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November 22, 2000


The opinion of the court was delivered by: Chin, District Judge.


In this case, the current and former trustees and sponsors of an employee retirement plan contend that defendant and third-party plaintiff John Hancock Mutual Life Insurance Co. ("Hancock"), a fiduciary of the plan, breached its obligations under the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), 29 U.S.C. § 1001 et seq.

The case was tried to the Court. For the reasons that follow, judgment will be entered in favor of plaintiffs against Hancock to the extent set forth below. My findings of fact and conclusions of law follow.


A. The Parties

Plaintiff Harris Trust and Savings Bank ("Harris Trust") is the former Trustee for the Unisys Master Trust, which is the successor to the Sperry Rand Master Retirement Trust No. 2. Plaintiff The Bank of New York ("BONY") replaced Harris Trust as Trustee for the Unisys Master Trust as of July 1, 1996. Counterclaim defendant and former plaintiff Chase Manhattan Bank, N.A. ("Chase") was a Trustee for the Sperry Rand Master Retirement Trust No. 2 in the 1970's and 1980's. Chase, Harris Trust, and BONY are hereafter referred to collectively as the "Trustee." The Sperry Rand Master Retirement Trust No. 2 and its successor, the Unisys Master Trust, are hereafter referred to as the "Trust."

Third-party defendant Sperry Corporation is a successor to Sperry Rand Corporation. Sperry Corporation merged with Burroughs Corporation in 1986 to form Unisys Corporation. Sperry Corporation, Sperry Rand Corporation, and Unisys Corporation are hereafter referred to as "Sperry." Sperry is the sponsor of the Sperry Retirement Program and its successor, the Unisys Pension Plan (together, the "Plan").

Third-party defendant The Retirement Committee of Sperry Corporation (the "SRC") was a "named fiduciary" for the Plan. The duties previously performed by the SRC are now performed by the Pension Investment Review Committee (the "PIRC") of Unisys Corporation.

Defendant Hancock, an insurance company, is a holder of assets and a fiduciary of the Plan. See generally John Hancock Mut. Life Ins. Co. v. Harris Trust & Sav. Bank, 510 U.S. 86, 101-06, 114 S.Ct. 517, 126 L.Ed.2d 524 (1993) (holding that assets at issue in this case were "plan assets" and that Hancock was a fiduciary for purposes of ERISA).

B. Hancock's Group Contracts

In general, during the relevant time period Hancock issued two types of group annuity or pension contracts: "participating" and "nonparticipating."

Holders of "participating" contracts participated in Hancock's overall investment experience, as deposits (or premiums paid to obtain retirement benefits) were commingled with other assets and investments in Hancock's "General Account." The General Account was used by Hancock to pay its operating costs and to satisfy its obligations to policyholders and creditors. The General Account also generated income as Hancock's general corporate assets were invested in different types of investments.*fn1 Hancock had the sole authority and discretion, with respect to its General Account, to set and execute investment policy and to allocate investment income, capital gains and losses, and expenses to particular lines of business, classes of contracts, and particular contracts.

Participation could be "dividend-rated" or "direct-rated." For dividend-rated contracts, investment income attributable to the contract, to the extent it was more favorable than interest assumptions incorporated into the contract, was distributed to the contract, in whole or in part, in the form of dividends. Hancock's Board of Directors annually voted, in its "dividend vote," to apportion and pay or allow a distribution of surplus with respect to eligible group annuity contracts and voted to adopt formulas for determining the distribution of such surplus. For direct-rated contracts, investment income attributable to the contract was directly credited to the contract's "fund."

Holders of "nonparticipating" contracts, such as Guaranteed Investment Contracts ("GICs") and Single Premium Annuity Contracts, were not entitled to share in the investment experience of the General Account. Instead, nonparticipating contracts usually contained a guaranteed rate of return or other similar type of guarantee.

In 1959, Hancock changed its method for allocating investment income by adopting the "investment generation" method, which tracked the net increase in the experience account of each contract for each year (the "cell").*fn2

C. GAC 50

In 1941, Hancock and Sperry entered into Group Annuity Contract No. 50 ("GAC 50") to fund a retirement plan for the benefit of Sperry employees. From its inception until December 31, 1967, GAC 50 was a dividend-rated participating contract. Since January 1, 1968, GAC 50 has been partially direct-rated and partially dividend-rated.

From its inception until December 31, 1967, GAC 50 was a deferred annuity contract. During this period, Sperry purchased deferred annuities from Hancock on an annual basis for each eligible employee. These annuities were payable to the employees (or their beneficiaries) upon their retirement.

Sperry paid Hancock premiums (which were deposited into Hancock's General Account and were sometimes referred to as "contributions") for each employee in accordance with purchase rate tables contained in the contract. In general, these tables incorporated three factors: (a) mortality rates that estimated actuarily (i) the probability that an annuitant benefit would be payable at each month following an annuitant's retirement at the assumed retirement age under the contract and (ii) if and when a death benefit would be paid; (b) an interest assumption for determining the "present value" of the stream of future benefits; and (c) a provision for future expenses, called "loading."

From its inception in 1941 until December 31, 1967, GAC 50 incorporated interest assumptions of 2% to 3%.

GAC 50 originally required Sperry to purchase deferred annuities annually from Hancock for all eligible employees. It also originally provided that, should Sperry cease making annual contributions to Hancock to purchase deferred annuities, the rights of eligible employees to the annuities already purchased would immediately become vested, even if such employees' rights to pension benefits had not yet vested under the Plan. Hence, Sperry was required to continue purchasing, on an annual basis, annuities for active employees or, if it ceased doing so, these employees' rights to pension benefits would immediately vest.

D. The 1968 Amendment

GAC 50 was amended as of January 1, 1968 (the "1968 Amendment"). It was converted from a deferred annuity plan to a Retrospective Immediate Participation Guarantee ("Retro-IPG") form of contract. The deferred annuities purchased prior to January 1, 1968, were cancelled and the assets supporting them were placed in a Pension Administration Fund (the "PAF"). The cancellation of these pre-1968 annuities did not affect Hancock's guarantee of benefits to participants and beneficiaries.

In its Retro-IPG form, GAC 50 operated as follows: net investment income from Hancock's General Account was directly credited to GAC 50's PAF on an annual basis. The amount credited depended upon the investment performance of Hancock's General Account and the allocation of the performance to the PAF.

The 1968 Amendment required Hancock to maintain the PAF at a level sufficient to meet the "Liabilities of the Fund" (the "LOF") as computed by Hancock. The LOF is the contractual reserve for the pension benefit obligations guaranteed by Hancock. For the pre-1968 cancelled annuities, the LOF was computed assuming rates of return of 2.5 or 3%, depending on when the benefits were first guaranteed, and using the 1937 Standard Annuity and 1951 Group Annuity Mortality Tables, with specified adjustments to reflect mortality improvement.

The 1968 Amendment also required the PAF to be maintained at a "minimum operating level" (the "MOL") of at least 105% of the LOF. Amounts in the PAF in excess of the MOL were referred to as "free funds."

If the PAF balance fell below the MOL, or if the Trustee sought to remove the "free funds" through GAC 50's transfer provisions, the PAF would automatically terminate and GAC 50 would cease to function as a Retro-IPG. Hancock would "repurchase" the cancelled pre-1968 annuities at the original 2 1/2 to 3% interest rates and the contract would revert back to a deferred annuity form. (PX 25 at Art. III, §§ 7, 9; Tr. 764-67). As a practical matter, removal of the "free funds" pursuant to the transfer provisions was not a viable option for the Trustee, for such a lumpsum transfer would have been prohibitively expensive because of the low interest rate assumptions used to price the "repurchased" annuities. (Tr. 150-51). Transfer under the contract also was also unattractive from the Trust's perspective because any such transfers were subject to an Asset Liquidation Adjustment ("ALA"), an adjustment to the amounts transferred to account for investment losses (or gains) to Hancock resulting from the liquidation of any assets. (PX 25, Art. III, § 9). In late 1981, Hancock estimated the ALA for GAC 50 transfers to be 39.4%, a figure that the Trust believed was excessive. (PX 561, 596; Tr. 728-29).

The 1968 Amendment also provided additional benefit payments to be guaranteed by Hancock. Upon the retirement of an eligible employee after 1968, Hancock would determine the amount by which the LOF would increase if the portion of the retirement benefit for the period after January 1, 1968, were to be "guaranteed" by Hancock. If GAC 50's PAF balance exceeded the MOL based on the increased LOF, Hancock would guarantee the payment of the additional pension benefits. Under the 1968 Amendment, Hancock had the right after 1972 to change these rate tables, but the new table would apply only to benefits guaranteed after the effective date of the change in the tables.

The 1968 Amendment also created a "Contingency Account," consisting of funds associated with GAC 50 to be held in Hancock's General Account. Since January 1, 1968, all investment income attributable to the Contingency Account has been allocated to GAC 50's PAF.

The 1968 Amendment also provided that Hancock would credit the PAF annually with the PAF's share and the Contingency Account's share of the net interest earned and apportioned to Hancock's Group Pension line of business, less 1% of such share.

Hancock has maintained a record, known as "Account 9," which included the amount of the risk charges in excess of one percent of net interest that would have been allocable to GAC 50 under Hancock's annual risk charge votes but for the 1% provision. The Account 9 record also included, among other things, the amounts of net interest, realized capital gains and losses, and taxes that would have been allocated to Hancock's unallocated surplus had the risk charges in excess of 1% of net interest been charged to GAC 50.

Since January 1, 1968, GAC 50's LOF has been equal to or greater than its PAF balance. Since at least the early 1970's, the PAF balance in GAC 50 has exceeded the MOL (and thus the LOF).

E. The 1977 Amendment

GAC 50 was amended again as of August 1, 1977 (the "1977 Amendment"). The 1977 Amendment converted GAC 50 to a Retrospective Immediate Participation Guarantee/Prospective Deferred Liability ("Retro-IPG-PDL") form of contract. Under this amendment, the LOF would not be automatically increased upon the retirement of an employee, and new retirement benefits would not be guaranteed by Hancock. The SRC had the right to ask Hancock to guarantee benefits for retirees, but in fact it did not do so.

The 1977 Amendment permitted the SRC to designate employees to receive non-guaranteed benefits using the "free funds" in the PAF. The Plan remained ultimately responsible for the pension liability to such individuals; the payment risk was not shifted to Hancock.

On the effective date of the 1977 Amendment, the automatic addition of new guarantees ceased. (PX 25, Amendment No. 17). Since then, Sperry has never asked Hancock to guarantee any additional annuities, so the population of retirees has been frozen. (Tr. 1337-38, 1369). The LOF decreased while the PAF continued to increase. (Tr. 1338-39; PX 1244).

F. The Use of Free Funds

The gap between the LOF and GAC 50 assets (the PAF plus the Contingency Account) was $22 million at year-end 1981 and $56 million at year-end 1987, according to Hancock's numbers. (PXs 1241, 1242, 1244). According to Sperry, the "true" excess, as of year-end 1981, was more in the vicinity of $38 million to $50 million or more. (PXs 1240, 1241; see also PX 561, 621D; Tr. 731). In short, Hancock was retaining more funds in its General Account with respect to Sperry pensioners and employees than was necessary, and the issue arose as to what to do with the excess, or free funds.

After the 1977 Amendment, the SRC did designate employees to receive non-guaranteed benefits. Hancock paid such benefits out of the free funds of the PAF through June 1982. Free funds were also withdrawn from the PAF on other occasions, using a "rollover" procedure that Hancock had adopted in 1972 to permit contractholders to withdraw a portion of excess funds without any "market value adjustment" to account for differences between the "book" and "market" value of General Account assets.

From the late 1970's on, the SRC sought to reduce the amount of Plan assets invested in Hancock's General Account as it changed its investment strategies. It sought to shift, to some extent, from the kind of fixed income investments generally purchased with insurance company General Account funds to equity investments. The SRC also was dissatisfied with the rate of return from Plan assets invested in Hancock's General Account; Thomas Hirschberg, for example, believed that income to the Plan could be increased by transferring free funds into "other media." (Tr. 1513). Richard Raskin, an actuary who provided pension advice to Sperry during the period in question, confirmed that the SRC felt it could "do better" in terms of investing by getting the excess funds back, and he noted also that the SRC had an obligation under ERISA to "maximize the investment return." (Tr. 712-13).

On three occasions, in 1977, 1979, and 1981, the Sperry Trust withdrew funds — a total of approximately $12 million of Plan assets — from the PAF's accumulated free funds, using the rollover procedure. The SRC transferred these amounts to the Plan's other money managers.

In 1982, the SRC attempted again to use the rollover procedure to withdraw accumulated free funds, but Hancock refused to let the SRC do so, citing its own cash-flow needs. (ASF ¶¶ 77-79; Tr. 1488-89, 1607-13, 1689-90). The SRC then attempted to withdraw accumulated free funds to pay non-guaranteed benefits, but Hancock provided notice that it would no longer pay non-guaranteed benefits under the Retro-IPG-PDL (as it had been doing through June 1982). (PX 662; ASF ¶¶ 83, 84; PX 675; Tr. 811-12, 894-96, 1325). As a consequence of Hancock's refusals to permit such access to "free funds," the only mechanism available for the SRC to withdraw "free funds" were the transfer provisions of GAC 50. Again, however, that was not a viable option because of the pricing scheme.

Hancock did not consider its obligations under ERISA to the Plan when it decided to terminate the rollover procedure or the payment of non-guaranteed benefits with excess funds. (Tr. 1352-54). Instead, it used Plan assets for its own benefit: to help address its own cash flow problems, as "one more way of limiting cash outflows." (Tr. 1612; see Tr. 736; see also PX 593). In addition, by refusing to permit the withdrawal of "free funds," Hancock was able to continue collecting charges on the investment income generated by these funds. (Tr. 313-14). There was no question that the "free funds" belonged to the Trust; the issues confronting the parties were how to compute the amount of the excess funds, when Hancock had to give them back, and under what circumstances. (See Tr. 752-54).

Throughout this period, Hancock assessed the Trust risk charges. Hancock did not actually face any risk with respect to the free funds during this time period, however, because it was "sufficiently protected" by other provisions of GAC 50 so that it was not at "material risk." (Tr. at 313-14, 343-44, 401-02). Therefore, the excess risk charges collected by Hancock during this time period constituted over-compensation.

G. Revaluation

For some years prior to 1981, Sperry had been questioning Hancock on whether it was willing to revalue annuities to reflect changes in interest rates. (PX 449). Hancock's response was that its "policy" was to continue to value the annuities "on the basis on which they were originally purchased." (Id.). Hancock itself recognized, however, that there was a problem in using the original rates:

Interest rates have risen dramatically over the last several years and have risen gradually over a much longer period. Over these periods the case earnings rate of most of our retro IPG conversions and issue IPG's has risen as well. However, most of these contracts contain fixed interest, mortality, and loading assumptions for a major portion of the LOF. The rise in case rates has resulted in sizable differences between the case rate and the various interest assumptions of the LOF, especially for canceled annuities. The difference approaches 5% in some instances. The current size of such differences has resulted in numerous customer complaints that LOF amounts are absurdly conservative and should be revalued using higher interest rates.

(PX 572). In an internal memorandum addressing the issue, Hancock recognized that "[f]ar greater margins exist in LOF amounts than were imagined when the fixed LOF basis was established, and we should pass these prospective gains on faster than we are doing now." (Id.). The memorandum showed, however, that Hancock was motivated ...

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