Will fourth time be the charm for pension funding reform?
I was watching a classic Monty Python movie to kill time while Congress deliberated on a fourth round of single-employer pension funding reform. A soliloquy by one of the characters (aptly named “King of the Swamp Castle”) caught my attention as a perfect metaphor for Washington’s repeated attempts to tweak the constraining rules of the original Pension Protection Act of 2006 (PPA).
- 2012 – Moving Ahead for Progress in the 21st Century (MAP-21): Everyone said I was daft to build a castle on a swamp, but I built it all the same, just to show them. It sank into the swamp.
- 2014 – Highway and Transportation Funding Act of 2014 (HATFA): So I built a second one. That sank into the swamp.
- 2015 – Bipartisan Budget Act of 2015 (BBA): So I built a third. That burned down, fell over, then sank into the swamp.
- 2021 – American Rescue Plan (ARP): But the fourth one stayed up. And that’s what you’re going to get, Lad!
The low rate swamp
Persistently low interest rates are the swamp into which the first three relief efforts sank. The goal of each was to allow for temporary use of higher interest rates to hold down contribution requirements until the underlying corporate bond rates recovered to higher, more “normal” levels.
PPA originally called for pension obligations to be funded based on market value corporate bond rates, which were about 6% at the outset of 2008. The subsequent mortgage crisis and corrective measures by the Treasury and Federal Reserve helped to halve these rates, which now sit closer to 3%. A drop of this magnitude can increase the liabilities of a typical pension plan by 30 to 50%.
Abandoning market values
Recognizing that low rates were beyond the control of plan sponsors, and partially driven by government policy, the decision was quickly made to abandon market value funding under the law.
Moving Ahead for Progress in the 21st Century passed in 2012 introduced a 25-year average bond rate as the basis for determining funding liabilities. Since rates a quarter century ago were much higher, this provided significant relief.
MAP-21 allowed use of 90% of this average rate for several years, after which the percentage would phase down to 70% at 5% per year. The hope was that market rates would rebound to “normal” before the phase-down could have significant effect, but the rates continued to sink into the swamp.
Kicking the can
The Highway and Transportation Funding Act of 2014 and Bipartisan Budget Act of 2015 were similar to MAP-21, effectively extending the time until the phase-down of the 25-year average would apply. The BBA phase-down was scheduled to first take effect for 2021, but rates remain in the swamp.
A sturdier castle?
The American Rescue Plan (ARP) of 2021 follows a familiar pattern, but its stabilizing effect on future pension funding is more robust than previous laws. There are also signs that bond rates may have finally bottomed, so perhaps ARP 2021 is the castle that will stay up.
There are several key differences between ARP and its predecessors, which should provide sturdier relief to plan sponsors.
- ARP allows 95% of the 25-year average bond rate to be used through 2025, after which the 5% annual phase-down to 70% will begin. The minimum for the 25-year average rate is effectively set at 5% regardless of how low rates remain in the long term.
- Unfunded liabilities are paid off over 15 years instead of 7 originally defined under PPA, which will reduce annual amortization payments by about half (though payable over a longer time).
- All past amortization bases will be wiped out, and a new “fresh start” unfunded liability will be determined upon adoption of ARP rules. This could have a dramatic impact for plans currently carrying around a stack of unfunded bases.
- ARP includes no increases to single-employer PBGC premiums.
The need and desire for pension funding relief varies widely by plan circumstances. As a result, ARP includes significant flexibility on when the new rules are first applied based on sponsor preference. Financially distressed plans may want to apply ARP retroactively to 2020 or even 2019, while fully funded plans may wish to defer adoption until 2021 or 2022 to avoid immaterial restatements.
So ARP 2021 is the castle you’re going to get, Lad, but you’ll probably want to talk to your actuary to see exactly when you’d like to build it.
Then we’ll hope this one stays up!
Mike Clark is a fellow of the Society of Actuaries (SOA), a member of the American Academy of Actuaries (AAA), and an honorary member of the Knights Who Say, “Ni!”
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