again quoting Register, the Sixth Circuit further explained that:
A feature of most cash balance plans is that the hypothetical account, which tells the employee how much his retirement benefit is worth, has two parts: “(1) ‘pay credits’ or ‘earnings credits,’ which are hypothetical contributions an employer makes usually expressed as a percentage of wages or salary and may vary with employee tenure, and (2) ‘interest credits,’ which are hypothetical earnings . . . on the account balance. Employers design cash balance plans so that when a participant receives a pay or earnings credit for a year of service, he also receives the right to future interest credits projected out until normal retirement age.”
Drutis, 2007 WL 2409762, at *4 (quoting Register, 477 F.3d at 63). “Because younger employees necessarily have a longer period of time before they reach age 65, the projected interest credits are necessarily larger because the projection includes a longer period of compound interest.” Drutis, 2007 WL 2409762, at *4. It is this “difference in the value of the projected interest credits attributable to each employee that can lead to the mistaken belief that cash balance plans discriminate based on age.” Id. at *5.
Plaintiffs argued that cash balance plans are discriminatory because younger workers, who received the same pay credit and interest rate contribution as older workers, would be entitled to a greater annuity at retirement and that this resulted in a “relative reduction in older employees’ rates of ‘benefit accrual’ in violation of § 204(b)(1)(H)(i).” Id. However, to reach this result, plaintiffs defined “the term ‘benefit’ in the phrase ‘rate of benefit accrual’ as the overall benefit that the employee is entitled to receive upon retirement at age 65, which ERISA [defines in another section as] the ‘accrued benefit.’” Id. The court was unwilling to equate the undefined statutory term “benefit accrual” with the defined term “accrued benefit” and thus rejected plaintiffs’ theory. Id.
In the court’s opinion, “the better view, which has been adopted by both courts of appeals to have considered this issue, is that the ‘rate of benefit accrual’ refers to the employer’s contribution to a plan, and therefore any difference in output as a result of time and compound interest does not violate” ERISA. Id. at *6. Accordingly, “the Seventh Circuit [in Cooper v. IBM Personal Pension Plan, 457 F.3d 636 (7th Cir. 2006)] is correct that, ‘the phrase “benefit accrual” reads most naturally as a reference to what the employer puts in . . . while the defined phrase ‘accrued benefit’ refers to outputs after compounding.’ ” Drutis, 2007 WL 2409762, at *6 (quoting Cooper, 478 F.3d at 639).
Based on this analysis, the Sixth Circuit agreed with the Third and Seventh Circuits in ruling that the term “benefit accrual” refers to an employer’s contribution to a defined benefit plan. Id. Accordingly, because under the plan at issue, “as with cash benefit plans generally, [n]either the contribution rate nor the interest rate change[d] with age,” the appellate court concluded that plaintiffs failed to show that the plan was age discriminatory. Id.
Drutis is the latest blow to lawsuits alleging that cash balance plans are inherently discriminatory. All three of the appellate courts that have considered these claims have ruled that cash balance plans do not violate ERISA § 204(b)(1)(H)(i). Moreover, the Pension Protection Act of 2006 repudiated the age discrimination theory on a prospective basis. ERISA § 204(b)(5), 29 U.S.C. § 1054(b)(5). More appeals are in the works, however, particularly in the Second and Ninth Circuits, so sponsors of such plans should stay tuned for more developments in this area.