Seyfarth Synopsis: Another court has found that actuaries who set discount rates for withdrawal liability purposes that are not based upon their “best estimate of anticipated experience” for investments under the plan—in this case, basing the rate assumption only on estimated returns for 40% of the Plan’s assets in low risk fixed income investments—cannot withstand judicial scrutiny.
Yet another multiemployer pension plan’s withdrawal liability interest rate assumption has been shot down by the courts, this time by the Federal District Court for the District of Columbia in Employees’ Retirement Plan of the National Education Association v. Clark County Education Association, Case No. 20-3443 (RDM), 2023 BL 62912 (D.D.C. Feb. 27, 2023), due to the actuary’s failure to adequately justify his decision to use a lower interest rate than that used for funding obligation purposes. This case is worth noting, as it interprets the D.C. Circuit Court’s decision in United Mineworkers of America 1974 Pension Plan v. Energy West Mining Co., 39 F.4th 730 (D.C. Cir 2022), which struck down the use of PBGC plan termination rates for withdrawal liability purposes.
For background, the Clark County Education Association (“CCEA”) was a contributing employer to the Employees’ Retirement Plan of the National Education Association of the United States (the “Plan”), a multiemployer pension plan. CCEA withdrew from the Plan in 2018, and the Plan subsequently assessed withdrawal liability of $3,246,349 against CCEA.
In calculating withdrawal liability, the Plan actuary did not use the PBGC plan termination rates, the Plan’s 7.3% funding rate-of-return, or any combination thereof, as the interest rate assumption. Instead, the actuary utilized a discount rate assumption of 5%, and explained this was his best estimate of the expected returns on low investment risk and fixed income investments of the types in which the Plan invested. The actuary explained he adopted this methodology, because the rate reflected both a low-rate investment environment and the expected returns on lower-risk fixed income investments. Moreover, such a lower rate recognized that a withdrawing employer no longer participates in any future risks regarding plan investments, and the actuary believed it did not make sense to value a liability based on higher rates of return that provided for additional investment risk that only the remaining participating employers had to bear.
After an arbitrator found the actuary’s assumptions to be unreasonable in the aggregate because the discount rate was unreasonable, the Plan appealed. The Court found it was “evident from the record that the 5.0% withdrawal liability discount rate . . . was not [the actuary’s] ‘best estimate of anticipated experience under the plan’ as Energy West interpreted that language.’” Granted, contrary to Energy West, where the actuary used PBGC plan termination rates totally divorced from Plan assets, the discount rate applied here was based investment types actually in the NEA plan. Yet only 40% of plan assets were in low-risk investments, and that did “not cut it.” “Energy West requires that an actuary ‘estimate how much interest the plan’s assets will earn based on their anticipated rate of return.’ 39 F.4th at 738. A discount rate assumption based on the expected returns on a type of asset that makes up less than half of a Plan’s portfolio falls short of that standard.”
The Court made clear that Energy West “does not deprive actuaries of all flexibility” in determining interest rate assumptions for withdrawal liability purposes, nor does it preclude any consideration of risk shifting. Instead, the Court recognized that there can be a range of permissible discount rate assumptions. The Court also noted that Energy West does not hold that an actuary’s estimate must encompass the expected rate of return of all of the Plan’s assets. It could preclude, however, estimates that disregard the expected returns of the majority of the Plan’s assets. The Court noted that the fact that the actuary reviewed a portion of the Plan’s assets cannot make up for the fact that he failed to consider most of them. An actuary may be able to weigh risk shifting in the course of selecting a discount rate assumption at the conservative end of a range of reasonable estimates of anticipated investment returns, but “an actuary cannot risk shift his way to a discount rate ‘divorced from’ a plan’s anticipated returns or, as in this case the majority of the assets that drive such returns.” (Citations omitted).
The Court also refused to credit the conclusion of the Plan’s expert witness that 5.0% could be a reasonable estimate of the expected returns of the Plan’s entire portfolio. The Court was focused not on what an actuary might have done, but what the actuary actually did. Here, the Plan actuary did not look at the Plan’s entire portfolio to determine what a reasonable discount rate was. The discount rate assumption was unreasonable because it did not give due regard to the Plan’s experience, and given the overall calculation contained no offsetting changes to blunt the impact of that assumption, was unreasonable in the aggregate as well.
Although the arbitrator ordered the NEA Plan to recalculate liability using the actuary’s 7.3% funding rate of return, the Court remanded the matter back to the arbitrator for reconsideration. The Court noted that while in certain circumstances arbitrators have the authority to impose set remedies, in general arbitrators must defer to the reasonable assumptions made by plan actuaries, and must avoid substituting their own views for those of the actuaries.
Here, the arbitrator did not explain why setting a discount rate as opposed to a more open-ended remedy was appropriate. On remand, and in light of the Court’s decision, if the arbitrator concludes it should give the actuary another opportunity to set a reasonable rate, it should do so. If the arbitrator finds that the actuary really believed that a discount rate of 7.3% reflected the Plan’s anticipated experience, then the arbitrator should say so and could order that rate be used.
Yet again, the use of a discount rate assumption that is divorced from the actual expected investment returns of the majority of plan assets has been found to be unreasonable in the aggregate, and not the actuary’s best estimate. While the pending PBGC regulations setting forth accepted discount rate methodologies—assuming they are adopted and withstand judicial scrutiny—may resolve this dispute for withdrawals going forward, litigation remains ongoing for those withdrawals that predate the ultimate adoption of the regulations.