The 11th Hour for Pension Reform

The House-Senate conference committee will try to reconcile the pension reform bills before April 15, when the next round of corporate pension contributions for calendar-year plans are due. But what will happen if pension reform doesn't pass this year? Without reform, pension law will "snap back" to pre-2002 law. Pension contributions and Pension Benefit Guaranty Corporation (PBGC) variable-rate premiums would have to be determined under old law, which could require many plan sponsors to pay much higher pension contributions and variable-rate premiums.

Under pre-2002 law, current liability is based on an interest rate range of 90 percent to 105 percent of the four-year average of 30-year Treasuries. For 2006 calendar-year plans, the interest rate range would be 4.37 percent to 5.10 percent — significantly lower than the interest rate range for 2005 or the range anticipated under pension reform. Instead of being based on 30-year Treasury yields, interest rates for 2005 and those anticipated for 2006 under proposed legislation are based on corporate bond yields.

For example, the interest rate range for 2005 was 5.49 percent to 6.10 percent, and the interest rate range for a 2006 calendar-year plan under the proposed legislation would be 5.19 percent to 5.77 percent. Thus, the snap-back to using 30-year Treasury rates would require sponsors to determine minimum contribution requirements using an interest rate about 67 basis points lower than that anticipated under pension reform.

Under pre-2002 law, PBGC variable-rate premiums are based on 85 percent of 30-year Treasury rates. So, instead of using a discount rate of 4.86 percent based on corporate bonds to determine variable-rate PBGC premiums for 2006, the snap-back would require plan sponsors to use 3.95 percent — a rate more than 90 basis points lower! However, sponsors that satisfied the full-funding exemption for their 2005 plan year would not be required to pay variable-rate premiums for 2006.

While plan sponsors need final pension reform in 2006, April 15 is not the watershed moment it was for the Pension Funding Equity Act (PFEA) in 2004. Had the PFEA not passed by April 15, plan sponsors would have had to re-determine their 2003 plan-year valuations to figure out whether they owed 2004 quarterly contributions and how much they owed.

Under current law, however, 2006 quarterly contributions are based on the lesser of 100 percent of minimum funding requirements for 2005 or 90 percent of the minimum funding requirements for 2006. Additionally, the 100 percent funded status test for determining whether quarterly contributions are required for 2006 will also be based on 2005 funded status, which was determined using corporate bond yields. Thus, even if pension reform comes to grief this year, plan sponsors may base their 2006 quarterly contributions (due April 15, July 15, October 15 and January 15, 2007) on their 2005 results.

However, that doesn't mean the pressure is off. Given the recent avalanche of defined benefit plan terminations and freezes, now is not the time to delay pension reform. Those plan sponsors still standing need funding predictability.

Moreover, the snap-back to pre-2002 law may already be affecting plan administration for 2006. Some companies that planned to transfer surplus assets to fund postretirement medical accounts may not be able to do so unless their plan's funded status exceeds 125 percent using the 30-year Treasury measurement. If plan funding falls below 110 percent using the 30-year Treasury measurement, a company may not pay not be able to pay out lump sum benefits to highly compensated employees. And if plan funding falls below 60 percent using the 30-year Treasury measurement, the plan could be subject to restrictions on benefit improvements.