On September 11, 2015, the Pension Benefit Guaranty Corporation (PBGC) finalized reportable event regulations under ERISA section 4043.
The major feature of the new regulation is a tightening of the ‘well-funded plan’ waiver and the addition of a new ‘low-default-risk’ waiver, shifting focus (for the first time in a PBGC rule) from the financial condition of the plan to the financial condition of the plan sponsor. The new rule makes certain other changes to reportable event policy that in some cases may ease the sponsor reporting burden and in other cases increase it.
In this article, we focus on some of the key changes made by the new rule.
Background – reportable events generally
Generally, the PBGC requires the plan administrator and each contributing sponsor of a single employer DB plan covered by Title IV of ERISA to file a reportable event notice with PBGC upon the occurrence of any of the following events:
Failure to make required minimum funding payments
Inability to pay benefits when due
Distribution to a substantial owner
Change in contributing sponsor or controlled group
Extraordinary dividend or stock redemption
Transfer of benefit liabilities
Application for minimum funding waiver
Insolvency or similar settlement
(There are certain other ‘events’ identified in the statute for which PBGC has granted, in effect, a permanent waiver from reporting.)
PBGC views the reportable event rule as providing a mechanism by which it will be alerted to “events that may present a risk to a sponsor’s ability to continue a plan.”
These rules matter to plan sponsors for several reasons: They are a compliance challenge. Sponsors and plan administrators must be alert to events – such as a reduction in active participants – that may trigger a reporting obligation. There may also be situations in which the report may trigger a review by regulators of a transaction, e.g., a corporate sale or a transfer of plan assets and liabilities, with possible follow-on consequences for the sponsor. And a reportable event may trigger certain loan covenants.
Generally, and unless a waiver or extension applies, notice of a reportable event must be provided within 30 days after a plan administrator or contributing sponsor knows or has reason to know that a reportable event has occurred. The notice must be filed 30 days before the effective date of: a change in contributing sponsor or controlled group; a liquidation; an extraordinary dividend or stock redemption; a transfer of benefit liabilities; an application for minimum funding waiver; a loan default; an insolvency or similar settlement.
The penalty for non-compliance is a fine of up to $1,100 per contributing sponsor/per day.
The new rule
The statutory definition of reportable events doesn’t do that neat a job of identifying events that “present a risk to a sponsor’s ability to continue a plan.” As a result, one of the key features (perhaps the key feature) of the reportable event regulation (both the ‘old’ one and this new one) is a series waivers, identifying events with respect to which reporting is not needed and therefore not required. The key changes made by the new regulation are to those waivers.
Critically, with respect what PBGC calls ‘Category 1 events,’ PBGC has tightened the (old rule) well-funded plan waiver, provided a new ‘low-default-risk’ waiver and modified the public company waiver. Category 1 events include extraordinary dividend or stock redemption, active participant reduction, change in contributing sponsor or controlled group, distributions to a substantial owner, and transfer of benefit liabilities events.
Tightening of the ‘well-funded plan’ waiver
In many cases, and particularly with respect to Category 1 events, the old regulation provided a waiver if the plan was at least 80% funded. PBGC has significantly tightened the funding requirement for that waiver. Under the new rule, the well-funded plan waiver is only available if no variable-rate premium is required to be paid for the plan for the plan year preceding the event year. Generally (and oversimplifying somewhat), no variable-rate premium is payable only if the plan’s vested benefits are 100% funded.
Adding a new ‘low-default-risk’ waiver
So, connecting the dots, administrators of plans that are less than 100% funded will now have to look for another waiver-of-reporting rule if they are to avoid reporting a Category 1 event. The main ‘new waiver’ the rule makes available is the ‘low-default-risk’ waiver.
Generally, a company qualifies for the low-default-risk waiver if it meets both criteria (1) and (2) below or it meets four of criteria (1) through (7):
- The probability that the company will default on its financial obligations is not more than 4% over the next 5 years or not more than 0.4% over the next year, in either case determined on the basis of widely available financial information on the company’s credit quality.
- The company’s secured debt (disregarding leases and debt incurred to acquire or improve property and secured only by that property) does not exceed 10% of the company’s total assets.
- The company has a ratio of retained-earnings-to-total-assets of 0.25 or more.
- The company has a ratio of total-debt-to-EBITDA (earnings before interest, taxes, depreciation, and amortization) of 3.0 or less.
- The company has positive net income for the two most recently completed fiscal years preceding the qualifying date.
- During the two-year period ending on the qualifying date, the company has not experienced a default on a loan with an outstanding balance of $10 million or more to the company regardless of whether reporting was waived ….
- During the two-year period ending on the qualifying date, there has not been any failure to make any minimum funding payments when due, unless reporting was waived under applicable reportable event rules.
The ‘qualifying date’ is, generally, the date annual financial statements are filed with the Securities and Exchange Commission.
PBGC, in the preamble, explained criterion (1) (“probability that the company will default on its financial obligations is not more than 4% over the next 5 years or not more than 0.4% over the next year”) as follows:
A shift in focus from plan financial condition to company financial condition
To be clear about what is going on with this change in reportable event reporting waivers: PBGC is trying to shift reportable event reporting from a focus on the financial condition of the plan to a focus on financial condition of the company. This approach has been very controversial. In the final rule, PBGC backed off somewhat on its tightening of the financial condition of the plan waiver (the proposal required, in effect, 120% funding) and added more flexibility to the financial condition of the company waiver.
Nevertheless, focusing on company financial condition represents a fundamentally new approach to PBGC reporting policy, and one that many sponsors (and not just financially ‘weak’ sponsors) have found problematic.
PBGC has also proposed revising premium calculation rules to take into account company financial condition, with lower premiums for financially ‘sound’ companies and higher premiums for financial ‘unsound’ ones. This new rule may set a precedent for such a change.
Public company waiver
Generally, reporting of Category 1 events (critically, including change in contributing sponsor or controlled group and transfer of benefit liabilities events) is also waived where “any contributing sponsor … is a public company and the contributing sponsor timely files a SEC Form 8-K disclosing the event under an item of the Form 8-K other than under Item 2.02 (Results of Operations and Financial Condition) or in financial statements under Item 9.01 (Financial Statements and Exhibits).”
PBGC believes that with these (and certain other) waivers “94% of plans covered by the pension insurance system will qualify for at least one waiver of reporting” for Category 1 events.
Other significant changes
Other significant changes to the old rule include:
Active participant reduction two-tiered test. Under the new rule, PBGC divides active participant reductions into two types:
Attrition events, where, at the end of a plan year, the number of active participants has fallen below the 80%/75% thresholds.
Single-cause events are subject to regular 30-day reporting; attrition events may be reported as late as the premium due date for the plan year following the event year.
Missed contributions. The new rule provides a waiver from reporting where a missed contribution is made up within 30 days.
Controlled Group Change. The new rule (1) clarifies that “a controlled group member’s ceasing to exist because of a merger into another member of the group is not a reportable event and (2) provides that “whether an agreement is legally binding is to be determined without reference to any conditions in the agreement.”
Transfer of benefit liabilities. Like the proposal, the new rule excludes from a “transfer of benefit liabilities” “the payment of a lump sum, or purchase of an irrevocable commitment to provide an annuity, in satisfaction of benefit liabilities.” This rule in effect takes de-risking and risk transfers out of reportable event reporting.
Loan default. The new regulation includes “waivers and amendments of loan covenants that are made to avoid a default” in loan default reportable events.
The new rule is effective for post-event reportable events occurring on or after January 1, 2016 and for advance reports due on or after that date.
The big question is, will PBGC be able to export this new approach – focusing on sponsor financial condition – into other aspects of its regulatory regime, including (emphatically) the determination of PBGC premiums.