Did Detroit Edison Mislead Retirees about Benefits?

Cincinnati, OH On March 23, the Sixth Circuit revived an ERISA lawsuit that alleges that Detroit Edison Co. misled plan participants about the benefits they could expect at retirement when the plan design was changed in 2002. The Appeals Court’s decision in Nolan v. Detroit Edison Co. gives the participants a fresh opportunity to show that the disclosure to participants about the plan’s conversion to a cash balance plan failed to meet basic ERISA requirements. Nolan seeks class action status.

ERISA specifically requires that notices and summaries of changes must be written in a manner designed to be understood by the average plan participant and must provide enough information for participants to understand the effect of a plan amendment. Transparency is what this ERISA lawsuit is about.

Dicey decision

In 2002, the Detroit Edison and its affiliated companies implemented a new retirement plan. Up to that point, the company had offered its employees a traditional defined benefit plan. Under the traditional plan, a retired employee would be paid an annuity calculated according to a formula based on the employee's salary and years in service.

The new plan, a cash balance plan, used a different formula. Under the new plan, the company established a hypothetical retirement account for each employee, which would grow from two sources: annual "contribution credits" (equal to a percentage of the participant's eligible earnings), and "interest credits" (initially linked to the interest rate of government-issued Treasury Bonds). 

When Detroit Edison made the change, it did not require existing employees who had earned benefits under the old plan to switch to the new plan. Instead, it provided a window for those employees to elect to stay with the traditional plan or opt in to the new one, thereby allowing them to receive future retirement benefits under one plan or the other, but not both. That choice carried some risks because no certain prediction could be made that at retirement an individual employee would do better under the new plan than the old one.

There was a further catch. Existing employees who elected to switch to the new cash balance plan would have their accrued retirement benefits frozen and then receive a hypothetical retirement account balance based on what they had accrued already under the traditional plan, projected forward to their retirement date, and then reduced to present value. That established their opening cash balance, against which future accruals would be measured.

In one way, that benefited them. It provided a guarantee that no matter how slowly their cash balance account grew compared to the opening balance, they would be guaranteed the monthly benefit upon retirement they had earned as of the date the account was frozen, and no less. However, their cash balance account would not grow beyond that initial balance until their accumulated credits caught up to that initial balance, a phenomenon known in pension jargon as “wear away.” It’s a complicated formula.

Leslie Nolan chose to switch to the cash balance plan in the spring of 2002, after she had worked at the company for just over 23 years.

Shock and surprise lead to lawsuit

When she went to retire in 2017 after 38 years with the company, Ms. Nolan was unpleasantly surprised to learn that her pension benefit had not grown much since her account was frozen in 2002. She believes that she should receive a monthly benefit as calculated under the traditional defined benefit plan plus the amount accrued under the cash balance plan since 2002, irrespective of the wear away.

She brought this ERISA lawsuit, alleging that the company:

• breached the terms of the retirement plan;
• failed to explain the election in terms that could be understood by the average person; and
• failed to give notice that the new plan could result in a reduction of accrued benefits.

The company moved to dismiss the complaint, and the District Court agreed. The Sixth Circuit Court of Appeals reversed the District Court’s decision in part and remanded the lawsuit to the District Court for further proceedings.

The Sixth Circuit concluded that Ms. Nolan had a colorable claim that the company did not clearly explain that employees transferring to the cash balance plan would not actually receive any new benefits if the benefit accrued under the new plan did not catch up to their frozen traditional plan benefit. Similarly, the company failed explain the effect that declining interest rates could have on the calculation of a monthly benefit.

The back story

Since the 1980s, employers have increasingly moved away from traditional defined benefit retirement plans and into other retirement savings vehicles including defined contribution plans. Then, especially in the 1990s, they turned to cash balance plans, which are essentially a hybrid defined benefit/defined contribution arrangement. Both alternative designs are cheaper for employers to maintain and generally shift financial risks to workers.

Along the way, however, retirement plans have become increasingly complex and demand far more sophistication on the part of retirement savers. Leslie Nolan, as a financial analyst at Detroit Edison, may have been comparatively well prepared to understand the changes.

Not every worker has the interest or financial acumen to follow the changes, however. If Ms. Nolan found the communications provided by the company ambiguous or self-contradictory, it is likely that other retirement savers may have also. Under the Sixth Circuit’s decision, they can continue to make their case.