Berger v. Xerox Retirement Income Guarantee Plan

• Decision Date: 01 August 2003
• Docket Number: No. 02-3674.,02-3674.
• Citation: 338 F.3d 755
• Parties: David BERGER and Gerry Tsupros, on behalf of themselves and others similarly situated, Plaintiffs-Appellees, v. XEROX CORPORATION RETIREMENT INCOME GUARANTEE PLAN, Defendant-Appellant.
• Court: U.S. Court of Appeals — Seventh Circuit

338 F.3d 755

David BERGER and Gerry Tsupros, on behalf of themselves and others similarly situated, Plaintiffs-Appellees, v. XEROX CORPORATION RETIREMENT INCOME GUARANTEE PLAN, Defendant-Appellant.

No. 02-3674.

United States Court of Appeals, Seventh Circuit.

Argued April 9, 2003.

Decided August 1, 2003.

Rehearing and Rehearing En Banc Denied September 15, 2003.

COPYRIGHT MATERIAL OMITTED

Lee A. Freeman, Jr. (argued), Freeman, Freeman & Salzman, Chicago, IL, for Plaintiff-Appellee.

Richard J. Pautler (argued), Thompson Coburn, St. Louis, MO, for Defendant-Appellant.

Before FLAUM, Chief Judge, and POSNER and KANNE, Circuit Judges.

POSNER, Circuit Judge.

The defendant, an ERISA pension plan, appeals from a judgment of some $300 million in a class action on behalf of plan participants. The plan (in the sense of the pension contract, as distinct from the entity that provides the pensions required by the contract — we use the word in both senses and trust to context to disambiguate) is what is called a "cash balance" plan. It is a defined benefit plan rather than a defined contribution plan, but resembles the latter. The ordinary defined benefit plan entitles the employee to a pension equal to a specified percentage of his salary in the final year or years of his employment. The plan might provide for example that he was entitled to receive 1.5 percent of his final year's salary multiplied by the number of years that he had been employed by the company, so that if he had been employed for 30 years his annual pension would be 45 percent of his final salary. A cash balance plan, in contrast, entitles the employee to a pension equal to (1) a percentage of his salary every year that he is employed (5 percent, in the case of the Xerox plan) plus (2) annual interest on the "balance" created by each yearly "contribution" of a percentage of the salary to the employee's "account," at a specified interest rate that in the Xerox plan is the average one-year Treasury bill rate for the prior year plus 1 percent. These annual increments of interest are called future interest credits.

The reason for the scare quotes in our description of the cash balance plan is that the employee has no actual account, the employer makes no contributions to an employee account, and so there is no account balance to which interest might be added. In a defined contribution plan, the employee's pension entitlement is to the value of his retirement account to which contributions (whether from the employer, the employee, or both) have been made, while in a defined benefit plan, as our numerical example illustrated, the entitlement is to the pension benefit that the plan promises. The cash balance form of defined benefit plan resembles a defined contribution plan because it provides the employee with a hypothetical account balance. He can compare that with the actual balance of a defined contribution plan if, as is commonly and in this case true, the employee is enrolled in both types of plan and when he retires will get to choose between the two pension entitlements (this is what is known as a floor-offset arrangement). At age 60 a Xerox employee might have $100,000 in his defined contribution account and $120,000 in his cash balance (hypothetical) account, and he would know that the former would be growing by the amount of the employer's annual contribution plus the investment performance of the account while the latter was growing by the specified percentage of his salary plus the one-year T-bill rate plus 1 percent. If he retired at the normal retirement age of 65, he would choose between the two plans on the basis of which had a larger expected value.

If an employee has worked for his employer for at least five years, his defined benefit pension benefits will have vested by operation of law. That is, they will have become an entitlement, specifically an entitlement to the "normal retirement benefit," 29 U.S.C. § 1053(a), defined, so far as applicable to this case, as "the benefit under the plan commencing at normal retirement age," id. § 1002(22), which is 65. If the employee leaves the company before he reaches the normal retirement age, his "normal retirement benefit," which is to say his pension entitlement, is the benefit that he has "accrued" to the date of his leaving. Id. § 1002(23)(A). In the case of a defined contribution plan (the benefits of which, incidentally, vest immediately), that benefit is simply the amount in his retirement account when he leaves the company's employment. Id. § 1002(23)(B). In the case of a standard defined benefit plan, the kind that entitles the retiree to a pension equal to a percentage of his salary based on his years of service, the entitlement is to a pension beginning at age 65, the amount depending on his years of service and his salary. But what about a cash balance plan? Xerox's cash balance plan entitles the departing employee not to the balance in his (hypothetical) account, but to the balance when he receives the "distribution" of his pension benefit. If he defers the distribution until reaching the normal retirement age of 65, the cash balance will grow between when he leaves Xerox's employment and when he turns 65 by the one-year T-bill rate plus 1 percent.

The plaintiff class, consisting of those employees of Xerox enrolled in the cash balance plan who left Xerox's employ between 1990 and 2000 and elected to take a lump sum when they left in lieu of a pension commencing when they reached 65, contends that the amount of the cash balance at age 65 (more precisely, the estimated amount, since the T-bill rate will vary over the period between the employee's leaving Xerox's employment and his turning 65) is the employee's accrued cash balance benefit and thus the basis for calculating the size of the lump-sum entitlement. Xerox acknowledges that employees who defer taking their pension benefits until they reach the age of 65 are entitled to an annuity, commencing then, or a lump sum then, either one reflecting the future interest credits. However, it is employees who leave Xerox before reaching age 65 but rather than waiting till they reach that age to receive their pension benefits ask for a lump sum now who compose the plaintiff class; and while Xerox gave them all a lump sum, they contend that the amount they received was not the actuarial equivalent of what they would have received either as an annuity or a lump sum had they waited until age 65. ERISA requires that any lump-sum substitute for an accrued pension benefit be the actuarial equivalent of that benefit. 29 U.S.C. § 1054(c)(3); May Dept. Stores Co. v. Federal Ins. Co., 305 F.3d 597, 600 (7th Cir.2002); Esden v. Bank of Boston, 229 F.3d 154, 164, 173 (2d Cir.2000).

The basic tradeoff involved in determining actuarial equivalence between a lump sum and an accrued pension benefit is between a present and a future value, and the method of equating them is the application of a discount rate to the future value. There is no single actuarial equivalence, because there is no single discount rate. A discount rate is simply an interest rate used to shrink a future value to its present equivalent, as distinct from swelling a present value to its future equivalent. If you have a right to receive $100 a year for 10 years beginning 15 years from now, and your discount rate is 10 percent (that is, you value receiving $90 today the same as receiving $100 a year from now), the present value of that right is the sum of $100 discounted at 10 percent 15 times, $100 discounted 16 times, and so forth to $100 discounted 25 times. Discounting produces dramatic differences between present and future values. For example, at a 10 percent discount rate the present value of $100 a year in perpetuity is only $1000, and even at a discount rate of only 5 percent that present value is only $2000. But at a zero discount rate, the present value of $100 a year in perpetuity would be infinite.

In the case of a standard defined benefit plan, the present value of the pension benefit is easily determined. The accrued benefit is determined by years of service and final salary when the employee leaves his employment — these are known quantities — and the application to the benefit of a discount rate generates the present value. Moreover — and critically as we are about to see — the discount rate is determined by the Pension Benefit Guaranty Corporation. Specifically, for pension plans of the vintage of the Xerox plan at issue in this case, the discount rate is the "rate which would be used (as of the date of distribution) by the Pension Benefit Guaranty Corporation for purposes of determining the present value of a lump sum distribution on plan termination." 29 U.S.C. § 1053(e)(2)(B) (1993); see also 26 U.S.C. § 417(e)(3)(B) (1993). That rate purportedly is derived from data on market interest rates. See 58 Fed.Reg. 5128-01, 5130 (Jan. 19, 1993), 40844-03, 40845 (July 30, 1993). For new pension plans, the 30-year T-bill rate is to be used as the discount rate. 26 U.S.C. § 417(e)(3); 29 U.S.C. § 1053(e)(2).

Because salary is not added to the employee's cash balance "account" after he leaves Xerox's employ, the key question, so far as the adequacy of the lump sum that he receives if he elects a lump-sum payout is concerned, is whether future interest credits are part of his accrued benefit. If they are, then in determining his pension entitlement (a future value, obviously, since we are dealing with employees who leave Xerox before reaching retirement age) the plan must add the credits to the employee's cash balance account. The resulting balance, discounted at the prescribed discount rate back to the date on which the employee left Xerox's employ, would then be the lump sum to which ERISA entitled the employee. The Xerox plan computed the lump sum differently. Instead of adding future interest credits to the departing employee's cash balance at the plan's...