July 9, 2012
On July 6, 2012, President Obama signed the Moving Ahead for Progress in the 21st Century Act, which primarily addresses transportation funding and student loan interest rates. The Act also provides significant short-term pension funding relief to sponsors of defined benefit pension plans, increases Pension Benefit Guaranty Corporation (PBGC) premiums for single and multiemployer plans, and extends and liberalizes the ability to use assets from certain overfunded pension plans to provide retiree welfare benefits.
Pension Funding Relief
In general, ERISA and the Internal Revenue Code require minimum annual pension contributions in an amount equal to the sum of the "normal cost" of the plan for the year (i.e., the benefit accruals for the year) plus an amount necessary to amortize the plan’s underfunding over seven years. For purposes of determining liabilities, corporate bond yields are used. Due to historically low interest rates, this has resulted in required contributions substantially higher than anticipated when the current funding rules were enacted by the Pension Protection Act of 2006.
The Act provides funding relief by "stabilizing" interest rates through use of a floor and a cap on the current year’s rate. The floor and cap are based on average interest rates over the 25 years preceding the year at issue. For 2012, the interest rate used for determining plan liabilities must be between 90% and 110% of the 25-year rate. The 90% figure decreases by 5% each year, and the 110% figure increases by 5% each year, until they reach 70% and 130%, respectively, for 2015 and subsequent years.
These changes are expected to increase by approximately 150 basis points the 2012 interest rate used by plans for valuing liabilities. As a result, many plans will see contribution reductions of 20% or more for 2012. Contributions should be lower than under prior law for the next few years as well. However, actuaries have projected that corporate bond yields will fall between the floor and the cap thereafter, so the Act will no longer provide funding relief in most cases (and, of course, the lower contributions over the next few years generally will have to be made up in future years since employers have the ultimate responsibility to ensure that pension plans have sufficient assets to pay all promised benefits).
PBGC Premium Increases
Single employer pension plans are required to pay both "flat" and "variable" rate insurance premiums to the PBGC. The annual flat rate premium is $35 per plan participant in 2012. The annual variable premium is $9 for each $1,000 of unfunded vested benefits.
The Act raises both the flat and the variable rate premiums. The flat rate premium rises to $42 per participant for 2013 and $49 per participant in 2014, with inflation indexing thereafter. The variable rate premiums will also be indexed for inflation and will rise to a minimum of $13 per $1,000 of underfunding in 2014 and $18 in 2015 and thereafter. There will also be a new cap of $400 per participant (indexed for inflation) beginning in 2013 for the variable rate premium.
Multiemployer pension plans only pay flat rate premiums. The current rate of $9 per participant is increased to $12 for 2013 and will be adjusted for inflation thereafter.
Transfers to Provide Retiree Welfare Benefits
In general, pension plan assets cannot be used to pay other types of benefits. However, plans that are more than 125% funded may use excess assets to provide current-year retiree medical benefits (and, for collectively-bargained employees, fund future-year benefits in some cases).
The Act extends this provision, which was to expire December 31, 2013, through December 31, 2021. It also allows transfers to fund certain retiree group-term life insurance, generally subject to a $50,000 per-retiree limit on the death benefit. This extension and modification of the rules will thus allow employers with very well-funded plans to use some of the plan’s excess assets. Although few plans are likely to be sufficiently funded at this time to take advantage of the transfer rules, this may change when interest rates rise.
The Act’s pension funding stabilization will provide short-term relief for many employers. Unfortunately, with the increase in PBGC premiums, Congress took back with one hand some of what it gave with the other. Nevertheless, on balance, the pension-related provisions in the Act are good news for many employers, especially those facing short-term cash constraints.
Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you work, or any of the following:
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Michael J. Collins – Washington, D.C. (202-887-3551, email@example.com)
Stephen W. Fackler – Palo Alto and New York (650-849-5385 and 212-351-2392, firstname.lastname@example.org)
David I. Schiller – Dallas (214-698-3205, email@example.com)
Sean Feller – Los Angeles (213-229-7579, firstname.lastname@example.org)
Dina R. Bernstein – Los Angeles (213-229-7206, email@example.com)
Krista Hanvey – Dallas (214-698-3425, firstname.lastname@example.org)
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