Pension Damages: The Basics
by Chad L. Staller and Brian Conley
An ironworker suffers a severe injury at the work site and is rendered totally disabled. His economic damages include past and future medical expenses, of course, and lost income through to his projected retirement age. In addition, he may have a claim for another element of loss — pension benefits.
Since pension benefits can account for 50 percent or more of the damages in a wrongful death or injury matter, a working knowledge of the various types of pensions and how benefits accrue can be extremely useful in evaluating damages. Here we present an overview of the basic types of pensions and some issues that arise in determining lost pension benefits.
Most pensions in the United States are either “defined benefit” plans or “defined contribution” plans. Defined-benefit plans pay a certain predetermined amount to the recipients according to the pension-plan formula. In defined-contribution plans, the employer, the employee or both make contributions to the employee’s retirement fund, but the ultimate benefits are not predetermined.
Historically, US workers have enjoyed defined benefit plans, but in the 1980s most private employers began moving away from this type of plan in favor of the defined contribution plan. Now, defined benefit plans are found mostly in union and public-sector employment. Some employers provide benefits under both type of plans. Union workers may have defined benefits plans but also may receive benefits from a union “annuity fund” set up as a defined contribution plan. Schoolteachers are typically eligible for both defined benefits and benefits from defined contribution plans.
Defined Benefit Plans
In a defined-benefit plan, the amount of the pension is determined by a set formula outlined in the pension plan or in a union’s collective-bargaining agreement. Defined-benefit plans typically require contributions from the employee as well as the employer. Under a typical collective-bargaining agreement, employer contributions to a union pension fund are a function of hours worked by the union members. The union member contributes to the pension fund via union dues.
Formulas for determining defined-benefit payouts vary significantly. They include:
Years of Service and Final Average Salary. Under this formula, the annual benefit is determined by a set percentage of the worker’s final average salary multiplied by years of service
The multiplier is usually 1-3% of the final average salary — typically, the final 3 or 5 years of employment, although some plans employee a “High 3” or “High 5” factor rather than a final average salary. In these plans, the average of the highest 3 or 5 years of pay is used as the basis of the pension, regardless of when they occurred during the employee’s tenure.
“Years of Service” comprise the employee’s tenure with the company/union/retirement system. Many unions require a minimum number of hours worked in order to receive credit for that year.
Years of Service only. This formula is typically seen only in union collective-bargaining agreements, most notably Ironworkers. Benefits are determined by multiplying a set dollar amount by years of service. Because this type of plan lacks a salary component, employees with equal service time receive equivalent benefits, regardless of position or salary throughout their tenure.
While some of these plans periodically increase the dollar multiplier to account for inflation, many plans of this type have been forced to “freeze” the dollar multiplier to avoid depleting their pension funds as the number of retired members grows. Typical damages calculations for litigation purposes assume periodic inflationary increases to the multiplier. In the wake of multiplier “freezes,” this may result in an overstatement of any pension loss.
“Pension Equity” Plans. These plans are based on “Pension Equity” points, which are typically determined using a sliding scale. Rather than relying solely on years of service, the number of PEP points received in a given year is determined by the sum of the employee’s age and years of service. The age-plus-years-of-service sums are broken into “bands” and a number of “PEP” points are assigned to each band. For example, the first band might comprise workers with less than 36 combined age and years of service and may equal two PEP points, while workers in the 36-45 band have 4 PEP points, those in the 46-55 band have 7 PEP points, and the 56-65 band workers have 10 PEP points. Thus, a 35-year-old employee with ten years’ service would have 4 PEP points and a 60-year-old employee with one year of service would have 13 PEP points.
One of the primary criticisms of defined-benefit plans is that they are biased towards older employees (i.e., benefit accrual is back-weighted to the end of a career). This bias is even more exaggerated under the Pension Equity Plan formula due to the disproportionate effect of age in determining PEP points. While this can be seen as an incentive for older employees to remain loyal to the company, it could also be a distinct disincentive to hiring older employees, as they will immediately begin to accrue significant pension benefits.
On retirement, workers with defined benefit plans typically have several payout options, including:
Single Life Annuity. This option gives the retired worker the maximum monthly payment until death. Payments cease at death with no continuing benefits to any beneficiaries.
Full survivor benefits. In exchange for taking a reduced monthly benefit, a beneficiary continues to receive full monthly payments after the death of the retired worker.
Reduced survivor benefits. In exchange for reduced monthly benefits, a named beneficiary continues to receive a reduced benefit after the retired worker’s death.
Defined Contribution Plans
In the 1980s employers moved away from defined-benefit plans due in large part to increased life expectancy and the mass of baby-boomers in the workplace. This created an imbalance between those receiving benefits and contributing workers; as with the federal Social Security system, fewer and fewer younger workers had to contribute more and more to maintain the benefits to already-retired workers.
These pensions, which include the popular 401(k) plan, sometimes entail contributions from the employer and sometimes are funded entirely by employee contributions. Employer contributions are either automatic or matching. In automatic plans, the employer contributes a set amount, either a percentage of salary or an amount per hours worked. In matching plans, the employer will match any contribution made by the employee up to a set percentage of salary. Typical matching arrangements include 100% (dollar-for-dollar), 50% (50 cents for each dollar contributed by the employee) and hybrids (e.g., 100% for the first 2% of salary and 50% on the next 6%).
On retirement, rather than receiving an annuity, the worker gains access to the retirement account and, typically, can decide on the rate of withdrawal from the account. Therefore, there is some risk that the account may be depleted before the retired worker’s death. And, unlike defined-benefit plans, defined contribution plans are subject to investment risk — pension plan funds can suffer significant losses. The federal Pension Benefit Guaranty Corporation (PBGC) guarantees payment of certain retirement benefits for participants in most private defined-benefit plans if the plan is terminated without enough money to pay all of the promised benefits, but the PBGC does not guarantee benefit payments for defined-contribution plans.
Pension as an Element of Damages
Since pensions can be such a significant element of loss in and injury and death claims, both plaintiffs and defendants should engage in focused discovery on this point. Key documents include collective bargaining agreements and the pension’s “Summary Plan Description,” outlining the details of the particular plan. The forensic economist needs all relevant pension-plan details to produce an accurate assessment of pension-related damages.
Beyond the details of individual pension plans, the claim itself needs to be carefully examined. Some pension-claims are questionable in light of trends in specific industries or the economy in general.
For example, a union ironworker recently claimed lost pension benefits based on an age-62 retirement projection, with the pension multiplier growing at the rate of 7.2 percent annually . However, an examination of the plan liabilities and assets showed a $147 million deficit, with a steady decline in hours worked by union members. The construction industry trend is toward concrete buildings — steel construction, and employment for ironworkers, has significantly diminished since 9/11. Thus, it is unlikely that that the iron worker would have enjoyed a full pension.
A forensic economist, retained early in the case evaluation and preparation process, can help guide discovery, ensuring that no significant pension-plan details are overlooked, and also examine the relative health of the pension plan in light on the general economy and the particular industry involved.
This article originally appeared in Products Liability Law & Strategy, October 2010. Reprinted with permission of ALM Properties Inc.