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PBGC web-page guidance on reverse spinoffs

PBGC has established a (new) Q&A web page – “Staff Responses to Practitioner Questions.” In a recent post to this page, PBGC staff indicated that it believes certain “two-step” spinoff/termination transactions that purport to reduce PBGC premiums for one year generally don’t work under ERISA.

In this article we briefly review the transactions and PBGC staff’s interpretation of ERISA. We conclude with some general observations about this strategy.

Two-step transactions

PBGC regulations provide (1) that the premium for a plan with a short plan year is pro-rated and (2) that plans terminated in a standard termination (in which all benefits are fully funded) are exempt from variable-rate premiums (VRPs) in the year of termination.

In its web page post, PBGC staff described the two-step spinoff/termination strategy as follows:

Some plans are considering a strategy to avoid paying a significant portion of the statutory VRP
by doing a two-step transaction under which (1) most plan participants are spun off late in the
year into a new plan that is virtually identical to the old plan, but with a new name, EIN, and plan
number, leaving only a small group of retirees in the original plan and (2) what’s left of the original
plan is terminated (i.e., annuities are purchased for the remaining retirees). If the premium rules
noted above apply to plans doing these transactions, the aggregate premium would be significantly
lower than the premium that would have been owed had the plan remained intact and simply
purchased annuities for that group of retirees.

PBGC staff position

According to the staff answer, this two-step transaction does not have the intended effect (of reducing PBGC premiums). According to PBGC staff, the special rules for standard terminations and short plan years are intended to apply where it “seemed overly burdensome to charge the entire statutory premium in a year.” Thus, it seems unreasonable to charge a variable-rate premium (which generally applies to unfunded benefits) where the sponsor has, before the end of the year, fully funded and terminated the plan. Similarly, in the case of a short plan year, charging a full year premium seems unreasonable where participants were only covered by the PBGC insurance system for part of the year.

In the two-step transactions under consideration, however, “the benefits of the vast majority of the participants who were in the plan at the beginning of the year have not been fully funded or paid in full, and PBGC coverage is still in effect for these participants.” Applying the special rules for standard terminations and short plan years to these transactions (which some would argue comply with the literal terms of the regulation) is therefore (according to PBGC staff) not authorized by the statute.
As authority for this “substance over form” interpretation, the PBGC staff cites “federal common law under ERISA and cases that look to the substance and not the form of a transaction.” PBGC goes on to say: “We are especially skeptical of this strategy because it seems plausible that some plans could engage in this sort of two-step transaction year after year.”

Observations

This PBGC staff “guidance” is not a new regulation or an amendment to current regulations – it is merely a post on a web page purporting to give PBGC staff views. Indeed, the web page states explicitly that these views “are not rules, regulations, or statements of the Corporation.” As such, it is at best unclear whether a court would give these views any sort of deference.

Moreover, PBGC could (theoretically) change these views by simply doing another web page post. Consider – at the end of 2016, the (Obama Administration) PBGC amended the web page describing its Early Warning Program to include elements of a sponsor’s financial condition as “triggers,” initiating PBGC action. Then, in May, 2017, the (Trump Administration) PBGC “updated” the web page to remove those sponsor financial condition Early Warning triggers.

Nevertheless, the PBGC staff’s reasoning makes some sense – sponsors engaging in these transactions are (substantively) getting PBGC coverage for their DB plan participants for a full year while only paying for it (if at all) for a (generally small) part of the year. The rules that they (the sponsors) are relying on, however, seem to be intended to apply in situations where the sponsor is not getting coverage for the entire year, e.g., in the case of full funding in connection with a standard termination during a year or a (totally) new plan whose participants are only covered by the PBGC insurance system for part of a year.

Certainly, after the publication of this web page, risk-averse sponsors will hesitate before engaging in one of these transactions. And those that do undertake them would be wise to budget for the possibility of litigation. (The precedent of litigation with respect to certain pre-Pension Protection Act aggressive cash balance designs is apposite here.) In this regard, there are a variety of actions PBGC can take, including, e.g., the imposition of a late premium penalty, to enforce its interpretation of these rules.

Finally, there are a number of other premium reduction strategies that a sponsor may consider (see, e.g., our article Splitting pension plans can reduce PBGC variable-rate premiums) that do not violate the principle the PBGC staff has articulated – that is, that do not result in full year coverage for a part-year premium.

* * *

We will continue to follow these issues.

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