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Responding to the PPA Funding Rules
Session 28

Moderator: Raymond J. Lee, The Savitz Organization
Presenters: Howard A. Freidin, Deloitte Consulting LLP; Gerard C. Mingione, Towers Perrin
Recorder: David Z. Kossoy, Watson Wyatt Worldwide

Overview
The Pension Protection Act (PPA), most of which is effective for plan years beginning in 2008, was passed in 2006. Some proposed regulations have been issued this year, but there are many open issues that have not been addressed in the proposed regulations yet, and none of the regulations have been made final.

Under the PPA, funding requirements target 100% funding over a seven-year period, and benefit restrictions apply to plans that do not maintain adequate funding, including lump sum limitations, and mandatory freezing of all accruals for extremely poorly funded plans. In addition, the new rules significantly limit the plan sponsor’s ability to use credit balances to delay contributions, and also limits the smoothing of assets to only two years.

PPA significantly increases the maximum tax-deductible contribution limit.

Assumption Setting
Under the PPA, the sex-distinct, RP-2000 Mortality table is mandated for valuation purposes. This table can be used either as a generational table, or as a static table, updated each year. This table generates a significant increase in liability for males, and a much smaller increase for females. In certain circumstances where there is credible experience, a substitute table may be used.

Also, Treasury will begin releasing a monthly yield-curve with weighted averages of corporate bond rates. These yield curves can directly replace the current single discount rate in the valuation, or can be used to generate segment rates. The segment rates would be the average yields for each of three segments – 0.5 through 5 years, 5.5 through 20 years, and 20.5 through 60 years – and would be applied as discount rates to expected payments projected to be made for the duration of each segment. The plan sponsor can elect to use the spot segment rates, 24-month average segment rates, or transitional segment rates, which are the weighted average of the 24-month average segment rates and the 30-year Treasury rates.

Financial Implications
In general, PPA will result in higher funding requirements, due to the 100% funding target (which replaces the 90% funding target under prior rules), and further increases in target liability for poorly funded plans. There is also less flexibility in delaying contribution requirements, due to restrictions on the use of the credit balances and constraints on plan operations based on funded status provide additional incentives to keep plans well funded.

The increase in funding requirements will impact moderately funded plans most strongly, as very poorly funded plans are likely to remain poorly funded and accept benefit limitations, while well-funded plans are likely to have no funding requirement under the old or new rules.

For mature plans with open groups, the segment rates will have very little impact on funding requirements. For plans that are frozen and have short durations, liabilities may increase significantly under the new interest rate method. In the end, there is still a great deal about the determination of the segment rates that is not known, so the impact of the final implementation can not be known.

While conventional wisdom suggests that the shorter smoothing period for assets, restrictions on the use of credit balances, and threat of at-risk status will result in increasingly volatile contribution requirements, this may not be the case. The enhanced ability to advance fund plans (due to higher maximum deductible limits) and ability to implement effective ALM strategies, as well as the lack of major funding “cliffs” (the 90% gateway percentage) will potentially lend stability to funding requirements. In general, however, there will be strong incentives for plan sponsors to move assets more heavily into long-duration bonds.

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