Do Government Pension Plan Sponsors Know Their Risk?

It has been just over a year since the Actuarial Standards Board introduced Actuarial Standard of Practice No. 51 (ASOP 51) which requires actuaries to disclose certain risks to plan sponsors. ASOP 51 directs the actuary to assess and disclose risks to the pension plan, but it does not require a detailed analysis of each risk be performed. Instead, it requires an actuary to recommend a more detailed analysis of specific risks when they believe it would be significantly beneficial to the plan sponsor.

While ASOP 51 applies to all pension plans, governmental plans have their own unique risks to consider. Let’s discuss a few of those risks that impact governmental plan sponsors and where additional analysis may help you better understand the pension plan risks.

Do Government Pension Plan Sponsors Know Their Risk?

Contribution Risk

There have been several states that have enacted laws aimed at requiring governmental agencies to make a certain level of contribution to their pension plans, however, that is not the case in all states. Even with those laws, there may be a risk that contributions are not adequate to fund the pension plan if the law does not require appropriate actuarial consideration in setting the required contribution amounts. Making lower contributions than are actuarially sound increases the risk to the plan and plan sponsor. Inadequate contributions will increase future appropriate contributions, which may be hard or impossible to make. Negative press and possible intervention or solvency issues would be the worst result.

Plan sponsors should check their historical contributions relative to the Actuarially Determined Contribution (ADC). They should consider additional analysis for situations that may be possible. For example, a simple multi-year projection assuming that the plan funds a set percentage, like 80%, of the ADC to see how it impacts the plan. This can provide valuable information on how future contributions would increase.

Investment Risk

For governmental pension plans, the accounting rules allow for the discount rate to be set to the expected Long-term Rate of Return (LTRR) of the plan’s asset portfolio.

This can lead plan sponsors into choosing a more risky portfolio than is appropriate to increase the assumed discount rate; however, doing this adds market risk to the plan. If the assets have a large drop in a single year or do not perform as expected over time, then the ADC will increase.

While a stochastic study (randomly generated trials) of the assets will provide the best insight into the investment risk, government plan sponsors may not have the budget to pay for such a study. Instead, you could look at shocks to the portfolio. Scenarios can be either historical, like asking. “What if the Great Recession were to happen again?”, or simplistic, like asking, “What if we had a 20 percent loss on equities?”. Then you could see how those scenarios impact the plan.

Demographic Risk

Governmental pension plans may have provisions for Cost-of-Living Adjustments (COLAs) or unreduced early retirement benefits. In all plans, the assumptions used by the actuary are not going to exactly match participant behavior, but when the plan has an increasing benefit or additional subsidy like these provisions, these demographic differences have a more pronounced impact on the plan.

If your plan has COLAs, unreduced early retirement benefits, or other subsidies that may increase liabilities to the plan, you should consider additional analysis. Such analysis can be simple scenarios or more robust. However, frequent assumption analysis and appropriate revisions to the assumptions to the most recently available information is a good way to reduce demographic risk.

Questions? Do you need help in assessing risk to your public plan? Contact the Findley consultant you normally work with or reach out to Matthew Gilliland directly with the form below.

Published June 29, 2020

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When Duty Calls Your Employees: USERRA and COVID-19

As companies across the country continue to adapt their operations to respond to the COVID-19 pandemic, nearly one million employees may be pulled from their employers to serve the federal government in its efforts to battle the disease. The recent “call up” authorization for up to one million reserve members to active duty is a good reason for businesses to review obligations of the Uniformed Services Employment and Reemployment Rights Act (USERRA).

In late March, President Donald Trump authorized a call up of “elected reserve and certain members of the individual ready reserve of the armed forces.” The call for service of reservists may be for a period of up to two years.

In 1994, USERRA was established to provide certain job protections for uniformed service members and impose employment-related obligations on their civilian employers. All private and public sector employers (including foreign employers doing business in the United States) are subject to USERRA — regardless of the employer’s size. Along with full-time employees, part-time and former employees are covered under USERRA. However, employees who are in positions not reasonably expected to continue indefinitely fall outside USERRA’s protections.

While the employer obligations and employee protections under USERRA have not changed, it’s important for employers to understand the compliance requirements and confirm that the necessary compliance documents and forms are in place. Organizations should also communicate with reserve employees in a responsive manner.

COVID-19 and USERRA

1. An employer cannot delay a service member’s reemployment solely out of concern that the service member’s service in a COVID-19 affected area may have exposed him or her to COVID-19.

In accordance with USERRA, an employer must reemploy Service members returning from service in the Uniformed Service ‘promptly’.  Title 20, Code of Federal Regulations (C.F.R.) 1002.181 states that ‘prompt’ typically means within two weeks of the employee’s application to return to work, unless unusual circumstances exist. In some cases, a reinstatement beyond the typical two-week period may be warranted due to the company’s policy regarding the COVID-19 health emergency as applicable to all employees.

Please also note that the company policy should be broad in scope and intended for all employees traveling to areas with a high risk for exposure to the Coronavirus. If an employer’s policy limiting return to work is focused only on service members, it could be viewed as discriminatory under USERRA. Please see 20 C.F.R. 1002.18 regarding discrimination.

The employer may want to consider “temporarily providing paid leave, remote work, or another position during a period of quarantine for an exposed reemployed service member or COVID-19 infected reemployed service member, before reemploying the individual into his or her proper reemployment position.”

2. An employee may still be laid off or furloughed upon return from their military (including National Guard) service if they would have been subject to that action unrelated to their service.

USERRA at a Glance

USERRA covers:

  • Pension plans covered by ERISA and certain pension plans not covered by ERISA, such as those sponsored by a State, government entity, or church for its employees. However, USERRA does not cover pension benefits under the Federal Thrift Savings Plan (which are covered under 5 U.S.C. 8432b).
  • Group health plans that are subject to ERISA and plans that are not subject to ERISA, such as those sponsored by State or local governments or religious organizations for their employees
  • Multiemployer plans maintained pursuant to one or more collective bargaining agreements between employers and employee organizations

The Protections and Obligations under USERRA are Extensive

Right to Timely Reemployment

When uniformed service members (with five years or less of cumulative uniformed service during the relevant employment period with the civilian employer) leave to perform uniformed service, they must be timely rehired upon their return, assuming “notice to employer” requirements had been met in advance (and no exceptions apply), and provided they were discharged under honorable conditions. It is important to note that notice is not required if “military necessity” prevents the giving of notice; or if the giving of notice is otherwise impossible or unreasonable. In addition, there are exceptions to the five-year requirement.

To qualify for USERRA’s protections, a service member must be available to return to work within certain time limits. These time limits for returning to work depend (with the exception of fitness-for-service examinations) on the duration of a person’s military service.

Right to be Restored

If uniformed service members are eligible to be reemployed, they must be restored to the job and benefits they would have attained had they not been absent due to military service or, in some cases, a comparable job.

Right to be Free from Discrimination and Retaliation

An employer may not discriminate (or retaliate) against a member of the uniformed services due to past, current, or future military obligations. The ban broadly extends to hiring, promotion, termination, and benefits. In addition, an employer may not retaliate against anyone assisting service members in asserting or seeking to enforce their USERRA rights, even if the person assisting them has no service connection.

Health Insurance Protections

If health plan coverage would terminate because of an absence due to military service, they must be allowed to continue their existing employer-based health plan coverage (including dependent coverage) for up to 24 months while in the military, and even if they elect not to continue coverage they must be allowed to reinstate their coverage upon return, and generally, without any waiting periods or exclusions (if one would not have been imposed had the person not been absent for military service) except for illnesses or injuries connected to their military service.

Note: If a service member is on active duty for more than 30 days, military health care is provided to the service member and their eligible dependents. In addition, service members cannot be required to pay more than 102 percent of the full premium for the coverage. If the military service was for 30 or fewer days, the person cannot be required to pay more than the normal employee share of any premium.

USERRA Notice/Poster

Employers, regardless of size, are required to provide to persons entitled to the rights and benefits under USERRA, a notice of their rights, benefits and obligations. Employers may provide the notice “Your Rights Under USERRA” by posting it where employee notices are customarily placed. Employers are also free to provide the notice to employees in other ways that will minimize costs while ensuring that the full text of the notice is provided (e.g., by handing or mailing out the notice, or distributing the notice by e-mail). The poster can be downloaded here from the Department of Labor website.

For a complete list of protections and obligations under USERRA, see A Guide to the Uniformed Services Employment and Reemployment Rights Act on the DOL website.

The DOL offers a USERRA checklist for employers.

To learn more, contact Scott Williamson at Scott.Williamson@findley.com or 615.665.5317 or John Lucas at  John.Lucas@findley.com or 615.429.3279

Published May 13, 2020

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Filing Extensions to July 15th for Approaching Form 5500 and PBGC Deadlines

A pair of government releases provides Form 5500 filing deadline relief for employee benefit plans, and PBGC filing relief for pension plans.

On April 9th, the IRS released Notice 2020-23, in which the Secretary of the Treasury determined that any person required to perform a time-sensitive action between April 1, 2020 and July 15, 2020 is affected by the Coronavirus/COVID-19 emergency. That includes filing a Form 5500 for an employee benefit plan, among other things. Any filing that is due on or after April 1, 2020, and before July 15, 2020, is automatically postponed to July 15, 2020. This is true for original filing deadlines and those obtained via a previous filing for extension. It is also automatic, so there is no need to contact the IRS or file any extension forms.

Filing Extensions to July 15th for Approaching Form 5500 and PBGC Deadlines

On April 10th, in Press Release Number 20-02, the Pension Benefit Guaranty Corporation (PBGC) announced it is offering flexibility to pension plan sponsors in response to the Coronavirus/COVID-19 outbreak.  Any deadlines for upcoming premium payments, and for other filings that originally fell on or after April 1, and before July 15, 2020, have been extended to July 15, 2020. So this includes regular premium filings as well as 4010 filings, but there are exceptions for filings that the PBGC requires related to tracking possible high risk of harm to participants or the PBGC’s insurance program. Some examples of exceptions are notification of large missed contributions through Form 200 and advanced notice of reportable events through Form 10-Advance. For a list of filings not covered by disaster relief announcements, see the PBGC’s Exceptions List.

These two releases provide welcome news for benefit plan sponsors with original deadlines approaching very quickly. However, it does not address deadlines for sponsors of plans with calendar year measurement periods. As more unfolds about how and when the stay-at-home requirements begin to be lifted, we may see additional deadline relief from the IRS and PBGC. Findley will continue to monitor these events and keep you updated.

Questions? Contact the Findley consultant you normally work with, or contact Colleen Lowmiller at colleen.lowmiller@findley.com, 216.875.1913.

Published April 14, 2020

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2020 Defined Benefit Plan Compliance Calendar

Calendar Plan Year & Calendar Employer Tax Year*

defined benefits plan compliance calendar 2020 January through June
defined benefits plan compliance calendar 2020 July through December

January 2020  

15   Due date to make fourth required quarterly contribution for 2019 plan year

31   Last day to file Form 945 to report withheld federal income tax from distributions

31   Last day to furnish Form 1099-R to recipients of distributions during 2019 calendar year

February 2020

28   Last day to file Form 1096 and Form 1099-R on paper with the IRS

March 2020

31   Last day to file Form 1099-R electronically with the IRS

31   Deadline for enrolled actuary to issue AFTAP certification for current year to avoid presumption for benefit restrictions (if applicable)

April 2020

01   Presumed AFTAP takes effect unless and until enrolled actuary issues certification of AFTAP for current plan year (if applicable).

01   Last day to pay initial required minimum distributions to applicable plan participants

15   Due date to make first required quarterly contribution for 2020 plan year

15   Last day to file financial and actuarial information under ERISA section 4010 with PBGC (if applicable)

15   Last day for C corporation employer plan sponsors to make contributions and take tax deduction for 2019 without corporate tax return extension

15   Last day to furnish Annual Funding Notice (for plans covered by PBGC that have more than 100 participants)

May 2020

01   Last day to provide notice of benefit restrictions, if restrictions are applicable as of April 1, 2020

July 2020

31   Due date to make second required quarterly contribution for 2020 plan year

31   Last day to furnish Summary of Material Modifications (SMM) to participants and beneficiaries receiving benefits

31   Last day to file Form 5500 for 2019 without extension.

31   Last day to file Form 8955-SSA without extension

31   Last day to provide a notice to terminated vested participants describing deferred vested retirement benefits (in conjunction with Form 8955-SSA)

31   (or the day Form 5500 is filed, if earlier) – Last day to furnish Annual Funding Notice (for PBGC covered plans with 100 or fewer participants without extension)

31   Last day (unextended deadline) to file Form 5330 and pay excise tax on nondeductible contributions and prohibited transactions (if applicable)

September 2020

15   Last day to pay balance of remaining required contributions for 2019 plan year to satisfy minimum funding requirements.

30   Last day to furnish Summary Annual Report to participants and beneficiaries (for non-PBGC covered plans)

30   Last day for enrolled actuary to issue AFTAP certification for current plan year

October 2020

01   If enrolled actuary does not issue AFTAP certification for plan year, then AFTAP for the plan year is presumed to be less than 60 percent and plan will be subject to applicable benefit restrictions.

15   Last day to file Form 5500 (with extension)

15   Last date to file Form 8955-SSA (with extension)

15   Last day to provide a notice to terminated vested participants describing deferred vested retirement benefits (in conjunction with Form 8955-SSA)

15   Due date to make third required quarterly contribution for 2020 plan year

15   Last day to file PBGC comprehensive PBGC premium filing and pay premiums due (for plans covered by PBGC)

31   Last day to provide notice of benefit restrictions, if restrictions are applicable as of October 1, 2020

December 2020

15   Last day (with extension) to furnish Summary Annual Report (for non-PBGC covered plans)

31   Last day for enrolled actuary to issue a certification of the specific AFTAP for current year if a range certification was previously issued

31   Last day for plan sponsors to adopt discretionary plan amendments that would be effective for the current plan year

*This calendar is designed to provide a general overview of certain key compliance dates and is not meant to indicate all possible compliance dates that may affect your plan.

© 2020 Findley • All rights reserved

If you would like more specific information about each compliance item, you may review or print the calendar below.

Print 2020 Detailed Benefit Plan Compliance Calendar

Interested in other compliance calendars?

Defined Contribution

Health & Welfare

Impact of Historic Interest Rate Decline on Defined Benefit Plans

How will defined benefit pension plans be impacted by historic year-to-year interest rate declines? The U.S. has experienced over a 100 basis point decrease on 30-year treasury rates and significant decreases across treasury bonds of all durations from year-to-year. After a slight uptick in rates during the fourth quarter of 2019, interest rates have plummeted in the first quarter of 2020. The low interest rate environment, coupled with recent volatility in the market arising from concerns over the Coronavirus, has pension plan sponsors, CFOs, and actuaries alike, taking an in-depth look at the financial impact.

Historic Interest Rate Decline on Defined Benefit Plans and options to consider.

How Will Your Company be Impacted by Historic Interest Rate Decline?

Under U.S. GAAP and International Accounting Standards, pension liabilities are typically valued using a yield curve of corporate bond rates (which have a high correlation to Treasury bond rates) to discount projected benefit payments. Current analysis shows that the average discount rate has decreased approximately 100 basis points from the prior year using this methodology.

Due to the long-term benefit structure of pension plans, their liabilities produce higher duration values than other debt-like commitments, that are particularly sensitive to movement in long-term interest rates. The general rule of thumb is for each 1% decrease in interest rates, the liability increases by a percentage equal to the duration (and vice versa). The chart below, produced using Findley’s Liability Index, shows the percentage increase in liabilities for plan’s with varying duration values since the beginning of 2019.

Pension Liability Index Results - 2/29/2020

Assuming all other plan assumptions are realized, the larger liability value caused by the decrease in discount rates will drive up the pension expense and cause a significant increase in the company’s other comprehensive income, reflecting negatively on the company’s financial statements.

Considerable Growth in Lump Sum Payment Value and PBGC Liabilities

Additional consequences of low treasury bond rates include growth in the value of lump sum payments and PBGC liabilities. Minimum lump sum amounts must be computed using interest rates prescribed by the IRS in IRC 417(e)(3) which are based on current corporate bond yields. PBGC liabilities are also determined using these rates (standard method) or a 24-month average of those rates (alternative method). For calendar year plans, lump sums paid out during 2020 will likely be 10-20% higher for participants in the 60-65 age group, than those paid out in 2019. For younger participants, the increase will be even more prominent.

In addition, if the plan is using the standard method to determine their PBGC liability, there will be a corresponding increase in the liability used to compute the plan’s PBGC premium. In 2020, there will be a 4.5% fee for each dollar the plan is underfunded on a PBGC basis. Depending on the size and funding level of the plan, the spike in PBGC liability may correspond to a significant increase in the PBGC premium amount.

What If We Want to Terminate our Pension Plan in the Near Future?

For companies that are contemplating defined benefit pension plan termination, there will be a significant increase in the cost of annuity purchases from this time last year. The actual cost difference depends on plan-specific information; however, an increase of 15-25% from this time last year would not be out of line with the current market. This can be particularly problematic for companies who have already started the plan termination process. Due to the current regulatory structure of defined benefit pension plan terminations, companies must begin the process months before the annuity contract is purchased. The decision to terminate is based on estimated annuity prices which could be significantly different than those in effect at the time of purchase.

Actions You Can Take to Mitigate the Financial Impact

Contributions to the plan in excess of the mandatory required amount will help offset rising PBGC premiums since the premium is based on the underfunded amount, not the total liability. Additional contributions would also help offset the increase in pension expense.

The best advice we can offer at this time is to discuss these implications internally and with your service providers. Begin a dialogue with your investment advisors about the potential need to re-evaluate the current strategy due to market conditions. Contact your plan’s actuary to get estimated financial impacts so you can plan and budget accordingly. If your plan has recently begun the plan termination process, you may need to reconvene with decision-makers to make sure this strategy is still economically viable.

Questions? For more information, you can utilize Findley’s Pension Indicator to track the funded status of a variety of plan types each month. To learn more about how this historic interest rate decline may impact your plan specifically contact your Findley consultant, or Adam Russo at adam.russo@findley.com or 724.933.0639.

Published on March 3, 2020

© 2020 Findley. All Rights Reserved.

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Pension Strategy Driver – 2020 PBGC Premium Rates Announced

For many sponsors of single-employer pension plans, the minimum cash funding requirement is no longer the most important number discussed with their actuaries every year. Instead, pension plan sponsors have shifted their focus to managing their PBGC premiums.

PBGC Premium Rates Chart 2007-2020. Flat-Rate vs. Variable-Rate

PBGC Premiums Defined

The PBGC premium is essentially a tax paid to a government agency to cover required insurance for the plan and the participant benefits in the event that the plan sponsor goes bankrupt. The annual premium is calculated in two parts – the flat-rate premium and the variable-rate premium – and is subject to a premium cap.

The flat-rate premium is calculated as a rate per person.

The PBGC variable-rate premium is an amount that each plan sponsor pays based on the underfunded status of its plan.

The variable-rate premium cap is a maximum amount that a plan sponsor of a significantly underfunded plan has to pay. It is calculated based on the number of participants in the plan. There are other caps that apply for small plans.

2020 Premiums Announced

For 2020, the flat-rate premium amount is $83 per person. This is 168% higher than the rate of $31 per person at the beginning of this decade.

For 2020, the variable-rate premium has jumped to $45 per $1,000 of the underfunded amount. Up until 2013, that rate was $9 per $1,000. That amounts to a 400% increase in just seven years.

The cap for 2020 is $561 per person; which means for a 10,000-life plan, the maximum PBGC variable premium is $5,610,000.

Therefore, the PBGC premium for a 10,000-life plan at the premium cap would total $6,440,000.

More information about various strategies to manage PBGC premiums can be found here: Managing PBGC Premiums: There is More Than One Lever.

More information regarding PBGC’s Current and Historical Premium Rates can be found on the PBGC’s website link above.

Questions? Contact the Findley consultant you normally work with, or contact Colleen Lowmiller at colleen.lowmiller@findley.com, 216.875.1913.

Published October 29, 2019

© 2019 Findley. All Rights Reserved.

Pension Mortality Updates May Decrease Liabilities

The Society of Actuaries’ (SOA) new Scale MP-2019 mortality improvement rates will lead to lower liabilities compared to the previous versions. Along with the improvement scale, the SOA’s Retirement Plans Experience Committee (RPEC) also released a set of new mortality tables, Pri-2012, both on October 23rd. The new tables and improvement scale may be used for financial reporting purposes now. The improvement scale is expected to be used in 2021 for PBGC, lump sum, and cash funding calculations.

Pri-2012 Mortality Tables

The Pri-2012 tables are the most recent private mortality tables released by the SOA since the RP-2006 tables. The SOA estimates that most plan liabilities will fall within 1.0% (up or down) of the liability they would have seen under the RP-2006 tables. The new tables were developed using data from 2010-2014 and reflect the RPEC’s commitment to update the base mortality tables every five years.

When compared to the RP-2006 tables, life expectancy for a 65 year old female remains at 87.4, while the life expectancy of a 65 year old male decreased from 85.0 to 84.7.

The new Pri-2012 tables are based on more multiemployer data compared to the prior tables. Mortality experience under multiemployer plans did not differ significantly from experience in single employer plans. The SOA determined that job classification (blue-collar and white-collar) is an increasing forecaster of mortality and more indicative of future experience than benefit amount.

The SOA identified that surviving beneficiaries had higher mortality than the general population and created separate mortality tables for this demographic with the Pri-2012 tables update.

MP-2019 Mortality Improvement Scale

The new mortality improvement scale MP-2019 is based on historical U.S. population mortality. This continues to fulfill the RPEC’s pledge to update the improvement scales annually.

Consistent with all prior updates since the first table (MP-2014) was released, the MP-2019 improvement scale will reduce liabilities for pension plans compared to the MP-2018 improvement scale. The SOA estimated that pension obligations will typically be 0.3% to 1.0% lower when compared to using Scale MP-2018.

According to the study, the observed age-adjusted mortality rate increased slightly from the prior year, yet it is fairly level relative to the last several years. Also, the age-adjusted mortality improvement rate averaged just 0.3% per year from 2010 to 2017, compared to 0.5% that was observed in the prior study from 2009 to 2016.

Implications for Pension Plans

Pri-2012 may be adopted for financial accounting disclosures and pension expense purposes. The adoption of the new tables will likely result in little change to liabilities. We expect plan sponsors will generally adopt the Pri-2012 tables to replace the RP-2006 tables.

Plan sponsors who have updated their improvement scale annually will generally adopt the MP-2019 improvement scale. As noted, it is expected to lower liabilities, and thus will result in lower pension expense.

We do not expect that the minimum funding calculations, PBGC premiums, and lump sum calculations will use the Pri-2012 table in the near future. However, the 2021 plan year will likely incorporate the MP-2019 scale based on the currently proposed intent from the IRS. Absent any other changes, this update will result in lower funding liability, PBGC liability and lump sum amounts for pension plans in that plan year.

More information regarding the Pri-2012 mortality table and the Scale MP-2019 mortality improvement scale release can be found on the Society of Actuaries’ website links above.

Questions? Contact the Findley consultant you normally work with, or contact Matthew Gilliland at matthew.gilliland@findley.com, 615.665.5306 or Matthew Widick at matthew.widick@findley.com, 615.665.5407.

Published October 28, 2019

© 2019 Findley. All Rights Reserved.

Minimum Participation Rule Puts Pension Benefits at Risk

Almost all pension plans are subject to certain compliance tests that are outlined by the IRS. The compliance requirements are in place to make sure that if a plan sponsor’s contributions to a pension plan are deductible for tax purposes, then the pension plan’s benefits must not be designed too heavily in favor of the highest paid employees. One set of compliance rules for most pension plans are the minimum participation requirements. As some defined benefit pension plans continue operating, these rules are causing compliance concerns.

Minimum Participation Rule Details

Under Internal Revenue Code (IRC) Section 401(a)(26), a defined benefit pension plan must benefit a minimum of

  • 50 employees or
  • 40% of the employees of the employer.

If the pension plan is not benefiting any highly compensated employees (HCEs), it automatically satisfies the rule.

HCE is generally determined as an individual earning more than a specified dollar threshold established by the IRS for the prior year. This dollar limit is $125,000 based on 2019 earnings to determine HCEs for the 2020 year. All others are considered non-highly compensated employees (NHCEs).

Unintended Consequences

Today, many pension plans have been “partially frozen” for years, which means they have benefits accruing only for a specified group of employees. As time passes and ordinary turnover and retirement occur, the number of employees that accrue benefits in these defined benefit pension plans is decreasing.

Although the original purpose was to provide “meaningful” benefits to employees across the plan sponsor’s organization, these requirements are now causing accruals to be shut off as some plans approach and fall below the minimum threshold of employees accruing benefits.

For the affected employees, it comes at a time close to retirement age when their promised pensions, by design, would be accumulating at the highest rates, and defined contribution style benefits, like 401k plans, can’t realistically replace all lost future accruals.

Potential Strategies

Do Nothing and Wait

  • We can hope that legislative relief will be passed to eliminate the participation issues. However, Congress has considered addressing these issues over the last 5 to 7 years, and no movement towards enacting relief rules has been seen yet.

Merge Pension Plans

  • This provides immediate relief to minimum participation issues.
  • It could be a temporary solution if the benefits are also partially frozen across the combined defined benefit pension plan. Review the demographics to project how long this solution will last when weighing the advantages of this strategy for your situation.

Open the Pension Plan

  • Reopen the pension plan to additional participants. (Yes, this could make sense!)
  • More employees will be benefiting and eliminate minimum participation rule issues.
  • New plan participants can receive a different formula (something similar to the current plan formula but reduced, cash balance formula, variable annuity formula, etc.)
  • Consider if recruiting or employee retention issues can be reduced or alleviated by designing new pension benefits for targeted employee groups.
  • This can be designed to help bridge the time until the potentially affected employees reach retirement age.
  • Watch the mix of HCEs and NHCEs because the additional pension benefit design still needs to satisfy other IRS coverage, nondiscrimination, and design-based compliance rules.

Freeze Remaining Pension Benefits

  • The freeze can be for all participants or only for current and future HCEs.
  • Replacement benefits can be provided to address employee retention and retirement readiness issues.
    • Provide projected lost benefits as cash payment(s).
    • Executive employees can have some or all lost benefits replaced in a nonqualified deferred compensation plan or other executive compensation arrangement.
    • Design partial replacement benefits in a 401k plan.
  • Consider the impact of the pension plan freeze on other sponsored benefit plans. For example, are there benefits that are automatically available, or not available, based upon whether an employee is accruing benefits in the pension plan?
  • Curtailment accounting rules are triggered which may require an additional one-time expense to be recognized through income in the year of the benefit freeze.

In Perspective

There are many valid business reasons that explain why a plan sponsor would want to stop pension accruals for everyone except a specified group. We know the IRS rules were not intended to cause the loss of benefits for employees late in their careers. Regardless, several pension plan sponsors are at the point where their partially frozen pension plans are close to becoming noncompliant. While we continue to wait for legislative relief for this issue (that may never come), if you sponsor a partially frozen pension plan, you should determine when this will become an issue for you. Begin discussing possible strategies, and have an approach in place well ahead of time to minimize the disruption to your organization as much as possible.

Questions? Contact the Findley consultant you normally work with, or contact Colleen Lowmiller at colleen.lowmiller@findley.com, 216.875.1913.

Published October 28, 2019

© 2019 Findley. All Rights Reserved.

Pension Financial Impact of Record Low Treasury Bond Rates

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How will defined benefit pension plans fare as a result of the 30-year U.S. Treasury bond rates falling below 2.00% for the first time in U.S. history? This 100 basis point drop from the beginning of the year and the fact that U.S. Treasury bond rates of all durations are down significantly from the beginning of the year, have pension plan sponsors, CFOs, and actuaries alike, taking an in-depth look at the financial impact.

How Will Record Low Treasury Bond Rates Impact Your Company’s Defined Benefit Plan?

Due to the long-term benefit structure of pension plans, their liabilities produce high duration values that are particularly sensitive to movement in long-term interest rates. For instance, a standard frozen pension plan may have a duration of 12 which indicates that a decrease in the discount rate of 100 basis points would produce a 12% increase in liabilities. 

Under U.S. GAAP and International Accounting Standards, pension liabilities are typically valued using a yield curve of corporate bond rates (which have high correlation to treasury bond rates) to discount projected benefit payments. Current analysis shows that the average discount rate has decreased over 100 basis points from the beginning of the year using this methodology. Assuming all other plan assumptions are realized, the larger liability value caused by the decrease in discount rates will drive up the pension expense and cause a significant increase in the company’s other comprehensive income, reflecting negatively on the company’s financial statements. 

Pension Financial Impact of Record Low Treasury Bond Rates

What If We Want to Terminate our Pension Plan in the Near Future?

For companies that are contemplating defined benefit pension plan termination, there will also be a significant increase in the cost of annuity purchases. The actual cost difference depends on plan-specific information; however, an increase of 10-20% from the beginning of the year would not be out of line with the current market. This can be particularly problematic for companies who have already started the plan termination process. Due to the current regulatory structure of defined benefit pension plan terminations, companies must begin the process months before the annuity contract is purchased. Their decision to terminate is based on estimated annuity prices which could be significantly different than those in effect at the time of purchase.

Consider Growth in Lump Sum Payment Value and PBGC Liabilities

Additional consequences of record low treasury bond rates include growth in the value of lump sum payments and PBGC liabilities. Minimum lump sum amounts must be computed using interest rates prescribed by the IRS in IRC 417(e)(3) which are based on current corporate bond yields. PBGC liabilities are also determined using these rates (standard method) or a 24-month average of those rates (alternative method). If current interest rates hold, lump sums paid out during 2020 will likely be 10-15% higher than those paid out in 2019 for similarly situated participants. In addition, there would be a corresponding increase in the liability used to compute the plan’s PBGC premium. In 2020, there will be an estimated 4.5% fee for each dollar the plan is underfunded on a PBGC basis. Depending on the size and funding level of the plan, the spike in PBGC liability may correspond to a significant increase in the PBGC premium amount.

Actions You Can Take to Mitigate the 2020 Financial Impact

There is potential to help mitigate the financial impact for 2020 by taking action now. Since lump sum payments are projected to increase significantly in 2020, offering a lump sum window to terminated vested or retired participants during 2019 could be a cost effective way to reduce the overall liability of the plan.

Contributions to the plan in excess of the mandatory required amount will help offset rising PBGC premiums since the premium is based on the underfunded amount, not the total liability. Additional contributions would also help offset the increase in pension expense.

The best advice we can offer at this time is to discuss these implications internally and with your service providers. Begin a dialogue with your investment advisors about the potential need to re-evaluate the current strategy due to market conditions. Contact your plan’s actuary to get estimated financial impacts so you can plan and budget accordingly. If your plan has recently begun the plan termination process, you may need to reconvene with decision-makers to make sure this strategy is still economically viable.

Questions? For more information, you can utilize Findley’s Pension Indicator to track the funded status of a variety of plan types each month. To learn more about how falling interest rates may impact your plan specifically contact your Findley consultant or Adam Russo at adam.russo@findley.com or 216-875-1949.

Published on August 22, 2019

© 2019 Findley. All Rights Reserved.

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Terminating an Overfunded Pension Plan? Who Gets the Excess?

If a single employer overfunded pension plan is terminating and its participants and beneficiaries are on track to receive full benefits, the plan sponsor will likely ask if the excess is theirs. In other words, will the surplus revert to the plan sponsor? The answer is maybe.

To determine how excess plan funds can be exhausted, which may include a reversion to the plan sponsor, there are 7 possibilities to consider. As always, the place to start with any retirement plan issue is to answer the question: what does the plan say?

Terminating an Overfunded Pension Plan

Possibilities to Consider if the Terminating Plan Document does not Permit a Reversion

A plan document may state that no part of the plan’s assets can be diverted for any purpose other than for the exclusive benefit of participants and beneficiaries. The plan may also indicate that the plan cannot be amended to designate any part of the assets to become the employer’s property. If an overfunded pension plan has these provisions, it is tempting to assume the only choice is to allocate the excess among participants and beneficiaries. However, even in the face of these explicit provisions, there may be other provisions that permit an employer to recover or use a portion of the excess assets.

Possibilities 1 and 2 – Return of Mistaken and Nondeductible Contributions

Plan documents generally indicate that if an employer makes an excessive plan contribution due to a mistake, the employer can demand the surplus is returned. The employer is required to request this from the trustee within one year after the contribution was made to the trust. In addition, plans generally provide that a contribution is made on the condition that the employer receives a corresponding tax deduction. In the unlikely event that the deduction is not permitted by the IRS, the contribution can be returned to the employer within one year following the IRS’ final determination that the tax deduction was not allowed.

An example of a contribution mistake may be an actuarial calculation error. In a 2014 Private Letter Ruling, the IRS considered a surplus reversion when a terminating single employer plan purchased an annuity contract. The excess assets were created when the purchase price selected to fully fund plan benefits actually came in at a lower price than estimated. Using reasonable actuarial assumptions, the plan’s actuary had advised the employer to contribute a higher amount than was ultimately calculated as necessary by the insurance company. In this case, the IRS permitted the return of the mistaken excess contribution. 

Possibility 3 – Have all Reasonable Plan Expenses Been Paid from the Trust?

Many plan documents provide that plan expenses can be paid from the trust. In some instances, appropriate and reasonable plan termination expenses will go a long way to exhaust excess assets. Reasonable plan termination expenses include determination letter costs and fees, service provider termination charges and termination implementation charges such as those for the plan audit, preparing and filing annual reports, calculating benefits, and preparing benefit statements.

Possibilities to Consider if the Terminating Plan Document Permits a Reversion

The overfunded pension plan may explicitly state that excess assets, once all of the plan’s obligations to participants and beneficiaries have been satisfied, may revert to the plan sponsor. On the other hand, the plan may not explicitly permit a reversion. In that case, the plan sponsor may want to consider amending the plan to allow a reversion well ahead of the anticipated termination.

Possibilities 4 – Take a Reversion

If the first three possibilities do not work or are inadequate to exhaust the surplus, and the overfunded pension plan allows a reversion, there are three more possibilities. In the first, the employer takes all. The employer can take all of the excess funds back subject to a 50% excise tax, as well as applicable federal tax.  Notably, a not-for-profit organization may not be subject to the excise tax on the reversion at all if it has always been tax-exempt.

Possibility 5  – Transfer the Excess to a Qualified Replacement Plan

The opportunity to pay only a 20% excise tax (and any applicable federal tax) on part of the surplus is available where the remaining excess assets are transferred from the terminating pension plan to a newly implemented or preexisting qualified replacement plan (QRP). A QRP can be any type of qualified retirement plan including a profit sharing plan, 401(k) plan, or money purchase plan. For example, an employer’s or a parent company’s 401(k) plan, whether newly implemented or preexisting, may qualify as a qualified replacement plan.

Once an appropriate plan is chosen, the amount transferred into the QRP must be allocated directly into participant accounts within the year of the transfer or deposited into a suspense account and allocated over seven years, beginning with the year of the transfer.

There are additional requirements for a qualified replacement plan. At least 95% of the active participants from the terminated plan who remain as employees must participate in the QRP. In addition, the employer is required to transfer a minimum of 25% of the surplus into a qualified replacement plan prior to the reversion. If all of the QRP requirements are satisfied, then only the amounts reverted to the employer are subject to a 20% excise tax and federal tax, if applicable. 

Possibility 6 – Provide Pro Rata Benefit Increases

If the employer chooses not to use a QRP, it can still limit the excise tax if it takes back 80% or less of the surplus and provides pro rata or proportionate benefit increases in the accrued benefits of all qualified participants. The amendment to provide the benefit increases must take effect on the plan’s termination date and must benefit all qualified participants. A qualified participant is an active participant, a participant or beneficiary in pay status, or a terminated vested participant whose credited service under the plan ended during the period beginning 3 years before termination date and ending with the date of the final distribution of plan assets. In addition, certain other conditions apply including how much of the increases are allowed to go to participants who are not active.

A Possibility That’s Always Available

Possibility 7 – Allocate all of the Excess Among Participants and Beneficiaries

It is always possible to allocate all of the excess assets among participants in a nondiscriminatory way that meets all applicable law. A plan amendment is necessary to provide for these higher benefits.

You may know at the outset of terminating your plan that there will be excess assets. On the other hand, a surplus may come as a surprise. Even if a pension plan is underfunded at the time the termination process officially begins, it is possible that the plan becomes overfunded during the approximate 12 month time period to terminate the plan. In this scenario, the plan sponsor will have to address what to do with the excess assets.

Dealing with the excess assets in a terminating defined benefit plan can be a challenge. There are traps for the unwary, and considerations beyond the scope of this article. Plan sponsors need to determine first how the excess was created, because the answer to that question may determine what happens to it. If there is no obvious answer in how to deal with the surplus, then the plan sponsor needs to look at all of the possibilities. It may be that a combination of uses for the excess plan assets is best. If you think you will find yourself in this situation with your defined benefit plan, consult your trusted advisors at your earliest opportunity so that you know the possibilities available to you.

Questions? Contact the Findley consultant you normally work with, or contact Sheila Ninnenam at sheila.ninneman@findley.com, 216.875.1927.

Published July 10, 2019

© 2019 Findley. All Rights Reserved.

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