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>Declaration of Claude Poulin, FSA, Expert Witness

Home page ERISA Pension Claims: Class Action Suits
Plaintiff's Complaint

U.S. District Court
District of New Jersey (Newark)
CASE #: 98-CV-3660
PHILLIP C. ENGERS, et al  v.  AT&T AND AT&T MANAGE, et al


DECLARATION OF CLAUDE POULIN, F.S.A., M.A.A.A., E.A.

I, Claude Poulin, am over 21 years of age and based on personal knowledge, state as follows:

 

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1. I am an Enrolled Actuary under ERISA, a Fellow in the Society of Actuaries, and a member of the American Academy of Actuaries. I have over 30 years of experience in designing, administering, and reviewing defined benefit pension plans, including providing advice to employers, unions, governments, employees and their representatives. My Curriculum Vitae is attached as Exhibit A.

2. I have been an actuarial consultant to the AARP, the EEOC, the Internal Revenue Service as well as the CWA, the IBEW and the UAW. For the last twenty years, I have also served as the Actuarial Trustee of the Connecticut State Employees Retirement Commission.

3. At the time the Employee Retirement Income Security Act (ERISA) was enacted in 1974, I was the Senior Actuary for the United Automobile Workers ("UAW"). In that capacity I was responsible for the review and compliance under ERISA of approximately 3,000 pension plans the UAW had negotiated. I testified several times before Congressional committees of both the U.S. House and Senate on matters related to ERISA.

4. I have attached as Exhibit B a list of the cases in which I have testified as an expert at trial or at deposition within the last four years.

5. I have been retained in this matter (1) to determine whether the levels of benefit accrual rates under the AT&T Management Pension Plan, as amended and restated effective January 1, 1998, were significantly lower than the benefit accrual rates in effect under the prior plan, in which case notice of the reductions should have been given to the affected participants; (2) to analyze the actuarial factors used to convert already accrued pension benefits into cash balance accounts on the January 1, 1998 date of the conversion; (3) to determine whether the accrual of additional benefits under the amended plan violated the 133% accrual rule; (4) to examine the relative values of benefits under the options offered to plan participants; and (5) to determine whether certain early retirement reductions found in the amended AT&T Management Pension Plan represent true actuarial reductions. I am compensated at the rate of $350 per hour.

6. In order to perform these analyses, I have reviewed copies of the documents listed on Exhibit C.

7. Until 1997, the AT&T Management Pension Plan was a traditional defined benefit pension plan providing retirement benefits equal to participants' average compensation during a pay base averaging period multiplied by their number of years of credited service times a benefit accrual percentage. As the Pension Plan stood in 1997, it provided benefits equal to an average of a participant's average compensation during 1987-92 multiplied by their years of credited service through the end of 1992 times 1.6%. For years after 1992, the benefit accrual rate was 1.6% of each year's annual compensation.

8. At a meeting held on April 16, 1997, the Board of Directors of AT&T adopted resolutions that resulted in two amendments to the plan: The first amendment was a Special Update, adopted December 19, 1997 and effective August 1, 1997, that updated the pay base averaging period under the prior formula from 1987-92 to 1994-96 and then added up to one year to active participants' years of credited service. The second amendment converted the existing plan to a Cash Balance plan, effective January 1, 1998. The latter amendment was not adopted until October 16, 2000.

9. The Cash Balance Plan amendment created cash balance accounts (hypothetical account balances) for active participants as of January 1, 1998 and provided future benefit accruals in the form of pay credits and interest credits. As explained in greater detail in paragraph 12, in order to determine the rate of future benefit accrual under a cash balance plan, the pay credits must be projected to the participant's normal retirement age (age 65) using the interest credits specified under the terms of the plan. The annual increase in accrued benefit at age 65 is then converted into a benefit accrual rate.

10. Even though a cash balance plan resembles a defined contribution plan in some respects because of the existence of pay credits and account balances, it is a defined benefit plan under ERISA and the Internal Revenue Code because individual accounts do not actually exist. The pay credits and account balances under a cash balance plan are entirely notional constructs. Under a defined benefit plan covered by ERISA, the "accrued benefit" is "expressed in the form of an annual benefit commencing at normal retirement age." Only under a defined contribution plan is the accrued benefit defined as the balance in the individual's account.

The Rate of Benefit Accrual under the Cash Balance Plan Is Significantly Lower than the Prior Benefit Accrual Rate

11. 
204(h) of ERISA states that if an amendment to a pension plan provides for a significant reduction in the rate of future benefit accrual, a notice with information sufficient to understand the effect of the plan amendment must be given to the affected plan participants.

12. In order to determine the employee's accrued benefit payable at normal retirement age under the AT&T Management Cash Balance Pension Plan, it is necessary to take the following steps as of any date of determination (DOD).

Step 1: determine the amount of the employee's hypothetical account balance at the DOD;

Step 2: determine the interest credit rate to be used between the DOD and the employee's normal retirement age of 65; this interest credit rate was 7% for calendar years 1998, 1999 and 2000 and 4% for subsequent years;

Step 3: determine the employee's attained age at the DOD;

Step 4: calculate the number of years from the DOD until the employee will attain the normal retirement age of 65;

Step 5: increase the account balance at the DOD with interest at the interest credit rate (determined in Step 2) for the number of years until the employee will attain age 65;

Step 6: divide the account balance as "projected to age 65" by the age 65 annuity factor specified in the Plan to determine the annuity payable commencing at age 65.

The above computation can also be stated in terms of the following mathematical formula:

normal retirement benefit = AB x (1 + i) 65-n a

where,

                    AB    = the employee's hypothetical account balance at the DOD;

                   i      = the interest credit rate at the DOD;

       (1+i)65-n = the mathematical expression for the accumulation of interest from the date of determination to age 65;

                   n      = the employee's attained age at the DOD; and

                    a      = the cost of purchasing an annuity commencing at age 65 based on the mortality table and the interest rate, or stipulated factors, as provided under the terms of the plan.

13. Each year's benefit accrual can be obtained by substituting for the account balance (AB) in the above formula the annual pay credit payable under the AT&T Management Cash Balance Pension Plan. The rate of benefit accrual is then determined by dividing the thus-obtained benefit accrual by the employee's compensation for the year.

14. The following table shows the pay factors, based on the employee's attained age, which multiplied by the employee's compensation up to the Social Security Wage Base provide the pay credits. For compensation exceeding the Social Security Wage Base, supplemental pay credits are based on factors equal to twice the amounts shown.

   Age Bands       Pay Credit Up to SSWB

      Below 30               3.00%

      30-34                     3.50%

      35-39                     4.25%

      40-44                    5.00%

       45-49                    6.50%

      50-54                    8.00%

55 and Above              10.00%

15. For each age from 21 to 65, the attached Exhibit D shows the annual pension benefit accrual at age 65 (Column 8) and the rate of benefit accrual (Column 9) under the cash balance plan based on the above pay factor table, interest credits of 4% a year and a compensation of $40,000. In the case of a 25-year old employee, a pay credit of $1,200 (3% of $40,000) in Column 6 accumulates to $ 5,761 with an interest credit of 4% a year during the 40-year period from age 25 to age 65. Based on the annuity conversion factors found in the Plan, this latter amount provides an annual pension benefit of $ 601 at the normal retirement age of 65, which represents 1.50% of the employee's $40,000 compensation. In other words, the AT&T Management Pension Plan provides a benefit accrual rate of 1.50% to employees age 25. On the other hand, in the case of an employee age 60, even though the pay credit of $4,000 (10% of $40,000) is greater, it only accumulates to $4,867 with the interest credit of 4% during the 5-year period from age 60 to 65, which in turn provides for an annual pension benefit of only $508 at age 65. This latter amount is 1.27% of $40,000 and therefore represents a benefit accrual rate of only 1.27% at that age.

16. Comparing the rates of benefit accrual at each age after the AT&T Management Pension Plan was converted to a cash balance plan (Column 9) with the 1.6% benefit accrual rate in effect before the conversion (Column 10) reveals that for all employees earning less than the Social Security Wage Base who are over age 23, the amended plan provides a lower rate of benefit accrual. This reduction is significant at all ages and even more substantial at the older ages.

17. The average reduction in the rate of benefit accrual as a result of the conversion to a cash balance plan was 15% for all ages combined. Plan participants between the ages of 55 and 65 experienced a 20% reduction in their benefit accrual rates. The benefit accrual rate of 1.04% at age 65 represented a 35% reduction compared to the 1.6% benefit accrual rate under the previous version of the plan. Exhibit E graphs the same reductions.

18. A similar analysis with respect to employees earning in excess of the Social Security Wage Base shows that, while the impact of the double pay credit for earnings in excess of the Social Security Wage Base results in higher rates of benefit accrual than for lower paid employees, a substantial portion of such plan participants still suffered a reduction in their rates of benefit accrual as a result of the plan amendment.

19. The Treasury regulations on Section 204(h) also provide that plan provisions that may affect the rate of future benefit accruals include new "benefit offset provisions." Treas. Reg. 1.411(d)-6, Q&A 6. AT&T's prior formula did not have any benefit offset provisions applicable to the 1.6% rate of accrual. The cash balance formula contains an offset under which receipt of participants' already earned benefits causes them to lose their cash balance accruals. This, too, results in a significant reduction in the rate of benefit accrual.

20. My findings that the new rates of benefit accrual are significantly lower under the AT&T Cash Balance Pension Plan are corroborated by calculations and graphs prepared by AT&T, which are attached in Exhibit F. AT&T's calculations show essentially the same accrual rates as my calculations. In particular, they show lower rates for all employee groups, with the exception of highly paid employees ($160,000+).

21. I reviewed the Certification of AT&T's actuary Kevin R. Armant, dated November 13, 2000, which was filed in this case, in which he stated that participants did not suffer "a significant reduction in the rate of future benefit accrual" as a result of the conversion to the Cash Balance Plan. He stated that "the annual single life annuity benefit payable at normal retirement age under the cash balance formula always exceeds the annual benefit payable at normal retirement age under the formula in effect prior to the Plan Amendment for each one of the named plaintiffs." In performing his analysis, however, Mr. Armant failed to compare rates of future benefit accrual on a consistent basis. Instead, he compared accrued benefits at age 65 under the cash balance formula with the accrued benefit payable at age 65 under the Special Update, but frozen at the 1997 level without any future benefit accrual. In other words, instead of comparing the rates of future benefit accrual, he compared a frozen or static benefit with a benefit increasing each year. Under his approach, any increase in benefit after 1997, however insignificant such as one based on a benefit accrual rate of 0.1% of future compensation, would have led to his conclusion.

22. The Temporary Regulations promulgated by the Secretary of the Treasury, 26 CFR 1.411(d)(6) which were in effect at the time of the plan amendments- and have since become Final - specified in Q&A-4 that Section 204(h) notice is required for an amendment to a defined benefit plan that provides for a significant reduction in the rate of future benefit accrual, and in Q&A-5 that "an amendment to a defined benefit plan affects the rate of future benefit accrual only if it is reasonably expected to change the amount of the future annual benefit commencing at normal retirement age." Mr. Armant's analysis failed to compare the change in the amount of future annual benefits under the cash balance plan with the prior 1.6% of pay formula.

The Initial Account Balances Represented Only Part of the Value of Participants' Benefits

23. On January 1, 1998, the date of conversion to a cash balance plan, initial account balances related to the pension benefits that had accrued up to that date were established for all active plan participants. However, the initial accounts did not represent the full actuarial equivalent of the previously accrued benefits at age 55, when they were most valuable. Instead, AT&T established initial accounts equal to a lump sum value of the participants' benefits deferred to age 65. My analysis shows that the interest rates used to compute the value of the age 65 benefits also exceeded those prescribed by Federal government standards for pension plans.

24.  Prior to the amendment, the AT&T Management Pension Plan contained very valuable features such as subsidized early retirement benefits that were not included in the initial account balances. For employees near age 55 who were eligible for full retirement benefits at age 55, the amount of their initial account balances represented less than 50% of the actuarial present value of the benefits they were expecting to receive starting at age 55. AT&T essentially excluded the value of ten years of undiscounted payments between ages 55 and 65.

25. My review also shows that the tabular conversion factors that AT&T used to establish the initial account balances were computed using an interest rate of 7.9% and the GATT mortality table to value the pension benefits payable after age 65. The conversion factors applicable before age 65 were computed with the 7.9% rate at age 65 and a 4% discount for the years before age 65. The 7.9% interest rate was substantially higher than the prevailing Section 417(e) rates prescribed by the IRS to calculate lump sum values. The 30-year Treasury rate under Section 417(e) was 5.81% at that time. The PBGC interest rate under the same section was 4.25%. A 2.1 to 3.65% higher interest rate produces lower lump sum values and lower initial account balances.

26. AT&T's conversion factors can also be analyzed in terms of implicit overall interest rates. On this basis the conversion factors translate to the following interest rates which are more favorable at the lower ages:

   Age          Implicit Interest Rate

     65                 7.90%

     60                 6.11%

     55                 5.28%

     50                4.85%

     45                4.60%

     40                 4.37%

     35                4.23%

     30                4.19%

     25                4.65%

     20                4.57%

27. As a result of the initial account balances being established at levels below the values of the pension benefits already existing before the conversion, there was a period of time called the wearaway period when the accruals or pay credits under the cash balance plan were not really credited. The duration of the wearaway period is a function of the difference between the actuarial present values of the protected retirement benefits and the initial account balances as well as the size of the pay credits and interest credits increase the values of the account balances. Under this design, it may take a large number of years (up to 13 years in some cases) until the cash balance account exceeds the value of the pre-cash balance benefit. Until then, the effective rate of benefit accrual for the individuals affected by the wearaway is zero.

28. A period of wearaway is not legally required or an inherent feature of a cash balance conversion. Over the years, a number of pension plan conversions have taken place without wearaway. The wearaway can be avoided by establishing initial account balances equal to the full value of the benefits already accrued on the date of conversion. It can also be avoided simply by protecting already earned benefits in annuity form and adding the benefits earned from cash balance to those benefits. These approaches are variously described as the "A + B" or the "sum of" approach. By comparison, AT&T's approach effectively offers either A with no B, or else less than 50% of A + B.

29. I understand from conversations with class counsel that AT&T advances the argument that the existence of the Special Update reduces the need for the elimination of the wearaway. The Special Update is apparently presented as a substantial additional benefit that could be characterized as an advance payment of accruals under the cash balance plan. This is not the case. Updating the compensation base for pension benefit purposes, which is what the Special Update is, is a well-established practice among modified career average plans such as the AT&T pension plan as it existed for the nearly two decades before its conversion to a cash balance plan. Before 1980, the AT&T Management Pension Plan was a final average plan, which means that pension benefits were based on the average compensation of plan participants for the period immediately preceding their retirement. Such plans do not need to be "updated" because the plan formula automatically adjusts the compensation base in the calculation of benefits. The situation is different for career average plans because their fixed pay base results in increasingly lower benefits in comparison to the employees' current salaries. Periodic adjustments to the pay base used for pension benefit purposes represent attempts to temporarily correct this feature of career average plans. At intervals of every three years or less, AT&T made seven such adjustments or updates between 1980 and 1994 which resulted in average benefit increases exceeding 10%. Exhibit K. The Special Update of August 1997 simply continued this practice. Although AT&T described it as an improvement, the crediting of an additional year of service for employees with over 20 years of service was merely in lieu of crediting their service in 1997 under the prior formula. For employees with less than 20 years of service, this "adder" was often less than their service in 1997.

Benefit Accruals under the Cash Balance Plan Do Not Meet the 133 1/3%Rule

30. In addition to providing lower rates of accrual in percentage terms, the AT&T's Plan document, as adopted on October 16, 2000, contains a new benefit offset provision which restricts participants' actual receipt of those accruals. The Plan stipulates that participants can receive the benefits they are supposed to earn under the cash balance formula beginning in 1998 only if they give up the early retirement benefits, payable from age 55, they have earned under the prior formula. The pre-1998 Plan document did not condition the 1.6% rate of accruals on losing part of the value of already earned early retirement benefits. Each year's accrual at the rate of 1.6% of pay was separate and unconditional.

31. As set out in Section 4.06(a) of the Plan document, a participant like named Plaintiff Don Noerr must accept AT&T's method of valuing his prior benefits in order to receive his annual accruals since 1998. AT&T converted Mr. Noerr's benefit to a cash balance account by excluding the value of his early retirement benefits of $1,523 per month starting at age 55. This conversion methodology established an opening account balance that was only 54% of the value of his special update. If Mr. Noerr selects the cash balance account, he gives up the value of the early retirement subsidy to which he was already entitled. If he selects the early retirement benefits, he loses the pay credits and interest credits to which he is entitled under the cash balance formula. Depending on his selection, there is a period during which Mr. Noerr either (a) accrues new benefits at the expense of losing a portion of his prior benefits, or else (b) accrues no additional retirement benefits.

32. Exhibit G illustrates numerically the impact of the initial account balances being lower than the values of the accrued benefits on the date of conversion in the case of Donald Noerr. On January 1, 1998, Mr. Noerr was eligible for a pension benefit of $18,276 a year or $1,523 a month. His initial account balance, however, was the actuarial equivalent of only $9,951 per year, or $829 a month. All the pay credits and the interest credits taking place between 1998 and 2003 are illusory because they will never be payable if Mr. Noerr elects to receive a pension benefit during that period as opposed to his cash balance account.

33. The same Hobbesian choice applies to other participants. Named Plaintiff Gerald Smit has a wearaway period in which he does not actually accrue additional benefits of 9 years. Exhibit L. Class member Bonny Berger had a wearaway period extending up to 13 years. Exhibit I.

34. Before and after the cash balance conversion, AT&T has represented in Applications for Determination to the IRS that its benefit formula complies with ERISA's 133 1/3% test. Under the anti-backloading rule of ERISA Section 204(b)(1)(B), the rate of benefit accrual in any year may not exceed the rate of benefit accrual in any previous year by more than 33 1/3%. This test looks at the "annual rate" of benefit accrual for each plan year. Higher rates in earlier years are not allowed to be averaged with lower rates in later years in order to pass this test. Treasury Reg. 1.411(b)-1(b)(3)(iii) (Example 3) (when the annual rate in a period of years is too low, the 133% test is not satisfied even if the "average rate of accrual" is "not less rapidly than ratably"). For several years, older and longer service AT&T employees will accrue no additional benefit under the cash balance formula as long as the value of their cash balance account is less than the value of the pension benefit they had already accrued under the prior formula. This will ultimately be followed by a period of benefit accrual. The rate of benefit accrual at that time will be infinitely greater than the zero accrual rate in effect during the wearaway period. The 133% rule requires annual accruals that are computed separately from previous years' accruals and are not subject to offsets based on previously years' accruals. Section 4.06(a) does not satisfy this test.

AT&T Has Not Explained the Relative Values of Benefit Options

35.  Before a participant and his or her spouse consent to an immediate distribution such as a lump sum distribution, Treasury regulations require AT&T to give participants and their spouses "sufficient" information "to explain the relative value of the optional forms of benefit available under the plan (e.g., the extent to which optional forms are subsidized relative to the normal form of benefit. . .)." Treas. Reg. 1.401(a)-20, Q&A 36.

36. The AT&T Management Pension Plan Pension Payment Election Forms that I have examined, attached as Exhibits H and I, do not explain the relative values of the various options. Participants and their spouses are asked to elect cash payments and give up lifetime annuity benefits with no disclosure that the annuities may have higher values. For example, Edward O'Brien's Pension Payment Election Form shows that the single life annuity to which he was entitled at the age of 50 years and two months was $999.65 and the 50% Joint and Survivor Annuity at the same age was $899.69. Exhibit H. However, the cash option presented to Mr. O'Brien was substantially less valuable than the annuity options. Based on the factors found in the AT&T Management Pension Plan, the cash option corresponded to a single life annuity of only $726.34 a month. In other words, Mr. O'Brien would have received 38% more by electing the annuity options. Comparisons of the relative values of these various options were not presented to him in a meaningful numerical, percentage, or even narrative form.

37. Ms. Bonny S. Berger's Pension Payment Election Form does not even present what was her most valuable option: The payment of a pension benefit of $1,672.63 a month starting at age 55. All the options shown on her election form were based on her Cash Balance Accrued Benefit of $2,058.16 at age 65, which was the actuarial equivalent of a pension benefit of only $1,173.59 at age 55. Exhibit I. Ms. Berger was, however, already entitled to a pension benefit of $1,672.63 at age 55 under the prior formula, which was 42.5% more than under the options in the Pension Payment Election Form. Comparisons of the relative values of the various options were not presented to her.

AT&T's 6% per Year Reduction Is Not a Reasonable Actuarial Equivalent of the Special Update at Age 55

38. Section 4.06(a)(ii)(A)(2) of the amended Plan document provides reductions equal to "one half percent for each calendar month or part thereof by which the Participant's age at the Pension Commencement Date is less than fifty-five years, except that each Participant with a Term of Employment of thirty or more years shall receive a monthly pension benefit reduced by one fourth percent for each calendar month or part thereof by which such Participant's age at the Pension Commencement Date is less that fifty-five years." In other words, the early retirement reductions provided under this section of the plan are 6% for each year a Participant with less than 30 years of service retires before age 55, resulting in a pension benefit reduced to zero at age 38. Needless to say, a pension benefit equal to zero can never be the actuarial equivalent of another benefit, at any age.

39. Treasury Regulation 1.411(a)-11(a)(2) provides that if a distribution option is offered to a "subsidized early retirement benefit," at least the present value of that benefit must be offered. Treasury Regulation 1.411(a)-4 further provides that "adjustments to plan benefits" in "excess of reasonable actuarial reductions can result in benefits being forfeitable."

40. I prepared the attached Exhibit J which compares the percentage of the age 55 benefit that would be payable at each retirement age from 38 to 55 under:

a) Reduction factors of 6% per year,

b) Reduction factors of 3% per year,

c) Reduction factors based on the table in Section B.03 of the monthly benefit derived from Cash Balance Accounts payable before Normal Retirement Age, and

d) Reduction factors based on GATT mortality and an interest rate of 5%.

41.  Exhibit J shows that the pension benefit payable at age 40 is reduced to 10% of the age 55 benefit with a 6% reduction, while it would remain at between 39% and 55% of the age 55 benefit under the other three sets of factors. While the percentages in Columns (4) and (5) vary slightly because they are based on different interest and mortality tables, both represent "reasonable actuarial reductions." The same may not be said of the 6% reduction.

42. Exhibit J also shows the average reduction factor by age band (38-40, 41-45, 46-50, and 51-55) under each set of factors. This shows that at ages below 50, the 6% reduction applied under the Plan is always substantially more than an actuarially equivalent reduction. In Ms. Berger's case, an actuarially equivalent benefit at age 41 and 1 month would be worth 2.6 times as much as with AT&T's 6% reduction. Dollie Dobbins, another employee who separated at age 48 and 4 months with nearly 30 years of service incurred a discount that was 10% more than with an actuarial equivalent. Exhibit M.

43. While the 6% early retirement reduction is common for retirements taking place between ages 60 and age 65, and to a lesser extent to retirements between ages 55 and 60, pension plans usually do not extend the 6% reduction below age 55, since it is deemed to be an excessive reduction resulting in pension benefits being less than what a true actuarial equivalent would produce.

44. AT&T's brochure entitled "Your Pension Plan Improvements," which was distributed to all participants in August 1997, stated that if a participant starts receiving payments before age 55, the "overall value of your pension likely will remain the same." Exhibit N. In my opinion, this was an inaccurate statement because the 6% reduction exceeds a reasonable actuarial reduction.

I declare under penalty of perjury that the foregoing is true to the best of my knowledge.

Signed: __________________
Claude Poulin

Date: October 3, 2003

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