An important decision by the United States Court of Appeals for the Sixth Circuit may significantly impact withdrawal liability assessments.  In Sofco Erectors, Inc. v. Trustees of the Ohio Operating Engineers Pension Fund,1 the Court held that the pension fund could not utilize the “Segal Blend” interest rate to calculate the employer’s withdrawal liability.  In so doing, the Sofco Court stated that the Segal Blend rate was based on a hypothetical rate of return that did not accurately reflect the current financial state of the fund.  Application of a higher interest rate assumption was undoubtedly good news for the employer insofar as it will result in a lower withdrawal liability assessment.  While the Sofco decision is only one of a few federal court opinions2 that disapproved of the Segal Blend, this most recent ruling may persuade other courts to follow suit.

Multiemployer Plans and Withdrawal Liability

Before delving into the Sofco decision, a brief review of multiemployer pension plans, withdrawal liability and interest rate assumptions is warranted.  Multiemployer pension plans are funded by contributions from two or more unrelated employers, typically within the same industry.  It is no secret that many multiemployer plans experienced funding deficiencies.  To address those underfunding issues, Congress enacted the Multiemployer Pension Plan Amendments Act of 1980 (“MPPAA”).  Among other things, MPPAA imposed financial obligations, known as withdrawal liability, on employers that withdrew from underfunded multiemployer plans.  Stated generally, withdrawal liability represents the employer’s proportionate share of the pension fund’s underfunded present and future benefit obligations, determined as the excess of the fund’s vested benefit liability relative to the fund’s assets.

The Role of Interest Rate Assumptions in Withdrawal Liability Calculations and Minimum Funding Analysis

Pension funds hire actuaries to evaluate minimum funding levels and withdrawal liability.  Analysis of funding levels is critical in determining whether the pension fund has sufficient assets to pay future liabilities.  This process requires the actuary to determine the present value of future liabilities or, in other words, what assets the pension fund needs today to pay future liabilities.  In performing this analysis, the actuary must make certain assumptions about the rate of return those current assets will generate.  If, for example, the pension fund experiences a high rate of return on its assets, the fund will need less in funds on hand to satisfy its future obligations.  Conversely, if the actuary applies a lower anticipated rate of return, the fund will require more current assets on its balance sheet to pay future liabilities.  The assumptions regarding the projected rate of return – the interest rate assumption – is necessary in determining the present value of future liabilities and played a critical role in the Sofco decision.

Facts and Procedural History of Sofco

Sofco Erectors, Inc. (“Employer”) was a party to a collective bargaining agreement (the “CBA”) with the International Union of Operating Engineers, Local 18.  Pursuant to the CBA, the Employer was obligated to make contributions to a multiemployer pension fund (the “Fund”) on behalf of its covered employees.  After the CBA was terminated, the Fund assessed the Employer with withdrawal liability in excess of $1 million.

Significantly, the Fund’s actuary used a lower interest rate assumption in calculating the amount of the withdrawal liability assessment than it used to determine the Fund’s required minimum funding.  In calculating withdrawal liability, the actuary employed the “Segal Blend” method which “blended” the interest rate used by the Fund for minimum funding purposes (7.25%) with the PBGC’s published interest rate on annuities (2-3%).3  Thus, the amount of the withdrawal liability was higher than it would have been had the same minimum funding rate been applied.

The Employer’s challenge of the withdrawal liability assessment was rejected in arbitration.  Thereafter, the litigation proceeded to the Sixth Circuit where the Court addressed the threshold question of whether it was reasonable for the Fund to apply two different interest rate assumptions.4

Sofco’s Holding

In evaluating the Employer’s challenge, the Sixth Circuit observed that ERISA requires an actuary’s calculation of withdrawal liability to use:

.actuarial assumptions and methods which, in the aggregate, are reasonable (taking into account the experience of the plan and reasonable expectations) and which, in combination, offer the actuary’s best estimate of anticipated experience under the plan…5

The Court concluded that the application of the Segal Blend violated ERISA because the resulting interest rate was not the actuary’s best estimate of anticipated experience under the plan.  The Sofco Court observed that the Segal Blend incorporated a rate of return that is typically applied when pension funds are terminated due to a mass withdrawal of contributing employers.6  Because the Fund had not experienced a mass withdrawal, and was not terminating, the Segal Blend did not reflect the anticipated experience under the plan.  In sum, the Segal Blend was not the best estimate of the Fund’s future experience, in that it factored in rates on annuities which the Fund might never be required to purchase and reflected a hypothetical termination of the Fund which might never happen.

Sofco’s Impact

The Sofco decision is significant for several reasons.  While the Court recognized that the actuary’s assumptions were entitled to deference, it ultimately refused to accept those assumptions as sacrosanct. Instead, the Court dissected the actuary’s analysis and found that the actuary’s findings did not comport with ERISA requirements (ie., assessments based on the actual experience of the plan and reasonable expectations).  This much is clear.

This opinion may also inspire both employers and pension funds to reassess their withdrawal liability strategies.  For their part, employers may be motivated by Sofco to challenge withdrawal liability assessments that are premised on the Segal Blend or other interest rate assumptions that do not reflect the fund’s historical experiences.  On the other hand, funds may reconsider use of the Segal Blend if it results in a significant departure from the rate used to evaluate minimum funding standards or would otherwise raise red flags.  On this, we will need to wait and see.