Achieve greater certainty through pension derisking

Achieve Greater Certainty through Pension Derisking

Legal Issues

Lori W. Jones J.D. , LL.M., Taxation

April 4, 2014

Key Laws Governing Retirement Plans

Internal Revenue Code (IRC)Qualification requirements for favorable tax

treatment. ERISA

Imposes fiduciary duties, reporting and disclosure rules, claims procedures.

Settlor vs. Fiduciary Functions

Settlor functions.Decisions relating to the establishment, design,

amendment and termination of plans.Not governed by ERISA.

Fiduciary functions.Activities undertaken to implement settlor

decisions.Administration of plan. Must comply with the ERISA fiduciary provisions.

Examples of Settlor Functions

Adoption of plan. Plan design.

Determining who will be eligible.Determining level of benefits .

Plan amendments. Plan termination.

Example of Fiduciary Functions

Selection and monitoring of investment options.

Managing plan investments. Determining claims and appeals. Selection of service providers and

determining whether fees are reasonable. Oversight of service providers.

Ways to Become ERISA Fiduciary

Designated by plan or trust. Designated by another fiduciary. Actually perform fiduciary functions.

Exercise discretionary authority or control over plan or plan assets.

Render investment advice to the plan or participants for a fee.

Exercise discretionary authority over plan administration

ERISA Fiduciary Duties

Exclusive benefit rule.Discharge duties solely in the interest of

participants and beneficiaries.Discharge duties for the exclusive purpose of:

Providing benefits to participants and beneficiaries;Defraying reasonable expenses of administering the

plan.

ERISA Fiduciary Duties

Prudent person standard of care.Act with the care, skill, prudence and diligence

that a prudent person acting in a like capacity and familiar with such matters would use.

ERISA Fiduciary Duties

Diversify plan assets.Diversify the investments of the plan to minimize

the risk of large losses unless the circumstances indicate it is clearly prudent not to do so.

Operate plan in accordance with its terms.Unless inconsistent with ERISA.

ERISA Fiduciary Duties

Do not cause plan to engage in prohibited transactionsTransactions between the plan and a party in

interest. Sale, exchange or leasing of property.Lending money.Transfer or use of plan assets to, by or for benefit of,

party in interest.Parties in interest include fiduciaries, service

providers, employer, related entities.

ERISA Fiduciary Duties

Key exemptions from prohibited transaction rules.Participant loans satisfying statutory and

regulatory requirements.Transactions for services reasonably necessary for

establishment or operation of the plan if fees are reasonable.

ERISA Fiduciary Duties

No self-dealing or conflicts of interest.Fiduciary must not:

Deal with plan assets in his own interest or for his own account (self-dealing).

In transaction involving the plan, act on behalf of a person whose interests are adverse to the interests of the plan (conflict of interest).

Receive any consideration in a transaction involving the assets of the plan.

Plan Reporting and Disclosure

Summary plan description. Annual information return (Form 5500). Summary annual report. Participant request for plan documents. Fee disclosure. Various notice requirements including

qualified joint and survivor annuity (QJSA) notices and spousal consents.

Fiduciary Liability

Losses resulting from fiduciary breach. Secretary of Labor may impose additional 20%

penalty. Criminal penalties in the event of willful

violation.

Fiduciary Protection

Plan sponsor purchases insurance indemnifying ERISA fiduciaries for negligence, errors and omissions.

Best Practices

Plan administrator.In absence of designation, the plan sponsor is the

named fiduciary.Naming the plan sponsor as fiduciary in the plan

documents may blur the distinctions between fiduciary and settlor functions.

In whose interest were decisions made?

Identify in writing delegation of fiduciary duties.

Plan administrator. Investments. Administration. Claims.

Best Practices

Committees.Separate fiduciary committee from design committee.Consider committee assignments.Two hat” issues (same individual having fiduciary and

settlor functions). Likelihood of individuals having inside information.Skills needed to perform the specific fiduciary function. Consider self-perpetuating committee based on titles.

Best Practices

Service providers. Document due diligence and selection process. Ask for explanation of fees. Regularly review performance and fees.

Best Practices

Process is important.Regular meetings.Document decisions.

InvestmentsWritten investment policy.Review investments on a regular basis and make a

record of review.If material information is released re investments

(e.g., change of manager of fund), review and make record of review.

Best Practices

Consider retaining independent consultants.Note rationale for any deviation from policy.

Why Derisking?

Control plan asset volatility. Remove pension liabilities from balance sheet.

Current Parameters for Derisking

Active employees. Can’t pay lump sums w/out plan

termination.Can’t annuitize without plan termination.

Term Vested not in pay status.Lump sums permitted.Annuitization permitted.

Current Parameters

Retirees in pay status.Lump sum w/out plan termination; consider

seeking private letter ruling from IRS.Annuitization w/out plan termination permitted.Both lump sum and annuitization permitted with

plan termination.

ERISA Advisory Council (EAC)

ERISA § 512 provides for the establishment of EAC.

Advises and submits recommendations regarding the DOL’s functions under ERISA.

In 2013 EAC commenced examination of issues relating to derisking.

Hearings in August 2013, Executive summary of recommendations on November 5, 2013.

ERISA Advisory Council

Originally EAC expected to recommend derisking regulations.Pros – Notice and comment procedures allow

input by plan sponsors and practitioners.Cons – Time-consuming

EAC Recommendations

Enhance IB 95-1 safest annuity available guidance.IB 95-1 provides fiduciary standards for selection

of annuity providers.Confirm that IB 95-1 applies to any purchase of

annuities (and not just plan termination).Consider implementation of safe harbors for such

purchases.

IB 95-1 Guidance on Annuity Purchases

All fiduciary duties apply.Act solely in best interest of participants and

beneficiaries.Act prudently.Obtain safest annuity available after thorough

review based on following factors:Quality and diversification of provider’s investment

portfolio.Size of insurer relative to contract for annuities.

IB 95-1 Guidance on Annuity Purchases

Level of insurer’s capital and surplus. Losses of business of annuity provider and other

indications of exposure to liability. Structure of annuity contract and guarantees

supporting annuities (e.g. use of separate account). Availability of additional protection through state

guaranty association and extent of guaranty.• May need consultants to determine.

IB 95-1 Guidance on Annuity Purchases

Need not choose safest available annuity where that option is only marginally safer but disproportionately more expensive.

Increased cost or other considerations never justify putting benefits of annuitized participants at risk.

Special care to avoid conflicts of interest. Consider engaging independent expert to select

annuity provider.

EAC Recommendations (cont.)

Provide guidance under ERISA §502(a)(9).Consequences of breach of fiduciary duty in

selection of annuity provider.What is appropriate relief under §502(a)(9).When is posting security required.

EAC Recommendations (cont.)

Enhanced disclosure for lump sum windows.90-day minimum advance notice.Disclosures similar to plan termination.Whether early retirement or other subsidies

included.Compare lump sum to promised benefits under

plan.Possible impact of tax penalties, if any.

EAC Recommendations (cont.)

Educate and outreach to plan sponsors concerning derisking.

Collect data on derisking transactions.

IRS Guidance

Treasury regulations prohibit lump sum for retirees in pay status unless exception applies.Generally, under IRC §401(a)(9) payments may not

be changed after commencement of benefits.Exception to pay increased benefits resulting from

a plan amendment.

IRS Private Letter Rulings

PLR 201228045.Amendment offered lump sum option during 60-

90 day window. Participants in pay status.Retired participants not yet in pay status.Term vested participants.Beneficiaries and alternate payees.

One-time offer to retirees in pay status does not violate §401(a)(9) because constitutes increased benefits from plan amendment.

IRS Private Letter Rulings

PLR 201228045 (cont.).No rulings under §§411, 415, 417 or 436.

PLR 201228051.Amendment offered lump sum option during 30-

60 day window. Participants and beneficiaries in pay status.

No violation of §401(a)(9). Affected participants could elect lump sum,

QJSA, or QOSA.

IRS Private Letter Rulings

Spousal consent required from current spouse and former spouse if annuitant remarried after the initial benefit commencement.

IRS Private Letter Rulings

Pending PLRs are being held up; apparently Treasury is considering policy implications.

Only taxpayers receiving PLRs can rely on them.

Verizon Case

Filed by retirees challenging annuitization of pension.Ended PBGC insurance protection.Not described in SPD.

District Court dismisses case with instructions.SPD not required to disclose possibility of

annuitization as a circumstance that could lead to loss of benefits.

Amendment of plan to permit annuitization was a settlor function and not a fiduciary function.

Verizon case (cont.)

No allegation that fees paid to Prudential were unreasonable or that choice of Prudential was imprudent.

No discrimination in choice of retirees eligible for annuitization.

Continuing participants have no standing; no injury because no sharing of impact on benefit payments.

Court did not actually approve annuitization.Plaintiffs given 30 days to reply and allege new

facts.

Verizon case (cont.)

Amended complaint filed on July 12, 2013. Verizon filed motion to dismiss on July 25,

2013. Various extensions. Court heard oral arguments on motion to

dismiss on March 7, 2014. More to come.

Thank you

The purpose of this slide show is to provide news and information on legal issues and all content is for informational purposes only and should not be considered legal advice.

Lori W. JonesPartner (314) 552-6568 ljones@thompsoncoburn.com