Participants Net $3 Million After Pension Calculation Deemed Wrong

US District Judge Leonard Davis of the US District Court for the Eastern District of Texas found reasonable PBGC’s conclusion that the employer should have used the 30-year Treasury security interest rate in effect during the month it paid out lump-sum distributions in Pension Benefit Guaranty Corporation v Wilson N Jones Memorial Hospital. Davis rejected the employer’s argument that under Treasury regulations, the applicable interest rate was the rate in effect when the plan was officially terminated, not when the benefits were paid, according to Washington-based legal publisher BNA.

Further rejected was the employer’s contention that the agency could not challenge the employer’s selected interest rate because the Internal Revenue Service (IRS) had approved two amendments that permitted that interest rate and that only the IRS and not the PBGC, could enforce sections of the tax code dealing with interest rates on lump-sum distributions.   “Put simply, a favorable IRS letter is not conclusive of compliance with Title IV” of ERISA, which the PBGC is intended to enforce, Davis said in the ruling.

Selecting a Rate

Wilson N Jones Memorial Hospital sought to terminate its pension plan in 1995. Prior to the termination process, all benefits payable under the plan were annuitized unless a participant’s benefits were valued at less than $3,500, in which case a participant would receive a lump-sum distribution. Under this version of the plan, lump sums were calculated under a formula that used an “annuity starting date,” defined in the plan as having the “meaning assigned in Section 417(f)” of the tax code. Section 417(f) provides that an annuity starting date means “the first day on which all events have occurred which entitle the participant to such benefits.”

In June of that year, the hospital executed an amendment providing that lump-sum distributions would be calculated using an annual interest rate on 30-year Treasury securities “for the second calendar month immediately preceding the first day of the” plan year during which the annuity starting date occurs. The amendment also provided that all participants would receive a lump-sum distribution upon termination of the plan.

The hospital issued a notice of intent to terminate the plan in October 1995. In January 1996, the hospital executed an additional amendment, which defined “annuity starting date” as “the plan termination date for purposes of determining the lump sum amount.”

PBGC Audit

In November 1996, 800 plan participants received lump-sum distributions with an interest rate of 8.08%. The interest rate was calculated and the annuity was started by the hospital using the termination date, December 31, 1995.

The PBGC conducted an audit of the terminated plan in 1998 and determined that the hospital should have used an interest rate of 6.26%. The PBGC reached this calculation by finding that the hospital should have used the 30-year Treasury securities rate in effect in November 1995, which was the second calendar month preceding the date on which the hospital issued the lump sum distributions. PBGC determined that as a result of using the 8.08% interest rate, the 800 plan participants were underpaid in an amount exceeding $3 million. When the hospital refused to pay the participants the additional $3 million, PBGC sued the hospital.

PBGC Has Authority

Granting summary judgment for the PBGC, the court rejected the hospital’s initial contention that PBGC could not challenge the hospital’s interest rate calculations because the IRS had approved the amendments that permitted the use of such interest rates.   The court also rejected the hospital’s assertion that PBGC could not enforce Section 417 of the tax code because only the IRS has such authority. “Title IV provides for PBGC audits of terminating plans to determine whether participants have received their benefit commitments. It would seem beyond dispute that the interpretation of section 417(e) and 417(f) concerns whether ‘participants and beneficiaries have received their benefit commitments,'” the court said in the judgment.

Thus, the court upheld the agency’s findings that the hospital should have used a 6.26% interest rate rather than the 8.08% rate. Turning to Internal Revenue Code Section 417(f), the court found for purposes of valuing a lump-sum payment, the term “annuity starting date” is defined as “the first day on which all events have occurred which entitle the participant to such benefit.”   Therefore, the court agreed with the PBGC’s interpretation of Section 417(f) as meaning that the annuity starting date for lump-sum distribution purposes is the date the lump-sum actually is distributed.

Also rejected by the court was the hospital’s argument that Treasury Regulation Section 1.401(a) supported the hospital’s determination that it could use the interest rate in effect at the time the plan was actually terminated, rather than the rate in effect at the time distributions were made. Treasury Regulation Section 1.401(a) “deals with annuity payments in the sense of a sum payable at regular intervals,” not lump-sum distributions, the court said.

“Applying appropriate deference to PBGC’s views, the Court concludes that PBGC’s determination of the annuity starting date was, at least, a reasonable construction of the statutes and regulations at issue,” the court said.

The case is Pension Benefit Guaranty Corporation v. Wilson N. Jones Memorial Hospital, E.D. Texas, No. 4:01-CV-94.