Senate Passes Pension Funding Relief

On Wednesday, January 28, 2004, the U.S. Senate passed legislation (an amendment revising a House-passed bill, H.R. 3108) to provide temporary funding relief for defined benefit plans. This will not become law until it is passed by the House and signed by the President. The major provisions of the Senate bill, which passed by a vote of 86 to 9, would:

• Replace the interest rate for 30-year Treasuries with a rate based on corporate bond indices as the benchmark for key funding and related requirements, for a two-year period,
• Roll back the Deficit Reduction Contribution (DRC) for many airlines and steel companies, and for other businesses subject to Internal Revenue Service (IRS) approval, for two years, and
• Give most multiemployer plans a little more time to make up the investment losses incurred in the early years of the decade, by enabling them to postpone amortization of losses that would have been recognized in the funding standard account for two plan years.

Interest Rate Update

Instead of the interest rate on 30-year Treasury bonds (which are no longer issued), the Senate bill would call for use of an interest rate based on conservative, long-term corporate bond rates to measure the value of a plan's current liability. That in turn is used to determine whether the DRC applies and how much additional funding it requires. This would apply for the 2004 and 2005 plan years. It replaces the earlier short-term response to the 30-year Treasury rate dilemma, which had prescribed the use of 120 percent of 30-year Treasuries for the 2002 and 2003 plan years.*

The bill gives the Treasury Department authority to determine the actual interest rate, directing that it be based on "the use of 2 or more indices that are in the top 2 quality levels available reflecting average maturities of 20 years or more."

For DRC purposes, the benchmark interest rate will be a four-year weighted average of this corporate bond rate. Plan sponsors will be able to use any rate that is within a 90 percent- to 100 percent- range of that number. The new corporate-bond interest rate approach will also be used to calculate variable-rate Pension Benefit Guaranty Corporation (PBGC) premiums. However, the actual rate used for that purpose will be 85 percent of the corporate bond-based rate as of the last month before the start of the plan year.

The new temporary interest rate based on corporate bonds will not apply for determining either lump-sum benefits or deduction limits. Also, under the bill, in applying the maximum benefit limitations of Internal Revenue Code (IRC) Section 415 to lump-sum and similar benefits that become payable in the 2004 or 2005 plan year, the maximum benefit limitations would be calculated using an interest rate of 5.5 percent -- rather than a variable rate based on 30-year Treasuries or other long-term bonds -- or the plan rate, whichever is greater.

As noted, the new corporate bond-based interest rate generally applies for the 2004 and 2005 plan years. Some funding and related provisions with which plans must comply in 2004 are triggered by the plan's funding status in the 2003 plan year. (Examples include the applicability of the DRC and the quarterly-contribution requirement.) The bill says that plan sponsors may apply the new interest-rate basis when applying these types of look-back tests.

Deficit Reduction Contribution Relief

For certain plans, the Senate-passed bill would limit the amount of additional contributions that would be required by the DRC, to 20 percent of what would otherwise be required for the 2004 plan year, and to 40 percent for the 2005 plan year.** A plan is only eligible for this relief if it was not subject to the DRC in the 2000 plan year.

This relief is automatically available to a plan maintained by an employer that is: "(I) a commercial passenger airline, [or] (II) primarily engaged in the production or manufacture of a steel mill product…"

Other types of companies can apply to the IRS to use the DRC relief. The agency has 90 days to review the application and turn it down, if it determines that the employer is not likely to be able to fund the plan as required in the future.

While this DRC relief is in effect, benefits cannot be increased unless:

• The plan's current liability is expected to be at least 75 percent funded at the end of the plan year in which the increase is adopted,
• The benefits are not based on compensation, and the increase is no higher than the contemporaneous increase in participants' average wages (i.e., the increase is equivalent to what participants would have received automatically under a pay-based benefit formula),
• The increase was agreed to in collective bargaining before the date of enactment of this provision, or
• The increase is de minimis or legally required.

Outlook for the Bill
Last year the House of Representatives passed two bills that would prescribe use of an interest rate based on corporate bond rates to determine current liability for DRC purposes in the 2004 and 2005 plan years. One of the bills - H.R. 3108 - would make the similar change for PBGC purposes. The other - H.R. 3521 - would limit the increase in contributions attributable to the DRC to 20 percent of what would otherwise be called for in both the 2004 and 2005 plan years. This DRC relief would apply only to commercial passenger airlines, and would not be linked to any restrictions on benefit increases.

Now the two Houses of Congress have to reconcile their differing responses to the pension funding dilemma, either through a Conference Committee or through less formal negotiations, leading to legislative language that both can accept. The Bush Administration has come out in favor of a short-term remedy for the 30-year Treasury problem, but opposed relief on the DRC or for multiemployer plans. The resounding Senate majority in favor of all three elements may strengthen the hand of those advocating that broader relief, unless the various sides conclude that it would take too long to agree on anything other than replacement for the interest rate benchmark.

All parties would like to resolve this by mid-February, before the Congressional recess in honor of Presidents' Day. The Segal Company will provide updates on developments.

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* Although 30-year Treasuries are no longer issued, the IRS constructs a synthetic 30-year Treasury rate based on the effective yield on the February 2031 30-year Treasury bond. (To return to the text, click here.)

** The 20 percent limit applies to the first plan year beginning after December 27, 2003 and the 40 percent limit to the plan year beginning after December 27, 2004. (To return to the text, click here.)

Compliance Alert, The Segal Company’s periodic electronic newsletter summarizing important developments affecting benefit plan compliance, is for informational purposes only. It is not intended to provide authoritative guidance. On all issues involving the interpretation or application of laws and regulations, plan sponsors should rely on their attorneys for legal advice.

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