2014 review of defined benefit plan issues

December 18, 2014

In 2014 there were several major DB policy developments, including a significant extension of MAP-21 funding relief, new mortality tables and the finalization of the hybrid plan regulations on ‘market rate of return.’ In addition, the year-end federal spending deal included ERISA section 4062(e) legislation. In this article we review these developments, beginning with the legislation Congress just passed.

Year-end federal spending legislation – 4062(e) reform

The year-end federal spending bill included detailed provisions intended to address the multiemployer plan funding crisis, reform the rules under ERISA section 4062(e) and clarify the definition of normal retirement age.

The language on ERISA section 4062(e) is identical to that included in S. 2511, introduced earlier this year by Senators Harkin (D-IA) and Alexander (R-TN). We discussed the ERISA section 4062(e) issue and the provisions of S. 2511 in detail in our earlier article Proposed changes to ERISA section 4062(e). Very briefly, the new legislation:

Clarifies the 4062(e) triggering event and exempts many transactions where there is no true or permanent cessation of operations.

Exempts ‘well-funded’ plans, defined as plans that are at least 90% funded (based on the fair market value of plan assets and liabilities as determined under the variable-rate premium rules).

Provides an alternative method of satisfying ‘4062(e) obligations,’ by making additional contributions that (oversimplifying a lot) fund the plan's shortfall attributable to the affected participants over 7 years.

The normal retirement age provision generally ‘clarifies’ that a plan that, as of December 8, 2014, defined normal retirement age as the earlier of (1) an (ERISA-permitted) age (e.g., 65) or (2) a number of years of service (not less than 30) did not violate ERISA.

We do not generally focus on multiemployer plan issues and will not review that part of the year-end budget deal here.

This legislation (as part of year-end spending legislation) was approved by the House and Senate; the President is expected to sign it.

* * *

In the rest of this article we provide a general review of the 2014 retirement policy developments that affected defined benefit plans. For defined contribution retirement policy developments see our article 2014 review of defined contribution plan issues.

Increased PBGC premiums

We begin our review with legislation enacted at the very end of 2013, the Bipartisan Budget Act of 2013 (signed into law by President Obama on December 26, 2013). BBA 2013 significantly increased Pension Benefit Guaranty Corporation premiums. Dramatically higher premiums challenged many sponsors in 2014 to re-think funding and de-risking policies.

The following table shows new single employer plan premium rates through 2016:

 Year   Flat-rate premium   Variable-rate
 premium (per
 $1,000 of UVB) 
 Per-participant cap 
 on variable rate
 premium
 2014  $49  $14  $412
 2015  $57  $24  $418
 2016  $64  $29  $500

(These numbers are from PBGC and updated through October 2014; the $29 number for the 2016 variable-rate premium is an estimate based on the expected inflation adjustment.)

For some sponsors, the increased premiums will make borrow-and-fund and/or de-risking strategies more attractive, in effect as an alternative to paying the higher PBGC premiums.

In this regard we note the potentially counterintuitive effect on variable-rate premiums of paying out terminated vested participants. Paying out terminated vesteds obviously reduces the PBGC flat-rate premium – fewer participants equals fewer ‘heads to count.’ But the gains are relatively modest -- $57 per year per participant in 2015. While less obvious, the gains in reduced variable-rate premiums can be much more significant. Those gains come from the headcount-based cap. The two key variables are (1) how well funded the plan is and (2) the ratio of unfunded vested benefits to the number of participants. We provided an article that went into this calculation in detail.

Ironically – given that PBGC's 2013 deficit was the pretext for BBA 2013 premium increases – the November release of PBGC’s 2014 Annual Report showed a dramatic decrease in its single employer program deficit, from $27.4 billion to $19.3 billion, an $8 billion/ 30% drop. Notwithstanding that those numbers did not reflect the BBA 2013 premium increase, PBGC experienced a $4 billion underwriting gain. At the same time, in 2014 the multiemployer program deficit increased by $34 billion (410%!), to $42.4 billion.

MAP-21 extended

While increased PBGC variable-rate premiums provided an incentive for more funding, in August 2014 Congress provided more relief from minimum funding requirements. The Highway and Transportation Funding Act (HATFA) extended ‘interest rate stabilization’ under 2012's Moving Ahead for Progress in the 21st Century Act (MAP-21) through 2020.

MAP-21 put a ‘floor’ under valuation interest rates. The floor is equal to (1) the average of rates for a 25-year period, (2) reduced by multiplying it by a percentage beginning at 90% in 2012 and ‘phasing down’ to 70% thereafter (we will call this the ‘phase-down percentage’). HATFA extends this relief by applying the 90% phase-down percentage through 2017.

The following chart compares the old MAP-21 and the new HATFA phase-down percentage rules.

 Phase- 
 down % 
 Applicable year
 -- current rules 
 Applicable year  
 — HTF 2014
 90%  2012  2012-2017
 85%  2013  2018
 80%  2014  2019
 75%  2015  2020
 70%  After 2015  After 2020

New mortality tables

In October 2014, the Society of Actuaries published its (new) RP-2014 Mortality Tables and Mortality Improvement Scale MP-2014, related reports and two documents responding to comments on its exposure draft. The RP-2014 tables/improvement scale reflect significant increases in mortality improvement relative to the current regulatory regime (RP-2000 plus mortality improvement Scale AA projection).

Defined benefit plan sponsors will want to consult their actuary as to the application of the new tables to their plan. Generalizing: if (as most believe) IRS adopts the SOA 2014 tables/improvement scale, then the cost of funding and lump sums will go up. The following table projects (based on estimates) the increase in annuity values for minimum funding purposes that would result from the adoption of the RP-2014 mortality tables/improvement scale by IRS for 2016.

   Age   
 Males  25  9.8%
   35  7.9%
   45  5.4%
   55  3.6%
   65  4.5%
   75  9.8%
   85  16.9% 
     
 Females   25  11.8% 
   35  10.3% 
   45  8.3%
   55  6.6%
   65  5.8%
   75  8.0%
   85  10.7% 

Hybrid plan rules finalized

On September 19, 2014, IRS published long-awaited final regulations on a number of issues affecting hybrid plans (generally, cash balance and pension equity plans). The most significant piece of the final regulations was final rules with respect to interest crediting rates permitted under the ‘market rate of return’ standard. Those rules are generally effective in 2016. The final regulations adopt an exclusive list of permitted cash balance plan interest crediting rates. The following chart summarizes the rates permitted:

   Rate  Permitted floor 
 Maximum fixed rate  6%  N/A
 Government bond rates +
 permitted margin
 3-month + up to 1.75%
 12-month + up to 1.50%
 1-year + up to 1%
 3-year + up to 0.5%
 7-year + up to 0.25%
 10-year (no margin)
 30-year (no margin)
 5% annual
 Investment grade corporate 
 bond rate
 First, second, or third segment rate 
 under the minimum funding rules,
 with or without adjustment for
 MAP-21 and HATFA
 4% annual
 Investment-based rates  Actual rate of return on the
 aggregate or a subset of plan
 assets; rate of return on a regulated 
 investment company, such as a
 mutual fund
 3% cumulative

Cash balance plans that use investment-based interest crediting rates function very much like defined contribution plans – investment risk (both positive and negative) generally falls on the participant, not the plan sponsor. These plans are, however, subject to a special ‘capital preservation rule’ requiring that the participant's benefit at least equal the sum of her principal credits (pay credits). We provided articles analyzing, generally, the issues the capital preservation rule presents and, specifically, the risk to sponsors under the rule.

De-risking

In addition to the incentive to de-risk that the PBGC premium increases provided, increases in 2013 year end interest rates made 2014 a ‘less expensive’ year (than 2013) to pay out lump sums. In the first part of the year, IRS released four Private Letter Rulings holding that in certain circumstances the payment of lump sums to retirees currently receiving annuities did not violate Tax Code minimum distribution rules

Those rulings dealt with an important issue in de-risking transactions involving retirees. Subsequently, however, IRS indicated that it would not issue more of these rulings. The suspension of rulings on this issue reflects the considerable push back on this trend. In this regard there were also attempts at the state level to limit de-risking transactions.

The ‘frozen plan issue’

There appears to be bipartisan support for relief for the DB ‘frozen plan issue.’ That issue is (briefly): when a defined benefit plan is frozen to new entrants (‘closed’), the group covered under the plan may become discriminatory over time because of, for instance, higher non-highly compensated employee turnover rates and pay increases that, in effect, turn non-highly compensated employees into highly compensated employees. Absent relief many sponsors are likely to terminate benefits for the frozen plan group rather than risk disqualification. In December 2013 IRS released Notice 2014-5, providing temporary relief on this issue for 2014 and 2015 for plans that meet certain conditions.

It looked like, at one point, 2014 year-end ‘tax-extenders’ legislation might include a proposal on this issue. However, after the President threatened to veto that legislation (on unrelated issues), it was dropped, and there will be no fix before year-end.

* * *

We will continue to follow these issues in 2015.

October Three Consulting, LLC is a full service actuarial, consulting and technology firm that is a leading force behind the reemergence of defined benefit plans across the country. A primary focus of the consultants at October Three is the design and administration of comprehensive retirement benefits to employees that minimize the financial risks and volatility concerns employers face.

Through effective plan design strategies October Three believes successful financial outcomes are achievable for employers and employees alike. A critical element of those strategies is the ReDB® plan design. The ReDefined Benefit Plan® represents an entirely new, design-based approach to retirement and to the management of both the employer’s and the employee’s financial risk, focusing on maximizing financial efficiency and employee value.

For more information:

233 South Wacker Drive, Suite 4620
Chicago, IL 60606-4902
info@octoberthree.com
Phone: 312-878-2440
Fax: 866-945-9676
Contact Us

 

Share this with your Colleagues:

Latest News:

  • November 2017 Pension Finance Update - Read More
  • Current outlook – November 2017 - Read More
  • Latest SOA analysis shows year-over-year increase in mortality - Read More
  • October 2017 Pension Finance Update - Read More
  • Current pension outlook – October 2017 - Read More
  • Cash Balance Plan Design - Read More
  • ReDefined Benefit Plan™ - Read More