The current financial crisis has resulted in a significant drop in the value of pension plan assets, which has greatly increased the obligations of many employers under the recently enacted pension funding rules contained in the Pension Protection Act of 2006 (PPA). Specifically, PPA included funding requirements meant to ensure that company sponsored defined benefit pension plans have the necessary cash to pay for the benefits promised to employees and retirees.
Under PPA, companies sponsoring underfunded pension plans must generally bring their plans up to full funding over the next seven years and quarterly contributions may be required if a plan's assets are valued between 80 percent and 100 percent of its liabilities. If a plan's assets are valued between 60 percent and 80 percent of its liabilities, lump sum and other accelerated payment forms are limited as to amount, special funding notices are required to be provided to participants and the PBGC and no amendments may be made to such plan that increase benefit liabilities. If a plan's assets are valued at less than 60 percent of its liabilities, lump sums and other accelerated payment forms are prohibited, special funding notices are required to be provided to participants and the PBGC and benefit accruals are frozen.
Because many of such plans are heavily invested in publicly traded stock, the recent drop in the stock markets (roughly 40 percent since its October, 2008 high) has caused much higher levels of underfunding than existed at the time PPA was enacted. The effect of the recent drop in assets values will be magnified by the fact that PPA requires that assets be valued at current market value, whereas the old funding system used "smoothing" valuation methodologies that reduced the effect of short-term market volatility.
In response to the funding requirements of PPA, which have been exacerbated by the significant drop in the value of pension plan assets due to the stock market decline, trade groups, such as the American Benefits Council, The ERISA Industry Committee and the National Association of Manufacturers, along with their member employers, have recently advocated pension funding relief. Specifically, a joint letter these and other organizations recently sent to Charles Rangel, Chairman of the Committee on Ways and Means, and other key Congressional leaders outlined their proposals, which included the following: permitting the smoothing of unexpected stock market losses over longer periods of time, allowing additional time to transition to the PPA's 100 percent funding requirements, and permitting changes to funding method elections in 2009 and 2010 without IRS approval.
Subsequent to the sending of this letter, Senate Finance Committee Chairman Max Baucus (Democrat) and Senator Charles Grassle (R-17) released details of legislation they intend to introduce that would phase in over three years from now 100 percent pension funding requirements set to go into effect pursuant to PPA.
At the time of this writing, it is not certain how any of these pension funding reform proposals will be received on Capitol Hill or if and when the legislation would be enacted. The argument in favor of pension funding relief is that the new accelerated funding rules, coupled with plunging asset values, will require plan sponsors to make huge funding contributions to their pension plans. Such increased funding obligations coincide with cash flow problems many plan sponsors are dealing with because of the recent credit crunch. Consequently, without new legislation, many companies will be forced to divert cash needed for job retention, job creation and business investments into their pension plans in order to fund long-term obligations which will not be due for several years after the current market conditions return to normal.
The main arguments against pension funding relief would presumably be (a) the potential increase in exposure to the Pension Benefit Guaranty Corporation, which essentially "insures" plan sponsors' promised benefits under defined benefit plans in the event of the bankruptcy of such plan sponsors and (b) the fact that the need for the reform may not be immediate because many companies are not required to commence contributing cash into their plans to raise funding levels until the later part of 2009, at which time market values may have recovered from recent declines. As a result, lawmakers may favor waiting until that time to get a clearer picture of the magnitude of the funding issue and to decide what, if any, pension funding relief is necessary.