Highway funding bill begets important pension plan provisions

Pension law changes can come in many forms.

They can be in the form of such specific tax laws as the Pension Protection Act of 2006 (PPA).

They can be included in technical corrections acts (See Technical Corrections To The Pension Protection Act Of 2006: Another Bite Of The Apple?

Or, they can be included in any other legislation where they can find a home, see (Pension Funding Relief For Airlines Lands In Iraq Funding Bill).

New pension funding rules took the other legislation route (pardon, the pun) as part of the recently passed Moving Ahead for Progress in the 21st Century Act (MAP-21). The bill which funds surface transportation programs at over $105 billion for fiscal years 2013 and 2014 also included several significant changes as to how defined benefit pension plan can be funded. MAP-21, by the way, also, included interest rate relief for student loans).

I’ll nicely skip the political commentary and the actuarial jargon and get right to what the new rules are all about, and how they impact defined benefit pension plans. Specifically, in two key areas:

• Pension funding, and
• Pension Benefit Guaranty Corporation (“PBGC”) premiums.

Pension Funding

The PPA required employers to use to use a rolling 2-year average of corporate bond rates to value their plan’s liabilities for funding purposes. Because of historically low interest rates, there were large increases in pension liabilities, and a corresponding increase in minimum funding requirements.

MAP-21 allows employers to use a 25-year average of corporate bond rates, i.e., higher interest rates. Higher interest rates mean lower liabilities and a reduction in the minimum funding requirements. In addition, lower liabilities may permit the removal of benefit restrictions for those plan that have funding shortfalls. The estimated reduction could be as much as 10% to 20%.

PBGC Premiums

Not all good news to CFOs, however. MAP-21 substantially increases PBGC premiums as shown on the table below. (Note:  Flat rate premiums for 2015 and 2016 and variable rate premium for 2016 to be adjusted for inflation).

There could be a further hit to underfunded plans since the new interest rate rules do not apply in calculating a plan’s variable rate premium.

Impact of the New Rules

Short-Term

The new rules are effective for plan years beginning in 2012. Employers, however, can elect to wait until 2013 for all purposes, or just for the purposes of determining whether benefit restrictions apply.

Even if the valuation has been done for 2012, it may be helpful to use the new rules to revalue liabilities.

Long-Term

While employers may be able to dramatically reduce contributions over the next few years, it’s only a temporary solution for under-funded plans, especially frozen plans waiting to be sufficiently funded in order to terminate. Shortfalls will have to be made up through contributions in the future.

In addition, PBGC premiums which are slated to increase may also increase further as a result of lower contributions.

Maybe the real solution is developing a strategic investment strategy that matches plan liabilities with investments, a/k/a liability driven investing (LDI).

For a discussion of the "funded" status of a pension plan, here is a link to my blog post, Inside The Actuarial "Black Box": What Employers Need To Know To Better Manage Their Pension Plans.