Dramatic Pension Funding Changes for Single-Employer Plans Proposed

Long-expected pension funding changes may be on the horizon. Revamping the pension funding rules for single-employer pension plans is one of three key elements in the Bush Administration's plan for dealing with defined benefit plan funding problems and reported threats to the long-term solvency for the Pension Benefit Guaranty Corporation (PBGC), which reported a record deficit of $23.3 billion for private, single-employer pension plans in 2004 in the wake of a growing number of plans being taken over by the PBGC.

The other key elements of the Administration's plan, as outlined by the Secretary of Labor,* are increasing PBGC premiums and its ability to limit its risk and requiring more disclosure of information about single-employer plans and their sponsors to participants and the government. The three proposals are discussed below. They are exclusively addressed to the rules governing the single-employer plan system.

It is important to keep in mind that Congress will need to hammer out both the basic policy and the details. A bill embodying the Administration's proposal has not even been introduced yet.

FUNDING REFORM

Believing that the current funding requirements are both unnecessarily complex and ineffective, the Administration's stated aims are to bring simplicity, perceived accuracy, stability and flexibility to the funding rules through the following reforms, all of which are intended to promote better funding of single-employer, defined benefit pension plans:

• Simplicity The Administration proposes replacing the current multiple measures of pension liabilities with one measure, adjusted to reflect the risk of termination of the plan. One possible impact of this change could be that employers sponsoring plans that are deemed to have a "risk of termination" would find their funding obligation increasing to reflect that possibility.
• Perceived Accuracy Pension liabilities would be measured on a more precise basis, using a "current duration-matched yield curve of corporate bond rates." Exactly how this would operate, especially in light of the objective for greater simplicity, is unclear. Moreover, funding targets would vary according to the financial health of the plan sponsor. If these reforms are introduced, plans with older covered populations and a heavy burden of retirees will see an increase in their liabilities, as will plans sponsored by employers going through tough economic times.
• Stability Employers would be required to make up funding shortfalls within a seven-year period. A "financially weak" employer or one with a "significantly underfunded" plan would be prohibited from making benefit increases unless they are paid for immediately. Benefit accruals would automatically cease if the employer's credit rating dips below investment grade.
• Flexibility To encourage full funding, the Administration's proposal would allow employers to make additional deductible pension contributions during good economic times.

PBGC PREMIUM INCREASES

The Administration proposes increasing both the PBGC flat-rate premiums and the risk-based portion. Flat rate premiums would be increased, initially, to $30 from $19 (a rate set in 1991) and after that would be indexed to wage inflation in the same manner that the PBGC's benefit guarantee is indexed.

The risk-based premiums would be pegged to the plan's funding target, as redefined under the proposal. That would make financially shaky employers, and those in bankruptcy, pay the highest premiums if their plans are not fully funded. The PBGC's board would be directed to adjust the risk-based premium rates periodically to achieve and maintain full funding for the agency.

INCREASED DISCLOSURE

To ensure greater transparency and accountability, the Administration also proposes increasing the amount of information about private sector defined benefit pension plans disclosed to employees, investors and regulators. Finally, the Administration proposes requiring faster reporting of information about the actuarial status of the plans.

OBSERVATIONS AND NEXT STEPS

Because it is very early in the policy and legislative process, the specific content of the proposals summarized above is less important than the general direction it indicates the debate and possible changes will take.

The Administration is expected to release more details about these proposals in the coming weeks. Before any of these reforms can be implemented, they must be introduced in Congress, passed by both Houses, and signed into law by the president.

The Administration proposals are expected to be the starting point for a debate over the details of the changes. Input is expected from employer groups, labor, the actuarial profession and other interested parties.

Because the law substituting corporate-bond rates for 30-year Treasury rates to determine the deficit reduction contribution expires on December 31, 2005, there is built-in pressure for some legislative action on pension funding this year.

It is premature for employers that sponsor pension plans to take action with respect to any of the Administration's proposals. The Segal Company will keep you informed of significant developments.

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.

Back to Top