Watson Wyatt
Senate Finance Committee chair Charles Grassley (R-Iowa) and ranking member Max Baucus (D-Montana) released a new version of their National Employee Savings and Trust Equity Guarantee Act (NESTEG) on July 22, placing a stronger focus on defined benefit funding and related pension reform issues. The Finance Committee approved NESTEG on July 26, 2005, thus advancing the pension reform debate. Like the administration's pension reform proposal released earlier this year and the Pension Protection Act approved by the House Education and the Workforce Committee on June 30, NESTEG would:
While NESTEG is substantially similar to the administration's pension reform proposal and the Pension Protection Act, there are also important differences.
Finance Committee approval is an important milepost along the legislative path, but reforms still would face a long and difficult journey to final enactment.
New Funding Targets Phased In
Like the administration's funding reform proposal and the Pension Protection Act, NESTEG would establish new funding targets for single-employer pension plans and give plan sponsors less time to fund any shortfalls. The funding target would be the present value of all benefits accrued as of the beginning of the plan year. Most plan sponsors would have to fund 100 percent of their funding target after a two-year phase-in period beginning in 2007. For plan years beginning in 2007, plan sponsors would fund 93 percent of their funding target. For the next plan year, plan sponsors would fund 96 percent of their target. For plan years beginning in 2009, sponsors would have to fund the full 100 percent. Plans with fewer than 100 participants would have a five-year phase-in period.
Plans would amortize funding shortfalls over seven years. The annual funding requirement would equal the present value of benefits expected to be earned during the year by all active participants plus required amortization payments, including amounts required to amortize any current or prior funding shortfalls and funding waivers.
NESTEG would limit annual increases or decreases to required contributions. Changes could not exceed the greater of 30 percent of the plan's target normal cost or 2 percent of the plan's target liability. Until a plan's assets equaled or exceeded its funding target, the minimum required contribution for a plan year could not increase by more than the minimum required contribution for the preceding year plus the limit ・and it could not decrease by more than the minimum required contribution for the preceding year minus the limit. For purposes of determining the limit, the minimum required contribution for the preceding plan year would not reflect interest imposed on contributions that were made after the plan's valuation date but would reflect any limit applied for that year. In addition, the minimum required contribution for the preceding plan year would be reduced by the amount of the last scheduled payment in a series of amortization installments. The limit would not apply to higher costs due to benefit improvements for the current plan year.
Special Rules for At-Risk Plans
NESTEG would impose special funding requirements on plans that were considered "at-risk." Like the administration's proposal, NESTEG would base at-risk status on the plan sponsor's financial health. In general, plan sponsors would be considered financially weak if their senior unsecured debt was rated below investment grade by each nationally recognized statistical rating organization (NRSRO) that rated the debt. If the plan had no sponsors whose senior unsecured debt was rated by an NRSRO, the plan sponsor would be considered financially weak if its credit were rated below investment grade by each NRSRO that issued a rating for the company. Under NESTEG, a plan sponsor would enter at-risk status by being financially weak on three consecutive plan valuation dates.
There would be special rules for financially weak plan sponsors whose fortunes were improving. If a financially weak plan sponsor earned an improved rating from any NRSRO, the improvement year would be disregarded. For example, suppose a plan was financially weak for both the 2007 and 2008 plan years. Its rating from an NRSRO was higher in 2008 but still below investment grade. As of the valuation date for the 2009 plan year, none of the NRSRO ratings improved. In that case, 2008 would be ignored as an improvement year, and 2007 and 2009 would be treated as consecutive plan years. In this case, the plan would not yet be considered at-risk, because the plan sponsor was not financially weak on three consecutive valuation dates. However, if the plan showed no improvement for 2010, the plan sponsor would be financially weak on three consecutive valuation dates - 2007, 2009 and 2010. To be considered an improvement year, a plan needs to receive a higher rating from only one NRSRO, even if another NRSRO gave it a lower rating.
Plans that were at-risk and less than 100 percent funded would have to assume that all participants would retire at the earliest available retirement age after the plan year for which at-risk target liability and target normal cost were being determined. The sponsor would have to assume that benefits would be distributed in whatever form would create the largest liability. At-risk target liability and target normal cost would never be less than they would be if the plan sponsor were not at risk. NESTEG would not impose a loading factor on at-risk plans. At-risk funding targets would be phased in over five years. There would be no increase in the funding target during an improvement year.
NESTEG would extend the current corporate bond interest rate for plan years beginning in 2006 and begin phasing in a yield curve for plan years beginning in 2007. The yield curve would be similar to the yield curve proposed by the administration ・a series of interest rates based on high-quality corporate bonds averaged over three months. The yield curve would be phased in during the 2007 and 2008 plan years, becoming fully effective for the 2009 plan year. In general, the yield curve would apply for determining lump sum distributions as well, but it would be phased in over five years rather than three years. Under a special rule, NESTEG would allow plan sponsors to change the interest rate used to determine certain optional forms of benefit.
Assets would be valued at their fair market value, but plan sponsors could average the values over the three months preceding the valuation date.
NESTEG would increase the maximum deductible contribution to 180 percent of the plan's funding target. It would give plan sponsors an extra cushion, allowing them to factor increases to future compensation (or, in certain cases, to benefits) into projected funding targets.
Employers could continue using credit balances. Like the Pension Protection Act, NESTEG would require plan sponsors to adjust credit balances annually to reflect investment gains and losses. In addition, plan sponsors would have to subtract credit balances from the value of plan assets when determining the plan's funding shortfall and minimum required contribution. But, plan sponsors would not have to subtract credit balances from plan assets when determining whether the act's benefit restrictions apply.
Higher PBGC Premiums
NESTEG would increase the flat-rate premium from $19 to $30 per plan participant for plan years beginning in 2006. After 2006, the premium would be indexed to the Social Security wage index each year. The Pension Protection Act also would increase the flat-rate premium to $30 but would phase in the increase over several years. Under NESTEG, all underfunded plans would pay the variable-rate premium.
New Limits on Benefits in Underfunded Plans
NESTEG would limit benefits and restrict accelerated benefit payments from underfunded plans. For example, a plan that is less than 80 percent funded for two consecutive plan years could not increase benefits without first bringing the funding ratio up to 80 percent. For plans that fell below a 60 percent funded ratio, NESTEG would disallow certain payments, suspend benefit accruals and freeze certain benefits until the plan actuary certified that the plan's funding ratio was at least 60 percent, or the employer provided sufficient contributions or security to increase the funding ratio to 60 percent. NESTEG would also impose restrictions on nonqualified deferred compensation arrangements if the qualified pension plan was at-risk and less than 80 percent funded.
The PBGC's guarantee to pay benefits in the event of a plant shutdown or other unpredictable contingent event would phase in as if a plan amendment had been adopted on the date of the event ・so the amount of the guarantee would phase in by 20 percent each year.
New Disclosure Requirements
Vested defined benefit plan participants would be entitled to a benefit statement every three years under NESTEG. The statement would have to indicate the total benefits accrued and vested accrued benefits (or the earliest date on which the accrued benefit would become vested). Plans that provided for permitted disparity or were part of a floor-offset arrangement would also have to explain any offset that might be applied in determining accrued benefits. The Secretary of Labor would develop model statements. Alternatively, the plan sponsor could issue an annual notice indicating that benefit statements were available and explaining how they could be obtained.
NESTEG would accelerate the deadlines for filing Form 5500 and Schedule B and require some additional information. It would also require plan sponsors to give participants a summary of Schedule B.
Schedule B would have to state the fair market value of the plan's assets, the plan's target liability and target normal cost, and the plan's at-risk target liability and at-risk normal cost (determined as if the employer had been financially weak for at least five consecutive years). This information would also be required in the summary annual report (SAR). The SAR would also have to state the plan's funded percentage for the plan year and the two preceding plan years, whether the plan sponsor was financially weak for the plan year and the two preceding plan years, and the limits on PBGC-guaranteed benefits if the plan were terminated while underfunded. Plan sponsors would have to provide the SAR within 15 days of the due date for filing Form 5500.
Other Provisions
The act would allow commercial airlines to freeze their benefit accruals and amortize their unfunded liability over 14 years. In addition, the act includes conversion standards and other provisions that have important implications for employers that sponsor hybrid pension plans.
NESTEG also would reform the rules for defined contribution plans. For example, defined contribution plan participants would have the right to diversify investments in employer securities and employer real property. To improve retirement education and investment advice, NESTEG would require employers to furnish basic investment guidelines annually. It would also create a safe harbor and establish tax incentives to encourage employers to hire qualified investment professionals to advise plan participants. NESTEG would also address plan portability and other issues.
Next Steps
Now the Senate Finance Committee and the House Education and the Workforce Committee have approved separate pension reform bills, but two committees with jurisdiction over pension reform ・the House Ways and Means Committee and the Senate Health, Education, Labor and Pensions Committee ・will not act until Congress returns from its August recess.
As the debate continues into the fall legislative session, plan sponsors may wish to review the act and how it would affect their plan contributions, PBGC premium payments and plan administration. Under NESTEG, the new funding, disclosure and benefit limitation rules would take effect for plan years beginning in 2007. A delayed effective date will become more important as the debate stretches into late 2005.