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Theodore R. Groom
Groom Law Group
1701 Pennsylvania Ave., NW
Washington, D.C. 20006-5893
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2001-03A
ERISA Sec. 3(2)
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Dear Mr. Groom:
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This is in response to your request for an advisory opinion from the
Department of Labor (department) regarding the applicability of Title I of
the Employee Retirement Income Security Act of 1974 (ERISA) in connection
with The Prudential Insurance Company of America’s (Prudential) proposed
plan of demutualization. Your inquiry specifically relates to certain
payroll deduction individual retirement annuities (IRAs) and tax deferred
annuities (TDAs) issued as group contracts to employers acting as the contract holder on behalf of their employees covered under the
contracts. You ask whether such IRAs and TDAs that are otherwise exempt from
coverage under Title I of ERISA by virtue of the department’s regulations
at 29 CFR 2510.3-2(d) and (f) would remain exempt if the employer as the
contract holder: (1) votes on the proposed plan of demutualization; (2)
selects an allocation method for distributing the demutualization proceeds
among the employees covered under the group contract.
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You represent that Prudential is a mutual life insurance company. As a
mutual life insurance company, Prudential has no authorized, issued, or
outstanding stock. Instead, the insurance and annuity policies issued by
Prudential combine both insurance coverage and proprietary ownership rights
(sometimes referred to as membership rights) in Prudential. You
indicate that Prudential is reviewing a proposed draft plan of
reorganization (Plan or Plan of Reorganization) to convert from a mutual
life insurance company to a stock life insurance company (a process known as
demutualization). The Plan of Reorganization is subject to the review
and approval of Prudential’s Board of Directors and the Commissioner of
Banking and Insurance of the State of New Jersey (New Jersey Commissioner).
The Plan will propose that 100% of the equity value of Prudential (currently
estimated to be between 15 and 20 billion dollars) will be distributed to
eligible policyholders in the form of stock, cash, or policy credits. All of
Prudential’s policyholder obligations will remain unchanged and fully in
force after the conversion.
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You state that New Jersey law requires that policyholders who are qualified voters vote as to whether the Plan should be approved. N.J.
Stat. Ann. § 17:17C-5. The demutualization will not be approved unless at
least one million policyholders (or such lesser number as approved by the
New Jersey Commissioner) cast votes and at least two thirds of those voting
vote yes. Id. Each qualified voter is entitled to cast only one
vote, irrespective of the number or value of policies held, unless the
mutual insurer’s charter or bylaws provide otherwise. Id. A qualified voter is defined as a policyholder who is 18 years of age or
more and whose policy has been in force for at least 1 year. N.J. Stat. Ann.
§§ 17:17C-1; 17B:18-13; 17B:18-23. Sections 17B18- 13 and 17B:18-23 of the
New Jersey statutes confirm the qualified voter shall be the
policyholder in the case of a group life or health policy and the contract
holder in the case of a group annuity contract.
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You indicate that under New Jersey law, the term policy means an
individual or group policy of insurance or annuity contract issued, or
deemed by the plan of reorganization to have been issued, by the mutual
insurer. The individual certificates or similar evidence of interests in
a group annuity contract that are given to employees covered under a
contract issued to an employer as group contract holder are not treated as
separate policies. However, for certain group policies or contracts
issued to a trust or group established by the insurer, the certificates or
evidence of interests may be deemed to be a policy solely for purposes of
determining the right to receive consideration under the Plan of
Reorganization. N.J. Stat. Ann. § 17:17C-1. Thus, you represent the vote on
the Prudential Plan of Reorganization will be exercisable by the group
contract holder (who will generally be the employer in the case of TDAs and
IRAs) and not individual certificate holders under a group contract.
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If the Plan of Reorganization is approved, all policyholders’ membership
rights in Prudential will be extinguished. Payments of stock, cash, or
policy credits (i.e., enhancements to policy values) will be made in
consideration of the policyholders’ extinguished membership rights. You
represent that Prudential, like other insurance companies that already have
demutualized, will grant policy credits instead of stock or cash
distributions to TDAs, IRAs, and certain individual contracts held under
plans qualified under section 401(a) of the Internal Revenue Code. You
represent that distributing only policy credits to TDAs and IRAs is
necessary to permit these plans to continue to operate in a manner
consistent with federal tax laws, to maintain the consideration in a
tax-favored retirement solution, and still to participate equitably in the
demutualization.
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The amount of the distributions will be established pursuant to actuarial
valuations reviewed and approved by the New Jersey Commissioner. You
represent that under Prudential’s proposed demutualization, there are two
components of compensation for eligible policyholders — fixed and
variable. Each eligible policyholder will be allocated the same basic fixed
component. The variable component will be provided to those eligible
policyholders whose policies produce a positive contribution to
Prudential’s surplus. The variable component focuses on the contribution
of the policy as a whole to Prudential’s surplus, including both the
historical and anticipated future contributions to surplus. A policy’s
contribution to surplus is determined by identifying the profit and expense
associated with that contract. Profits and expenses can be affected by, for
example, the type of policy, the date it was issued, and the period during
which it was outstanding. Moreover, Prudential’s surplus, as reflected on
applicable financial statements, will not be distributed to policyholders.
Instead, the relative contribution to surplus of each eligible contract is
determined, and then each policyholder is given a corresponding percentage
allocation. That percentage allocation is then translated into a number of
shares, and the results of the initial public offering will determine the
value of those shares.
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With respect to the allocation of policy credits among individual
certificate holders under group IRA and TDA contracts, you note that the
most likely of the possible allocation methods among individual participants
in a group policy are pro rata by account balance (or premiums paid) or per
capita. You indicate that neither method is necessarily more appropriate in
all cases. For example, the pro rata approach may recognize the relative
amounts paid into the contract by individual participants (certificate
holders), but it allocates to current participants with large current
balances (or premium histories) a higher share of the historical surplus, a
surplus that may have been attributable to long-departed employees. The per
capita approach generally will allocate an equal share of the group
contract’s demutualization proceeds to all the individual participants
(certificate holders) covered under the group contract (even lower-paid
participants with small overall account balances) and will not favor highly
compensated employees, but does not recognize that the higher premiums paid
by certain certificate holders might have contributed to Prudential’s
profitability. You represent that Prudential will use the per capita method
as the default allocation method for those IRA and TDA policyholders
(as well as other record- keeping clients) who do not affirmatively
designate an allocation method. The per capita method was chosen
because Prudential concluded it was fair under the circumstances.(1)
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Finally, you represent that in connection with the vote, each policyholder,
including group policyholders, will be provided with a Policyholder
Information Booklet, that provides: (1) notice of a public hearing to be
held by the insurance department; (2) notice of the policyholder vote; (3) a
detailed summary of the proposed
Plan. Prudential will also provide a
Group Guide to group policyholders. The Group Guide identifies issues that
must be addressed by plans, group TDAs and group IRAs receiving
demutualization proceeds, including the possibility that proceeds will have
to be allocated among individual participants covered by a group contract.
Following the distribution of the Group Guide, Prudential will send a letter
to each group policyholder: (1) specifically describing the methods of
allocating the proceeds among the individual participants/certificate
holders covered by the group policy that Prudential is administratively able
to implement; (2) soliciting the group policyholder’s direction as to
its desired participant allocation method (Allocation Letter). A
follow-up letter (Follow-up Letter) will be sent to those group
policyholders who have not provided an affirmative participant allocation
direction within 30 days after the Allocation Letter is sent. The Follow-up
Letter will reiterate Prudential’s request for an affirmative direction,
but indicate that if a direction is not received by a date that is at least
30 days from the date of the Follow-up Letter, the policyholder will be
deemed to have directed Prudential to implement the default allocation
method (i.e., the per capita method).
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Under provisions of the Internal Revenue Code (Code), individual taxpayers
may establish IRAs and TDAs that are tax-favored if operated within the
requirements of the Code. With respect to Title I coverage of such IRAs and
TDAs, the department published regulations at 29 CFR 2510.3–2(d) and (f),
establishing safe harbors under which an IRA or TDA established by employees
and funded through payroll deductions will not be considered to be an ERISA-
covered "pension plan’’ within the meaning of section 3(2) of Title I
when the conditions of the regulation are satisfied.(2) If one or more of
the conditions of the regulations are not met, the employer may be
considered to have established or maintained an ERISA-covered pension
plan. The department has acknowledged that group annuity contract
arrangements may offer cost advantages to employees and has agreed that an
employer may become the holder of such a group contract and may exercise
certain rights with respect to the contract on behalf of its employees
without exceeding the limits on employer involvement set forth in 29 CFR
2510.3–2(f). See 44 Fed. Reg. 23525 (April 20, 1979). The department emphasized, however, that an employer who wishes to meet the terms of the
regulation could not exercise rights under a group contract except as an
authorized representative of its employees covered under the contract. Id.
Similarly, the department believes that an employer may be the holder of a
group IRA contract and may exercise certain rights with respect to the
contract as an authorized representative of its employees without exceeding
the limits on employer involvement set forth in 29 CFR 2510.3-2(d).
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The department further believes that even in cases where employer actions
may not fully conform with the safe harbor provisions in 29 CFR
2510.3-2(d) and (f), an IRA or TDA program may nevertheless be treated as
not established or maintained by an employer for the purposes of Title
I of the Act. In this case, it is the department’s view that group annuity
arrangements consisting of either payroll deduction IRAs or TDAs that are
otherwise exempt from coverage under Title I of ERISA by virtue of the safe harbors in 29 CFR 2510.3-2(d) and (f) would not be treated as
pension plans covered by Title I of ERISA solely as a result of the employer
in whose name the group policy is issued voting on the Plan of
Reorganization as provided for by New Jersey law and selecting one of the
allocation methods for distributing the demutualization proceeds among the
employees covered under the group contract.(3) In reaching this conclusion,
we note in particular that: (1) actions of Prudential independent of the
employer gave rise to the employer’s need, as the titled group contract
holder, to take action on behalf of the covered employees with respect to
the demutualization; (2) the employer would be acting in accordance with
specific provisions in New Jersey law governing the demutualization and
pursuant to the requirements of Prudential’s Plan of Reorganization that
is being approved and supervised by the New Jersey Commissioner of Insurance;
(3) the vote on the demutualization and the decision on the
method for allocation of proceeds thereunder are unique, one-time acts that
do not involve the employer retaining any discretion regarding the on-going
administration or operation of the IRAs or TDAs.
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As noted above, however, the employer may be considered to have established or maintained an ERISA covered pension plan if the IRA or
TDA arrangements do not otherwise meet the requirements of 29 CFR
2510.3-2(d) or (f), including the requirement that the employer receive no
direct or indirect consideration or compensation in cash or otherwise other
than reasonable compensation to cover the actual costs of the salary
reduction or payroll deduction program of the employer described in
subparagraphs (d)(1)(iv) or (f)(4). In that regard, so long as all the
demutualization proceeds are distributed among the individual participants
covered under the group IRA or TDA contract, the department would not view
the receipt of an allocated share by an employer who is also a participant
in the group contract in and of itself to be employer consideration within
the meaning of 29 CFR 2510.3-2(d)(1)(iv) and (f)(4).
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This letter constitutes an advisory opinion under ERISA Procedure 76-1, 41
Fed. Reg. 36281 (1976). Accordingly, this letter is issued subject to the
provisions of that procedure, including section 10 thereof, relating to the
effect of advisory opinions.
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Sincerely,
John J. Canary
Chief, Division of Coverage, Reporting and Disclosure
Office of Regulations and Interpretations
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Prudential has chosen the per capita
allocation method for the Prudential-sponsored plans involved in the
demutualization.
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ERISA section 3(2)(A) provides that
??any plan, fund, or program . . . established or maintained by an
employer or by an employee organization, or by both,’’ shall be a
pension plan ??to the extent that by its express terms or as a result
of surrounding circumstances such plan, fund, or program . . .
provides retirement income to employees, or . . . results in a
deferral of income by employees for periods extending to the
termination of covered employment or beyond, regardless of the method
of calculating the contributions made to the plan, the method of
calculating the benefits under the plan or the method of distributing
benefits from the plan.
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Whether or not an IRA or TDA is part
of a Title I pension plan, the prohibited transaction provisions of
section 4975 of the Code are applicable to transactions by the IRA or
TDA. Under Presidential Reorganization Plan No. 4 of 1978, the
authority of the Secretary of the Treasury to issue interpretations
regarding section 4975 has been transferred, with certain exceptions
not here relevant, to the Secretary of Labor. This letter does not
provide any views on the applicability of Code section 4975 to any
decisions by Prudential or by any employer with respect to the
demutualization or the allocation of demutualization proceeds among
employees. Certain Title I and corresponding Code section 4975 issues
relating to the demutualization are addressed in a companion letter (ERISA
Opinion 2001-02A) issued simultaneously with this letter.
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