ERISA and the Administration of Health and Retirement Accounts

With a lot of retirement savings and pension plans taking huge hits from the retrenchment on Wall Street in the past several months, people are rightly worried whether they’ll have enough left to retire on. This is an even bigger worry in our modern economy since so many companies have dropped defined benefit plans that guarantee a fixed income upon retirement in favor of defined contribution plans that rely on voluntary employee payroll deductions, sometimes with the employer contributing as well. The Employee Retirement Income Security Act (ERISA) of 1974 sought to address these concerns by establishing minimum standards for employers to follow if they offer pension plans. That “if” is a big qualifier, however, since neither ERISA nor any other federal law mandates that companies offer pension plans.

The drive to safeguard pension plans began under President John F. Kennedy in the early 1960s. The demise of auto manufacturer Studebaker in 1963 added momentum. Lacking the money to fully honor its employees’ pension plans, Studebaker divided everyone into three groups. The first group, those who had reached the retirement age of 60, got full pensions. The second group, those who had worked for the company for at least ten years and were between 40 and 59 years old, received checks for 15 percent of the value of their accounts. The third group—everyone else—got nothing. Regulatory debate in the nation’s capital dragged on for years afterward but heated up in 1970 when NBC aired Pensions—The Broken Promise, a television special that showcased the dire plight of many retirees.

Thus was born ERISA a scant four years later. It was signed into law by President Gerald Ford on Sept. 2, 1974, Labor Day. ERISA sought to protect the interests of employee benefit plan participants and their beneficiaries by requiring the disclosure to them of financial and other pertinent information about their plans; by establishing standards of conduct for plan fiduciaries; and by providing for appropriate remedies and access to the federal courts. ERISA also created the Pension Benefit Guarantee Corporation (PBGC) to protect the assets of defined benefit plans. PBGC, however, does not guarantee other types of retirement accounts that are set up and maintained in the individual’s name and are portable such as 401(k) and 403(b) investment instruments, and even when it does take over a defined pension plan from a failed company, PBGC can greatly reduce the payouts.

Who and What Is Covered?

ERISA applies to all businesses at the moment a health, welfare or retirement plan is adopted by the company for its employees. It is enforced by the U.S. Department of Labor (DOL) and the Internal Revenue Service (IRS). ERISA requires plan administrators to provide participants with plan information about features and funding; establishes fiduciary responsibilities for those who manage and control plan assets; requires plans to establish a grievance and appeals process for participants to get benefits from their plans; and gives participants the right to sue for benefits and breaches of fiduciary duty.

Under ERISA, pension plans must provide for vesting of employees' pension benefits after a specified minimum number of years. ERISA requires that the employers who sponsor plans must also satisfy certain minimum funding requirements. ERISA also regulates the manner in which a pension plan may pay benefits. For example, a defined benefit plan must pay a married participant's pension as a "joint-and-survivor annuity" that provides continuing benefits to the surviving spouse unless both the participant and the spouse waive the survivor coverage.

Health plans, however, do not vest, and ERISA does not require employers who promised retiree health benefits to honor that promise should circumstances change and they decide to drop such coverage. The employee’s or retiree’s only option if that happens is to sue for breach of contract. This is the opposite of retirement accounts, which do vest after a specified length of time, enabling employees to take control of the accounts after they leave the employ of the company.

The Consolidated Omnibus Budget Reconciliation Act (COBRA) of 1985, the subject of another Personnel Concepts white paper, does provide for continuation of health coverage after leaving a company, but it must be paid for by the employee. Depending on circumstances, the coverage will run either 18, 29 or 36 months, with 18 being the norm outside of other triggering events. In the current economic climate, however, the government has established a program to subsidize 65 percent of COBRA payments for qualifying employees who have been involuntarily terminated. The program expires, unless renewed, on Dec. 31, 2009. In addition, insurance plans sometimes allow for the conversion of the group plan to an individual plan, but rates generally escalate rapidly.

As for vesting of retirement plans, it was not unusual in the past for companies to set the bar high, requiring employees to work for decades and retire fully before being vested. The Pension Protection Act of 2006, however, changed all that. Now, defined benefit plans must vest after five years or after seven years if using a graded-vesting plan (20 percent vesting in each of the final five years until fully vested). For defined contribution plans, the employer part of the contributions must vest after three years or six years if using a graded-vesting scale (20 percent a year during the final five years until fully vested). Employee contributions are always fully vested. Employers may choose to vest on an earlier date, of course.

ERISA Trumps the States, But Not Completely

ERISA has a preemption clause that mandates its superiority over local and state laws with some clearly defined exceptions: state insurance, banking, or securities laws; generally applicable criminal laws; and domestic relations orders that meet ERISA's qualification requirements. In addition, the Hawaii Prepaid Healthcare Act is wholly exempted because it was enacted shortly before ERISA. However, ERISA froze Hawaii’s health plan in place and forces Hawaii to work through Congress if it wants to make any non-administrative changes to the law.

Though states can regulate insurance companies and place mandates on the policies they sell, they cannot mandate health benefits directly to employers or their plans. Section 514(a) of ERISA states that ERISA preempts “any and all State laws insofar as they . . . relate to any employee benefit plan” governed by ERISA.This limitation came into prominent play when San Francisco passed an ordinance requiring employers to “pay or play” in the health insurance field. Covered employers (generally with 20 or more employees) would have to prove they were spending at least $1.23 or $1.85 an hour on health insurance for each employee, depending on total number of employees, or pay a similar sum, or its differential, to the city and county.

The Golden Gate Restaurant Association immediately sued, alleging the law was in violation of ERISA’s preemption, and a federal district court granted the group summary judgment, throwing the law out the window…momentarily. The city and county appealed to the Ninth Circuit Court, where a three-judge panel ruled that there was no violation of ERISA because the law didn’t mandate or regulate benefits but simply placed a financial requirement on employers. The Golden Gate Restaurant Association appealed to the full court but was denied a hearing. The next step is a possible review by the U.S. Supreme Court, but the whole matter could become moot if the Obama administration comes up with its own U.S.-wide employer mandate.

In health care as in life and politics, there are always unintended consequences of one’s best-laid and most well-intentioned plans, and ERISA had its share of unforeseen reactions. The shift by employers, by and large, from defined benefit to defined contribution pension plans in the wake of ERISA has already been noted. Another shift came about as states began piling on mandate after mandate in their regulation of health insurance policies. Those companies that could afford to do so, however, simply set up their own insurance plans that were not subject to state regulation and were thus exempted under ERISA. Define what you want to cover, set deductibles and co-pays, and get Blue Cross or another company to administer it—you’re home free so long as you fund it all.

What happens if you cheat and get caught? Employers face a range of penalties for violating ERISA. Their retirement plans can be disqualified and immediately taxed. Failure to file the annual report called Form 5500 can also result in a fine. Combined damages can range from $2500 up to 80 percent of the plan’s assets. Finally, fiduciaries of the plan, including the company officers who help administer the plan, may be held personally liable for claims for benefits under the plan and/or for penalties associated with errors in administering the plan.

Outside the workplace, ERISA also has had a lasting impact by creating a provision for Individual Retirement Accounts, commonly known as IRAs, which are still used widely as retirement investment vehicles.

As health care reform heats up, it will be interesting to see what role ERISA plays in the final brew concocted in the nation’s capital. While the states can’t place mandates directly on employers, the feds certainly can, and they can also muddy the free-market waters by offering their own health plan at a price lower than the insurance companies can reasonably match. If doing that is unprofitable and piles on to the national debt, so be it, the short-range thinking goes. The government is already printing what’s called helicopter money (money that is showered all over the land from a helicopter, figuratively speaking), so what’s a few billion more here and there? Don’t be surprised if the promised health care reform visible on the horizon ends up costing more than the Troubled Asset Relief Program (TARP). After all, President Obama’s “down payment” on health care is already above $600 billion, and that’s before Congress even creates its own wish list of goodies and mandates in the quest for “affordable” and “universal” health care.

Personnel Concepts’ handy HR Desk Reference covers ERISA and every other applicable workplace law and regulation in detail and is an invaluable resource to have at one’s disposal.

About the author:
Gary McCarty is a researcher and Web Content Manager for Personnel Concepts.

Note: The details in this white paper are provided for informational purposes solely. All answers are general in nature, not legal advice and not warranted or guaranteed. Readers are cautioned not to rely on this information. Because laws change over time and in different jurisdictions, it is imperative that you consult an attorney in your area regarding legal matters and an accountant regarding tax matters.