Church-plan status under increased scrutiny

A growing number of lawsuits and some key court rulings are making it harder for church-affiliated defined benefit plans to be exempt from federal pension rules.

While the practice of getting that exemption, which is obtained in case-by-case rulings from the Internal Revenue Service, is not new, plan participants increasingly are hiring lawyers to challenge the efforts by some of the biggest names in health care that are affiliated with religious organizations.

And court decisions in recent cases are favoring the participants.

The latest and most definitive court decision came July 22, when U.S. District Court Judge Thelton Henderson in San Francisco ruled the pension plan of Dignity Health should not be able to keep its church plan exemption, but instead should be covered by the Employee Retirement Income Security Act. Lawyers for San Francisco-based Dignity Health had argued its pension plan had long operated as a church plan sanctioned by the IRS. That, said Mr. Henderson, was “an erroneous IRS ruling (that) should not be permitted to trump a court's interpretation of a statute.”

Dignity Health executives said in a statement after the ruling that they will continue to defend the case. Dignity Health remains “committed to ensuring our retirees and beneficiaries receive the benefits they have earned,” the statement said.

“We are starting to get a read of the way the courts are looking at this when the issue is squarely teed up in front of them,” said Lynn Sarko, a principal with Keller Rohrback LLP in Seattle, which along with Cohen Milstein Sellers & Toll PLLC in Washington is leading the legal campaign to undo church plan rulings benefiting large hospital systems.

The eight lawsuits filed by the two ERISA law firms are collectively seeking more than $2 billion in missed pension contributions and other damages. Among other claims, the lawsuits challenge interpretations made by the IRS and the Department of Labor that allowed large non-profit hospitals, which have varying degrees of church affiliations, to be exempt from ERISA. The cases single out “those that are clearly abusing the system and trying to misuse a narrow exemption,” said Mr. Sarko.

Until now, said Karen Handorf, partner and head of Cohen Milstein Sellers & Toll's employment benefit practice, “the stakes weren't that high, or people didn't know they were. These are huge plans and they're underfunded by hundreds of millions of dollars. There's big money at stake.”

One big draw for organizations to claim church plan status is the greater flexibility over how and when they fund their pension plans. A 2013 Standard & Poor's Rating Services report on pension funding in the non-profit health-care sector showed 2012 funding levels for Ascension Health Alliance, Catholic Health Initiatives and Dignity Health at 93.1%, 75.2% and 65.5%, respectively, down from 94.1%, 88.6% and 75% a year earlier. The 2013 median funded level for the non-profit health-care sector was 80%, after four years at roughly 70%, according to S&P.

Church plan sponsors also avoid paying premiums to the Pension Benefit Guaranty Corp. and can get up to six years of PBGC premiums refunded retroactively after receiving IRS designation as a church plan. An analysis of PBGC documents obtained by the Pension Rights Center, Washington, showed 85 plan sponsors, at least 60% of them not-for-profit health-care companies, received a total of $18 million in premium refunds from 1999 until 2007.

The lack of PBGC support is a key worry among plan participants, along with the exemption from ERISA-mandated funding and reporting requirements.

Other attempts by plan sponsors to dismiss cases — including those brought against Saint Peter's Healthcare System, New Brunswick, N.J and Catholic Health East, Newtown Square, Pa. — also have been rebuffed by the courts. Judge Michael Shipp from the U.S. District Court in New Jersey on March 31 said the IRS determination for Saint Peter's “conflicts with the plain text of the statute and is therefore unreasonable.” For the case against Catholic Health Initiatives in Colorado, a magistrate has recommended the U.S. District Court revoke the church plan status.

The one exception so far in recent cases involves Ascension Health Alliance, St. Louis, whose case was dismissed May 9 by U.S. District Court Judge Avern Cohn in Detroit. “The church exemption is a congressional choice of historic proportion. And while it may appear to be an irrational distinction, it is a distinction mandated by law,” he wrote in his opinion.

Those differing judicial readings of congressional intent have legal experts watching for more judges to weigh in on the district and appeals court levels, a process that could lead to the Supreme Court for a final word.

Pension rights advocates are encouraged that as more plaintiff law firms get involved, more challenges could be in the wings. “Until these law firms came forward ... nobody knew about the problem,” said Karen Ferguson, director of the Pension Rights Center. “From our perspective, the decisions are very significant. They correctly read the law and the legislative history, and we think they will be followed by other courts and be upheld.”

What happens after the judges weigh in is another matter. “There is no question that applying the actual law ... will create a messy situation in terms of compliance for plans that have ignored ERISA's requirements,” wrote Drexel University law professor Norman Stein in a recent summer 2014 law journal. “But the situation would be far messier if more and more faux church plans are able to decline responsible funding and break promises that Congress, in ERISA, said must be kept.”

Church-affiliated plan sponsors need to take notice, legal experts say. “We are trying to alert all the church plan sponsors out there that haven't been sued that they ought to pay attention to this possible litigation risk,” said David Powell, a principal with Groom Law Group in Washington, which represents several church plan sponsors. ”It's really about having them think about their own plans. It's a risk management exercise.”

He noted the outcome of these cases could affect more than just church-related hospital defined benefit plans. If ERISA is found to apply, it could extend to 401(k), 403(b) and welfare plans of those and other church-related charities as well.

“The plaintiffs appear to be focused on the underfunded DB plans, but it just logically follows from their arguments that if those are covered (by ERISA), then none of the plans sponsored by such a charity are church plans.” n