White v. Sundstrand Corp., s. 00-2613

• Decision Date: 03 July 2001
• Docket Number: 00-4075,Nos. 00-2613,s. 00-2613
• Parties: (7th Cir. 2001) William R. White, et al., on behalf of themselves and a class of others similarly situated, Plaintiffs-Appellants, v. Sundstrand Corporation, et al., Defendants-Appellees. & 01-1126
• Court: U.S. Court of Appeals — Seventh Circuit

Page 580

256 F.3d 580 (7th Cir. 2001)

William R. White, et al., on behalf of themselves and a class of others similarly situated, Plaintiffs-Appellants, v. Sundstrand Corporation, et al., Defendants-Appellees.

Nos. 00-2613, 00-4075 & 01-1126

In the United States Court of Appeals For the Seventh Circuit

Argued May 18, 2001

Decided July 3, 2001

Appeals from the United States District Court for the Northern District of Illinois, Western Division. No. 98 C 50070--Philip G. Reinhard, Judge.

Before Easterbrook, Manion, and Evans, Circuit Judges.

Easterbrook, Circuit Judge.

Until it became a subsidiary of Sundstrand in 1984, Sullair Corporation had a floor- offset pension plan. Distinctive features of that plan still apply to persons who worked at Sullair before the acquisition. A floor-offset plan uses a defined- benefit structure (with pension payments linked to years of work and high salary) to buffer the uncertainty of a defined- contribution system (where pension payments depend on the performance of investments in each employee's account). See Brengettsy v. LTV Steel (Republic) Hourly Pension Plan, 241 F.3d 609 (7th Cir. 2001); Regina T. Jefferson, Rethinking the Risk of Defined Contribution Plans, 4 Fla. Tax Rev. 607, 668-71 (2000). Sullair's pre-acquisition defined-contribution plan was an Employee Stock Ownership Plan. Employees were entitled to buy Sullair stock, which the esop would hold for their account. An esop is a high-risk investment: employees' retirement wealth is undiversified, so if something happens to the firm a retiree can end up with little beyond Social Security benefits, while if the firm prospers he may live in the lap of luxury. A defined-benefit component ensures that retirees have some supplement to Social Security even if the employer (or the stock market) goes south. The principal question in this class action is how the plans interact when an employee quits Sullair after pension benefits have vested, but before retirement age.

Sullair's floor-offset plan gives retirees the greater of the defined- benefit amount and the value of an annuity that could be purchased with the stock held for the retiree's benefit by the esop. If the annuity that could be purchased with the esop stock is less than the defined-benefit amount, then the defined-benefit plan pays the difference, topping up the employee's pension. Two aspects of this arrangement give rise to the question at hand. First, the employee does not surrender the esop units in order to receive a supplemental payment from the defined-benefit plan; the employee is free to cash out the esop and buy an annuity but also is free to keep the stock and continue to bear the risk. Second, and essential in light of the first, the coordination between plans is done with a hypothetical annuity, which presents the question how the monthly annuity benefit will be calculated.

An example shows how the floor-offset arrangement works. Suppose that a given employee who retires at age 65 would be entitled to a $2,000 monthly pension from the defined-benefit plan. This serves as the floor. If this employee has a $100,000 balance in the esop, the plan administrator determines how large an annuity the $100,000 could purchase. That would be about $900 per month (assuming 7% annual interest and a 15-year life expectancy). Sundstrand then would offset the $900 hypothetical annuity and pay the retiree $1,100 per month; the esop balance is the retiree's to annuitize, hold, or invest as he pleases. If, however, the employee has a $300,000 esop balance on retirement, an amount that could purchase an annuity of about $2,700 monthly, then the payment from the defined-benefit plan would be zero. Again the retiree retains the ability to draw down or invest the esop balance. Everything works smoothly when the employee starts receiving pension benefits immediately on leaving Sullair.

What happens when there is a gap between leaving Sullair and retiring? The plan's administrative committee calculates the monthly defined-benefit amount based on the employee's length of service and terminal salary. That much is uncontroversial. What about the defined- contribution offset? The plan takes the value of the employee's esop account on the day he left Sullair's employ and places that amount in a hypothetical savings account, at the same interest rate used in the annuity calculations, until the day the employee becomes eligible for retirement; at that point the balance is annuitized, and the resulting monthly benefit subtracted from the defined-benefit amount. So if an employee quits at age 45, with $100,000 in the esop account, and plans to retire at age 65, the plan assumes that this balance will compound for 20 years at the going rate (7% in our example), producing a kitty of almost $390,000 by retirement. This sum, when annuitized, is about $3,500 per month, so the monthly defined- benefit is zero (but, as always, the employee can do what he pleases with the esop balance from age 45 onward). This process is equivalent to asking what monthly annuity an employee could buy with $100,000 today, when payments on the annuity would be deferred for 20 years. The parties call this approach the "deferred rate" calculation. The other approach, which the plaintiffs favor and call the "immediate rate" calculation, asks how large an annuity a 45-year-old could buy with $100,000 for immediate commencement. That would be about $640 monthly--less than the $900 calculated in our first example because payments would be expected to last 35 years instead of 15. Under the immediate-rate calculation, then, the retiree's benefit from the pension plan would be $1,360 monthly, starting at age 65. Meanwhile the esop balance is likely to grow to $390,000 by age 65, so this person's total monthly benefit will be about $4,900 (the $1,360 from the plan, plus the $3,500 monthly that could be obtained by using the esop balance at age 65 to purchase an annuity). The difference between deferred and immediate calculation can be substantial (though there will be no difference if even the immediate-rate calculation exceeds the monthly pension generated by the defined-benefit component). The functional question is: Who gets the benefit of interest between quitting and retirement age, the employee or the plan?

Any pension plan giving retirees the greater of two amounts, as opposed to the sum of these amounts, can be described as confiscating the difference. That's the nature of a floor-offset plan: the retiree always "loses" the defined- contribution balance (principal and interest) up to the floor in the defined- benefit plan. What the employee loses, the plan receives. Using the esop to fund part of the defined-benefit promise makes any given level of promised benefits cheaper to the employer and so may increase the fallback pension. But under erisa that is neither here nor there. The Employee Retirement Income Security Act does not require employers to establish plans that are particularly favorable to employees. There is no fiduciary duty to employees when establishing plans' provisions. See Hughes Aircraft Co. v. Jacobson, 525 U.S. 432 (1999); Lockheed Corp. v. Spink, 517 U.S. 882 (1996). The employer's fiduciary duty, as plan administrator, is to implement faithfully the provisions of the plan as written. Thus we arrive at the critical language of the Sullair plan (we quote the 1981 version, which has not been altered substantively):

The amount of monthly pension which could be provided on a straight life annuity basis by application of an amount equal to the fair market value as of such specified date of the Participant's vested interest in the balance credited to his account under the Sullair Corporation Employee Stock Ownership Plan, and, for this purpose, such amount of monthly pension shall be determined on the basis of the annuity purchase rates in effect as of such specified date under and as set forth in the Group Contract.

So the hypothetical calculation uses the "annuity purchase rates"--whatever they are. In 1981 and for many subsequent years they were set by Bankers Life (now Principal Mutual Life Insurance Co.), which underwrote the plan with a group annuity contract. The first time the issue came up, Bankers Life used an immediate-rate approach, but it reversed itself before any benefits were paid and told the Plan Benefit Committee in May 1985 that a deferred-rate approach should be used. The Committee agreed, and a deferred-rate approach has been in force ever since.

Plaintiffs observe that immediate-rate calculations are used for persons still on Sullair's payroll at retirement, and they demand the same for themselves. Moreover, when the plan uses a deferred- rate calculation for persons who leave Sullair before retirement age, the floor- offset system loses some or all of its risk-buffering function. The deferred- rate calculation assumes that the balance in the esop will grow at some steady rate to retirement age. If it grows less (or even shrinks), the employee bears the whole loss, without any assistance from the defined-benefit component, although an employee who works at Sullair through retirement receives the assurance that if the esop's value collapses at the last moment, the defined-benefit floor still is there. (A person who leaves Sullair before retirement does have the option, however, of rolling the esop balance over into a more diversified fund, thus protecting against firm-specific risks.)

If immediate-rate calculations are used, however, then employees who...