On March 11, 2021, President Biden signed into law the American Rescue Plan Act of 2021 (ARPA) which included significant single employer defined benefit plan interest rate stabilization/funding relief.
The changes to ERISA DB funding requirements in ARPA were the culmination of a policy project that began in the early 2000s, to bring more responsible funding to our private DB system.
To be clear at the top: I think that project, as embodied now (and finally) in ARPA, was and is a success.
The Problem
In the early 2000s, policymakers were—for good theoretical and practical reasons—concerned about the fiscal integrity of the private single-employer system. We had a set of minimum funding rules that were unrealistic, requiring, e.g., the amortization of past service liability over 30 (and in some cases even 40) years. And providing for valuation interest rates that were subject to a somewhat baggy “reasonableness” test.
At the same time, we had a system for insuring benefits under those plans—the Pension Benefit Guaranty Corporation (PBGC) single-employer fund—that was underfinanced: sponsors paid a headcount premium of $19 per participant and a variable-rate premium on unfunded vested benefits of 0.9%. PBGC’s single employer fund deficit in 2005 was over $20 billion.
Plan A: Mandating Funding
In the early 2000s the Bush administration and a bipartisan group in Congress mounted an effort to reform this system – to, in effect, make it more responsible—that resulted in the passage of the Pension Protection Act of 2006 (PPA).
The PPA “solved” this (very real) problem of inadequate plan funding + inadequate PBGC premiums by imposing a stricter solvency regime on sponsors. The PPA mandated that liabilities be valued based (more or less) on a yield curve using current (or 24-month average) interest rates on high quality corporate bonds. It required that the plan’s funding shortfall be amortized over 7 years. And it imposed benefit restrictions on plans that were less than 80% funded.
At the time it was adopted (in 2006) it was understood that this approach was going to put a stress on the cash of many companies, but that that was a price that could and should be paid in order to bring the pension insurance system into some kind of balance and ensure that the promises DB sponsors had made would be kept.
Perfect Timing: Increased Funding During the Financial Crisis
Then—in 2008, the year the new rules went into effect—we were hit with the global financial crisis. Companies suffered extraordinary (and for many, unsustainable) cash demands, and policymakers immediately began seeking ways to delay the effect of the new rules by various “hacks”—e.g., allowing the cherry picking of valuation interest rates.
More significant for policy, the federal government itself suffered a massive cash crunch, and (by 2011) there was a Republican House of Representatives that was very focused on the budget and on spending.
Plan B: A Rational Premium Structure
Before continuing with the story, let’s go back to the drawing board for a second.
There had always been two alternative policy solutions to the plan funding/benefit insurance challenge Congress faced in the early 2000s. One was the one adopted in the PPA—to require more funding. The other—the road not taken—was to adopt a more realistic PBGC premium regime. I once asked one of the key governmen policy experts why the latter approach had not been pursued, and he told me that they looked at it and decided that charging realistic PBGC premiums would just be too expensive for companies to sustain and would drive too many plans out of the system.
In 2012—with a federal budget crunch, continued interest rate declines, and companies demanding relief from the stringent PPA funding requirements—Congress opted for that other road. “Road” being an ironically apt metaphor here, because the one thing that a divided Congress/government could agree to spend money on was highways.
A Budget Solution
This alternative approach—of relaxing funding and increasing PBGC premiums—had three great virtues. It increased tax revenues because companies that did not make contributions to their plans did not take the corresponding deduction and thus paid more taxes. It increased “revenues” because PBGC premiums were counted in the general federal budget, notwithstanding that they could only be used to pay unfunded single employer DB benefits. And it did all of this without raising taxes, or at least without raising tax rates (another Republican bugaboo).
And so we got the Moving Ahead for Progress in the 21st Century Act (MAP-21) in 2012, then Highway and Transportation Funding Act (HATFA) in 2014, the Bipartisan Budget Act of 2015, and (finally) ARPA. Each of these statutes progressively increased valuation interest rates—so that, in 2021 under ARPA, for a typical plan, the minimum funding valuation interest rate is more than 300 basis points higher than current market rates. ARPA also got rid of 7-year amortization, setting all amortizations bases to 0 (at the sponsor’s option as early as 2019) and amortizing shortfalls thereafter over 15 years.
A PBGC Deficit Solution
And as PBGC premiums have been progressively increased—the VRP “tax” on unfunded vested benefits is now 4.6%, more than five times what it was in 2006—DB sponsors have increasingly focused on managing their PBGC premium obligation, paying out participants to get them off the books and (you guessed it) funding benefits to reduce the VRP obligation.
Amazingly, this new approach has worked extraordinarily well. In 2012, PBGC’s single employer program had a nearly $30 billion deficit. It now has (as of PBGC’s 2020 Annual Report) a $15.5 billion surplus. And there is widespread agreement that PBGC’s single employer plan premiums are (if anything) too high.
How to Do Policy
I want to draw, from all this, one meta-lesson about how to make (and how not to make) policy.
The best policy solutions are those that allow the affected parties (here, plan sponsors) to adjust their compliance strategies based on their own individual needs. Sponsors that “need cash” (have a higher use for it than plan funding) can simply pay PBGC its VRP premiums. Those that don’t (have a higher use) can (and do) pay down their liabilities.
This is a much better solution than forcing all plan sponsors—no matter their individual situation—into a one-size-fits-all funding regime.
And as long as premiums are adequate to cover the risk, no one gets a free ride.
As “The Office” character Michael Scott would say—that’s a win-win-win.
Michael P. Barry is a senior consultant at October Three and President of O3 Plan Advisory Services LLC, which provides retirement plan regulatory analysis targeted at plan sponsors and those who provide services to them.
Opinions expressed are those of the author, and do not necessarily reflect the views of ASPPA or its members.
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