Benefits Legislation Active as 2007 Session Hits Midpoint

As Congress headed into the July 4 recess, compensation and benefits were high on the legislative agenda. The focus is expected to last through the year, with health care likely to play a role in the presidential elections as well. After the prolonged debate preceding enactment of the Pension Protection Act of 2006 (PPA), retirement issues slipped down the agenda a few notches. However, Congress enacted some technical corrections to the PPA and is discussing others, as well as retirement savings, 401(k) fees, hedge fund disclosures and other retirement matters.

Compensation Continues Climb Up Legislative Agenda
Executive compensation remains a hot issue. Earlier this year, the Senate voted to impose new limits on nonqualified deferred compensation (NQDC) and broaden the definition of a “covered employee” – twice. The provisions would cap annual deferrals under section 409A at $1 million and add former covered employees to the definition in tax code section 162(m) (see Watson Wyatt Insider, February 2007 and May 2007).

The House has yet to vote on these provisions, but both provisions are scored as significant revenue raisers and so are expected to remain on the agenda. These executive compensation provisions could become law during the 2007-2008 legislative term.

In a separate development, Senator Tom Harkin (D-Iowa) introduced the Restoring Pension Promises to Workers Act (S.1725), which would require companies that sponsor NQDC arrangements to also sponsor a defined benefit plan for rank-and-file employees. Although it may not go far, the bill reflects a continuing focus on fairness in compensation and pension matters.

Executive stock options received new attention during the Senate’s Homeland Security and Governmental Affairs Committee’s Permanent Subcommittee on Investigations hearing on June 5 (see Watson Wyatt Insider, July 2007). The hearing focused on the mismatch between the expensing of stock options for financial-reporting purposes and the tax treatment of those options – the “book-tax” gap. Although subcommittee Chair Senator Carl Levin (D-Michigan), who has strongly criticized stock options, plans to introduce legislation to close the book-tax gap, the prospects for further action remain unclear.

The Shareholder Vote on Executive Compensation Act (H.R.1257) cleared the House on April 20 in a 269-134 vote. Sponsored by House Financial Services Committee Chair Barney Frank (D-Massachusetts), the act would give shareholders an annual, nonbinding vote on executive compensation packages. It also would grant them a (nonbinding) vote on golden parachute arrangements triggered by mergers, acquisitions or similar corporate transactions. The Senate’s companion bill has not been discussed, and the outlook for the legislation is uncertain.

Health Care Issues Active on the Agenda
Health care has been much in the news, and Congress is considering several bills that would affect employer-sponsored plans. Enactment seems likely for bills to expand mental health parity requirements and to prohibit discrimination based on genetic information. Other health care proposals – such as expanding coverage or overhauling the tax treatment of employer-provided benefits – could receive more attention as the 2008 elections approach.

Mental health parity
Proponents of mental health parity have been pushing to expand the current-law parity requirements for years. The Mental Health Parity Act of 1996 prohibits plans from imposing lower annual or lifetime dollar limits on mental health benefits than they impose on medical and surgical coverage. But the act does not mandate parity for substance abuse benefits or in other financial requirements or treatment limitations. Bills currently being considered by the House and Senate would extend parity requirements to payments and treatments, including substance abuse benefits.

The Paul Wellstone Mental Health and Addiction Equity Act (H.R.1424), under discussion in the House, and the Mental Health Parity Act of 2007 (S.558), which is making the rounds in the Senate, take significantly different approaches. For example, the House bill would require plans that cover any mental health benefits to cover all mental health and substance abuse disorders in the Diagnostic and Statistical Manual of Mental Disorders. Both bills are expected to move to floor votes in their respective chambers shortly. If the bills proceed as currently written, a House-Senate conference committee must negotiate a compromise before presenting the legislation for President Bush’s signature.

Genetic nondiscrimination
Congress is also likely to act on the Genetic Information Nondiscrimination Act (S.358/H.R.493), which would prohibit health and employment discrimination based on genetic information about a plan participant, employee or family member. For example, group health plans and health insurance issuers could not adjust group premiums or contributions on the basis of genetic information; ask or require anyone to undergo a genetic test; or request, require or purchase genetic information for underwriting purposes. The act also would outlaw employment discrimination based on genetic information and prohibit employers from requesting, requiring or purchasing genetic information except in limited circumstances.

The House approved its version of the Genetic Information Nondiscrimination Act on April 25 by a vote of 420-3. The Health, Education, Labor and Pensions (HELP) Committee approved the Senate version on January 31, which is cleared for a floor vote. In previous years, the Senate approved the act unanimously, so the legislation is expected to become law during the 2007-2008 legislative term.

Prescription drugs
Prescription drugs also have received congressional attention this year. When the Democrats took control of the House and Senate in January 2007, they made repealing the Medicare Part D “non-interference clause” a priority, which would give the secretary of Health and Human Services (HHS) the authority to negotiate prescription drug prices for the Part D program. The House approved the Medicare Prescription Drug Price Negotiation Act (H.R.4) on January 12 (see Watson Wyatt Insider, February 2007), which would require the secretary to negotiate Part D drug prices. The Senate tried to vote on the Medicare Fair Prescription Drug Price Act (S.3) in April, which would allow, rather than require, price negotiation. However, Senate leaders needed 60 votes to overcome a procedural hurdle before taking a final vote, and the procedural vote failed 55-42. Senate supporters said they would keep trying, but the legislation has not yet resurfaced. Even if Congress passes it, it may not be able to override a threatened presidential veto.

So far, supporters of prescription drug importation have failed to clear the hurdles that block permanent, legal importation. On May 7, the Senate approved two importation provisions. Senator Byron Dorgan (D-North Dakota) sponsored a provision to allow pharmacies, groups of pharmacies, wholesalers and individuals to import prescription drugs from Canada and other countries whose regulatory requirements are similar to those in the United States. Senator Thad Cochran (R-Mississippi) sponsored a provision to require the HHS secretary to certify that imported prescription drugs are safe and would significantly reduce costs. Senator Cochran’s provision effectively nullifies Senator Dorgan’s provision, as similar certification requirements have done in the past. The administration opposes importation.

Another legislative proposal involving prescription drugs would allow the U.S. Food and Drug Administration to approve generic biologic drugs — drugs derived from living organisms. The Senate HELP Committee approved the Biologics Price Competition and Innovation Act on June 26. Supporters hope that the legislation will reduce consumer and employer health care costs – similar to the savings achieved by traditional generic drugs — but its prospects are uncertain.

Health savings accounts
Congress enacted important changes to health savings accounts (HSAs) in late 2006, but the administration and the business community want additional changes. President Bush’s budget proposal for fiscal year 2008 and legislation introduced in Congress would simplify HSA prescription drug coverage, allow those with family coverage to meet individual deductibles, make it easier for those whose spouses have a health care flexible spending account (FSA) to qualify for an HSA and make other changes requested by the employer community. Such legislation is unlikely to move this year, because the Democratic leadership in the House and Senate opposes HSAs.

Other health care issues
Many other health care issues have been discussed but are not likely to get off the ground anytime soon. For example, President Bush proposed repealing the tax breaks for employer-provided health benefits and establishing a new standard deduction for health insurance for individual purchasers (see Watson Wyatt Insider, February 2007). The proposal attracted considerable media and congressional attention at first but then lost momentum. During the upcoming debate over reauthorization of the State Children’s Health Insurance Program (SCHIP), the president and some lawmakers may try to push this or another market-incentive proposal, but such ideas are unlikely to take hold during this legislative term.

Expanding health care coverage is a key issue for Congress, and hearings have addressed the role employer-sponsored health plans play in the current health care system. For example, one hearing focused on whether to grant ERISA waivers to give states more flexibility for reform initiatives, while others addressed the role of employer-sponsored plans in expanding coverage.

In one of those hearings, Congressional Budget Office Director Peter Orszag told the Senate Budget Committee that rising health care costs are the nation’s “central fiscal challenge” and represent a critical issue for employers, enrollees and patients. He discussed the role of employer-sponsored plans in the current system and the challenges Congress will face in reforming the employment-based system.

A second hearing by the Senate Budget Committee focused on the Healthy Americans Act (S.334), which is sponsored by Senator Ron Wyden (D-Oregon). Senator Wyden’s proposal would generally sever the link between employment and health coverage, while still requiring employers to share the cost of coverage.

Although comprehensive health care reform is unlikely during the 2007-2008 term, health reform almost certainly will play a role in the 2008 elections.

Pensions Take Legislative Backburner but Remain on Agenda
As the general effective date for the PPA nears, implementation issues and technical corrections remain under discussion. In addition, lawmakers are urging the IRS to rethink its position that “greater of” cash balance transitions violate the pension back-loading rules.

Technical corrections to PPA
Some technical corrections to the PPA were enacted on May 25 when President Bush signed the Iraq supplemental appropriations bill (H.R.2206, P.L.110-28), which included the Small Business and Work Opportunity Tax Act. The corrections clarified the revocation of an election to be treated as a multiemployer plan, qualified retiree health transfers under code section 420, and the alternative-deficit-reduction contribution rules and current-liability interest rate for plans sponsored by commercial passenger airlines.

A working group composed of staff members from committees with jurisdiction over the PPA continues to discuss technical corrections. In a May 3 hearing by the House Education and Labor Subcommittee on Health, Employment, Labor and Pensions, the business community requested several changes, including a delayed effective date, modification of the phase-in rules for plans not subject to the deficit-reduction contribution, asset smoothing rather than averaging, changes to the restrictions on lump-sum distributions for underfunded plans and changes to the multiemployer provisions. The business community also is seeking clarification of the combined plan limit under section 404(a)(7). The U.S. Department of the Treasury’s interpretation of the PPA applies the combined plan limit to the deductibility of contributions even if the employer contributes less than 6 percent to its defined contribution plan. Some employers may have exceeded the combined plan limit for 2006, making them subject to an excise tax.

Some lawmakers seem sympathetic to requests to extend the PPA’s effective date – especially as plan sponsors otherwise will have to comply with the PPA without being able to comment on the implementing regulations.

Hybrid plans
Lawmakers are monitoring some PPA implementation issues – especially those involving hybrid pension plans. For example, some Republican lawmakers wrote to the Treasury Department about the intent of the PPA’s interest crediting, whipsaw and plan conversion provisions. These lawmakers said that Congress intended to permit a broad array of interest crediting rates, including rates that provide a “reasonable minimum guaranteed rate of return,” along with features such as allowing participants to choose from a variety of interest rates. They also suggested that guidance should confirm the resolution of the whipsaw issue for future distributions. They urged the Treasury Department to support flexibility by allowing employers to offer a variety of conversion techniques, such as grandfathering older, longer-service employees, providing the greater of two formulas or offering a choice between the old formula and the new one (see Watson Wyatt Insider, July 2007).

According to the IRS, plans using a "greater of" approach may violate the 133 1/3 percent accrual rule. IRS officials maintain that the interpretation is part of long-standing policies and informally indicated that the policy is mandated by the statute (see Watson Wyatt Insider, July 2007).

Retirement savings
Lawmakers also are discussing retirement savings. Senators Gordon Smith (R-Oregon) and Kent Conrad (D-North Dakota) introduced the Women’s Retirement Security Act (S.1288), which would:

• Require so-called automatic IRA payroll deductions
• Expand 401(k) eligibility requirements to include certain part-time workers
• Allow transfers of some unused FSA amounts to retirement savings plans
• Exclude certain annuity payments from gross income
• Amend and expand the Saver’s tax credit (a nonrefundable tax credit available to eligible taxpayers for their retirement plan contributions)
• Allow a limited exclusion for qualified retirement planning services when employees are offered a choice between such services and cash
• Provide for the division of pension benefits when a participant becomes separated or divorced

The automatic IRA provisions also appear in the Automatic IRA Act (S.1141) sponsored by Senator Jeff Bingaman (D-New Mexico). The Retirement Security for Life Act (H.R.2205) sponsored by Representative Stephanie Tubbs Jones (D-Ohio) also includes provisions that would shield some annuity income from taxes. The exclusion would not apply to annuity payments from section 401(a) qualified plans, section 403(b) plans and section 457 governmental plans.

The Retirement Savings for Working Americans Act (H.R.2724), sponsored by Representatives Rahm Emanuel (D-Illinois) and Jim Ramstad (R-Minnesota), would make the Saver’s credit refundable. The act also would apply the tax credit to contributions to section 529 plans and certain other educational accounts, require the credit to be deposited directly into the retirement or educational savings account, expand income eligibility levels and make other changes. Congress is not expected to focus on enacting new retirement provisions this year, but the act could resurface in future retirement savings discussions.

Senate Finance Committee Chair Max Baucus (D-Montana) and ranking member Charles Grassley (R-Iowa) introduced the Defenders of Freedom Tax Relief Act (S.1593). Under current law, service members called to active duty for long or indefinite periods before January 1, 2008, may take penalty-free withdrawals from their retirement plans. The act would make that right permanent. It also would permanently extend the election to include combat pay for determining earned income credit and grant additional tax relief for combat pay and retirement savings for military personnel and their families. Another provision would encourage businesses to provide differential pay to employee reservists called to active duty.

The Defenders of Freedom Tax Relief Act also includes several expatriate provisions. It would require U.S. citizens who expatriate and permanent residents who give up their U.S. residency to recognize any unrealized gain or loss of more than $600,000 on all property as of the day before the expatriation date. A special rule for retirement plans would treat the present value of the expatriate’s nonforfeitable accrued benefit as a taxable distribution on the day before the expatriation date. An adjustment would be made when the gain or loss was realized or when benefits were distributed. The Finance Committee may consider the bill soon. The provisions addressing taxation of expatriates’ retirement benefits have been approved by the Senate Finance Committee in the past. The House Ways and Means Committee approved separate expatriate provisions as part of a bill to prohibit the IRS from hiring private debt collectors. As revenue raisers, the provisions are likely to remain active.

In addition to requiring sponsors of NQDC arrangements to provide a defined benefit plan to their rank-and-file workers, the Restoring Pension Promises to Workers Act would prohibit the elimination of certain early retirement subsidies during mergers, acquisitions and certain other transactions; impose a three-year statute of limitations on recovery of overpayments to participants and provide that, in cases of hardship, retirees would not have to repay overpayments; amend the benefit reductions for critical-status multiemployer plans; establish an Office of Pension Participant Advocacy in the U.S. Department of Labor (DOL) and make other changes.

Fees in 401(k) plans and hedge fund disclosure
Fees in 401(k) plans have become a key issue for Congress and the administration. On March 6, the Education and Labor Committee held a hearing on 401(k) fees and more hearings are expected this year. In addition, Education and Labor Committee Chair George Miller (D-California) introduced legislation to increase participant-level disclosure as well as to address conflicts of interest, appropriate investment menus and remedies under ERISA. Elsewhere in Washington, the DOL and the Securities and Exchange Commission are discussing 401(k) fees as well (see Watson Wyatt Insider, May 2007 and July 2007).

Disclosure of pension investments in hedge funds attracted some attention when Representatives Mike Castle (R-Delaware) and Tim Mahoney (D-Florida) introduced the Pension Security Act (H.R.2683). The act would require companies to disclose the value of plan investments in hedge funds on their Form 5500 annual reports. Congress has become increasingly concerned about hedge funds and the extent of such investments by defined benefit plans. The Senate Finance Committee has requested a General Accountability Office (GAO) report on hedge fund investments, which will look into whether hedge funds threaten retirement security. The topic also was discussed in recent hearings and more hearings are expected, although it is not clear whether they will result in legislation.

Looking Ahead
The first half of 2007 was a busy one for compensation and benefits issues, and many of these discussions will continue through the year. Moreover, several bills with important implications for executive compensation arrangements and employer-sponsored health plans could be enacted before the 2007 session ends.