United States: District Court Rejects ERISA Challenge Of Annuitizing $7.4 Billion Of Pension Liabilities, Supporting "De-Risking" Strategy

Last Updated: May 19 2014
Article by Maria P. Rasmussen and James P. McElligott, Jr

Last month, the U.S. District Court for the Northern District of Texas dismissed, for the third time, a class action against Verizon Communications Inc., challenging its decision to transfer approximately $7.4 billion of pension liabilities to The Prudential Insurance Company of America through the purchase of a group annuity contract, thereby guaranteeing the benefits of some 41,000 Verizon retirees. Lee v. Verizon Communs., Inc., No. 3:12-CV-4834-D, 2014 U.S. Dist. LEXIS 50083 (N.D. Tex. Apr. 11, 2014) (Lee III). Of particular significance is the court's dismissal of plaintiffs' second amended complaint "with prejudice," meaning that it would not accept any further amendments to the complaint, and that it completely rejected plaintiffs' ERISA fiduciary claims.

Facts and History

In Lee v. Verizon Communs., Inc., No. 3:12-CV-4834-D, 2012 U.S. Dist. LEXIS 173559 (N.D. Tex. Dec. 7, 2012), plaintiffs sought declaratory and injunctive relief against the Verizon pension plan's purchase of a group annuity contract guaranteeing the benefits of nearly 41,000 Verizon retirees. Plaintiffs alleged various ERISA claims. Their motion for the restraining order was denied, as the district court found that plaintiffs' claims were unlikely to succeed on the merits.

Less than seven months later, in Lee v. Verizon Communs., Inc., 954 F. Supp.2d. 486 (2013) (Lee II), the district court again ruled that plaintiffs had not stated any ERISA cause of action and dismissed their claims. This time, the court also rejected a new set of claims made by a different set of approximately 50,000 retirees, who remained Verizon pension plan participants and whose benefits were not transferred via the annuity contract to Prudential. This set of retirees claimed that Verizon breached its fiduciary duties by depleting the plan's assets by expending too much (including the premium payment to Prudential) to effect the transaction.

In Lee II, the district court ruled that:

  • Verizon was not required to disclose the "possibility" of an annuity transaction in a summary plan description;
  • Verizon's decision to purchase an annuity was not a fiduciary function, and it did not breach its fiduciary duties by purchasing the annuity;
  • Verizon's payment of approximately $1 billion to cover expenses (commissions and professional fees to third parties) was not necessarily unreasonable, and plaintiffs' conclusory assertion that Verizon violated ERISA's exclusive benefit rule failed to state a plausible claim; and
  • Verizon did not discriminate against plaintiffs by removing some retirees from the plan, while allowing others to remain.

Although the court granted Verizon's motion to dismiss, it offered the two classes of plaintiffs yet another opportunity to amend their complaint.

In Lee III, after considering plaintiffs' second amended complaint, the district court still found plaintiffs' claims deficient and rejected them in their entirety, dismissing the lawsuit with prejudice. The court ruled that there was no failure to disclose, no breach of fiduciary duty and no violation of the exclusive benefit rule. The court referred to the U.S. Supreme Court's pleading standard in Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009), i.e., "[t]hreadbare recitals of the elements of a cause of action, supported by mere conclusory statements, do not suffice."

Importance of Lee III

At the heart of Lee III is the plaintiffs' failure to distinguish between business decisions that are settlor functions and those that are fiduciary functions/duties. The court emphasizes that ERISA permits an employer to make business decisions, in its "settlor capacity." Hence, the decision to pursue a particular de-risking settlement strategy, including the right to transfer assets and liabilities to an insurance company, is one that ERISA empowers a plan sponsor to make. The court stated:

[P]laintiffs fundamentally disagree with the premise that an ERISA pension plan can, as here purchase an annuity to fund plan benefits and remove only some plan members, thereby eliminating the protections of ERISA and the PBGC [Pension Benefit Guaranty Corporation] for the removed members. * * * But at bottom, plaintiffs are disagreeing with the right of a settlor under ERISA, and such a disagreement must be addressed to Congress through requests for legislative changes to ERISA, not through litigation that complains of the decisions that ERISA empowers a plan sponsor as settlor to make.

Id. at *26-27. By contrast, the implementation of a de-risking strategy such as an annuitization is a fiduciary act under ERISA. Interpretive Bulletin 95-1 of the Department of Labor (DOL), 29 C.F.R. Sec. 2509.95-1, provides guidance as to the fiduciary standards under ERISA when selecting an annuity provider for a defined benefit pension plan.

What Comes Next?

Plaintiffs have appealed Lee III to the U.S. Court of Appeals for the Fifth Circuit. The likelihood of their success is questionable, given their failure to allege facts supporting their claims of breach of fiduciary duty.

Will Congress act to impose a moratorium on pension risking approaches? So far, there does not appear to be any appetite for legislation, perhaps due to the complexity and time necessary to study the area; it is more likely that we will hear from the PBGC, the DOL and the Internal Revenue Service (IRS) on the subject, as noted below.

The PBGC, understandably, has voiced concerns about the negative financial implications. The transition from defined benefit pension plans to 401(k) plans already has reduced the number of participants in pension plans steadily over the years. Further reductions on account of annuitization could precipitate another hike in PBGC termination insurance premiums as the premium base shrinks further; rates are already scheduled to increase by 40 percent this year, compared to 2012. Although annuitization of pension benefits reduces the PBGC's liability to guarantee those benefits, it is often the case that plans undertaking annuitizations are financially healthy and therefore did not pose a significant risk to PBGC in the first place.

The DOL and the IRS also may enter the fray to provide much needed guidance on the mechanics of implementing "de-risking" strategies.

  • The 2013 ERISA Advisory Council recommended to the DOL that Interpretive Bulletin 95-1 be updated.
  • It was reported last month that the IRS again would begin issuing private letter rulings as to various tax qualification issues facing plan sponsors who seek to offer lump-sum payments to retirees receiving monthly pensions. It had been earlier reported this year that despite issuing two such rulings, the IRS and the Treasury Department were continuing to debate the permissibility of offering such lump-sum payments and that the IRS was putting a "hold" on ruling requests since the first two rulings were issued.


Other pension de-risking strategies include plan freezes and asset reallocations. However, the conversion of retiree pensions to group annuities represents the biggest pension de-risking opportunity for employers, as evidenced by the Verizon annuitization as well as by a similar program implemented by General Motors Co. (purchase of annuities, also from Prudential, for some 110,000 retirees, for a payment of approximately $25 billion), and is sometimes referred to as the "ultimate transfer of risk." Even better than lump-sum payments (which, except for small amounts, require participants' consent), this approach reduces employer exposure to the following risks:

  • Adverse investment that may shrink plan assets;
  • Continued low interest rates that may balloon the value of future benefit obligations;
  • Ever-increasing lifespans (coupled with new but not-yet-effective mortality tables) that will increase the ultimate cost of participants' benefits; and
  • The removal of significant liability from the plan sponsor's balance sheet and relief from ongoing liability for participants' benefits.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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