Compliance

Foot Locker Fails in Cash Balance ‘Wear Away’ Litigation Appeal

Participants successfully challenged Foot Locker’s determination of benefit accruals after the conversion of a traditional pension plan into a cash balance arrangement. 

By John Manganaro editors@strategic-i.com | August 18, 2017
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The 2nd U.S. Circuit Court of Appeals has ruled against Foot Locker in an Employee Retirement Income Security Act (ERISA) lawsuit involving communications and benefit accrual formulas in the company’s evolving pension offerings.

The bench trial took place in the United States District Court for the Southern District of New York, before Judge Katherine B. Forrest, and resulted in Foot Locker being ordered to reform its cash balance plan to calculate accrued benefits in a way participants argued they were entitled to. Participants’ arguments revolved around that fact that Foot Locker did not fully describe or disclose a period of “wear-away” that could result for some participants during the transition from a traditional defined benefit to a cash balance approach, “a phenomenon which effectively amounted to an undisclosed freeze in pension benefits.”

Judge Forrest ruled the plan’s summary plan description (SPD) as well as other communications to participants failed to inform them that their benefits would be subject to a period of “wear-away” during which new accruals would not increase the benefit to which a participant was already entitled.

Background information provided in case documents shows that under the original defined benefit plan, participants had been entitled to an annual benefit beginning at age 65 that was calculated on the basis of their compensation level and years of service. The benefit took the form of an annuity, and, “with exceptions not relevant to the appeal,” employees were not given the option to receive its aggregate value as a lump sum. In contrast, under the newly introduced cash balance plan, participants held a hypothetical account balance that, upon retirement, could be paid out as a lump sum or used to purchase an annuity.

As such, Foot Locker established a beginning balance based on any given participant’s earned DB plan benefit and a 9% discount rate, as well as a mortality discount. Following the conversion, participants’ account balances were credited with pay credits and an interest credit at a fixed annual rate of 6%.

According to Foot Locker’s stance, the problem of potential cutbacks was rectified by a stopgap measure that defined a participant’s actual benefits as the greater of the participant’s benefits under the defined benefit plan as of December 31, 1995; and the participant’s benefits under the new cash balance plan. The “greater of” provision, Foot Locker argued, “had the benefit of ensuring that participants would not lose money due to Foot Locker’s switch to a cash balance plan, consistent with ERISA’s ban on plan amendments that reduce a participant’s accrued benefit, which is known as the anti-cutback rule.”

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