Lawsuits Serve as Warning to DB Plans: Review Your Actuarial Assumptions

Increases in life expectancy resulting from medical advancements and better health habits are generally viewed as a sign of progress for society. But for defined benefit plans that haven’t updated the assumptions used to determine payouts to participants, increasing life expectancy could lead to an increasing risk of being sued.
 
Benefit plan participants and beneficiaries have filed several high-profile lawsuits against major defined benefit plans, alleging that the organizations used outdated mortality tables that resulted in the underpayment of benefits. While the majority of these lawsuits remain unsettled, plan sponsors should view these examples as a wake-up call to reexamine the actuarial assumptions they use to determine benefit payouts.
 

Background: Benefits Must Be Actuarially Equivalent to a Single-Life Annuity
The 1974 Employee Retirement Income Security Act (ERISA) requires that all forms of benefit provided by defined benefit plans must be no less than the amount that is actuarially equivalent to a single-life annuity at a normal retirement age, as outlined by plan documents. Single-life annuities may not fit every participant, so defined benefit plans typically list other forms of acceptable benefits, like certain and life annuities and joint and survivor annuities. For joint and survivor annuities, the benefit is paid to the participant until the participant dies, before transferring to the spouse for his or her lifetime at a reduced rate, as designated in the plan documents.
 
If a plan participant or beneficiary desires an alternative form of payment, such as a certain and life annuity or a joint and survivor annuity, a conversion must be calculated. Plans use interest rate assumptions and mortality tables to calculate such conversions.

Understanding the “Reasonable” Clause in the Law

Neither ERISA nor the Internal Revenue Code (IRC) explicitly states that plan sponsors must use the most current mortality table or interest rate to make such conversions. Instead, ERISA says that plan sponsors must use “reasonable” assumptions to determine actuarially-equivalent benefits. This “reasonable” clause has been the focus of lawsuits—and should serve as a red flag for other defined benefit plan sponsors who may need to reconsider whether their mortality tables and interest rates meet this subjective standard.
 
When outdated mortality tables with shorter life expectancies are used, they often result in lower benefit payouts. Plaintiffs argue this is not reasonable and constitutes an ERISA violation because plan fiduciaries are obligated to act in the best interests of plan participants. These lawsuits seek compensation for the difference between benefits received and benefits that would have been generated using “reasonable” mortality tables and interest rates.
 
The defendants in these cases have filed motions to dismiss the cases, generally arguing that neither ERISA nor the IRC requires the use of specific mortality tables. In addition, defendants have argued that the plaintiffs haven’t satisfied the burden of proof to show the unreasonableness of the variables used to calculate the conversions.
 

BDO Insight: Don’t Wait for a Lawsuit to Review Your Plan’s Mortality Tables and Interest Rate Assumptions
Mortality tables and interest rates are set when the defined benefit plan initially becomes effective. Many plan sponsors have been unaware that they should evaluate these assumptions on a regular basis.
 
ERISA’s “reasonable” clause is subjective, as we see being played out in the recent lawsuits. But just because the law isn’t clear-cut, that doesn’t mean that plan sponsors should take a “set it and forget it” approach to their mortality tables and interest rate assumptions.
 
Plan sponsors who want to avoid lawsuits should develop a proactive strategy with their actuaries and ERISA attorneys to determine whether their assumptions used to calculate conversions can withstand a test in court.