New legislation, Moving Ahead for Progress in the 21st Century Act (“MAP-21”), has provisions affecting defined benefit (“DB”) pension plans. Plan sponsors who want to terminate their DB plans want their plan assets to be about equal to their plan liabilities on a termination basis (e.g. insurance company annuity or PGC lump sum). This way they will not have to make a large contribution (if they are underfunded) or pay a lot to the government in excise taxes (if they are in surplus.) Map-21 doesn’t affect the termination liabilities. Therefore, we only have to see how Map-21 affects DB plan assets.
Underfunded DB Plans
Underfunded DB plans have plan liabilities that exceed plan assets. The main benefit of Map-21 is funding relief (lower company contributions). If the plan is underfunded, companies may choose to have fewer contributions will go into the plan and, if they do so, it will take longer to become fully funded and, therefore, longer before they can terminate their plan. However, funding relief is likely much larger in the next few years, but less in years 4-5 and beyond.
MAP-21 also increases the Pension Benefit Guaranty Corporation (“PBGC”) significantly. Both the flat-rate and variable-rate premiums will see large increases over the next couple of years, with inflation increases continuing after that. For plan sponsors that are underfunded, the impact of the premium increases will be much greater since the variable rate premium is determined based on how underfunded the plan is (and does not take into consideration the funding relief when determining the underfunded level).For underfunded DB plans that pay PBGC premiums out of plan assets, lower plan assets will result in a longer time before the DB plan can be terminated.
DB Plans in Surplus
Surplus DB plans have plan assets that exceed plan liabilities. Map-21 should have a much less impact on these DB plans:
• These plans should already pay little or no company contributions. Funding relief will have little or no further benefit.
• Only the relatively small flat rate PBGC premium increase applies to surplus DB plans. The variable rate premium does not apply to surplus DB plans.
• The Map-21 provision to fund retiree medical and life premiums with surplus assets, only significantly helps reduce surplus for those companies that still have any significant retiree and/or life benefits and choose to take advantage of this provision.
Where are we now?
Although Map-21 will have some impact on DB plan terminations (especially underfunded plans), companies who want to terminate pension plans will become fully funded sooner when:
- For underfunded plans, plan assets spike up (I don’t think interest rates can get any lower), and
- For surplus plans, plan assets take another major drop.
In the meantime, I believe that companies should adopt a “glide path” strategy to manage their DB plan’s funded status. As a plan’s funded status improves (whether from asset performance in excess of liability growth or from sponsor contributions) the gains would be preserved by shifting assets to a better liability hedging asset. Over time this should provide a relative stable path toward full funding and plan termination.