Cash-strapped companies may be celebrating the pension funding stabilization measure that Congress tucked into the recently passed highway bill, but the relief comes with a catch: Companies that sign up for it will be forced to pay higher fees to the Pension Benefit Guarantee Corp. (PBGC).
“These rules will be a great relief to plan sponsors because they will eliminate a necessity of higher funding in the short term,” says Steven Friedman, chair of the employee benefits practice at labor and employment law firm Littler Mendelson. “However, the ultimate health of the plan will not be remedied by these rules. These rules just get an employer out from under the very difficult funding position that they are currently in on account of absurdly low interest rates.”
Congress passed and President Obama signed into law the Moving Ahead for Progress in the 21st Century Act, or MAP-21, as it is now known. The bill is primarily focused on highway funding, but it also includes student loan and pension provisions. The pension funding stabilization portion of the bill gives companies the flexibility to reduce cash contributions to their pension plans, but it also increases the premiums they must pay to the PBGC, which backs all privately sponsored pension plans. And the more underfunded the plan, the steeper the hikes.
In essence, the relief is a revenue raiser inserted into the bill to help pay for the highway and student loan provisions, says Bruce Cadenhead, a partner and chief actuary with the U.S. retirement risk and finance business for human resources consulting firm Mercer. That means there are costs to the relief. The increase in PBGC premiums is one, he says. The relief also raises revenue by decreasing the deductions a company might claim by contributing cash to their pension plans. “By lowering required contributions in the near term, it makes corporate tax deductions lower because companies will put less into their funds,” he says.
The funding relief is provided by changing the way companies are allowed to measure their liabilities, says Cadenhead. Currently, liabilities are measured based on yields on long-term, high-quality corporate bonds. “Bond yields have gotten very low lately, and that has caused liabilities to grow substantially,” he says. MAP-21 allows companies to use a 25-year average of interest rates rather than more current market rates to measure the liability. “It acts as a collar to discount liabilities,” he says. Mercer estimates it will reduce liabilities by 10 percent to 20 percent.
“To have these premiums go up this way says the PGBC thinks it needs a lot more money. It also gives plan sponsors a very strong incentive to keep their plans closer to 100 percent funded.”
—Alan Glickstein,
Senior Retirement Consultant,
Towers Watson
The Internal Revenue Service will soon issue guidance on how to implement the new liability measurement option and is likely to tell companies what the 25-year average rate is for measuring pension liabilities, says Jack Abraham, a principal in PwC's human resource services group and leader of its retirement practice. “We believe the IRS is going to come out with a 25-year average on a liability-weighted basis something just south of 7 percent,” he says. That would raise the discount rate companies are currently applying to measure their pension liabilities from lows of 4.75 to 5.25 percent to as high as 6.3 percent, he says. “The bottom line is that companies are going to be allowed to use a higher rate when determining their pension obligations,” he says.
Higher PBGC Fees
On the insurance side, MAP-21 raised the premium companies will pay to the PBGC in two ways, says Abraham. Companies pay a flat rate based on the number of participants covered by their pension plan, and that rate is rising from $35 per participant to $42 in 2013 and $49 for years after 2013, he says. The rate will be adjusted for inflation going forward, and it will be applied to all plan sponsors. “That flat rate premium cannot be avoided,” he says. “Some plans try to reduce that by cashing out as many former employees as they can, and that's really the only way to reduce that amount.”
PENSION FUNDING STABILIZATION
Below is a brief summary of pension funding stabilization from Buck Consultants:
Pension interest rate stabilization and PBGC premium hikes have been enacted with the 2012 student loan and transportation legislation titled Moving Ahead for Progress in the 21st Century (MAP-21)signed today by President Obama. The interest stabilization changes apply to ERISA single-employer plans that base liability calculations on PPA segment rates and are predicted to trim 2012 contribution requirements by 15 percent to 25 percent or more for typical plans.
Background
Section 412 of the Internal Revenue Code (Code) and Section 302 of the Employee Retirement Income Security Act (ERISA) set minimum funding standards that single-employer defined benefit plans subject to ERISA must satisfy. These standards were radically changed by the Pension Protection Act of 2006 (PPA). Key changes included a shortened period for amortizing funding shortfalls and specified interest rates based on corporate bond yields for valuing liabilities. The economic recession that developed shortly after PPA went into effect pushed interest rates and asset returns down and the resulting plan
liabilities—and contribution requirements—up. Employers sought relief from Congress to address the expectation that the economy would improve and interest rates would soon rise to a more normal level.
Congress responded with the Pension Relief Act of 2010 (PRA). Under PRA, employers could choose between two amortization-extension options for reducing current cash contribution commitments to their plans. Details on the relief provided in 2010 are explained in our June 28, 2010 For Your Information.
The opportunity to select one of the relief options in PRA expired at the end of the 2011 plan year.
Because interest rates remain historically low at least in part due to government efforts to stimulate the economy, employers returned to the Hill to ask for additional measures to stabilize their contribution requirements and allow corporate funds to instead be used to expand operations and reduce unemployment.
Congress Delivers 2012 Pension Relief Act
In MAP-21, Congress responded to employers with new funding relief in the form of interest rate stabilization, but also dished out Pension Benefit Guaranty Corporation (PBGC) premium hikes. Because reduced employer contributions to pension plans reduce the tax deduction claimed by employers, funding relief is scored for U.S. budget purposes as a “revenue raiser.” The revenue from funding relief will help pay for a temporary extension of the Stafford student loan interest rate reduction as well as the cost of the MAP-21 transportation changes.
Source: Buck Consultants.
The bill also raises the variable rate premium that applies to all defined benefit plans, says Abraham. Currently, the rate is $9 per thousand dollars that a plan is underfunded. It will rise to $18 per thousand by 2015 and then be adjusted for inflation thereafter, he says. “So we'll see a doubling of the amount,” he says.
The insurance premium increases in particular send a strong message that companies need to heed, says Alan Glickstein, senior retirement consultant at benefits consulting firm Towers Watson. “To have these premiums go up this way says the PGBC thinks it needs a lot more money,” he says. “It also gives plan sponsors a very strong incentive to keep their plans closer to 100 percent funded.”
The legislation also calls for a study of PBGC's funding needs to determine future requirements to ensure the stability of the pension-backing system. “With competing views over what the right level of premium ought to be, Congress couldn't figure out who was right,” he says. The timing of the increases gives policy makers time to figure it out and adjust premiums later if the study warrants further adjustments, he says.
Jonathan Waite, director of investment management advice and lead actuary for SEI's Institutional Group, points out that the funding provisions of MAP-21 have no effect on the accounting for pension obligations on corporate balance sheets and no effect on the requirement to ultimately fully fund pension plans, regardless of timing. Because of that, the decision of whether or not to take the relief comes down to available funds. “Are you focused on the accounting numbers or are you focused on cash?” he asks.
For companies that have cash to keep their plans adequately funded and are concerned about the numbers on the balance sheet and income statement, the funding relief may hold little appeal. “They still get tax deductions, and they will lower their pension expense by not deferring it into the future, they will lower their PBGC premiums, and they will have better communication with their employees,” he says. “So there are some benefits to continue funding on a non-relief basis.”
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