The new federal pension rules could help employers postpone as much as $63 billion in funding payments over the next 5 years.
Gaobo Pang and Mark Warshawsky, pension analysts at Towers Watson & Company, New York (NYSE:TW), write about that possibility in an analysis of recent changes in U.S. pension laws.
The new federal Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act (PRA) has given defined benefit pension plan sponsors eagerly sought flexibility to make up funding shortfalls over a longer period of time.
The old rules, set by the Pension Protection Act (PPA) of 2006, have required sponsors to amortize funding shortfalls over 7 years.
The Worker, Retiree and Employer Recovery Act (WRERA) of 2008 has been letting employers cope with what are believed to be short-term fluctuations in asset values by using smoothed asset values.
“For minimum funding purposes, plan sponsors can measure pension liabilities using either the full yield curve (a 1-month average of interest rates) or the 24-month-average segment rates,” Pang and Warshawsky write.
The Internal Revenue Service (IRS) issued guidance in March 2009 that lets sponsors choose the most favorable interest rate for valuing 2009 plan liabilities, and another batch of IRS guidance will let sponsors switch to a different interest rate and asset valuation method for plan year 2010 without seeking IRS approval, the analysts say.
Plans also can switch from segment rates for 2010 to the yield curve for 2011 or a later plan year, the analysts say.
Now, the PRA pension funding provisions will let sponsors of underfunded pension plans chose either a 2 plus 7 rule or a 15-year amortization rule for any 2 years between 2008 and 2011.
Under the 2 plus 7 rule, the sponsor makes interest-only payments for 2 years followed by regular 7-year amortization.
Under the 15-year rule, the sponsor amortizes the funding shortfall over 15 years. The 2 relief years need not be consecutive, but the same relief method must apply to both years.
Other twists and restrictions may apply, particularly to sponsors that pay what the federal government believes to be “excess” employee compensation.
Projections based on May 2010 economic conditions suggest that, if the PRA did not exist, the average pension plan funded status would start at 87% this year and fall to about 82% in 2013. The minimum total required contribution would be about $78 billion this year and about $159 billion in 2013.
If sponsors use the PRA interest-only years provision with the 15-year amortization option in 2010 and 2011, they might have to contribute $72 billion to funds in 2010, but they would have to contribute only $143 billion in 2013, and they might reduce total 2009-2013 contributions by about $63 billion, the analysts say.
If sponsors use the PRA interest-only years provision with the 2 plus 7 amortization option in 2010 and 2011, they could cut total 2010 contributions to less than $66 billion. They could reduce total 2009-2013 contributions by about $49 billion. But they would end up contributing about $170 billion in 2013 — $11 billion more than they would have paid in 2013 under the pre-PRA rules.
“To maximize relief for the 2010 and 2011 plan years, sponsors can take advantage of the interest-only provision in the 2 plus 7 option, thereby reducing minimum required contributions by about $47 billion for these 2 years,” the analysts say. “Once the relief expires in 2013, however, these sponsors will have to contribute roughly $11 billion more than they would without the relief.”
“So the 2 plus 7 rule may be the better choice for those sponsors more concerned with immediate cash flow,” the analysts say. “Otherwise, the 15-year amortization rule gives more and smoother relief.”
Earlier this month, Towers Watson found its consultants expect only about 25% of plan sponsors to use the funding relief provisions.
“For those likely to elect the relief, most employers intend to reflect it for plan years 2010 and 2011 and use the 15-year amortization option,” the company says.