(From the June 20, 2011 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

PBGC Finalizes Rule on Termination of Underfunded Pension Plans in Bankruptcy

Last week the PBGC finalized regulations — substantially as they were proposed in 2008 — to implement provisions of the Pension Protection Act (PPA) of 2006 which provide that underfunded, single-employer pension plans that terminate while the sponsor is in bankruptcy are treated as if the bankruptcy filing date is the date of plan termination.

Effective for bankruptcy filings on or after September 16, 2006, the PPA requires that ERISA §§ 4022 and 4044 — which determine the benefits guaranteed by the PBGC and those that are entitled to "priority category 3" status — be applied by treating the date the sponsor filed for bankruptcy as the termination date of the plan. The purpose of the change in law was to prevent the substantial increase in liability imposed on the PBGC where a sponsor in bankruptcy continues a plan (e.g., continues to accrue and pay benefits but not make minimum required contributions) but then decides to terminate it after the plan's financial condition worsens. Regulations to implement the new PPA requirements were proposed in July 2008. With only minor changes, the proposed regulations were published as final on June 14, 2011.

Guaranteed Benefits Key Off the Bankruptcy Filing Date

The PPA change means that a participant's PBGC guaranteed benefit cannot be greater than the nonforfeitable accrued benefit as of the bankruptcy filing date, even though a participant may continue to accrue, vest and become entitled to benefits under the plan after that date. Disability retirement benefits or early retirement subsidies to which a participant becomes entitled after the bankruptcy filing date but before the plan termination are, as a result, not guaranteed. The limits on the PBGC guarantee are also determined as of the bankruptcy filing date, based on the participant's age and the form of the benefit being paid at the later of the bankruptcy filing date or the date benefits begin to be paid by the PBGC. A slight exception is carved out under the final rule where the participant dies before termination and it affects the form of benefit being paid at termination, in which case the guarantee limits are applied based on the form being paid/payable and the person who is receiving or entitled to receive a benefit from the PBGC as of the termination date.

Category 3 Benefits Key Off the Bankruptcy Filing Date

Similar to guaranteed benefits, the PPA provisions made changes to the priority category 3 asset allocation. (Category 3 benefits are a higher priority than guaranteed benefits in category 4 — so, if the plan's assets are sufficient to pay all benefits in priority category 3, those benefits will be paid regardless of whether they are guaranteed.) Before PPA, the benefits in category 3 were those that were in pay status as of the beginning of the three-year period ending on the termination date (or that would have been in pay status as of that date if the participant had retired), but based on the plan provisions during the five years before the termination date under which the benefit would be the least. As a result of the PPA, the three-year and five-year periods are measured back from the bankruptcy filing date, rather than the plan termination date. A refinement is carved out in the final regulation with regard to the five-year period, however, to address those infrequent circumstances where the benefit may have decreased between the bankruptcy filing date and the plan termination (e.g., due to the expiration of a temporary supplement or the elimination of an ancillary benefit not protected under Code §411(d)(6).) Under the final rule, the priority category 3 benefit is the lowest benefit payable under plan provisions in effect for the five years prior to the bankruptcy filing date plus the additional time from the bankruptcy filing date to the plan termination.

As a result of these changes, some guaranteed benefits that previously would have been in priority category 3 will now fall into priority category 4. Also, the net amount of a participant's benefit in priority category 5 (i.e., all other non-forfeitable benefits under the plan) will be affected by the changes to the benefits in priority categories 3 and 4. For example, benefits that are not guaranteed (i.e., priority category 4) because they became non forfeitable between the bankruptcy filing date and the plan termination date will not be in priority category 4 but will be in priority category 5.

Other Refinements in Final Regulation

Other refinements in the final regulation address: (1) the determination of the plan's unfunded benefit liabilities, which is based on the plan's assets and liabilities as of the termination date (i.e., the value of unfunded nonguaranteed benefits is multiplied by the recovery ratio, as in pre-PPA terminations); and (2) the definition of "basic type benefits," which was amended to specifically include benefits that are not guaranteed solely because they accrued or became non-forfeitable between the bankruptcy filing date and the plan termination (i.e., so that those benefits are not subject to less favorable treatment in priority category 5).

The final regulations are effective on July 14, 2011, which is 30 days from the date of publication in the Federal Register.

Copyright 2011, Deloitte.