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In what is likely to be the last retirement-related legislation before the November election, Congress approved limited DB funding relief and an increase in Pension Benefit Guaranty Corporation premiums, as “revenue raisers” in a bill that includes transportation legislation and an extension of student loan interest rate relief. In this article we discuss the funding relief and premium increase in detail.
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 24 months. These rates are at “historical lows” (as the Joint Explanatory Statement for the legislation puts it). Low rates = bigger liabilities = bigger funding costs, as we discuss in our recent article How low can you go? Interest rates and DB plans.
The new law puts a floor (and a ceiling) on these segment rates, based on a trailing 25-year average:
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 its impact.
| Year | Minimum/Maximum |
| 2012 | 90%/110% |
| 2013 | 85%/115% |
| 2014 | 80%/120% |
| 2015 | 75%/125% |
| After 2015 | 70%/130% |
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.
The funding relief only applies if the sponsor is using 24-month average segment rates. If the sponsor has elected to use the ‘full’ spot-rate yield curve, it does not apply. Generally, an election to use the full yield curve may not be revoked without the consent of the Secretary of the Treasury. Under the new law, however, a sponsor may revoke such an election (i.e., opt in to segment rate treatment and funding relief) without consent within one year after the date of enactment.
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, 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 will 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.
In subsequent years (after 2012), this relief will become less significant, as the floor is, in effect, lowered. However, the new law is likely to provide meaningful relief to sponsors for 2013 and 2014 as well, and, if rates continue at their current low levels, relief will continue to provide somewhat lower contribution requirements through 2016. After 2016, the new law would only be useful if rates moved downward from current levels.
Prior DB funding relief, which expired in 2011, only affected the funding number — electing sponsors were allowed to delay funding by increasing the period over which funding shortfalls must be amortized. The relief under the new law changes the liability calculation itself. So, for instance, this relief will affect the calculation of the AFTAP (the adjusted funding target attainment percentage) used to calculate funding-based benefit restrictions (e.g., the rule that limits a plan’s ability to pay lump sums when the funded percentage is lower than 80%). Thus, benefit restrictions that would have applied under old law may not apply after interest rates are adjusted (stabilized) under the new law.
While, generally, lump sums are calculated on the same basis as funding, the relief does not apply to lump sum calculations. So, sponsors will fund on an adjusted valuation basis but pay out lump sums on the current law (unadjusted) basis. Practically, this means that lump sums will be bigger than they would be if (adjusted) funding rules applied to their valuation.
Adjustments to interest rates will also not apply for purposes of calculating PBGC premiums. Interestingly, because the relief will, in effect, reduce plan funding, the total amount of variable-rate PBGC premiums sponsors pay will go up. (As discussed below, the legislation also increases PBGC premium rates.)
In addition, the adjusted interest rates do not apply to: the calculation of the limits on deductions to qualified plans; qualified transfers of excess pension assets to retiree medical accounts; and ERISA section 4010 reporting to the PBGC.
For years 2012-2014, additional information must be included in the plan’s annual funding notice if:
(1) The plan’s “adjusted” funding target (that is, the value of liabilities determined using the “floor” provided under the new law) is less than 95% of the plan’s “unadjusted” funding target (that is, the value of liabilities determined without using the “floor” provided under the new law),
(2) The plan has a funding shortfall, determined without using the floor, that is greater than $500,000, and
(3) The plan sponsor had 50 or more participants in defined benefit plans on any day during the preceding plan year.
The additional information that must be provided is:
A statement that the new law modifies the method for determining the interest rates used to determine the actuarial value of benefits earned under the plan, providing for a 25-year average of interest rates to be taken into account in addition to a 24-month average.
A statement that, as a result of the new law, the sponsor may contribute less money to the plan when interest rates are at historical lows.
A table showing, for the applicable plan year and each of the two preceding plan years, the plan’s funding target attainment percentage, funding shortfall, and the employer’s minimum required contribution, each determined both using “adjusted” and “unadjusted” segment rates.
A sponsor may elect not to have adjusted segment rates apply to the 2012 plan year either: (1) for all purposes; or (2) solely for purposes of the funding-based benefit restriction rules.
Under prior law, the flat-rate premium for single employer DB plans was $35 per participant (the flat-rate premium is indexed for inflation). The per-participant variable rate premium was $9 per $1,000 of unfunded vested benefits divided by the number of participants (the variable rate premium is not indexed for inflation).
The new law increases the flat-rate premium to $42 in 2013 and $49 in 2014, with indexing thereafter.
The rate for variable-rate premiums (0.9% of unfunded vested benefits under current law) will increase to 1.3% in 2014, 1.8% in 2015, and be indexed (you read that correctly) thereafter. Also, a $400 per participant cap (also indexed) is added to the variable premium calculation.
In essence, the annual premium owed by underfunded plans will double by 2015, with a ceiling for plans with a high ratio of unfunded vested benefits to participants.
The legislation also includes a number of provisions designed to improve the governance of the PBGC.
The PBGC premium increase is estimated to raise a little less than $9 billion in revenue, around half of what the Administration had been asking for. It’s possible that the issue of PBGC premiums will come up again in the relatively near future (e.g., perhaps next year).
The new law also adds a provision allowing for the transfer (from overfunded DB plans) of assets to fund retiree group-term life insurance, on a basis similar to the current rules for transfers to fund retiree health benefits.
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As we said at the beginning, this law is likely to be the last piece of retirement-related legislation prior to the election. It provides significant relief for many DB plan sponsors.
These provisions were included in a larger transportation bill as a “pay for” — a revenue-raiser offsetting the cost of the transportation and student loan initiatives. Generally, it seems, action in “our world” (the world of pension/401(k) regulation) is being driven by outside issues — critically, concern about the budget. Thus, a proposal like interest rate stabilization that raises revenue (sponsors make smaller tax deductible contributions to plans and as a result pay more taxes) gets more attention than a proposal like automatic IRAs (which is a key policy initiative of the Administration), which costs revenue.
After the election, there may be a productive lame duck session (to deal, among other things, with the impending “fiscal cliff” set to kick in at year-end based on tax increases and spending cuts set to take effect under current law). Certainly 2013 will be an active legislative year, with a number of “our issues” in play.