Opinion ID: 174853
Heading Depth: 2
Heading Rank: 1

Heading: Solvay's Pension Plans

Text: Before 2005, Solvay's pension plan determined the annual retirement benefit for an employee retiring at 65 (the normal retirement age) by multiplying the employee's years of qualified service by a percentage of the employee's highest average five-year compensation [2] (plus a smaller percentage of the portion of that compensation exceeding the Covered Compensation for persons of that age in the current IRS table, see, e.g., Rev. Rul. 98-53, 1998-2 C.B. 630 (1999 Covered Compensation Tables)). If the employee took retirement benefits before age 65, benefits were reduced based on age, though there was no reduction for those retiring after reaching age 55 whose age plus service years totaled at least 85. On January 1, 2005, Solvay's plan switched to a new method of calculating benefits, a cash-balance formula. [3] Under the new plan each employee has a hypothetical retirement account, which is credited every quarter with a pay credit (based on compensation for that quarter and the sum of age and years of service) and an interest credit (equal to the account balance multiplied by the interest rate on 30-year Treasury securities). The employee may take the account balance as a single lump-sum payment; or the employee may take the balance as a monthly annuity whose value is the actuarial equivalent of the account balance when the annuity begins, whatever the employee's age at that time. To calculate the actuarial equivalence, the plan uses the mortality table prescribed by the Secretary of the Treasury and an annual discount rate, which may change over the history of the plan but was assumed to be 5% when the plan conversion occurred. The calculation under the new plan is somewhat more complicated for employees who had worked for Solvay while the old plan was in effect and continued to work for Solvay after December 31, 2004, under the new plan. [4] The opening balance of their hypothetical accounts is the actuarial equivalent of their normal-retirement benefit (which is, essentially, the monthly pension available if the employee begins receiving benefits at age 65) accrued under the old plan as of December 31, 2004. That is, roughly speaking, the opening balance would be a sum that could purchase an annuity that would pay the same monthly benefit as the already vested age-65 pension. Also, when an employee takes early retirement (before age 65), if the monthly benefit under the cash-balance formula is less than the monthly benefit that the employee had accrued under the old plan by December 31, 2004, the employee receives the monthly benefit accrued under the old plan. Plaintiffs' concerns relate to two consequences of the conversion to the new plan. First, employees who continued to work for Solvay would not receive as large a pension as they would have if Solvay had retained the old plan. Second, employees who continued to work for Solvay might have to work several years before their early-retirement benefit increased beyond what had vested on the date of the plan conversion. Plaintiffs refer to the second consequence as a wear-away of benefits. They assert that both negative consequences affect older employees (those in Plaintiffs' class for this litigation) more than younger employees. It is worth taking a moment to explain both consequences. To begin with, we describe how the benefits under the new plan would be less than what employees would have received if they had continued to be covered by the old plan as they worked for Solvay after December 31, 2004. Because of additional complexities that arise with respect to early-retirement benefitscomplexities that we will address in the upcoming discussion of wear-awayswe will consider only the benefit that an employee would receive if the employee waited until age 65 to start taking benefits (although the employee may have ceased working for Solvay years earlier). On the first day under the new plan, the employee was entitled to the same age-65 retirement benefit as the employee would have received under the old plan. This result follows from the method by which the employee's initial cash-balance account was calculated. That initial balance was the actuarial equivalent of the value of the age-65 pension. In other words, if on December 31, 2004, the employee had a vested benefit under the old plan of $1,000 a month when the employee reaches age 65, then the employee's initial cash balance under the new plan would have been the amount of money it would take to buy an annuity that would pay the employee $1,000 a month once the employee turns 65. [5] From that date on, however, the benefits under the old and new plans diverge. Under the new plan the employee's age-65 pension benefit would increase every quarter because pay and interest credits are added to the cash-balance account. This increase, however, would not be as rapid as the benefit increase would have been under the old plan. As a result, if the employee continued working until age 65, the pension would be significantly less than it would have been if the old plan had continued, sometimes less than half as much. This is the first consequence that Plaintiffs have concerns about. The description of the second consequence wear-awaysis more complex. As we shall see, wear-aways result from Solvay's subsidy for early-retirement benefits (received after reaching age 55 but before age 65) under the old plan, a subsidy that was not continued under the new plan. [6] We have already noted that on the day of conversion from the old plan to the new plan, the cash-balance-account pension at age 65 would be the same as the age-65 pension under the old plan. But the pension that the employee would receive upon retirement at an earlier age (say, age 55) would be more under the old plan than would be calculated under the cash-balance method. Under the old plan, an employee who decides to take early retirement would receive a monthly benefit equal to the benefit that the employee would receive at age 65, less a percentage of that amount for every year early the pension starts (unless one has reached age 55 and one's age plus service years equals at least 85, in which case there is no reduction). The annual percentage reduction is 3% if the employee had reached age 55 before leaving Solvay employment; otherwise it is 4% per year. Thus, one who leaves Solvay at age 55 and immediately begins to take retirement benefits will receive a monthly benefit that is 30% (10 x 3%) less than she would have received if she left work at age 55 but deferred receiving benefits until age 65. If the employee would have received $1,000 a month at age 65, the employee would receive $700 a month at age 55. Under the new plan the early-retirement benefit is calculated differently. Just as the age-65 retirement benefit is determined by calculating the monthly annuity at age 65 that is actuarially equivalent to the hypothetical cash-balance account, the early-retirement annuity (say, at age 55) is also actuarially equivalent to the amount in the cash-balance account. If the cash-balance account is large enough at one point that it could purchase a $1,000 monthly annuity beginning at age 65, it could purchase a monthly annuity of something less than $500 beginning at age 55. (The new plan assumes an annual discount rate of 5%, so the reduction for taking retirement 10 years earlier would be more than 50%.) The important point is that interest rates and mortality rates are such that the ratio of the early-retirement monthly annuity at age 55 to the monthly annuity for an age-65 pension will be less under the new plan than under the old plan. If the employee would receive an age-65 monthly annuity of $1,000 under both plans, the age-55 monthly annuity would be $700 under the old plan (70% of the age-65 annuity) and less than $500 under the cash-balance formula (less than 50% of the age-65 annuity). To describe this from another perspective, for the early-retirement annuity to be actuarially equivalent to the age-65 annuity, the early-retirement benefit would need to be reduced by significantly more than 3% for each year before age 65 that the employee begins receiving benefits. It cost the old plan much more when an employee decided to receive benefits before age 65 than if the employee deferred receipt until age 65. That is, the old plan subsidized early-retirement benefits. The new plan does not. The reason for the wear-away effect is that even after conversion to the new plan, the employee is entitled to at least as high a benefit as the employee had accrued under the old plan before the conversion. An example will illustrate the point. Assume as before that at the time of conversion to the new plan, the employee's vested benefit would be a monthly annuity of $1,000 beginning at age 65. Because the opening cash balance under the new plan would be actuarially equivalent to that annuity, the employee would receive the same age-65 monthly annuity under the cash-balance calculation. But, as just explained, the early-retirement annuities under the two plans could be quite different. Under the old plan, the employee would be entitled to a monthly pension of $700 beginning at age 55 ($1,000-(10 × 3% × $1,000)). In contrast, under the cash-balance plan the amount in the employee's account would pay for only a monthly annuity of less than $500 beginning at age 55. The employee, however, is entitled to the benefit that he had accrued under the old plan before the conversion, so the employee would receive $700 a month if he chose to begin receiving benefits at age 55. How then would things look after the employee works another year for Solvay under the new plan? Although the employee's cash-balance account will have grown because of pay and interest credits, it is unlikely to grow enough to purchase a $700 monthly annuity at age 55. The employee is still entitled to a $700 monthly annuity beginning at age 55 (because that benefit had accrued under the old plan), but that is the same early-retirement benefit that the employee had been entitled to a year earlier. The extra year's work did not increase that benefit. (We should point out, though, that the age-65 annuity would always increase; there is no wear-away period with respect to that benefit (except as noted in footnotes 5 and 6) because the hypothetical-account balance increases each year and the initial balance was calculated as the amount that would pay for the age-65 annuity that had already accrued under the old plan.) This could go on for several years. The number of years of work it takes before the employee's early-retirement benefit under the cash-balance formula exceeds the vested benefit under the old plan is called the wear-away period. According to Plaintiffs' actuarial expert, Mr. Jensen's wear-away period would be 4.9 years and Mr. Goff's, 11.4 years.