Peoria Union Stock Yards Co. Retirement Plan v. Penn Mut. Life Ins. Co.

Decision Date04 April 1983
Docket NumberNo. 82-1720,82-1720
Citation698 F.2d 320
PartiesFed. Sec. L. Rep. P 99,059, Fed. Sec. L. Rep. P 99,162, 3 Employee Benefits Ca 2590, 4 Employee Benefits Ca 1566 The PEORIA UNION STOCK YARDS COMPANY RETIREMENT PLAN, et al., Plaintiffs- Appellants, v. The PENN MUTUAL LIFE INSURANCE COMPANY, Defendant-Appellee.
CourtU.S. Court of Appeals — Seventh Circuit

Edward F. Sutkowski, Sutkowski & Washkuhn Assoc., Peoria, Ill., for plaintiffs-appellants.

Roger E. Holzgrafe, Westervelt, Johnson, Nicoll & Keller, Peoria, Ill., Lawrence J. Latto, Benjamin W. Boley, Shea & Gardner, Washington, D.C., for defendant-appellee.

Before PELL and POSNER, Circuit Judges, and BONSAL, Senior District Judge. *

POSNER, Circuit Judge.

This appeal brings up to us a variety of questions relating to the regulation of pension plans--in particular whether an insurance company that sells a "group deposit administration annuity contract" to pension trustees is subject to the anti-fraud provisions of the federal securities laws and to the fiduciary obligations imposed by ERISA, the federal law regulating pensions.

The plaintiffs are the pension plan set up by the Peoria Union Stock Yards Company for its salaried employees; the trustees of the plan's assets; and beneficiaries of the plan. The plan is a "defined-benefit" plan; that is, it specifies the benefits that the beneficiary is to receive during retirement. See 1 CCH Pension Plan Guide p 2423 (1981). When he retires the plan buys him an annuity that pays him the specified benefits annually for the rest of his life. And the plan is "funded," meaning that the employer must make annual contributions at a level that, combined with the income from investing the contributions, is reasonably calculated to cover the entire cost of the annuities that the plan must purchase for its beneficiaries as they retire. If there is not enough money in the plan when the time comes to buy an annuity for a retiring employee, the employer must make an additional contribution since his obligations to the employees covered by the plan are unconditional.

The creation and administration of such a plan require both actuarial and investment skills. Actuarial computations enter into determining the cost of an annuity that will provide the specified benefits to the retiring employee (because the cost is a function in part of the employee's life expectancy) and the level of contributions that the company must make to fund the plan (the level depends in part on how many of the company's employees live to retirement). Investment skills are needed in the accumulation period, when the contributions made by the company are earning interest toward the day they will be used to purchase annuities, and also affect the annuity's cost, which is a function not only of the annuitant's life expectancy but also of the investment income that the money used to buy the annuity will earn while he is drawing benefits.

Actuarial computations and investment management are the life blood of life insurance companies, so it is no surprise that such companies offer to lift from employers' shoulders the burdens of designing and administering suitable plans. The defendant in this case, Penn Mutual Life Insurance Company, offered to do just that for the Peoria Union Stock Yards Company in 1970 when the company was thinking of setting up a defined-benefit plan. The company took up the offer, which was for a "group deposit administration annuity contract." Under this type of contract, described in McGill, Fundamentals of Private Pensions, ch. 13 (4th ed. 1979), the insurance company determines what the employer must contribute annually to fund the plan; the contributions are deposited with the insurance company, which invests them as a single account rather than setting up a separate account for each employee; and the funds in the account are commingled for investment purposes with the funds of other customers of the insurance company, in much the same way as investments of different investors are pooled in a mutual fund or common trust fund, in order to obtain diversification while minimizing brokerage and management costs. When an employee retires, the insurance company informs the employer how much the employee's retirement annuity will cost. The employer can purchase the annuity from the insurance company with a portion of the funds on deposit or it can withdraw funds and purchase the annuity from another insurance company.

The contract was signed and took effect in 1971. This suit, a suit for damages, was brought in 1980. The complaint alleged that the contract between Penn Mutual and the pension trustees was a security within the meaning of the federal securities laws, that Penn Mutual was a fiduciary under ERISA, and that it had fraudulently marketed and administered the contract in violation of federal and Illinois securities laws, ERISA, and the common law of Illinois, and on top of all this had broken the contract. The district court dismissed the complaint for failure to state a claim, 518 F.Supp. 1302 (C.D.Ill.1981), the plaintiffs filed an amended complaint which the district court again dismissed for failure to state a claim, and this appeal followed.

According to the amended complaint, Penn Mutual actively promoted the group deposit administration annuity concept to the trustees after having designed a defined-benefit plan for them. The contract provided for the employer's contributions to be paid into a deposit account at Penn Mutual. Penn Mutual would guarantee interest on contributions made during the first three years of the contract at a rate declining from 7 1/2 percent to 3 1/2 percent over the period these contributions were on deposit. Interest on contributions made after the first three years was to be credited to the deposit account "at such rates as shall be determined by Penn Mutual," but it was also provided that "this contract shall participate in divisible surplus while it is in force. Dividends of such surplus, if any, to be apportioned to this contract shall be determined annually by the Board of Trustees of Penn Mutual ...." The plaintiffs, not implausibly, interpret this to mean that to the extent money in the deposit account earned interest above the interest guarantee, which was zero on contributions made after the third year of the contract, the interest must be credited to the deposit account--Penn Mutual could not pocket it. Penn Mutual's counsel so conceded at oral argument.

The contract also specified a modest expense charge if the annual contribution fell below a certain level, a modest surrender charge if the contract was terminated, unless the deposit account was used to buy annuities from Penn Mutual, and one other small charge--all to be deducted from the deposit account. If the pension plan's trustees terminated the contract, as they were allowed to do upon notice, Penn Mutual was to pay over to them "the net value" of the deposit account, but it could spread payment over a period of five years. During this time it had to credit interest to the deposit account at an annual rate of 3 percent.

Between 1972 and 1980 Penn Mutual provided the trustees with an annual "deposit funds summary," showing the plan's contributions, interest credited, money withdrawn to buy annuities, expense charges, and the ending balance in the deposit account. The summaries showed interest being credited at annual rates of between 6.4 and 7.3 percent, and trivial expense charges, dropping from $423 in 1972 to $67 in 1976 and zero thereafter. Only two employees covered by the plan retired during this period and the withdrawals required to buy annuities for them were small--$38,000 and $43,000, compared to annual contributions to the plan that rose from $33,000 in 1972 to $85,000 in 1980.

Then in May 1980 one of Peoria Union Stock Yards' senior executives reached retirement age. Penn Mutual told the trustees it would charge them $432,000 for the annuity required to provide this employee with the benefits to which he was entitled under the plan. The trustees decided to shop around. They found they could buy the same annuity from another insurance company for only $310,000. (At oral argument Penn Mutual's counsel said it was not the same annuity, but we are just stating the facts as alleged in the complaint.) They began asking questions and discovered that Penn Mutual compiled, but did not disclose, annual "internal account summaries" of the deposit account. These summaries showed the same annual contributions by the pension plan as the accounts sent to the trustees, but everything else was different. The interest credits were higher, ranging from 6.3 to 8.1 percent, and so were the expenses charged against the deposit account. The expenses were in three categories-- "valuation fee," "commissions," and "general administration and payment charges"--and they grew over time rather than declining as did the expenses shown in the deposit fund summaries; in 1979 they came to almost $6,700. But because the extra interest credited in the internal account summaries exceeded the extra expenses debited in them, the ending balances were higher in the internal account summaries than in the deposit fund summaries. Penn Mutual explained that a group deposit administration annuity contract is (though not so described in the contract itself) a "rear-end load contract in which contractholder does not see actual expenses.... Only the guaranteed rates of interest are credited even if 'new money' rates are higher. Usually it takes several years for contract to be in a dividend position."

When the trustees discovered all this, they exercised their right of termination. Penn Mutual told them they were entitled to receive $756,000, which was the ending balance in the latest fund summary, but that if they wanted immediate payment rather than payment over five...

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