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.
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
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
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 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
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.
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
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
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
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
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).
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.
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 ...