Cypen & Cypen
AUGUST 9, 2007
Stephen H. Cypen, Esq., Editor
Our readers know that the Treasury Department recently reversed itself, and announced that self-insurance health plans will be eligible to participate in the Healthcare Enhancement for Local Public Safety (HELPS) Retirees Act (see C&C Special Supplement for May 22, 2007). Previously, many firefighter and police officer health plans were not eligible to receive the pre-tax payments under the HELPS programs because they did not utilize services of an outside insurance company to provide health benefits. Now, the “Pension Protection Technical Corrections Act of 2007" has been introduced on August 2, 2007 in the Senate as S. 1974 and on August 3, 2007 in the House of Representatives as HR 3361. The Bill contains technical corrections relating to Titles I through XII of the Pension Protection Act of 2006 (Pub. L. No. 109-280). Staff of the Joint Committee on Taxation has prepared a description of the new Bill, in part as follows:
One less thing to worry about.
Following a recent decision to the same effect (see C&C Newsletter of June 21, 2007, Item 2), the United States Court of Appeals for the Third Circuit decided that the Employee Retirement Income Security Act of 1974 gives an ostensibly cashed-out former employee the right to sue the administrator of his former employer’s 401(k) plan for allegedly mismanaging plan assets and thus reducing his share of benefits. Because ERISA includes such a plaintiff in its definition of “participant,” he has statutory standing to assert his claim. Graden had been a Conexant employee until September, 2002 and an participant in its retirement saving plan until October, 2004. Like most 401(k) plans, Conexant’s is a “defined contribution” one in which participants and the employer contribute money into the participants’ individual accounts. Participants elect to invest their money in various predetermined investment packages. Graden’s choice was a fund composed entirely of Conexant common stock. According to Graden’s complaint, a precipitous drop in the value of Conexant’s shares was the result of a risky and ultimately failed merger. He alleged that Conexant breached its fiduciary duties to him and other plan participants by (1) offering the stock fund as an investment option despite the fact that it was not (and was known not to be) a prudent investment and (2) making false and misleading statements about the merger that caused him to invest in the fund. The court concluded that, when determining participant’s standing under ERISA, the relevant inquiry is whether the plaintiff alleges that his benefit payment was deficient on the day it was paid under terms of the plan and the statute. If so, he states a claim for benefits, which, if colorable, makes him a participant with standing to sue. If, on the other hand, he seeks extracontractual damages or benefits that never vested, then he is not participant, and a federal court cannot entertain his suit. Here, because Graden merely seeks the full amount of benefits owed him given Conexant’s alleged breach of its duty of prudent investment, he has standing to maintain his suit. Therefore, the appellate court vacated the district court’s order dismissing Graden’s complaint for lack of statutory standing, and remanded for further proceedings. Graden v. Conexant Systems Inc., Case No. 06-2337 (U.S. 3d Cir., July 31, 2007).
Firefighters, scientists and teachers are seen as the most prestigious occupations by U.S. adults, while bankers, actors and real estate agents are the least prestigious occupations. These results are from the annual Harris Poll measuring public perceptions of 23 professions and occupations. Six occupations are perceived to have “very great” prestige by at least half of all adults -- firefighters (61%), scientists (54%), teachers (54%), doctors (52%), military officers (52%) and nurses (50%). They are followed by police officers (46%), priests/ministers/clergy (42%) and farmers (41%). By way of contrast, the list includes ten occupations that are perceived by less than 20% of adults to have “very great” prestige, with two being under 10%. The lowest ratings for “very great” prestige go to real estate brokers (5%), actors (9%), bankers (10%), accountants (11%), entertainers (12%), stock brokers (12%), union leaders (13%), journalists(13%), business executives (14%) and athletes (16%). And what about lawyers? Those who say lawyers have “very great” prestige total 22% (down from 36% in 1977).
The United States Government Accountability Office recently convened a forum to address some of the key issues related to modernizing federal disability policy. The economic, medical, technological and social changes have increased opportunities for persons with disabilities to live with greater independence and more fully participate in the workforce. In addition, social and legal changes have promoted the goal of greater inclusion of persons with disabilities in the mainstream of society. However, GAO’s reviews of the largest federal disability programs indicate that such programs have not evolved in line with these larger societal changes and, therefore, are poorly positioned to provide meaningful and timely support for persons with disabilities. Furthermore, program enrollment and costs for the largest federal disability programs have been growing and are poised to grow even more rapidly in the future. The forum brought together a diverse array of experts, including employers; advocate groups, researchers and academia; and federal officials. Although comments expressed do not necessarily represent views of individual participants or the organizations they represent (including GAO), GAO did make some concluding observations. To the extent that federal disability programs are in line with 21st century realities, benefits can be achieved for individuals with disabilities, business and government. Solutions are likely to require fundamental changes, including regulatory and legislative action. Without federal leadership at this critical time to lead this transformation, there could be fewer options in the future available to policymakers seeking to improve federal disability programs. As the country moves forward, the fiscal implications of any new actions -- as well as cost of keeping the status quo -- must be considered. GAO-07-934SP (August, 2007).
The cover story on a recent BusinessWeek deals with “Death Bonds” and profiting from mortality. Death Bond is shorthand for a gentler term the industry prefers: life settlement-backed security. Whatever the name, it is as macabre an investing concept as Wall Street has ever cooked up. Some 90 million Americans own life insurance, but many of them find the premiums too expensive; others would simply prefer to cash in early. “Life settlements” are arrangements that offer people the chance to sell their policies to investors, who keep paying the premiums until the sellers die and collect the payout. For the investors it is a ghoulish actuarial gamble: the quicker the death, the more profit is reaped. Most of the transactions are done by small local firms called life settlement providers, which in the past have typically sold policies to hedge funds. Now, Wall Street sees huge profits in buying policies, throwing them into a pool, dividing the pool into bonds and selling the bonds to pension funds, college endowments and other professional investors. If the market develops as Wall Street expects, ordinary mutual funds will soon be able to get in on the action, too. But the investment banks are wading into murky waters. The life settlements industry increasingly finds itself in a grip of dubious characters devising audacious and in some cases illegal schemes to make money. Many are targeting elderly people with deceptive sales pitches, so many that the National Association of Securities Dealers has issued a warning about abusive practices. Others are promising investors unrealistic returns or misleading them about the risks. Some are doing both. Here is how a life insurance policy becomes a death bond:
Now who said there are a lot of creeps on Wall Street?
Apropos of the previous item, insurance companies do not know what to make of life settlements. On the one hand, they can jeopardize profits that for years have been easily garnered; on the other hand, this burgeoning market cannot be ignored. Before emergence of life settlements, customers who no longer wanted coverage either stopped paying the premiums or sold their policies back to the insurance companies for a fraction of the potential death benefits -- the so-called surrender values. Insurers have long banked on not having to pay on a certain percentage of their policies. Obviously, life settlements eat into those profits. Carriers are especially critical of stranger-initiated policies, which are paid for by hedge funds or other outfits other than individuals. Elderly customers are enticed by life insurance with promotional offers such as free cruises or a promise of free coverage for a short time. After two years, those consumers usually sign over the policies to a hedge fund or another financier, which collects when they die. The insurance industry is fighting back, lobbying regulators to crack down on what it thinks are predatory or outright fraudulent practices. A few states have enacted rules to make it more difficult to generate such policies. Increasingly, insurers are also challenging policies in the first two years after issue, in what is known as the contestability period. During that time, insurers can void a policy if they find evidence of misrepresentation. Other companies are making those policies less attractive by hiking premiums for customers over age 70. Companies figure they will sacrifice income now to protect future profits by scaring off speculators. But most carriers also realize life settlements are not going away, and so they are getting into the game. American International Group, Inc., the world’s largest insurance company, for example, is one of the biggest buyers of life settlements. By sinking money into the sector, the insurers can get back at least some of the money they now have to pay out in death benefits. If someone is going to profit, insurers have realized, it might as well be they. Double creep.
The Miami Herald reports that strong growth in the high-wage financial activity sector and fewer low-paying professional business jobs helped pushed average weekly wages in Miami-Dade County to the fastest-growing among the country’s largest counties. Wage growth in Miami-Dade County was up 8%, more than double the national average, during the fourth quarter of 2006 compared to the same time the year before. The average weekly wage in Miami-Dade was $898.00. Wage growth was slower in Broward County, at $861.00 a week, 5.6% growth between 2005 and 2006. Broward’s average weekly wage was identical to that of the national average. Wages were also boosted by an increase of financial activity employment, which in Miami-Dade grew more than three times faster than the national average. Those jobs are also the highest-paid of any other sector in the County, with average weekly pay of $1,331.00. At 6.5%, construction employment growth in Miami-Dade also bucked the national trend. (Caution: the data are six months old.)
A piece from Deloitte reviews a recent Tax Court decision addressing the disability exception to the Internal Revenue Code §72(t) 10 percent excise tax on early distributions from pension plans and IRAs. The Tax Court concluded that a detention officer with Hepatitis C who took a leave of absence, changed shifts and ultimately quit his job was not “disabled” for purposes of the exception, and thus was required to pay the 10 percent excise tax on the distribution he took upon termination of employment at age 50. Basically, IRC §72(t) imposes a 10 percent excise tax on early distributions from tax-qualified retirement plans, 403(b) plans and IRAs. The 10 percent tax does not apply to distributions:
At issue in this case was the exception for early distributions attributable to the employee’s being “disabled.” In order to qualify for this exception, the employee must be unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration. Substantial gainful activity refers to the activity, or a comparable activity, in which the individual customarily engaged prior to the arising of the disability. Thus, an employee who can still work might be “disabled” if he cannot continue in the same job, or at least a comparable one. A remediable impairment is not a disability. An individual will not be deemed disabled if, with reasonable effort and safety to himself, the impairment can be diminished to the extent that the individual will not be prevented by the impairment from engaging in his customary or any comparable substantial gainful activity. The employee took an early distribution, filed his income tax return claiming the excise tax did not apply because the distribution was attributable to his being disabled, and IRS assessed a deficiency. The Tax Court sided with IRS: even though the Tax Court acknowledged the employee’s illness may have prevented him from working during his treatment, it concluded he failed to show his illness was expected to continue for a long and indefinite period. According to the Tax Court, “indefinite” means it cannot reasonably be anticipated that the impairment will, in the foreseeable future, be so diminished as no longer to prevent substantial gainful activity. The Tax Court decided the employee’s condition was not indefinite, in part, because the employee testified at trial that he had recovered and “feels fine now.” In our judgment, the Tax Court really stretched credulity in this decision. Note: This case does not involve new paragraph (10) of IRC §72(t) added by Section 828 of the Pension Protection Act of 2006 (see C&C Newsletter for September 28, 2006, Item 1). The new section enables police officers, firefighters and emergency medical workers to receive payments from a plan if they leave active service after attainment of age 50, instead of age 55, without being subject to the additional 10 percent early distribution tax.
Moving to clear up confusion about a recent tax law change, Internal Revenue Service has reassured teachers and other school employees that the new deferred-compensation rules will not affect the way their pay is taxed during the upcoming school year. Recently, IRS has received inquiries from teachers who had been told that they had to make certain decisions about their pay, this month, or risk severe penalties. At issue is a 2004 law change that applies to people who decide to defer compensation from one year to a future year. In April, the Treasury Department and IRS issued final rules implementing this law change. Under the 2004 law, when teachers and other employees are given an annualized election -- that is, they are allowed to choose between being paid only during the school year and being paid over a twelve month period -- and they choose a twelve month period, they are deferring part of their income from one year to the next. For instance, a teacher chooses to get paid over a twelve month period, running from August of one year through July of the next year, rather than over the August to May school year, falls under this law. IRS has clarified that the new rules do not require school districts to offer teachers an annualization election. Thus, school districts that have not been offering teachers the selection are not required to start. School districts that offer annualization elections may have to make some changes in their procedures. IRS announced that the new deferred compensation rules will not be applied to annualization elections for school years beginning before January 1, 2008, so school districts and teachers will have time to make any changes that are needed. IR-2007-142 (August 7, 2007).
“If children grew up according to early indications, we should have nothing but geniuses.” Goethe
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Items in this Newsletter may be excerpts or summaries of original or secondary source material, and may have been reorganized for clarity and brevity. This Newsletter is general in nature and is not intended to provide specific legal or other advice.