Indianapolis - A federal court has thrown out charges of age discrimination against Onan Corp.'s cash balance pension plan.
The detailed ruling by the U.S. District Court for the Southern District of Indiana in its Sept. 29 Eaton vs. Onan Corp. opinion could make it tougher for other plan participants to sue their employers for violating age discrimination laws after a cash balance conversion.
"This doesn't settle the issue by any stretch of imagination, but to have such a well-written and well-reasoned decision out of the block is a good sign for cash balance plans on this issue," said Kyle N. Brown, retirement counsel at Watson Wyatt Worldwide, the Bethesda, Md.-based employee benefits consulting firm.
The judge has not yet ruled on other issues raised in the lawsuit.
Since last fall, the U.S. Equal Employment Opportunity Commis- sion has received more than 650 complaints of age discrimination from workers and retirees of companies that have converted to cash balance plans from traditional defined benefit plans. The EEOC is still investigating those claims and is not expected any time soon to make pronouncements on whether cash balance plans discriminate against older workers.
The EEOC itself seems divided over the matter. Earlier this year, the agency decided not to file legal papers with the Indianapolis-based federal court supporting Onan's participants after its four commissioners deadlocked over the issue (Pensions & Investments, May 29).
In a statement, the Minneapolis-based company said, "Onan has always believed that the conversion of its more traditional retirement plan to a cash balance plan was in full compliance with the law, and will continue to work to resolve the remaining issues left in the case."
Even so, lawyers representing Onan's workers and retirees who filed the lawsuit are expected to appeal the court's decision, although William K. Carr, a Denver-based attorney representing the plaintiffs, declined to discuss his plans.
"Regardless of what the decision was, the assumption was that this was going to go up to the appeals court anyway," said David Certner, senior coordinator for economic issues at the AARP, Washington. Although the AARP didn't file supporting legal briefs before the lower court, it might file an amicus brief if the matter goes to an appeals court.
Still, the lower court's dismissal of the age discrimination claim and the persuasive evidence it presented to buttress its decision might make it hard for plaintiffs to overturn the decision on appeal, observers said.
"I would think that other employers would love to have this appealed because they think the court got it right and they would like to have an appellate court say it," said Hubert V. Forcier, partner in Minneapolis law firm Faegre & Benson LLP, who helps corporations design such plans.
"The district court vindicates (me)," said Richard Shea, a partner in Washington law firm Covington & Burling, who represents Onan in the lawsuit. "The judge did not come to this opinion lightly. He came to it very deliberately, and this is going to be very hard to appeal."
In any case, Onan's participants probably won't be able to appeal the court's dismissal of the age discrimination claims until the court decides on the other issues, including a claim that the company discriminated against older workers when it did not let them take as a lump sum the present value of "grandfathered pay-based credits." The company offered these credits so older workers would not be hit so hard by the switch from the traditional pension plan to the cash balance plan.
The court's opinion discards the argument - made by Onan employees and retireees, and often cited by groups representing participants - that cash balance plans discriminate against older workers because the rate at which benefits accrue declines with an employee's age.
Age discrimination provisions in 1986 tax law changes, which amended the tax code and federal pension law as well as the Age Discrimination in Employment Act, state that defined benefit pension plans are biased against older workers if "an employee's benefit accrual is ceased, or the rate of an employee's benefit accrual is reduced, because of the attainment of any age."
Under cash balance plans, employers base pensions on the employees' current pay, not their pay in the last few years of their careers. Under these plans, employers create faux individual accounts and credit all employees' paper accounts with an amount linked to pay, for example, 5% of current pay. On top of that, all individual accounts usually earn the same interest rate, such as one based on 30-year Treasury bonds. (A handful of companies, however, let employees link the growth of their individual accounts to an investment option of their choice from among a range.)
This presents a problem similar to that created by 401(k) plans - because of the time value of money, younger workers with longer careers ahead of them can build bigger account balances than can older workers. Smaller account balances naturally buy smaller annuities at retirement age. Some newer cash balance plans have tried to compensate for this by giving older workers a bigger service or pay-based credit, but that was not the case in Onan's cash balance plan.
Viewed differently, though, account balances for all employees in cash balance plans continue to grow over time, so benefit accruals should increase, not decrease, as workers get older, as participants suggest.
The problem is that for all their similarity to 401(k) plans, cash balance plans legally are defined as benefit pension plans, and the rules for DB plans state that accrued benefits should be defined as annuities at retirement age - and that is what employees and retirees of Onan, a wholly owned subsidiary of Cummins Engine Co., charged in this lawsuit.
In a similar lawsuit, employees and retirees of IBM Corp., Stamford, Conn., last October filed a class-action lawsuit against the computer maker for discriminating against older workers when it converted its traditional defined benefit pension plan into a cash balance plan.
Onan converted its plan in December 1994 and adopted the structure retroactive to January 1989. Under the new plan, all employees received 2.5% of their pay up to the Social Security wage cap and 4.25% of their pay above the Social Security wage cap credited to their hypothetical individual accounts. At retirement, or when they quit, Onan's participants would receive the amount of money they had built up in their notional accounts.
In an age discrimination complaint with the EEOC in November 1996, and in a class-action lawsuit filed in May 1997, Onan's pension plan participants charged that the company's cash balance plan discriminated against older workers because the rate at which benefits accrue declines with age. Essentially, they charged, the interest credited to their faux individual accounts would buy them a smaller annuity at retirement age than younger workers would receive.
But Judge David F. Hamilton, in the district court's ruling, methodically set out to show that the age discrimination provisions enacted as part of the Omnibus Budget Reconciliation Act of 1986 were intended to ensure that employers could not arbitrarily cut off pension accruals for employees continuing to work beyond age 65 and did not apply to workers below that age.
For starters, the heading over the provisions supports this view. Section 9202 of the law, which includes both the Employee Retirement Income Security Act provisions and the tax code provisions, is titled "Benefit Accrual Beyond Normal Retirement Age," Mr. Hamilton points out in his opinion.
The conference report of lawmakers who sponsored the legislation made it clear that the provisions were intended to ensure that workers who continue working beyond 65 could continue to accrue pension benefits and were not intended to apply to workers who had not reached retirement age, Mr. Hamilton's opinion states.
"The rules preventing the reduction or cessation of benefit accruals on account of the attainment of age are not intended to apply in cases in which a plan satisfies the normal benefit accrual requirements for employees who have not yet attained normal retirement age," the conference report notes.
What's more, Mr. Hamilton reasoned, even if the provisions of that law do apply to workers younger than 65 years old, ERISA, the tax code and the ADEA do not require that the rate of benefit accrual be measured solely as the change in value of an annuity payable at retirement age.
"There is no statutory or public policy reason that the rate of benefit accrual could not be measured, at least for these purposes, in terms of the rate of change in the balance of an employee's hypothetical account. In fact, that measure provides a precise, quantifiable and clear measure that does not require any estimates or actuarial assumptions," Mr. Hamilton stated.
In fact, since the 1986 age discrimination provisions apply solely to benefit accruals after retirement age, Mr. Hamilton pointed out the absurdity of valuing benefits based on an annuity at age 65. The participants' application of the law would make the example in the 1986 conference report illegal, he noted.
Moreover, in considering the impact of laws, courts are free to consider unusual interpretations and their impact on public policy. But, the court noted that Onan's participants had failed to offer any explanation of how their interpretation of the "rate of benefit accrual" would serve any public interest.
Finally, the court noted that cash balance plans are akin to defined contribution retirement plans. An employer's $1,000 annual contributions will have different values for a 45-year-old worker, as compared to a 25-year-old, because the contributions will go a lot further for the younger worker than the older one, the court explained. Age discrimination laws forbid defined contribution plan sponsors from treating employees differently based on their age, Mr. Hamilton noted.
But the court did not decide all the issues brought before it in the lawsuit. One question left open is whether Onan discriminated against older workers when it did not let those who had been covered by the old plan take the present value of those additional amounts, over and above their account balances, as lump sums. The court is scheduled to meet with lawyers for both sides on Nov. 2 to decide the remaining issues in the case.