journal of pension planning & compliance - Kluwer Law International

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2 / JOURNAL OF PENSION PLANNING & COMPLIANCE required by this Act to fund pensions adequately. This paper traces the developments that have taken place since the Act was passed and the potential financial consequences that have resulted. An aggregate model is created to evaluate the consequences of the funding formula in light of changing interest rates. The alternatives to full funding that firms might consider are examined. THE PENSION PROTECTION ACT (PPA) The Pension Protection Act (PPA), known as (PL109-280), was signed into law by President George W. Bush and was viewed as a landmark pension reform bill. It was the first major federal law that addressed retirement programs in the United States since the enactment of the Employee Retirement Income Security Act (ERISA) in 1974. The PPA was a comprehensive federal law consisting of 907 pages and contained fourteen major Titles ranging from Title I “Reform of Funding Rules for Single-Employer Defined Pension Plans” to Title XIV “Tariffs Provisions” (Lucas, 2008). The primary goal of the PPA was to bolster the traditional defined pension system in the United States by requiring employers to maintain certain pension funding levels (Landsberg, 2008). In essence, the PPA increased the accountability of employers relating to the defined benefit plans offered by an employer (Lucas, 2009). Under Title I Section 303 of the PPA, new minimum funding standards were established for a traditional defined benefit plan. “Funding Targets” were established for defined benefit plans and were to be phased in at 92% in 2008, 94% in 2009, 96% in 2010, and 100% in 2011 (PL109-280, 2006). The established funding target requirements were to ensure that the assets of the defined benefit plan covered the plan’s promised retirement benefits (Lucas, 2009). The PPA also contained a provision for special rules for those defined benefit plans that were considered “at-risk plans.” An “at-risk plan” was defined as a plan with “the funding target attainment percentage for the proceeding year was less than eighty percent” (PL109-280, 2006). Within the context of the PPA, a transition rule was established for “at-risk plan” with 65% in 2008, 70% in 2009, and 75% in 2010 (PL 109-280). The Secretary of Treasury was given the authority to govern and apply at-risk provisions outlined under the PPA (PL 109-280). In retrospect, the PPA was enacted to address the underfunding of traditional defined pension plans in the United States. In essence, the PPA was to bolster the traditional defined benefit pension system by requiring employers to maintain certain pension funding levels of the offered retirement benefit. An important question that still remains is whether the PPA would achieve its goals of protecting traditional defined benefit pensions offered by an employer.
WILL THE PENSION PROTECTION ACT PROTECT DEFINED BENEFIT PENSIONS? / 3 THE EVOLUTION OF THE PBGC: HOW WE GOT HERE When the Pension Benefits Guaranty Corporation (PBGC) was created in 1974, there was an urgency to get the agency staffed and operating. The procedures and policies needed to be enacted quickly. Based on a nonscientific sampling of a few annuities, the PBGC’s actuaries put together a set of tables that insured pension plans were required to implement. The tables were peculiar in that they reflected an inverted yield curve and were heavily loaded in favor of the insurer (Lucas and Furdek, 2008). This was beneficial for the pensioners when the pension plans were amply funded. When interest rates were comparatively high and the economy was in a growth mode, most firms were adequately funding their pension obligations. Many key factors changed when major firms began to outsource production and faced international competition in their markets. One factor was that a significant number of firms were falling behind in funding pensions partly due to falling interest rates and opted to pay higher premiums. Coupled with Chapter 11 bankruptcies of large companies, namely LTV Steel and United Airlines, the PBGC found itself in a serious financial situation and began to run chronic deficits. Following the resolution of a conflict with the Internal Revenue Service, the PBGC changed its methodology for evaluating pension obligations, utilizing 30-year Treasury Security yields to evaluate pension liabilities. This reduced obligations for pension funds briefly, but with a slowing economy and even lower interest rates, pension funds continued to lag in the financial obligation to fully fund pensions. Realizing that many pension plans were in jeopardy with inadequate financial backing, coupled with the precarious financial situation at the PBGC, Congress passed the PPA with the intent of providing the PBGC with a solid financial foundation as well as insuring adequate funding to protect defined benefit pension plans. One feature of the PPA was a reconstitution of the method that firms would determine the value of pension assets and to establish the value of the pension obligation. The U.S. Treasury would publish three rates each month that firms would use to determine the value of assets and three different rates to determine the value of the pension obligation. The difference would be used to determine the cost of the insurance premium. The intent of the three rates, one rate for obligations over years 1 through 5, another for years 6 through 20, and a third for 21 or more years into the future, was to represent more accurately the yield curve of a blend of AA bonds and U.S. Treasury securities. The purpose of these requirements on pension plans was to insure adequate funding for the PBGC and to provide a better financial foundation for existing pension plans.
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