Senate passes highway bill with DB funding relief
On March 14, 2012 the Senate passed the Highway Investment, Job Creation and Economic Growth Act of 2012 (S. 1813). The bill now goes to the House, which has been working on its own highway bill, although passage is not expected in the immediate-term. S. 1813 includes defined benefit funding relief that may be useful to many DB plan sponsors.
In this article we review the funding relief in the Senate bill and discuss some issues it raises for sponsors.
Provisions of S. 1813
Under current law, generally, DB liabilities are, for plan funding purposes, valued using three (short, medium and long term) “segment rates” derived from a corporate bond yield curve based on rates averaged over two years. Many have questioned the appropriateness of this approach in view of the Federal Reserve’s explicit policy of “keeping interest rates low” — low rates = bigger liabilities = bigger funding costs.
As a solution to what some have called “artificially low” interest rates, some have proposed using a corridor to limit “outlier” interest rates. S. 1813 includes such a proposal. Under S. 1813:
If a segment rate … is less than the applicable minimum percentage, or more than the applicable maximum percentage, of the average of the segment rates … for … the 25-year period ending with September 30 of the [preceding calendar year], then the segment rate … shall be equal to the applicable minimum percentage or the applicable maximum percentage …, whichever is closest.
The minimum/maximum percentage (aka the corridor) widens after 2012, reducing the impact of the corridor:
As a general matter, in the current environment at least, all that matters is the “minimum” number. And the easiest way to think of this provision is as a floor on valuation interest rates equal to, in 2012, 90% of a trailing 25-year average. That floor gets “lower” over 2013-2015, hitting “bottom” at 70% in 2016.
Note that this relief only applies if the sponsor is using 2-year average segment rates. If the sponsor is using the “full” spot-rate yield curve, it does not apply.
We will have to wait for detailed IRS guidance before we will have exact numbers for the impact of this (proposed) change. At this point, our rough calculations suggest that the 2012 relief will increase the “effective interest rate” for plans by 100 to 150 basis points. This translates to a decrease in liabilities of 10%-20% for most plans. So, for instance, a plan with $100 million in liabilities under current interest rates would have only $80-$90 million in liabilities after reflecting the 2012 corridor.
That is, as they say, real money. Each employer will have to do the math as it applies to its plan(s), and, as we said, we will have to wait for IRS to come out with “official” numbers. But it’s clear that for some employers at least this relief will be significant.
Obviously, in subsequent years (after 2012), this relief will become less significant, as the floor is, in effect, lowered. Absent circumstance more extreme than anyone can remember, the 70% floor is likely never to apply — so that by 2016 the relief will have fully phased out.
Changing the FTAP/AFTAP
Prior DB funding relief, which expired in 2011, only affected the funding number itself — electing sponsors were in effect allowed to delay funding by increasing the period over which funding shortfalls must be amortized. The relief in S. 1813 would change the liability number itself. So, for instance, this relief would affect the calculation of the AFTAP (the adjusted funding target attainment percentage) used to calculate benefit restrictions. Benefit restrictions will apply under current rules that would not apply if this bill passes.
Given the timing problems that already exist with respect to AFTAP certifications, if a highway bill with this (or similar) relief in it ultimately becomes law this year, sponsors may be able to reevaluate these certifications. In this regard, April 1 is the first big date — that is when, for calendar year plans, the AFTAP “haircut” is applied. (Under the benefit restriction rules, if for the prior year a plan was within 10 percentage points of a benefit restriction, then if the plan’s actuary has not certified the plan’s AFTAP by April 1, the plan is assumed to have an AFTAP for the current year of 10 percentage points less than its AFTAP for the prior year.)
There will also be timing issues for, e.g., quarterly contributions. For calendar year plans the first quarterly contribution for 2012 is due April 15.
Relief does not apply to calculations of lump sums and PBGC premiums
While, generally, lump sums are calculated on the same basis as funding, the relief in S. 1813 would not apply to lump sum calculations. So, the sponsor would fund on an adjusted valuation basis but would pay out lump sums on the current basis. Practically, this means that lump sums will be bigger than they would be if funding rules applied to their valuation.
Adjustments to interest rates under the proposed relief would also not apply for purposes of calculating PBGC premiums, which is interesting because it means that companies that choose to contribute less under funding relief would therefore pay more in PBGC premiums.
S. 1813 passed by a wide margin and with bipartisan support (the vote in the Senate was 74 – 22). But, while many believe that some sort of highway bill will pass this year, whether it will have DB funding relief in it is anybody’s guess.
As we understand it, the House has had significant problems with its own highway bill, and many in the House are not comfortable with the DB funding relief in the Senate bill. One alternative revenue-raiser under consideration: raise PBGC premiums.
We will continue to follow this legislation.