US Supreme Court addresses conflicts of interest in ERISA plans

ERISA provides that an individual denied benefits under an employer benefit plan may challenge the denial in federal court.  Last week, the US Supreme Court addressed the standards for review when the entity that administers the plan -- usually an employer or insurance company -- both decides eligibility for benefits and pays the benefits out of its own pocket. 

The Court has earlier signalled that federal courts must give considerable deference to a plan administrator's decision.  In the 1989 Firestone case, the Court held that, if the plan document gives the fiduciary discretionary authority, courts reviewing a denial should focus on the fairness of the claim denial process and not on whether the outcome was correct.  The reviewing court must defer to the fiduciary's decision, reversing it only if there was no evidence upon which to base the decision.

The Firestone opinion raised, but did not resolve, the issue of how a plan administrator's conflict of interest factors into the reviewing court's decision.  For example, if a self-insured employer denies a claim, thereby increasing its profits, should the reviewing court automatically conduct a more searching review, or is the plaintiff first required to prove that the conflict affected the fiduciary's decision?  In the 20 years since Firestone, Circuit Courts have developed various strategies for determining what to do when a fiduciary has a conflict.

Last week in Metropolitan Insurance Co. v. Glenn, the Supreme Court said there is no one-size-fits-all rule for reviewing a decision by a fiduciary having a conflict of interest:  "a reviewing court should consider that conflict as a factor in determining whether the plan administrator has abused its discretion in denying benefits; and that the significance of the factor will depend upon the circumstances of the particular case." 

This directive from the Court fails to show what a plan fiduciary can do to avoid a conflict, or how either the plan or participant should prove the presence or absence of one.  Plan fiduciaries may be protected by taking procedural actions, such as isolating claims administrators from management or employer influence, to prevent any possible conflict from tainting the claim review process, according to the Court.  But the Court refused to create a bright-line test for reviewing claims decisions even when such protections are in place. 

Deferred compensation plans must comply with new law by year end

By the end of this year, the IRS requires every "deferred compensation plan" to comply with Internal Revenue Code Section 409A.  What is a deferred compensation plan?  The definition covers a number of employment arrangements, such as severance agreements, stock options, and change-in-control agreements.  A recent article in the Portland Business Journal by Northwest Business Litigation Blog contributor John Walch addresses the treatment of severance agreements under Section 409A. See our earlier posts about the new law here, here, and here. 

Every employer we have worked with has had at least one deferred compensation arrangement that needed to be brought in line with Section 409A.  To avoid the year-end rush, employers should now review any existing agreements with employees, directors and consultants, and discuss those agreements with their benefits attorney.

Plan participants can sue to recover investment losses, U.S. Supreme Court holds

The U.S. Supreme Court unanimously decided yesterday that ERISA retirement plan participants can sue plan fiduciaries for losses to their individual accounts caused by alleged fiduciary breaches.

In LaRue v. DeWolff, Boberg & Associates, Inc., the plaintiff alleged that the plan fiduciary had not carried out his investment directions properly, causing $150,000 in losses.  ERISA allows participants to bring actions against plan fiduciaries for breaches of the fiduciary's duties, but previous Supreme Court decisions had limited recovery to losses to the plan as a whole, not to individual participants.  Since only one participant alleged damages in this case, the fiduciaries hoped the court would toss the lawsuit.

Plaintiff LaRue argued successfully that the earlier decisions denying relief involved defined benefit plans, where plan assets are held and invested collectively by the fiduciaries.  LaRue's claim involved a 401(k) plan that, as almost all do, allowed participants to invest their individual account in a variety of investment options.  The court agreed that distinction justified not applying the earlier decisions and allowing the suit to proceed.  As a result, the case now heads back to the trial court to resolve the issues on the merits.  Although plan fiduciaries may not like the outcome, at least the decision clarified an issue that had grown increasingly uncertain over the past few years.

Plan fiduciaries should clearly understand the risks inherent in their position and how to mitigate them.  Good processes, competent advisors and insurance coverage all play a part in protecting fiduciaries.

Washington business, labor and Legislature react to the Brink's drive-time ruling

Blog contributor Brenda Molner has published an article addressing the responses of business, labor, and the Washington legislature to the Washington Supreme Court's October 2007 ruling in Stevens v. Brink's Home Security, Inc.  The article is in the February 2008 edition of the Puget Sound Chapter of the National Association of Women in Construction's newsletter.  The Brink's case deals with payment of drive-time to employees who use company vehicles to commute to and from work.  The article is a follow-up to a previous article in the same publication.

You may access Washington HB 3294 and SB 6867, referenced in the article, by clicking on the links provided.

Oregon Court of Appeals affirms employer's unilateral changes to retirement plan

Applying the contract law doctrine of accord and satisfaction, the Oregon Court of Appeals last week held that an employer did not breach a contract with its employees when it unilaterally increased the amount the employees must contribute to their retirement benefits.

In Lauderdale v. Eugene Water and Electric Board, the court held that the employer, EWEB, contracted to give its employees free or low-cost lifetime retirement benefits equal to active employees' benefits. Since those rights vested when the employees accepted employment or continued to work, EWEB could not unilaterally modify or revoke the retirement benefits without breaching the contract. The court held, however, that those plaintiffs who were still working at the time of a unilateral cost increase accepted the increase as an accord and satisfaction by continuing to work for EWEB and not challenging the change in benefits.

State-mandated health benefits vs. ERISA, Round 4

We previously alerted readers to San Francisco's attempt to force employers to provide a certain level of health benefits to employees, or to pay a tax to fund the city's public health programs.  A Unted States District Court has held that the city ordinance violates ERISA's preemption provision, following a similar outcome in the Fourth Circuit reviewing a Maryland statute. 

The Ninth Circuit recently stayed the district court's ruling, allowing the ordinance to become effective pending the Circuit Court's consideration of the appeal addressing the substantive issue of ERISA preemption.  It appears the panel thinks that ERISA does not preempt the ordinance; part of the standard for granting the stay is "likely success on the merits."  That outcome would create a direct conflict with the Fourth Circuit decision on a very similar statute, suggesting that the Supreme Court will eventually have to resolve conflicting circuit decisions addressing the relationship between ERISA and attempts by local government to fund health care for the uninsured. 

New year, new laws from the Oregon legislature

Oregon greets 2008 with a raft of new legislation.  Laws affecting Oregon businesses include an expansion of the family medical leave law under House Bill 2635 to cover grandparents who must care for sick grandchildren.  New mothers must be given break time and a private place to express milk at work, per HB 2372.  Senate Bill 2 prohibits discrimination based on sexual orientation.  Health insurers are now required to include coverage for contraceptives (HB 2700) and for prosthetic and orthotic devices (HB 2517).  And HB 2513 makes it unlawful to sell gift cards that expire or have a face value that declines over time with lack of use.  See summaries of other new laws in this press release from the legislature. 

Deferred Compensation Deadline Extended

The IRS recently extended the deadline for deferred compensation arrangements to comply with section 409A of the Tax Code.  Although employers now have until the end of 2008 to have all deferred compensation arrangements documented in a plan or agreement that complies with the statute, the arrangements must comply in operation now.  For example, distributions from such an arrangement can occur only upon the occurrence of an event described in section 409A, even if the written arrangement provides otherwise.

We recently issued a Client Alert describing section 409A and the new extension.

California mandates leave for spouses of those serving in the military

Last week California adopted a new law that requires employers to provide unpaid time off work to an employee with a military spouse who is home on leave. 

All employers with at least 25 employees are subject to the law, including governmental and tax-exempt employers.  Employees working an average of 20 or more hours each week qualify for the benefit.  Qualified employees with a spouse deployed to a designated combat area who returns home on leave are eligible for up to ten days of unpaid leave.  Note that the members of the National Guard or reserves deployed to a combat area are included in the definition of military spouses.

An employee must notify his or her employer within two business days of receiving notice that the military spouse will return home on leave.  The employee must also certify that the military spouse is on leave from deployment during the requested time off.  This statutory leave is in addition to any other leave or benefit that the employee is entitled to receive.  Retaliation against an employee for taking the leave is prohibited.

California is not the first state to adopt such mandatory leave laws and will not be the last.  Such statutes are becoming increasingly popular as the hardships  placed on military families by the war on terror become better appreciated.

Must a Fiduciary Disclose Helpful Information to Participants?

Victor Washington played in the NFL for five years before a string of injuries ended his career. The NFL's disability plan agreed that he was disabled. However, the plan asserted Washington had a "non-football" disability, entitling him to a lower monthly benefit than a football-related injury. The plan limited football-related disabilities to those caused by a single football injury. The plan asserted Washington's disabilities were cased by multiple injuries, none of which were disabling by themselves.

Washington disputed this interpretation but eventually settled his claim. Later, the plan lost a case with another player involving the same issue. The court hearing the matter held the plan's position regarding the single/multiple injury distinction was unreasonable.

Upon learning of that decision, Washington sued to rescind his settlement. He argued the plan should have told him that the reason for denying his claim was unreasonable. The Ninth Circuit in a divided decision held that the decision was not “material” information and therefore the fiduciaries did not have to disclose it.

The Ninth Circuit’s decision includes a helpful summary of the duties of loyalty and disclosure imposed on fiduciaries. Although the judges disagreed about the materiality of the other player's lawsuit, they agreed, “a misrepresentation is material if there is a substantial likelihood that it would mislead a reasonable employee in making an adequately informed decision in pursuing disability benefits to which she may be entitled.”

Deferred Compensation Deadline Approaches

Two years ago, Congress passed new laws that for the first time impose strict rules on "deferred compensation plans."  Congress chose to define that term broadly as "the legal right to compensation in one year that is not paid until a future year." That definition includes all kinds of common arrangements not usually considered "deferred compensation:” employment offer letters, change in control agreements, stock options, bonuses, etc. Employers must understand how the law works to avoid triggering retroactive income taxes with interest and a 20% penalty.

Employers should therefore take the following steps to ensure that they do not unintentionally create a significant tax liability:

1. Identify all potential deferred compensation arrangements. As mentioned above, this potentially includes any employment or severance agreement and any incentive compensation program, including bonuses, stock options and stock appreciation rights.

2. Review the arrangements for compliance with the law. Certain arrangements are grandfathered out of the law; others have exemptions. 

3. Consider alternatives for compliance with the law. If an arrangement is subject to the law, it must comply in operation even if the written terms of the arrangement do not. There are usually several options available to achieve compliance.

4. Prepare any required amendments. Arrangements subject to the law must comply by year-end 2007. Discuss any changes necessary with employees and record-keepers.

5. Adopt the changes by the end of 2007. This may require action by the Board or Compensation Committee, affected employees or consultants. For them to have time to do due diligence, employers should begin this process now.

What Do Employees Want?

A recent survey of over 1,200 employees indicates that exceptional health benefits are the most desired benefit currently not offered by employers.  In fact, comprehensive health benefits are one of the three top reasons why survey respondents have stayed with their employers.  And among benefits employees do not have, 100% health care coverage is considered more desirable than competitive salary. 

The survey also indicated that 62% of employees are currently actively or passively looking for a new job; 41% do so while at work.  Given that degree of potential employee loss, employers should pay careful attention to what benefits will encourage employees to stay.  In addition to health care coverage, competitive salary and compressed work weeks were top priorities.  401(k) matching contributions and tuition reimbursement programs were also popular with employees.

We have previously mentioned the skyrocketing cost of providing health coverage to employees.  What options are available to an employer who cannot afford increasing coverage?  The best may be to treat employees with respect and make them feel rewarded for their efforts.  The survey reports that 32% of employees who are not satisfied with their current employer would become so if they were treated better.  And 26% of employees said feeling rewarded and inspired was a leading reason they stay with their current employer.  Almost 20% of employees with fewer than 5 years' tenure left because they felt they lacked inspiring work. 

Diversify or Else!

Last August the federal Pension Protection Act of 2006 (PPA) became law.  One of the PPA's many provisions requires that company-sponsored retirement plans allow participants to diversify out of company stock in their account.  Prior to the PPA, plans could and frequently did place severe restrictions on employees selling company stock.  Employers did not want employees dumping large quantities of company stock and thereby sending a very negative signal to investors.

The PPA required plans to make two changes.  First, the PPA mandated minimum diversification requirements.  For example, participants must have at least three different non-company stock investment options and must be allowed to diversify company stock investments into the other options at least quarterly.  Second, the plan must provide a notice to participants that explains their right to diversify and how important diversifying retirement assets is.  This notice must be given at least 30 days before the participant first becomes eligible to diversify assets -- usually after three years of service. 

On Friday, the U.S. Dept. of Labor published final regulations that include a $100 per day penalty for failing to provide a timely notice.  That doesn't sound like much, but do the math: forgetting to send a notice to 10 participants until a year later when the DOL audits the plan can cost $365,000.  The final regulations (and the penalty) are effective October 9, 2007.  However, the diversification and notice requirements were effective January 1, 2007.

Local Government vs. ERISA, Round 3

Previously, we discussed Maryland's unsuccessful attempt to force large employers either to provide certain levels of health benefits or to pay taxes to the state.   In the latest effort to provide health coverage to more people -- this time by a local government -- San Francisco has passed a universal health care coverage ordinance. 

San Francisco funds the program by requiring employers of 20 or more employees to provide health benefits costing from $1.17 to $1.76 per hour per employee, or to pay the City that amount and let the City provide the coverage.  A group of San Francisco restaurants filed suit to block the ordinance, arguing, as in the Maryland case, that ERISA preempts compelled levels of benefits.  The City filed a motion to dismiss the suit, and the restaurants filed a motion seeking summary judgment on ERISA preemption.  A federal district court judge will hear argument on the motions in August. 

Debate about the role that ERISA plays (or should play) in our nation's health care system will continue.  Access to health care and how to pay for it is a major issue among the candidates running for President.  Expect dozens of local and federal proposals to continue appearing as our elected leaders struggle to find a solution.

Employer health insurance costs continue to skyrocket

The California Health Care Foundation just released a study of U.S. employer health insurance costs.  The first finding is no surprise to employers: health insurance premium costs per employee for employers offering health benefits increased more than $1,700, or 85%, from 1996 to 2005.  Salaries and wages increased just 39% over the same period.  In 2005, health insurance premiums constituted almost 11% of total payroll costs, an increase from 8% as recently as 2000.

The study is full of charts that all point to the same conclusion: health insurance costs are increasing rapidly, will likely continue to do so, and employers who get smart about ways to control health care costs have a competitive advantage over those who do not.  Health Savings Accounts, health reimbursement arrangements, wellness plans, and other techniques offer tools to manage these costs proactively.   Adopting these practices can reduce absenteeism, cut costs, and actually enhance the quality of benefits provided to your employees.

Court allows COBRA claim against employer with fewer than 20 employees

COBRA requires an employer with more than 19 employees to provide health insurance to its former employees.  So if a plaintiff asserting a COBRA claim admits her employer has fewer than 20 employees, the court should dismiss the claim, right?  A case issued last week by the Sixth Circuit shows that life (or at least employee benefits law) is never that simple.

In Thomas v. Miller, a former employee admitted that her employer had fewer than 20 employees, but nonetheless sued for COBRA benefits.  The Sixth Circuit allowed the lawsuit to proceed because the employee claimed the employer used “conduct or language amounting to a representation” that employees were entitled to COBRA benefits.  A legal doctrine called estoppel prevents a party from asserting a defense at the expense of another person who was entitled to rely on the party's conduct.  The Sixth Circuit held that if the employee could prove the employer made such a representation, estoppel prevented the employer from asserting the statutory threshold defense.

The message to employers is that if provide employee handbooks or communications that refer to COBRA, you  may be liable for COBRA benefits. Small employers should carefully review the material provided by their insurers and all other employee benefit communications to ensure that they do not include COBRA references.  Otherwise, the employer could be stuck with an employee's medical bills without an insurance company to turn to for reimbursement.

Domestic partners and employee benefit plans

Last month, Oregon joined the small but growing number of states that recognize domestic partnerships of same-sex couples.  Many employers question the impact the new law will have on their employee benefit plans, and how they should respond.

Health Insurance and Health Savings Accounts (HSA)

Employers may provide tax-free health insurance benefits to non-employee domestic partners if the partner meets the Internal Revenue Code definition of "dependent."  That requires, among other tests, that the domestic partner receive at least one-half of his or her support from the employee.  To entitle a domestic partner to benefits, the employer's health plan must expressly provide for such benefits.   Employers should review their plan's eligibility provision to ensure that the plan reflects the employer's intent.  Employers choosing to offer benefits to a domestic partner may consider requiring an affidavit or other certification process to determine and document the eligibility of the domestic partner.

COBRA does not consider a domestic partner to be a "spouse" entitled to COBRA benefits, and such partners are therefore not entitled to COBRA rights or notices.  Despite this, and since COBRA provides minimum coverage requirements, an employer's health plan may offer COBRA benefits to a domestic partner since COBRA does not prohibit an employer from offering continuation coverage to a larger group than required.  Again, careful drafting and close consultation with the health plan insurer are required.  HIPAA has a slightly different definition of dependent that may require providing a special enrollment period for domestic partners who lose their own coverage.

Dependent Care Assistance Program (DCAP) and Health Flexible Spending Account (FSA)

As above, these plans may provide benefits for domestic partners that satisfy the tax code's definition of dependent, provided that the plan eligibility provision is drafted to do so.  Again, the employer should review the plan(s) to ensure they are working correctly. 

Retirement Plans

Many 401(k) or profit sharing plans allow hardship distributions for certain educational or medical-related expenses of the participant's dependent.  Such expenses incurred on behalf of a domestic partner that satisfy the dependent definition are eligible for hardship distributions.

One important element that is not available to domestic partners is automatic inheritance of a retirement plan benefit.  Federal law limits that automatic right to a "surviving spouse," defined as the surviving member of an opposite-sex marriage.  An employee who wishes to have his or her non-employee partner receive any death benefit must complete a beneficiary designation form for that purpose. 

Cafeteria (Section 125) Plans

Cafeteria plan rules allow participants to make changes to their elections if the participant has a "change in status event."  One such event is a change in "legal marital status."  However, registering as domestic partners is not considered a change in legal marital status.  Even a same-sex marriage is not a change in status event, again because of the federal law's restrictive definition of "marriage." 

Other benefit plans (life insurance, dental, vision, etc.) should undergo a similar analysis.  Failing to know and understand the tax consequences of benefit plan coverage in a rapidly evolving area of the law can have an adverse impact on both the employer and the employee.

Claims for broken employment promises not preempted by ERISA

ERISA's extensive regulation of pensions preempts many state law claims that an employee might seek to bring against his employer.  A recent case from the Sixth Circuit provides a good discussion of the many types of claims that ERISA preempts, and of the one asserted by the plaintiff that it does not.

Plaintiff alleged that during employment negotiations Pfizer orally promised him a retirement pension of $3,100 per month.  After accepting the job, Pfizer notified him that the correct benefit amount was $816.  He filed a lawsuit seeking two alternative remedies: reliance damages, or the value of what he lost by taking the job, such as stock options from his former employer, and expectation damages, or the difference between what Pfizer promised and what he would actually receive.

The District Court dismissed the complaint, finding that both remedies were preempted by ERISA as seeking from the pension plan benefits that it did not provide.  The Circuit Court reversed the District Court regarding the reliance damages.  It held:

"What we have here is simply a case of a person who left his old employer based on promises made by his new employer.  These promises could have concerned anything — for example, an increase in wages, more vacation days, or free parking.  Here, these promises just so happened to concern retirement benefits.  We see no reason to bind employers to some promises used to induce acceptance of an employment offer, but give them a ‘get out of jail free card’ when their promises concern the scope of a plan governed by ERISA."

The Court declined the preemption argument because the alleged promises were made before plaintiff, as an employee, became eligible for the plan. The only connection to the pension plan is the damages sought. The Circuit Court held that connection is too remote to preempt the claim at the pleading stage.  The Court offered this counsel to employers:

"If adhering to promises regarding ERISA-governed plans proves too cumbersome for employers, then during the recruitment process, those employers must simply be more careful before informing potential employees of the ERISA governed benefits to which they might be entitled."

Wise counsel, but certainly easier said than done.

Senator Smith's retirement plan proposal

As recently as 30 years ago, the overwhelming majority of employee retirement plans were defined benefit plans.  A defined benefit plan typically guaranteed a fixed monthly payment for the life of the retired worker.  Currently, defined benefit plans are becoming rare outside the public sector.  Most non-public employers instead offer a defined contribution plan.  These plans make no guarantees about lifetime income.  Instead, the employer simply makes (or allows employees to make) contributions.

This shift has received lots of media attention and policy-maker concern.  One of those concerns is the impact on women, who tend to have fewer years in the workplace before retirement age and live longer afterwards, when compared to men.  Working less years at typically lower wages reduces not only retirement savings opportunities with the employer, but also Social Security retirement benefits, which are based upon wages earned.

Oregon Senator Gordon Smith, along with bi-partisan co-sponsors, introduced a bill in the Senate that addresses one aspect of this problem.  Among other retirement incentives, the bill provides special treatment for assets received as annuities (a guaranteed payment for life) from both qualified retirement plans, such as 401(k) or profit sharing plans, and non-qualified plans.  Annuity payments from qualified plans are 10% income tax-free up to a limit of $2,000 annually.  Annuity payments from non-qualified plans are 50% tax-free up to $20,000. 

The bill also allows the tax-free purchase of longevity insurance, a special type of insurance policy that begins making life annuity payments when a person attains their life expectancy.  Many retirees budget their retirement savings over their life expectancy.  The insurance would guarantee an income stream for those individuals who live longer than their expected life span.

It's too soon to know whether this bill will become law, and what impact it will have if it does.  But it's good news that policy makers continue to seek solutions for Americans' chronic inability to save for retirement.

Washington State legislature passes paid family (really parental) leave act

Washington is now only the second state in the United States to provide for paid family leave – the other state is California.  Under the recently enacted Engrossed Second Substitute Senate Bill 5659,  employees will be able to apply to the state for up to two hundred and fifty dollars per week in wage replacement benefits for parental leaves of absence lasting up to five weeks.  Such paid leave becomes available October 1, 2009.  Leave is available for bonding with a newborn or newly placed adopted child.

The enacted bill is less comprehensive than a prior version that would have in addition provided paid leave for the employee's serious health condition or for the serious health condition of a family member.  It also leaves unresolved how the paid parental leave will be funded.  The enacted bill simply establishes a task force charged with determining the most appropriate method of financing and administering the paid leave program.  The task force is required to report to the legislature by January 1, 2008.

ERISA and prenuptial agreements don't always mesh

Benefit plans that provide benefits upon a participant's death allow the participant to designate a beneficiary to receive the post-death payments.  A frequent source of controversy is participants' failure to update beneficiary designations following a divorce, marriage or other change in circumstances.

Problems can arise when a participant seeks to provide the benefit to children of a former marriage instead of a new spouse.  Often, a prenuptial agreement explicitly addresses the benefits and the new spouse may agree to waive any interest in the benefit.  However, almost as often, the participant then forgets to file a new beneficiary designation form with the plan administrator. 

Most employer-sponsored benefit plans are subject to ERISA, which has very strict rules about beneficiaries.  For example, ERISA provides that a participant cannot designate a non-spouse beneficiary without the spouse's written consent witnessed by the plan administrator or a notary.  Often, such consents are signed before the spouse is actually married to the participant, as in a pre-nuptial agreement.  In such a case, courts require the plan to pay the spouse since ERISA requires the plan to do so, unless a beneficiary designation, consented to by the spouse, indicates otherwise.

Does a prenuptial agreement satisfy the ERISA requirement?  No, because when signed, the prenuptial agreement is not signed by a "spouse" -- the couple are not yet married.  As clearly stated in the Dept. of Labor's regulations: "An agreement entered into prior to marriage does not satisfy the applicable consent requirements."  What if the agreement is signed after the wedding?  At least then the timing is proper, and if the form of the agreement and its execution are proper, then it may satisfy the requirement.  A better practice is to use the plan's beneficiary form and have the new spouse indicate their consent on the form, witnessed by a notary or plan administrator.

The lesson for participants is to periodically check beneficiary designations to ensure that the any post-death benefits will go to the persons the beneficiary wants to receive them, not the person ERISA would otherwise require.  For plan fiduciaries, the lesson is to know and understand the consent requirements and ensure that they are followed.  Otherwise, the plan risks paying a benefit twice: to the person the plan thought should have received the benefit, and to the one who won the lawsuit against the plan for paying the wrong person.

New IRS regulations address post-termination 401(k) deferrals

As a general principle, only an active employee may make deferrals into a 401(k) plan, because an individual who is not an active employee does not satisfy the plan's eligibility provisions and the IRS deferral rules.  Given this rule, plan administrators have struggled to determine whether they may take deferrals out of a commission check earned before termination but paid afterwords, or a severance payment made to induce early retirement.

Last week the IRS updated its 1981 limitations on benefits and contributions under qualified retirement plans.  One area of particular interest to employers was handling post-severance salary or other payments.  The IRS general rule is that amounts received after severance from employment are not considered "compensation" from which contributions to a plan may be made, since the recipient is no longer an active employee.  But in last week's new regulations, the IRS created several exceptions to the general rule. 

Payments made under bona fide sick, vacation or other leave plans that would have been available if termination had not occurred are "compensation" (eligible for contributions) if made within 2½ months of termination or the end of the plan's current limitation year, if later.  So, employers that make lump sum payments of unused sick or vacation leave to departing employees at or shortly after employment termination may now include those amounts as eligible for plan contributions (but may require a plan amendment to do so). 

Post-severance distributions from non-qualified deferred compensation plans that would have occurred at the same time if the individual had remained employed are also now included as "compensation" if they occur within that same 2½ month/limitation year time period, as are amounts included in income under Code section 409A.  And post-termination payments to permanently disabled participants are also excepted, if certain conditions are met. 

The lengthy new regulations make many other adjustments and clarifications, some of which have already been well-established in practice over the last 25 years based on IRS Announcements, Notices or other non-regulatory guidance.  As with any other changes to the rules governing a qualified plan, consider how these changes might affect your plan, which ones provide potential benefits to your employees, and discuss with your plan counsel how your plan should respond.

7th Circuit prohibits mandatory exhaustion of paid leave benefits during paid FMLA leave

Most employers require employees who want to take family medical leave (FML) -- which is typically unpaid -- to use accrued paid leave (e.g., vacation and sick leave) benefits during the period of absence.  If an employee has not yet used his annual paid leave benefits, this requirement has the effect of limiting the amount of time employees can spend away from work each year.  Requiring the use of paid leave during an unpaid portion of FML is permissible under state and federal law.  However, an employer's ability to require the use of paid leave is not absolute.

In Repa v. Roadway Express, Inc., the 7th Circuit Court of Appeals recently found an employer in violation of the Family Medical Leave Act when it required an employee who was receiving disability pay (from a health and welfare benefit fund to which the employer contributed) to use her accrued sick and vacation leave benefits.  The court relied on a Department of Labor Regulation, 29 CFR 825.207(d), which provides that when an employee is receiving disability or workers compensation pay, the leave is not unpaid and the section of the regulation allowing for the substitution of paid leave is inapplicable.  Although Roadway argued that the regulation contravened Congressional intent and was therefore invalid because it allowed employees to take time off in excess of 12 weeks, the court refused to consider the argument because Roadway failed to assert it in the lower court.

As the federal regulation remains intact for now, Oregon employers who are subject to the Federal Family Medical Leave Act (those with 50 or more employees) are well advised to follow it.  However, employers who are only covered by the Oregon Family Leave Act (those with 25 to 49 employees), should be aware of the difference between state and federal law on the subject of exhaustion of paid leave benefits.  Under OFLA regulations, the employer, with the employee's consent, may make deductions from the employee's sick leave while the employee is receiving workers compensation, provided the sick leave payments make up for, but do not exceed, the employee's daily wage that is not covered by time loss benefits.  See OAR 839-009-0280(3) (citing ORS 656.240).  OFLA regulations do not otherwise limit an employer's ability to require employees to use paid leave benefits concurrently with other types of paid or unpaid leave.

Contraception as an Employee Benefit

ERISA does not mandate that any health care plan provide any level of benefits. Instead, ERISA leaves benefit decisions to the plan sponsor. Does that mean an ERISA plan sponsor can adopt a health plan that provides benefits in a way that arguably discriminates against women? A recent case from the 8th Circuit (covering Arkansas north to the Dakotas) discusses whether an ERISA health plan violates the Pregnancy Discrimination Act (PDA) by excluding coverage for contraception.

In Union Pacific Railroad Employment Practices Litigation, Union Pacific’s plan excluded from coverage “both male and female contraceptive methods, prescription and non-prescription, when used for the sole purpose of contraception." A class of 1500 female plan participants sued, claiming the exclusion violated the PDA. The District Court agreed, finding that the plan violated Title VII, the foundation of federal anti-job discrimination laws, as amended by the PDA. The court reasoned that the plan “treats medical care women need to prevent pregnancy less favorably than it treats medical care needed to prevent other medical conditions that are no greater threat to employees’ health than is pregnancy.” Although no Courts of Appeal had directly addressed this issue, a 2001 decision from a federal court in Washington required a health plan to provide prescription contraceptives to female participants or beneficiaries.

The 8th Circuit reversed the District Court in a 2-1 decision, finding that “contraception” is not “related to” pregnancy for PDA purposes because the two are mutually exclusive: “contraception is not a medical treatment that occurs when or if a woman becomes pregnant; instead, contraception prevents pregnancy from even occurring.”

The dissent argued otherwise:

When one looks at the medical effect of Union Pacific’s failure to provide insurance coverage for prescription contraception, the inequality of coverage is clear. This failure only medically affects females, as they bear all of the health consequences of unplanned pregnancies. An insurance policy providing comprehensive coverage for preventative medical care, including coverage for preventative prescription drugs used exclusively by males, but fails to cover prescription contraception used exclusively by females, can hardly be called equal. It just isn't so.

Expect more decisions on the collision of federal anti-discrimination statutes and ERISA plan benefits in the future. Although an ERISA plan is not subject to state-mandated benefits, it is subject to other federal laws. That provides an opportunity for plaintiff’s attorneys to argue for an expansion of benefits beyond what the plan sponsor intended to offer.

Employee benefit costs continue to grow

According to a recent U.S. Chamber of Commerce survey, employee benefits now constitute 44% of total payroll costs, a 4% increase over last year.  According to the survey, medical expenses totaled $5,924 per employee, or 14.5% of payroll, an increase from 11.9%.  Payments for time not worked (holidays, vacation or other leave) increased 0.6% to 11.1%.  Retirement plan contributions increased slightly to 8.6% of payroll, or $3,612 per employee.  Urban employers reported spending about $1,500 more than non-urban employers for each employee, and for-profit employers far outspent non-profits, which reported spending 34.8% of payroll on benefits.

Employers should be commended for continuing to shoulder an ever-increasing cost to provide their employees with benefits.  However, employers should also approach benefit expenses with the same strategic analysis they would any other expense: what critical business objective is advanced by offering this benefit (or level of benefit) to our employees?  And as benefit costs continue to increase, employers should consider alternative designs or approaches that might offer strategic advantages over competitors as well as lower costs. 

IRS Gives Employees Relief for Backdated Options

The Internal Revenue Service announced a program aimed at providing relief for rank-and-file employees affected by their companies’ issuance of backdated and other mispriced stock options.  While the program will be available to help these employees who may be unaware that they held backdated options, it is not available for backdated options exercised by most executives or other insiders.

Many companies have backdated or mispriced options, either issued intentionally or through sloppy option issue practices.   Some companies failed to disclose the practice to shareholders, as required by securities laws, or forged documents to hide the practice. 

Under a 2004 law, the tax consequences associated with backdated and other mispriced stock options issued at a discount affect most recipients who exercised their options in 2006 or later.  The law does not affect options that were earned and vested before 2005, however.  If an employee exercised a backdated stock option after 2004, the employee may owe an additional 20-percent tax, plus an interest tax, on all the employee's vested options, even if the other options were not backdated. 

If the option had been properly priced, the employee normally would only have owed income tax on the difference between the value at the date of grant and exercise for a nonqualified option.  A qualified or incentive option issued with the proper exercise price is not taxed at either grant or exercise.  Where an option has been backdated, the employee remains obligated to pay the full amount of income tax due upon exercise, including any additional gain realized from backdating, whether or not the employee was aware of the backdating.

The new program, described in Announcement 2007-18, allows companies to pay the additional 20-percent tax and any interest tax that employees owe.  The program does not permit the company to pay the additional tax for stock options exercised by its top executives or other insiders.  The IRS pointed out that for these individuals, the IRS was continuing its enforcement investigations and coordinating activities with the SEC and Dept. of Justice, and the program had no effect on any SEC or DOJ investigations.

Employers must notify the IRS of their intent to participate by Feb. 28, 2007.  The employers, in turn, are required to contact affected employees by Mar. 15, 2007 to inform them that the employer has applied to participate in the Compliance Resolution Program.

Affected employees who have not previously taken corrective action on their own will remain liable for the additional 20 percent tax and the interest tax if their employers do not participate in the program or fail to abide fully by its terms.  Importantly, the IRS allows companies until December 31, 2007 to correct unexercised backdated options for non-executive employees.  Companies should take corrective steps now to avoid having the employee or employer face the additional tax that occurs upon exercising a backdated option.

Corporations that elect to participate and relieve their affected employees will be required to provide the specific details about the options, including specifics on the tax calculation that will enable the IRS to ensure the U.S. Treasury has received the full amount of taxes owed.   

The taxes the companies will pay to relieve employee tax bills will be treated as additional 2007 compensation income for those employees in the 2007 tax year. 

Appeals Court holds that ERISA preempts Maryland's effort to expand health coverage

In a ruling that could have a broad impact on states' efforts to expand health care coverage, the Fourth Circuit has struck down Maryland's "Fair Share" law.  In July we posted our summary of the Maryland Fair Share Act that required employers with more than 10,000 employees (i.e., Wal-Mart) to provide health benefits that cost at least 8% of payroll, or pay the difference to the state.  Wal-Mart challenged the statute, claiming ERISA preempted it.  The trial court agreed, finding that the statute mandated a Maryland-specific level of benefits that conflicted with the Wal-Mart benefit plan.  The court held that  ERISA prohibits states from enacting such statutes.  Otherwise, national employers like Wal-Mart would have to provide 50 or more different benefit plans to their employees, with the resulting costs and complexity.

Maryland appealed, and argued that the Act did not have an impermissible "connection with" ERISA plans because it did not directly impose any actual benefit or coverage requirements on an employer's health benefits plan. Rather, it gave employers two alternatives to increasing benefits to employees: (1) paying to the state the difference between actual health care expenses and 8%; or (2) increasing health care spending in ways that did not qualify as an ERISA plan.

Rejecting this argument, the Fourth Circuit held this week that the Act violated ERISA's preemption clause by effectively mandating the structure of health benefits to meet the Act's minimum spending threshold.  Also, the court stated, the Act would disrupt employers' administration of plans on a uniform, nationwide basis by requiring them "to segregate a separate pool of expenditures for Maryland employees."

The Fourth Circuit points out that other states and local governments have adopted or are considering similar laws, so the Maryland law would require Wal-Mart to tailor its health plans to each state--the very thing ERISA is designed to avoid.  In fact, last week California's Governor Schwarzenegger proposed a similar minimum benefit/tax program to provide universal health care in California. 

Although this decision renders Maryland's Fair Share Act unenforceable, similar laws already adopted or under consideration by other states or local governments may be sufficiently different to avoid ERISA preemption.  However, observers expect challenges to those laws, as well as greater Congressional interest in ERISA and its effects.

2007 Benefit Plan Limits

The Internal Revenue Code places limits on most employee benefit plans that restrict the amount of employer and employee plan contributions.  Many of these limits adjust each year based on inflation.  The IRS usually issues a press release in mid-October that announces the coming year's limits.  Some of the 2007 limits are:

• Elective deferral limit for 401(k), 403(b) and 457(b) plans:            $  15,500
• "Catch-up" (age 50+) deferrals (same for all plans above)               $   5,000
• Total Contributions (sum of employer and employee contributions) $  45,000
• Annual Compensation limit                                                           $225,000
• Highly Compensated Employee threshold                                       $100,000
• SIMPLE plan deferral limit                                                             $ 10,500
• SIMPLE plan "catch up" limit                                                          $  2,500
• High Deductible Health Plan minimum deductible (individual)          $  1,100
• High Deductible Health Plan minimum deductible (family)               $   2,200
• Maximum Health Savings Account contribution (individual)             $   2,850
• Maximum Health Savings Account contribution (family)                  $   5,650

Plan administrators should ensure that their participant communications and payroll processing reflect the updated amounts. 

IRS issues guidelines on Deferred Compensation Plans

On November 30, the IRS provided guidance on the reporting and withholding rules applicable to "deferred compensation plans" (DCPs) subject to tax code section 409A.  Pursuant to new IRS rules, a discounted stock option -- one with an exercise price less than the fair market value of the stock on the grant date -- is a "deferred compensation plan" and is subject to a 20% retroactive penalty tax and interest.  Employers sponsoring such a plan are now required to report as wages any income related to the DCP.  Even if the employee did not exercise the option, the IRS requires the employer to report income as if the option had been exercised on December 31.  Yes, employers are now required to report fictitious income based on transactions that did not occur.

The bad news gets worse.  The IRS treats similar arrangements as a single plan.  Thus, ALL options -- both discounted and not -- are treated as part of the same plan.  A discounted option now violates section 409A, and since each such option is considered part of the same plan as options that did not violate 409A, the income tax calculation includes ALL vested options, not just the discounted ones. 

Employers have generally responded by taking one of the following steps:

• Increasing the strike price to the fair market value on the grant date,
• Amending the option to set a fixed date on which the holder would exercise the option, and
  
• Canceling the old option and issuing a new, compliant option.

However, some of these steps may not work if discounted options were exercised during 2006.  Additional solutions and mitigation techniques may help avoid both a nasty shock to a valued employee and a burdensome reporting and withholding requirement on the employer.  Employers must immediately review their grant practices and evaluate whether they have awarded discounted options.  The IRS has given employers a December 31 deadline to address insider recipients subject to SEC rule 16(b).  For other employees, the IRS extended the deadline to December 31, 2007. 

Year-end benefit plan to-do list

Just as a car needs ongoing maintenance to run well or operate legally, employee benefit plans benefit from periodic check-ups.  With Congress making continuous changes to the income tax code and the IRS issuing a never-ending stream of interpretive guidance, most plans will require some amendments this year.  Some of the more common amendments and the deadlines are:

401(k) Plans -- All 401(k) plans and plans with after-tax employee or employer matching contributions must adopt a "good faith" amendment implementing the final 401(k) regulations by the end of the 2006 plan year (December 31 for calendar year plans).

Safe Harbor Notices -- The 401(k) regulations modified the required content of 401(k) safe harbor notices by adding additional requirements regarding vesting, distributions and contact information.  In addition, because the Pension Protection Act (PPA) shortened allowable vesting schedules for employer profit sharing contributions, the Notice will need to reflect the correct schedule.  Plans that adopted automatic enrollment provisions under the PPA must also include information about the deferral procedures.  Notices should be distributed to participants by December 1 for a calendar year plan.

ROTH Amendments -- If a plan permitted ROTH after-tax deferrals to a 401(k) plan during 2006, the plan sponsor must adopt a conforming plan amendment by the end of the 2006 plan year.

EGTRRA Restatements -- Individually designed plans (primarily ESOPs, stock bonus or cash balance plans) sponsored by an employer with an EIN ending in 1 or 6 must restate the plan document, and submit it to the IRS for a favorable determination letter if desired, by January 31, 2007.

Discounted Stock Options or Stock Appreciation Rights (SAR) -- New Tax Code section 409A imposes severe income tax penalties on recipients of some "discounted" options or SARs.  A discounted option or SAR is one with an exercise price lower than fair market value on the grant date.  The IRS is providing a transition period until December 31, 2006 to correct this situation.  Typical corrections include increasing in the exercise price, a cash-out of the grant (with a post-2006 payout), replacing the grant with a new grant or conforming the existing grant to the 409A requirements.  The decision may impact several other sensitive areas, such as SEC disclosures for public companies, triggering deduction limits or shareholder disclosure and consent.

Additional rules may apply to your particular type of plan or situation.  Consulting with your employee benefits expert should be part of your annual year-end cycle to ensure that the plans stay in compliance and that the plan sponsor and participants avoid any unnecessary taxation or penalties.

401(k) Plan Fee Lawsuits Begin

Plaintiff's attorneys have begun filing ERISA class action lawsuits against Fortune 500 companies in the midwest.  The plaintiffs are participants in their employers' 401(k) or profit sharing plans that allow participant-directed investing among a menu of investment options.  Defendants are the plan sponsors, their directors, and individuals (usually high-level employees) serving as plan administrator or on a plan administrative or investment committee.  Plaintiffs allege that the defendants breached their duties under ERISA by causing the plans to pay excessive fees or expenses, unnecessarily reducing the participants' account balances. 

Plan fiduciaries are personally liable to plan participants for any improper or excessive fees paid by the plan, so the stakes in large plans such as these can be millions of dollars.  And recent investigations by the U.S. Securities and Exchange Commission and other regulatory agencies suggest that service providers often do not adequately disclose fees.  Plan fiduciaries are often not aware of all the expenses paid by the plan and therefore fail to ensure that those fees are reasonable or proper.  The large number of providers (third party administrators, investment providers or consultants, recordkeepers, trustees or custodians, etc.) makes tracking plan expenses difficult.   

Plan fiduciaries must be extremely diligent in monitoring all plan activities, including who the plan is paying for services and how much those services cost.  Although the first wave of lawsuits involve midwestern companies, it is simply a matter of time before local employers are named in similar actions.  Already, a well-known Seattle law firm is investigating this issue and inviting plan participants to contact them.

Plan fiduciaries are subject to very high standards of care in how they perform their duties and face personal liability for failing to properly do so.  Being ignorant of what those duties are or how much a plan is paying for the services it receives ensures a very painful and expensive learning experience.

Pension Reform Finally Arrives

After months of political debate, last month the President signed the Pension Protection Act of 2006 (PPA).  It's 907 pages of new processes, new rules, and changes for employers to deal with; a copy of the PPA is available at http://www.aspa.org/government/gacpdf/HWC_373_xml.pdf.  Some of the more notable changes include:

• "Automatic Enrollment."  In most 401(k) plans, if the employee does not submit enrollment forms (and many do not) they do not participate.  To pass IRS required participation tests, employers wanted to create "opt-out" plans: unless the employee turn in a form saying they would not particate, they are in the plan.  The IRS approved such arrangements almost 10 years ago.  However, many states (including Oregon) have state wage laws that prohibit an employer from taking payroll deductions without written employee consent.  The PPA explicitly preempts such statutes, at least to the extent they would otherwise restrict automatic enrollment in a 401(k) plan.
• Investment Advice.  The PPA provides some additional ways for plans to provide investment advice to their participants without engaging in a prohibited transaction, or a violation of ERISA's strict fidcuairy rules.  The first is to utilize investment advisors that charge flat fees that do not vary based upon transactions.  The second is to use certain types of computer-modeling to develop a portfolio for a particular participant.
• Liberalized Plan Asset Rules.  ERISA has very draconian rules for anyone acting as a plan fiduciary.  A fiduciary includes anyone who has control of "plan assets."  If an entity has at least 25% of its equity controlled by IRAs or qualified plans, the entity's assets become plan assets.  The PPA carves out exceptions for certain types of plan sponsors (government, church or foreign plans) and reduces the likelihood that other types of plans still subject to the rules will become fiduciaries.

The PPA has literally dozens of other changes that affect nearly all types of retirement plans.  Most provisions are either effective immediately or for the 2007 plan year, so employers have very little time to get up to speed on the changes.

The Cost of Going Green

Several employers have recently begun offering various benefits to employees to offset the rising cost of gasoline.  http://www.shrm.org/hrnews_published/ARCHIVES/CMS_017366.asp.  Locally, one company's incentive costs the employer almost $5,000/year.   http://www.oregonlive.com/weblogs/atwork/index.ssf?/mtlogs/olive_atwork/archives/2006_07.html#166529.  Gas cards or subsidized automobiles are allowable employee benefits.  But employers considering such programs should consider the following.

First, these benefits, like any other, are taxable income to the employee and considered wages.  So that $100 gas card needs to be included on the employees W-2, and is subject to FICA and FUTA.  For large subsidies, such as the $400/month hybrid car payment, the employee will have to consider adjusting their income tax withholding amounts to ensure that the proper amount is withheld.  The employer will have to ensure that its payroll staff considers the subsidy when computing FICA, FUTA and other wage-based taxes.  The IRS recently issued a press release reminding employers of these issues.  http://www.irs.gov/newsroom/article/0,,id=160030,00.html

Second, programs requiring on-going benefit administration or claims processing are likely to be subject to ERISA, unless sponsored by a governmental or church entity.  That may trigger discrimination or eligibility rules, disclosure requirements such as Summary Plan Descriptions or fiduciary duties and compliance with the U.S. Dept. of Labor's claims processing regulations.

Finally, the employer should consider what strategic business objective any of its benefit programs advance, and whether the perceived value of the benefit to the employees will exceed its cost.  With the rising cost of gas for employees, perhaps these types of programs will become more common and valuable as a retention tool.

HP's victory on retirement benefit comes at a high price

A recent case reminds employers of the importance of complying with ERISA's claims procedures.  A case seeking $7,000 in benefits ended up costing HP a trip to the Ninth Circuit because of a poorly prepared claim denial letter. 

Kenneth Chuck resigned from Hewlett-Packard in 1980 and received a distribution of his retirement plan.  He objected that the amount was less than the plan owed him.  The plan disagreed in a series of letters exchanged with Chuck.  Over ten years later Chuck again exchanged several letters with the plan about the benefit, with the plan ultimately telling Chuck in 1992 that "[n]o further retirement benefits are payable from our U.S. plans."  Chuck continued a sporadic letter writing campaign until filing a lawsuit in 2003, over 23 years after last working for HP.  The trial court upheld HP's position and Chuck appealed.

The Ninth Circuit focused on HP's core argument: the statute of limitations barred Chuck's claim.  ERISA does not impose its own statute of limitations on claims for benefits, such as the one brought by Chuck, but looks to the most analogous state law statute.  The Ninth Circuit decided that is Oregon's six-year statute applied to breach of contract claims (ORS 12.080(1)).  Since Chuck received a distribution in early 1981 and brought his suit in 2003 HP thought it was pretty clear that the lawsuit was filed far too late.  But Chuck made an interesting argument: HP's denial of his claim failed to comply with the U.S. Dept. of Labor's (DOL) regulations that require the plan to provide specific information when it denies a participant's claim.  Chuck argued that if the plan failed to provide the correct information and explanations required by the DOL, the statute of limitations did not begin to run, so his claim was timely.

The Court agreed that if a plan provided a shorter limitation period, failure to substantially comply with the claims denial regulations would not trigger the plan's period for bringing suit.  However, as for the statutory limit, "a plan's violation of its notification and review obligations under ERISA is a highly significant factor, but not a dispositive one, in determining whether a claim has accrued for benefits under ERISA."

The court then considered whether Chuck "could have reasonably believed his benefits had not been finally denied, or whether instead he had reason to know of a clear and continuing repudiation of his claim."  The court held that although HP's explanation "came nowhere close to complying" with ERISA's requirements, the various explanations provided by HP were sufficient to cause Chuck to know that the plan would not pay him the benefit he sought by 1992 when it said no further benefits were payable.  As a result, the court upheld the summary judgment awarded HP.

Two lessons from the case: first, in Oregon ERISA retirement plan participants have six years to bring a claim under ERISA.  In California, it is four years.  The plan can shorten that period and make it uniform regardless of what states the plan covers by imposing its own, shorter period of time.  The only limitation that courts have placed on a shorter limitations period is the period must be "reasonable."  Courts have upheld periods as short as six months as "reasonable."

Second, plan administrators must know, understand and scrupulously comply with the DOL's ERISA claims regulations.  Although HP's response to Chuck was not compliant it was specific enough that this court found it triggered the running of the statute.  A different court might have concluded differently.  Rather than taking that risk, plans may decide to have plan counsel draft claims denials to ensure that the Notice is fully compliant with ERISA.  Although HP was ultimately successful in this case, its attorney's fees surely far exceeded the $7,000 in benefits that Chuck sought to obtain.  Chuck v. Hewlett-Packard Co., et.al.

Wal-Mart "Fair Share" Law Overturned

Wal-mart and its allies won a victory as a federal District Court overturned a Maryland statute that required employers with over 10,000 employees to spend at least 8% of in-state payroll on health care.  The court ruled that ERISA preempted the state statute, in accordance with ERISA's stated objective of permitting multi-state employers to provide nationwide benefits.  Otherwise, the court held, nationwide employers could possibly face 50 different state rules plus a nearly unlimited number of local benefit rules.  The decision is available here: http://www.retail-leaders.org/new/resources/RULING.pdf

Maryland's Attorney General intends to appeal the decision.  One argument against preemption likely to arise on appeal is that ERISA preempts laws requiring mandatory benefits but not taxes or other statutes of general application.  The statutory language appears to require the employer, not the employer's benefit plan, to comply.  ERISA preemption issues have made frequent appearances in federal Courts of Appeal and the Supreme Court.  This case is likely to provide additional guidance on the breadth of ERISA's preemptive reach. 

Approximately 30 states have enacted or are considering "Fair Share" statutes, including Oregon.  Generally, these statutes require large employers to provide health benefits that exceed a specified percentage of in-state payroll.&n