Sen. Harry Reid, D-Nev., and, in the background, Sen. Mitch McConnell, R-Ken. Photo credit: AP Images

Sponsors of defined benefit pension plans will be able to use excess money in their plans to fund the purchase of life insurance for their retirees for the first time under a provision of legislation passed by Congress Friday.

The provision was among a number of defined benefit plan issues addressed as part of H.R. 4348, the Surface Transportation Extension Act of 2012.

The bill was passed by the House and Senate within minutes of each other. Besides extending the highway construction program until Sept. 2014, the bill also reauthorized the National Flood Insurance Program until 2017 and ensured that the rates on student loans remained the same until next July.

Pension provisions included in the omnibus legislation include an adjustment to defined benefit funding requirements sought by industry, as well as an increase in premiums used to fund the Pension Benefit Guaranty Fund. The premium increase is designed to raise $9 billion over 10 years.

The insurance provision extends Sec. 420 of the IRS Code, which provides sponsors of defined benefit plans the authority to transfer excess pension assets, but only to fund retiree health benefits. The provision expands Sec. 420 by allowing transfers so that a plan can purchase retiree life insurance.

As under current law, a transfer is permitted only if, after the transfer, the pension fund still has assets equal to more than 120% of the liabilities of the fund. The pension fund is protected by the funding level requirement, which also narrows the number of companies that can use the provision.

Officials of the American Benefits Council, which asked the House Ways and Means Committee in February to extend the provision and expand it, argue that it will enable employers to maintain retiree coverage. The provision is estimated to raise $363 million over ten years.

 “These transfers facilitate the continuation of retiree health insurance for countless retirees,” says ABC President James Klein, “Expanding this provision to allow transfers to pay the costs of retiree life insurance will also help foster personal financial security for seniors.”

ABC also lobbied for the so-called “pension-smoothing” provision, which allows companies to use the 25-year corporate bond average when determining the discount rate used to appropriately fund defined benefit plans. Under existing law, companies have to use the last two-year corporate bond average when determining their discount rate. 

Consequently, companies’ discount rates will rise, meaning smaller pension contributions and, therefore, higher net income. ABC contends the pension-smoothing provision gives companies a more historically accurate and less volatile method of achieving full funding.

“Employers will now have a somewhat easier time maintaining their pension plans, and can therefore devote resources to important job retention initiatives,” Klein says. “The legacy of this legislation for defined benefit pension plan sponsors will largely depend on each company’s unique circumstances.”

“For some, the urgent need for funding stabilization will outweigh the cost of premium increases,” Klein adds.

For others, premium increases will present a more serious challenge, he said.

“For the latter companies, the legislation could serve as another incentive to exit the system, which we know is not Congress’ intent,” Klein says.