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
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
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
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
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
normal retirement benefit = AB x (1 + i) 65-n Ö a
the employee's hypothetical account balance at the DOD;
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;
the employee's attained age at the DOD; and
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.
Bands Pay Credit
Up to SSWB
Below 30 3.00%
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
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
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 Ð 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:
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 Ð called the wearaway period Ð 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 Ð 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,
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.
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.
Date: October 3, 2003