The Pension Benefit Guaranty Corporation (PBGC) recently issued a final rule (the Rule) on the phase-in of PBGC’s guarantee of shutdown pensions and other benefits payable upon the occurrence of unpredictable contingent events.
Shutdown Pensions and the PBGC Guarantee
Shutdown pension benefits – such as “rule of 65” or ‘‘70/80” pensions – are typically collectively-bargained special pensions that allow employees with the right combination of age and service to begin receiving early unreduced pensions if they are terminated due to a layoff or plant closing. For example, 70/80 pensions provide full pensions in the event of a plant closing to employees whose age plus service equals 70 (if at least age 55) or 80 (at any age). Thus, an employee hired at age 18 with 31 years of service would qualify for an unreduced early pension at age 49.
Shutdown benefits often are found in the pension plans of old-line steel, aluminum, automotive and other heavy-manufacturing employers. Some companies provide a version of these special pensions to their salaried employees.
Because the benefit is contingent on the occurrence of an unpredictable event, plan sponsors are not obligated to provide for advance funding of shutdown benefits. Before the Pension Protection Act of 2006 (PPA), shutdown benefits adopted more than five years before the triggering layoffs were fully guaranteed by the PBGC. In many cases, pension plans paying shutdown pensions terminated with unfunded benefit liabilities within a few years of the shutdown, forcing the PBGC to pick up this liability.
Not surprisingly, plant shutdowns often occur when the employer is experiencing financial difficulty and pension funding is jeopardized. Since 1987, PBGC has assumed more than $1 billion of unfunded benefit liabilities from shutdown and similar benefits.
Phase-in of PBGC Guarantee of New Pension Benefits in General
PBGC administers a termination insurance program for single-employer pension plan terminations under Title IV of ERISA. Typically, when an underfunded pension plan subject to Title IV terminates, PBGC is appointed as the trustee of the plan and becomes responsible for paying benefits.
ERISA has a phase-in scheme for PBGC’s guarantee of any new pension benefits or benefit increases that a plan sponsor creates. The phase-in of PBGC’s guarantee protects PBGC from losses caused by benefit increases made effective shortly before plan termination. The phase-in of the guarantee allows time for the funding of new liabilities before they are fully guaranteed.
Under ERISA Section 4022, PBGC’s guarantee is phased in over a five-year period, which begins on the later of the date the new benefit or benefit increase is adopted or the date it is effective. The phase-in is based on the number of full years the new benefit or benefit increase has been in the plan. Generally, 20 percent of a benefit increase is guaranteed after one year, 40 percent after two years and 100 percent after five years. If the amount of the monthly benefit increase is less than $100, the annual rate of phase-in is $20 rather than 20 percent.
Phase-in of PBGC Guarantee of Shutdown Pensions and Other UCEBs
The PPA addressed the problem of unfunded shutdown benefits by adding ERISA Section 4022(b)(8), which changed the phase-in rules for “unpredictable contingent event benefits” (UCEBs) in the case of “unpredictable contingent events” (UCEs) occurring after July 26, 2005. UCEBs are benefits or benefit increases – such as shutdown pensions − that become payable solely by reason of the occurrence of a UCE. Under Section 4022(b)(8), for purposes of the phase-in limit, the date a UCE occurs is treated as the adoption date of the plan provision for the related UCEB. This provides PBGC a greater measure of protection from losses from unfunded UCEBs.
PBGC’s Rule Implementing the PBGC Guarantee for Shutdown Pensions and Other UCEBs
The Rule largely adopts the proposed rule PBGC published in 2011 to implement Section 4022(b)(8). Specifically, the Rule (1) incorporates the definition of UCEB that is used under ERISA Section 206(g)(1)(C) and Treasury Regulation Section 1.436-1(j)(9); and (2) provides that PBGC’s guarantee of UCEBs is phased-in from the latest of (i) the benefit provision’s adoption date; (ii) the provision’s effective date; or (iii) the date the UCE occurs.
The Rule incorporates the definition of UCEB used in Section 206(g)(1)(C) and Section 1.436-1(j)(9). These provisions define a UCEB to include benefits payable solely by reason of (1) a plant shutdown or similar event; or (2) an occurrence other than an event, such as the attainment of a certain age or performance of service, that would trigger eligibility for a retirement benefit.
Under the Rule, PBGC will determine whether a benefit is a UCEB based on the facts and circumstances. The substance of the benefit, not what it is called, determines whether it will be considered a UCEB by PBGC. Also, the Rule clarifies that a UCEB does not cease to be a UCEB for phase-in purposes merely because the UCE has already occurred or its occurrence has become reasonably predictable.
Date UCE Occurs
The Rule requires that PBGC determine the date a UCE occurs based on the plan provisions and other facts and circumstances, including the nature and level of activity at a facility that is closing and the permanence of the event. Shutdown pensions are frequently the subject of grievances, arbitrations and court cases, and determinations made by an employer, plan administrator, union, arbitrator or court about the UCE date may be relevant but are not controlling as to the PBGC’s determination.
If a plan provides that a UCEB is payable upon the occurrence of more than one UCE, the guarantee will be phased in from the latest date when all such UCEs have occurred. For example, if a UCEB is payable only if a participant is laid off, and the layoff continues for a specified time period, then the phase-in period begins at the end of the specified time period.
The Rule clarifies that plan provisions will determine whether a UCEB phase-in determination applies on a participant-by-participant basis, as opposed to a facility-wide or some other basis. For example, the UCE date of a UCEB triggered by a reduction in force will be determined as to each participant. Therefore, layoffs occurring on different dates will have distinct UCEs. Alternatively, UCEBs triggered by a complete shutdown of an employer’s entire operations applies plant-wide. Therefore, the UCE date for all participants will be the same – the shutdown date. Interestingly, a participant-by-participant determination of the UCE date, such as the case with sequential layoffs, may result in participants who are laid off earlier in a shutdown process receiving a greater phase-in percentage than participants laid off later in the process.
Date UCEB Phase-in Begins
The Rule provides that the phase-in period for a UCEB guarantee will begin on the latest of the UCEB provision’s adoption date, its effective date, or the date the UCE occurs. Also, if a UCEB becomes payable because a restriction under Code Section 436 is removed − for example, an adequate funding contribution is made − then the effective date of the UCEB for phase-in purposes is determined without regard to the restriction.
In general, ERISA Section 4022(g) provides that when an underfunded pension plan terminates while its contributing sponsor is in bankruptcy, the amount of benefits guaranteed by PBGC under Section 4022 will be determined as of the date of the bankruptcy filing rather than the plan’s termination date. The Rule clarifies that if a UCE occurs after the bankruptcy filing date, UCEBs arising from the UCE are not guaranteed because the benefits are not nonforfeitable as of the bankruptcy filing date.
Similarly, the Rule clarifies that if a UCE occurs before the bankruptcy filing date, the five-year phase-in period for any resulting UCEBs is measured from the date of the UCE to the bankruptcy filing date, rather than to the plan termination date. For example, if a permanent shutdown occurs three years before the bankruptcy filing date, the guarantee of any resulting UCEBs will be only 60 percent phased in, even if the shutdown was more than five years before the plan’s termination date.