A couple of recent court rulings illustrate the potential pitfalls of converting a pension plan from defined benefit (“DB”) to defined contribution (“DC”). It is probably no coincidence that these cases have arisen in an economic environment in which investment returns in DC plans have been lower than many pension plan members have expected.
A “conversion” of a pension plan from DB to DC can have differing meanings and take on various forms. Technically, a DB/DC conversion is a retroactive change in which an existing DB entitlement is converted to a DC account balance. In this case, members who have earned a DB benefit in respect of a period of past service, that would otherwise be paid at some point in future as a lifetime pension, “convert” that entitlement into a lump sum in a DC plan. The eventual benefit in members’ retirement years will be whatever can be provided with the lump sum and accumulated investment returns.
A change from DB to DC can also be accomplished on a purely prospective basis. Technically, this is not a plan conversion because the DB benefits are not converted to a lump sum in a DC account. Under this approach, plan members retain their DB entitlements in respect of past service and participate in a DC plan for future service only. Upon retirement, they will have a DB pension and a DC account balance. The DB pension benefit, if calculated based upon a final average earnings formula, may continue to be based upon final average earnings at retirement, or sometimes, final average earnings are “frozen” on the date of the change in the plan from DB to DC.
Dawson v. Tolko Industries Ltd., 2010 BCSC 346
In this recent decision of the British Columbia Supreme Court, 64 Employees and former employees of Tolko Industries Ltd. (“Tolko”) commenced an action against Tolko, the actuarial firm that Tolko retained and the actuary employed by the actuarial firm. Tolko converted its DB pension plan to a DC plan. Under the conversion, plan members were provided the choice of converting their past service DB benefits to lump sum balances in the new DC plan, or the members could retain their DB benefits in the plan.
The choice to employees was presented in the way of written materials and informational seminars. As is typical with plan conversions, actuarial projections were provided with differing assumptions to illustrate the potential relative value of converting to a DC benefit. The plaintiffs’ statement of claim alleged breaches of fiduciary duties and duties of good faith on the part of Tolko and the actuarial firm in failing to properly advise the plaintiffs of the risks and personal considerations, in failing to have regard to the best interests of the plaintiffs and in using incorrect or unreasonable interest rates and assumptions.
The plaintiffs alleged that their benefits under the DC plan were much less than what they would have been under the DB plan. 17 of the 64 plaintiffs in this case had their employment terminated by Tolko over a period of four years. Each of these plaintiffs were given termination settlements and they signed releases. The “releasing plaintiffs” eventually discontinued their claims against Tolko on account of the terms of the releases. The claims were continued against the actuarial firm and the individual actuary.
This case was a summary trial application by the defendant actuarial firm and actuary to dismiss the claims by the 17 releasing plaintiffs on the grounds that the releases signed by the plaintiffs released the actuarial firm and the actuary as well. The court held that, while the actuarial firm and the actuary were agents of Tolko in a general sense, and while the release included agents of Tolko, they were not agents for purposes of the releases. At the time of signing the releases, the parties would not have intended the releases to cover any and all agents, but rather a more limited range of agents more directly connected with the terminations of employment. As a result, the trial on the merits of this case will continue.
This case is interesting from a pension perspective because it will raise issues as to the nature and extent of the duties owed by an employer, by a plan administrator and by an actuary toward pension plan members. The exercise of duties is brought into sharp focus whenever significant changes to a pension plan are made, such as is the case with a DB/DC conversion. Years later, employee communication materials that were used at the time of conversion can be introduced as evidence. Attention must be given to employee communications to ensure accuracy and consistency.
Halliburton Group Canada Inc. v. Minister of Finance and Superintendent of Pensions of the Province of Alberta, 2010 ABCA 254
This is a decision of the Alberta Court of Appeal, released earlier this month, in which the court considered the validity of amendments to a pension plan to change the design from DB to DC on a prospective basis only. Although the court referred to this as a conversion, DB benefits were not converted to DC account balances. Members of the pension plan retained their defined benefits for service prior to the change. The issue centered on whether the freezing of the DB benefit as of the date of the change constituted a reduction in members’ accrued benefits.
Affected members of the pension plan participated in a final average earnings DB pension plan. The employer submitted amendments to the pension plan with the Alberta Superintendent of Pensions for approval of the change in the pension plan from DB to DC. The aspect of the amendments that purported to freeze the members’ salaries for purposes of determining the members’ final average earnings under the DB formula were not accepted by the regulator. The regulator required Halliburton to project members’ salaries and to file revised actuarial reports.
The legislative scheme in Alberta under the Employment Pension Plans Act (“EPPA”), like every jurisdiction in Canada, prohibits the reduction of members’ accrued benefits payable from single-employer pension plans. The legislation also contains an exception to this general rule such that the prohibition against the reduction of accrued benefits does not apply to the portion of a member’s benefit attributable to salary projections after the date of the amendment, if the particular pension plan so provides. In other words, in a pension plan that provides benefits on a final average earnings basis, the benefit of projected pay increases may be reduced (or eliminated), depending upon the plan wording.
In this case, it was agreed by the parties that as a result of the change of the plan from DB to DC, members of the plan would receive less of a benefit from the DB part of the plan on account of members’ earnings being frozen as of the date of the amendment. The question addressed by the court was whether the entitlement to a DB benefit using projected earnings was a vested right that could not be reduced under the provisions of the EPPA.
The court found on the basis of the pension plan documents that “at the point that any individual becomes a participant in the Plan, they are entitled to have their defined benefit calculated in accordance with the DB formula. The formula requires that the compensation number used is the one that is the highest for five of their last ten years of employment ‘prior to [an employee’s] normal retirement date’” (underlining added by the court).
The court further held: “as I read the Plan, the seventeen employees prior to the effective date of the amendment were entitled to a pension promised upon their projected five years of employment preceding their normal retirement date. Amendments that deprive them of that entitlement contravene the Act and entitle the Superintendent to order deregistration of the amendments.” According to the court, the employees had acquired a right to have their benefits calculated on a prospective basis using earnings upon retirement.
Other aspects of the judgment concerned the degree of deference to be given to pension regulators and tribunals on matters other than strict interpretations of law. Most matters involve the interpretation of facts or mixed facts and law, as this case did. In such matters, the courts are to give the regulator a high degree of deference, such that if their decisions are found to be reasonable, they should not be overturned. This highlights the importance of initial dealings with pension regulators, namely, getting it right the first time. Succeeding on appeal on these sorts of matters can be very difficult, because it must be shown that the regulator acted unreasonably.
Both of the above decisions illustrate the importance of accurate communication with employees, especially involving significant change such as a plan conversion or a prospective change from DB to DC. Effective negotiations with pension regulators and drafting plan amendments that comply with applicable pension legislation are critically important. The courts view pension regulators as having highly specialized expertise. As such, courts are increasingly reluctant to overturn regulators’ decisions, except involving matters of pure statutory interpretation.