Berger v. Xerox: looking for law in all the wrong places.

This article discusses the recently decided Berger v. Xerox Retirement Income Guarantee Plan, 338 F.3d 755 (7th Cir. 2003). The Seventh Circuit became the third federal circuit to uphold the IRS's "whipsaw" rules governing how a cash balance plan must value lump sum distributions. As a result, the plan must distribute lump sums to participants that exceed the "account balances" promised to them by the plan.

This article explains the technical aspects of the case. But the article's real point is that the implications of Berger go beyond the specific cash balance issues involved. Despite the widespread and growing adoption of cash balance plans, and despite repeated requests by employers and practitioners for guidance on how basic ERISA rules apply to these plans, the Treasury department has neglected its executive job of writing guidance. The task of writing rules for these plans has thus fallen to the courts.

As Berger shows, the courts are a poor forum for answering these questions. In writing an opinion that addressed the specific plan before it, the Berger court raised issues that throw into question the way the accrued benefit may be determined by every defined benefit plan in the county--and not just cash balance plans. These questions are the main point of this article.

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The cash balance wars heated up this summer, claiming two casualties. The Seventh Circuit upheld the Internal Revenue Service's (IRS's) controversial "whipsaw" rules governing how a cash balance plan values lump sum distributions. Berger v. Xerox Retirement Income Guarantee Plan, 338 F.3d 755 (7th Cir. 2003). A federal district court held that the IBM cash balance plan--and so all or nearly all cash balance plans--violate federal age discrimination law. Cooper v. the IBM Personal Pension Plan, 2003 WL 21767853 (S.D. Ill. 2003). We write here about Berger, as Cooper is discussed elsewhere in this issue, and because Berger raises significant "sleeper" issues that we think have not been addressed in the quantities of ink already spilled about both cases.

Berger raises no new strictly cash balance issues. What is new about Berger--and what we focus on here--is that a federal court stepped into the middle of a contract and rewrote the conditions for earning benefits in an Employee Retirement Income Security Act (ERISA) pension plan--without explaining what was wrong with the old ones or what was right with the new ones. In doing so, it hinted at several theories but never gave one. On its face a case about valuing lump sum distributions, at its heart Berger goes to the limits of the employer's ability to set the terms for earning benefits under ERISA pension plans of all kinds.

Stripped of the technicalities that confound cash balance discussions, what happened in Berger was this: the case involved employees who left Xerox's employ before the plan's age 65 normal retirement age. Former employees who left money in the plan were granted additional interest earnings at a stated rate. Former employees who took their money out of the plan got a distribution that included an estimate of future interest earnings--but at a lower rate than those who kept their money in the plan. That is, to get the higher interest earnings, ex-employees had to leave their money in the plan. The Seventh Circuit disallowed this arrangement. The court held that for ex-employees who took their money out of the plan, the estimate of future interest earnings had to include interest at the higher rate--even though under the plan's terms the higher rate was given only to participants who left their money in the plan, and even though these ex-employees would no longer satisfy the plan's conditions for earning it. For this class of participants, the court in effect rewrote the accrued benefit to include, as an unconditional right, those additional interest earnings that under the plan's terms were conditional--without explaining why the plan's conditions for earning them were illegal. The court then held that the plan violated ERISA's vesting rules by failing to offer them the higher benefit as so rewritten. In addition, the court held that the amounts paid to these ex-employees should include an estimate of the value of the pre-age 65 death benefit contingently payable had they instead left their money in the plan until age 65 (contingently payable, as by definition it would be paid only to participants who left their money in the plan until age 65, but died before reaching that age).

At its heart, Berger is a case about the employer's ability to write the accrued benefit, and the courts' ability to rewrite it. The real question raised by Berger are these:

* What are a plan's limits for setting conditions for when pieces of the accrued benefit accrue?

* Can accrual be, for example, conditioned on events that happen after employment?

* Or, when the participant leaves employment, are all prospective post-employment changes in the benefit "fixed" and subject to estimation as part of the benefit he or she gets at that time?

What is the scope of the court's authority to rewrite the accrued benefit in a defined benefit plan? The Berger court rewrote the plan's accrued benefit without ever determining what the accrued benefit was under the plan's original terms, or analyzing why it was illegal, and then held the plan's failure to give the rewritten benefit was a vesting violation. This ignores the structure in place since Alessi v. Raybestos Manhattan, Inc., 451 US 504 (1981), which says the court must first determine what the accrued benefit is, before deciding whether the plan failed to deliver it.

This question is of more than theoretical interest. The Berger court's failure to define the plan's accrued benefit--and whether and how it departed from ERISA--in practice meant that the court rewrote the benefit unconstrained by the plan terms or the sponsor's intent. We believe this is wrong as a legal matter and alarming as a cost one. The right answer, we believe, is the court's ability to rewrite the plan bounded by the twin constraints of the plan's intent on the one hand and ERISA's requirements on the other. Under these constraints, a court could rewrite a noncompliant plan only to the minimum extent necessary to comply with ERISA. The implications of the very different Berger approach is the conceivable creation of remedies staggeringly out of proportion to participants' reasonable expectations about the employer's side of the benefit "contract."

Is the plan's pre-age 65 death benefit part of the "accrued benefit?" To recast the question as presented to the court: may a plan reduce the pre-age 65 benefit payout to reflect the value to the participant that, without the early payout, death before age 65 might possibly cause the participant to forego it, if the plan provides a death benefit to the survivors of a participant who dies before age 65? (This reduction is typically called the mortality discount.) Berger says no, not if the death benefit equals the amount of the retirement benefit. Death in this case does not cause loss of the benefit, and avoiding the risk of death (mortality risk) has no value. While maybe the most green-eyeshade point in the case, this may have the largest cost implication of any part of the decision. The Berger opinion can be read to say that--to the extent of any pre-age 65 death benefit--receipt of the age 65 retirement benefit is a certainty. To this extent, the retirement benefit paid before age 65 cannot be reduced for mortality. This potentially rewrites the benefit of the pre-age 65 lump sum paid by every plan that provides a pre-age 65 death benefit--which is to say the lump sums paid by every defined benefit plan in the country, because by law all must include a death benefit payable to the participant's spouse.

The Treasury Department failed for over ten years to define the accrued benefit in a cash balance plan--how it is defined, measured, or earned. Faced with these questions in the plan before it, the Berger court declined to do in its judicial capacity what the Treasury should have done in its executive one. That is, the court answered them for the one plan, but on the basis of no general legal principles the court was willing or able to articulate. But of course the law is general and not specific. The resulting opinion, with its absence of any principled explanation of its conclusions, raises questions about the employer's ability to define the terms of plans of all types--questions with no answers in sight from the courts or regulators.

BRIEF CASH BALANCE REVIEW

Before our discussion of the more general aspects of Berger, we want to remind the reader of what a cash balance plan is, and the specific cash balance questions that launched the case.

Generally, a cash balance plan is a defined benefit plan designed to look like a defined contribution plan. For example, the typical cash balance plan might express each participant's benefit as a hypothetical "account balance," which each year is credited with amounts equal to a stated percentage of pay (pay credit) and interest at a stated rate, which may be defined as a fixed rate or linked to an index such as the rate on one-year Treasury bills (interest credit).

Cash balance plans have run into trouble with participants and the courts, because of the way the hypothetical account balance interacts with the "accrued benefit" as defined by ERISA.

The clash arises because the participant's accrued benefit fixes his or her benefit …