Pension Funding Relief Extended

In August, Congress passed, and the President signed, the Highway and Transportation Funding Act of 2014 (HATFA 2014). The legislation includes an extension of 2012’s Moving Ahead for Progress in the 21st Century Act (MAP-21) defined benefit plan ‘funding stabilization’ relief.

In this article we briefly review the DB funding provisions of HATFA 2014 and consider their significance for plan sponsors.

HATFA 2014

As discussed in our Legislative and Regulatory Update – July 2014, MAP-21 put a ‘floor’ under valuation interest rates. The floor is equal to (1) the average of rates for a 25-year period, (2) reduced by multiplying it by a percentage beginning at 90% in 2012 and ‘phasing down’ to 70% by 2016 and thereafter (we will call this the ‘phase-down percentage’). HATFA 2014 extends this relief by applying the 90% phase-down percentage through 2017.

The following chart compares current and HATFA 2014 phase-down percentage rules.

Benefit restrictions

The retroactive nature of HATFA 2014 relief creates an issue for those plans that, based on their funded status under current rules, were required to impose benefit restrictions in 2013. To address that issue, the legislation allows a plan to disregard the new MAP-21 extension, for 2013, for all purposes (e.g., funding and benefit restrictions) or just for purposes of benefit restrictions. Some plans may, however, have imposed restrictions for 2014 – that possibility is not addressed in the legislation.

Effect on plan finance

To be clear about what is happening in HATFA 2014: Under current (pre-HATFA 2014) law, the MAP-21 floor would, for, e.g., 2014, be the 25-year average of interest rates multiplied by 80%. Under HATFA 2014 the 25-year average is multiplied by 90%. How does that affect minimum funding requirements?

To give a feel for that effect, the following chart shows 2014 valuation interest rates (segment rates) based on: (1) PPA rules (without the application of MAP-21 relief); (2) MAP-21 (without the extension in HATFA 2014, i.e., with an 80% phase-down percentage); and (3) HATFA 2014 (i.e., with a 90% phase-down percentage).

* October Three estimate as of August 31, 2014.

The increase in valuation interest rates between MAP-21 and HATFA 2014 (0.56%-0.77%) translates to a decrease in pension liabilities for a typical plan of about 8%.

Consider a plan with (for 2014) $79 million in assets and, under MAP-21 rules, $100 million in liabilities. Under those rules this plan would be 79% funded and subject to all the restrictions, etc. that apply to a plan less than 80% funded. Applying the HATFA 2014 extension, this plan would be 86% funded [$79 million divided by $92 million ($100 million minus 8%)].

Effect of PBGC premium increase

Since MAP-21 was adopted, however, there have been significant increases in the Pension Benefit Guaranty Corporation variable premium, from $9 per $1,000 of unfunded vested benefits in 2013 to (an estimated) $30 in 2016. For this purpose, unfunded vested benefits are determined without regard to MAP-21 or HATFA 2014.

PBGC variable rate premiums function like a tax on underfunding. And, because for that purpose MAP-21 and HATFA 2014 are disregarded, sponsors taking advantage of HATFA 2014 funding relief will still have to pay this ‘tax’ (the PBGC variable rate premium) on the funding that HATFA 2014 provides relief from.

As we discussed in our article PBGC variable premium vs. borrow-and-fund: impact of higher premiums, the increase in variable rate premiums may make funding now – rather than delaying funding and paying the PBGC premium – an attractive alternative for many sponsors.

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Clearly, HATFA 2014 will significantly reduce contribution requirements over the next several years. DB plan sponsors will, however, want to consider the effect of taking advantage of this relief on PBGC premiums.