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Employee Benefits Security Administration

Advisory Opinion

June 26, 2003

2003-08A
ERISA Sec. 403(2) to 403(d)(2)

Stephen R. Kern
McNees Wallace & Nurick LLC
PO Box 1166, 100 Pine Street
Harrisburg, PA 17108-1166

Dear Mr. Kern:

This is in response to your request for an advisory opinion under Title I of the Employee Retirement Income Security Act of 1974 (ERISA) as to the disposition of surplus assets on the termination of the Pennsylvania Automotive Association Insurance Trust (Trust or Plan). Specifically, you ask whether, after all outstanding claims for benefits have been satisfied and all surplus attributable to participant contributions has been used for the provision of benefits, the remaining surplus assets may be transferred to a charitable foundation that is not a party in interest under section 3(14) of ERISA in accordance with the terms of the trust document. You also ask whether it is permissible under section 410 of ERISA for an entity related to the Plan sponsor to agree to indemnify the Plan and its trustee fiduciaries for any claims that might be asserted against them as a result of the termination of the Plan so long as the indemnification will not relieve the fiduciaries of any liability for breach of fiduciary duty.

You represent that the Pennsylvania Automobile Association (Association) is a trade association exempt from federal income tax pursuant to section 501(c)(6) of the Internal Revenue Code of 1986 (the Code), as amended. The Trust is a multiple employer welfare benefit arrangement (MEWA) that was originally established by the Association on October 1, 1947, and was most recently amended and restated effective as of January 1, 1998. You represent that the Association meets the definition of “employer” in section 3(5) of ERISA, and therefore, the Trust is a plan within the meaning of section 3(1) of ERISA.(1)

The Plan provides health, life, short-term disability, long-term disability, vision and dental insurance to the employees of those members of the Association who choose to participate in the Plan. You represent that at present, approximately 1,000 employers participate in the Plan and that the Plan provides welfare benefits to approximately 27,000 participants and beneficiaries. All benefits under the Plan are provided through insurance contracts with five insurance carriers with respect to which the Plan is the policyholder.

You further represent that on an annualized basis, approximately $60 million of premium payments for the various insurance contracts are funded through the Trust. A small portion of the funding is derived from employee contributions. You represent that the Plan currently holds approximately $4 million in an operating fund (Operating Fund). You state that one of the purposes of the Operating Fund is to protect participants and beneficiaries by paying monthly insurance premiums if their employers fail to pay these premiums when due, in which case benefits would otherwise cease for affected individuals. The Plan’s trustee fiduciaries established a policy that the Operating Fund is not to exceed an amount equal to one month’s total premium payments for benefits under the Plan ($5 million). The source of the Operating Fund’s assets are administrative fees paid by all participating employers, “reinstatement” fees paid by delinquent employers, investment income, and dividends paid prior to 1999 by Prudential Financial, Inc., formerly known as Prudential Insurance Company of America (Prudential), one of the insurance carriers with which the Plan has contracted to provide benefits under the Plan.

You state that since 1998, the Association has been considering terminating the Plan and Trust and establishing a new approach to providing welfare benefits to the employees of its members. You indicate that certain insurance carriers now prefer, for business reasons, to contract directly with a corporate entity rather than with the Trust. Moreover, the Association has reviewed its role in relation to the Trust and determined that it does not, as settlor, wish to continue to use a funding vehicle in the nature of the current Trust, due to the time and expense associated with the operation of such an arrangement. The Association intends to establish a new plan (the Association Plan) to provide various welfare benefits to employees of the participating Association members.

On December 15, 2000, Prudential announced to its policyholders that it would be undergoing a demutualization.(2)  In January of 2002, pursuant to Prudential’s demutualization, the Plan, as a Prudential policyholder, received 217,222 shares of Prudential stock that had a value of $27.50 per share on the date of issuance.

In connection with its decision to terminate the Plan, the trustees determined that the portion of the Trust surplus attributable to participant contributions, which includes both a portion of the Operating Fund and the Prudential demutualization proceeds, will be utilized to provide benefits to the Plan’s participants and beneficiaries. In that regard, because whether, and to what extent, employee contributions are required is determined on an employer-by-employer and benefit-by-benefit basis by each of the 1,000 participating employers, the trustees could not determine the exact amount attributable to employee contributions, most of which have been made in the last few years of the Plan’s 54-year operating history. The Plan’s trustee fiduciaries engaged a CPA firm (“the CPA Firm”) to devise and perform a data sampling analysis in order to determine the amount of the Prudential proceeds and Operating Fund assets that are attributable to participant contributions. The CPA Firm determined, based on its sampling analysis, that the portion of the Prudential demutualization proceeds attributable to participant contributions is less than 7.2% of the total proceeds.

You also represent that the Plan’s trustee fiduciaries determined, in connection with its decision to terminate the Plan, that 46% of the Operating Fund’s revenues during the 10-year period ending December 31, 2000, were generated by revenue from Prudential, which was the only revenue source attributable to participant contributions. As noted above, the trustee fiduciaries determined that less than 7.2% of the demutualization proceeds were generated by participant contributions. Accordingly, the trustee fiduciaries have determined that separate and apart from the demutualization proceeds, 3.3% of the funds in the Operating Fund (7.2% of 46%) are attributable to participant contributions.

You represent further that prior to the Plan’s termination, all remaining Plan liabilities will be satisfied. All remaining insurance contracts held by the Trust will be terminated. The Association Plan will establish new contracts with various insurance providers. As part of the termination of the Plan, however, the Association Plan will assume any of the Plan’s potential liability for unfiled, unanticipated claims, if any, so that affected Plan participants and beneficiaries will be fully protected.

After the portion of the Plan’s Operating Fund and the demutualization proceeds are used to provide benefits for participants and beneficiaries and all remaining Plan liabilities are satisfied, the trustees propose to distribute the surplus plan assets remaining pursuant to Section 1 of Article IX of the Trust, which provides, in pertinent part, that “the Trustees may transfer all or a part of a surplus in the Fund to a foundation qualified under Section 501(c)(3) of the Internal Revenue Code of 1986, as amended, the purpose of which shall be to carry on educational and charitable activities as defined for the purposes of Section 501(c)(3) for the benefit of Employees and those generally affiliated with the automotive industry in the Commonwealth of Pennsylvania.”(3)

You represent that the Association established a foundation (Foundation) on December 6, 2001, to carry on educational and charitable activities on behalf of the former participants and beneficiaries in the Plan, as well as those generally affiliated with the automobile dealer industry in the Commonwealth of Pennsylvania. Such activities include industry training and educational programs, among other things, none of which, according to your representations, constitute employee welfare benefit plans. You indicate that on April 15, 2002, the Internal Revenue Service (IRS) determined that the Foundation qualified for tax-exempt status under Code section 501(c)(3).(4)

You also represent that a related entity of the Association will agree to indemnify the Plan and its trustee fiduciaries for any claims that might be asserted against them as a result of the termination of the Plan. This indemnification will not, however, relieve the fiduciaries of any liability for breach of fiduciary duty under Title I of ERISA.

You have requested an advisory opinion with regard to the following questions:

  1. Whether on termination of the Trust, the trustee fiduciaries may use the portion of the Operating Fund assets and demutualization proceeds attributable to participant contributions to provide benefits to participants and beneficiaries no later than the date for the distribution of the remaining surplus assets on termination without contravening the provisions of section 403(c)(1) or 404(a)(1)(A) of ERISA.

  2. Whether, after the portion of the Operating Fund assets and demutualization proceeds attributable to participant contributions is used to provide benefits to participants and beneficiaries no later than the date for the distribution of the remaining surplus assets on termination and the other liabilities of the Plan are satisfied, upon termination of the Plan, it is permissible under section 403(d)(2) of ERISA, to transfer the remaining surplus assets to the Foundation in accordance with the terms of the Plan.

  3. Whether the transfer of the Plan’s surplus assets to the Foundation is a prohibited transaction involving the Plan’s trustee fiduciaries within the meaning of ERISA sections 406(b)(2).

  4. Whether the proposed indemnification agreement in favor of the Plan and its trustee fiduciaries is an exculpatory provision prohibited by section 410 of ERISA.

The Department ordinarily will not issue advisory opinions regarding sections 403(c)(1) and 404(a)(1) of ERISA. See ERISA Advisory Opinion Procedure 76-1, sec. 5.02(n) and (o). We note, however, that section 403(c)(1) of ERISA provides that except as provided in section 403(d), the assets of a plan shall never inure to the benefit of any employer and shall be held for the exclusive purposes of providing benefits to participants in the plan and their beneficiaries and defraying reasonable expenses of administering the plan. In addition, section 404(a)(1) of ERISA provides, in part, that subject to sections 403(c) and (d), a fiduciary shall discharge his or her duties with respect to a plan solely in the interest of the participants and beneficiaries and for the exclusive purpose of providing benefits to the participants and beneficiaries.

Section 403(d)(2) provides that the assets of an employee welfare benefit plan that terminates shall be distributed in accordance with the terms of the plan,(5) except as otherwise provided in regulations of the Secretary of Labor. Although no regulations have been issued under section 403(d)(2), Conference Report No. 93-1280, 93rd Congress, 2d Session, at page 303, states in part that it is intended that the terms of the welfare plan will govern distribution or transfer of assets upon termination of the plan, except to the extent that implementation of the terms of the plan or agreement would unduly impair the accrued benefits of the plan participants. See Advisory Opinion 93-14A (May 5, 1993). We note further in this regard that section 404(a)(1)(D) of ERISA requires that plan fiduciaries discharge their duties in accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with Titles I and IV of ERISA.

We believe that the trustees’ proposal to treat, in connection with the termination of the Plan and the winding down of the Trust and its liabilities, the surplus attributable to participant contributions as a plan liability requiring the provision of benefits to the Plan’s participants and beneficiaries, is appropriate under the circumstances and is consistent with the provisions of sections 403 and 404 of Title I of ERISA.(6)

With regard to your second question, there is nothing in section 403(d)(2) of ERISA, in the absence of regulations by the Secretary, that would preclude, after the proper termination of the Trust in accordance with the Trust terms and the provisions of part 4 of Title I of ERISA, including the satisfaction of all Trust liabilities, the transfer of surplus assets to an unrelated charitable foundation.

As for your third question, section 406(b)(2) provides that a fiduciary with respect to a plan shall not in his or her individual or in any other capacity act in any transaction involving the plan on behalf of a party (or represent a party) whose interests are adverse to the interests of the plan or the interests of its participants or beneficiaries. If the Plan has properly been terminated and all claims have been either paid or properly forfeited, the proposed subsequent transfer of surplus funds by the trustees of that Plan would not violate section 406(b)(2). Assuming the contemplated transfer is in accordance with the terms of the plan, then it is specifically allowed under section 403(d).

With regard to your last question, section 410(a) of ERISA provides generally that any provision in an agreement or instrument that purports to relieve a fiduciary from responsibility or liability for any responsibility, obligation or duty under part 4 of Title I of ERISA shall be void as against public policy. ERISA Interpretive Bulletin 75-4, 29 CFR 2509.75-4, provides in pertinent part that the Department interprets section 410 of ERISA to permit indemnification agreements that do not relieve a fiduciary of responsibility or liability under part 4 of Title I of ERISA. It further provides that indemnification provisions that leave the fiduciary fully responsible and liable, but merely permit another party to satisfy any liability incurred by the fiduciary in the same manner as insurance purchased under section 410(b)(3), are therefore not void under section 410(a). So long as the terms of the indemnification agreement do not relieve the trustee fiduciaries of liability under part 4 of Title I of ERISA, the entity related to the Association may agree to indemnify the Trust and the trustees. See Advisory Opinions 93-15A (May 18, 1993), 93-16A (May 18, 1993), and 93-18A (May 28, 1993).

This letter constitutes an advisory opinion under ERISA Procedure 76-1. Accordingly, it is subject to the provisions of that Procedure, including section 10 thereof relating to the effect of advisory opinions.

Sincerely,
Louis Campagna
Chief, Division of Fiduciary Interpretations
Office of Regulations and Interpretations

Footnotes

  1. For the purposes of this letter, we rely on your representation that the Association is a cognizable, bona fide group or association of employers within the meaning of section 3(5) of ERISA. We note, however, that if the Association in fact consists of unrelated employers that have executed participation agreements or similar documents merely as a means to fund benefits, in the absence of any genuine organizational relationship between the employers, no employer association would be recognized, and the Trust would not be a plan within the meaning of section 3(1) of ERISA. See Advisory Opinion 2001-04A (Mar. 22, 2001).

  2. A “demutualization” is the process used by an insurance company to convert from a mutual insurance company to a stock insurance company. When an insurance company demutualizes, it distributes its equity value to eligible policyholders in the form of stock, cash, or policy credits.

  3. This provision of the Trust Agreement has been in effect for several years and was included as part of the amendment and restatement of the Trust effective as of January 1, 1998.

  4. You represent that you have requested a private letter ruling from the IRS as to whether the distribution of the Plan’s surplus to the Foundation will be a prohibited “reversion” within the meaning of section 4976 of the Code. The opinions expressed in this letter are limited to issues under Title I of ERISA.

  5. Whether the distribution complies with provisions of law other than those in Title I of ERISA, including the provisions of the Internal Revenue Code, is not within the jurisdiction of the Department of Labor.

  6. See Advisory Opinion 2001-02A, footnote 2.