Return to The Proceedings Index

Benefit Restrictions –
Who, What, When, Where, and Why?
Session 42

Moderator: Robert J. Reiskytl, Hewitt Associates LLC
Presenters: Brian Donohue, JPMorgan; Heidi Rackley, Mercer
Recorder: Michael J. Petrauskas, JPMorgan

One of the key implications of PPA revolves around benefit restrictions being established for under funded pension plans. In general, these provisions are designed to improve overall benefit security and enable under funded plans to shore up their funded status. However, along with the new benefit restriction rules comes a set of rather complicated guidance that still is being sorted through by the actuarial profession.

In general, benefit restrictions will be required of plans that have their adjusted funding target attainment percentage (AFTAP) fall below various thresholds. As a general rule, the AFTAP can be calculated as follows:

Assets – prefunding credit balance – carryover credit balance + annuity purchases for non-HCE’s over the past two years
PPA funding target (without at-risk assumptions) + annuity purchases for non-HCE’s over the past two years

For plans with an AFTAP below 80%, lump sums (with the possible exception of small cashouts) are limited to the lesser of the PBGC maximum guaranteed benefit and 50% of the accrued benefit. Benefit increases, with the exception of pay increases, average wage increases and fully funded benefit improvements, also are restricted at this threshold. If a plan’s AFTAP falls below 60%, it must freeze benefit accruals, discontinue paying lump sums altogether, and restrict the payment of shutdown benefits. Generally, plans less than five years old are exempt from these restrictions, and collectively bargained plans may remain exempt from these restrictions until 2010.

As one might guess from analyzing the formula for calculating the AFTAP, plans may have some flexibility to improve their AFTAP and avoid certain benefit restrictions by burning either their prefunding or their carryover credit balance. Other potential ways to avoid benefit restrictions include making additional contributions to the plan and establishing additional security through a surety bond or escrow account. In addition, fully funded plans (those with assets greater than or equal to their PPA funding target) are exempt from having to subtract their credit balances from their assets in their AFTAP calculation. This exemption extends to plans with a ratio of their assets to their PPA funding target of 92% in 2008, 94% in 2009, and 96% in 2010.

Rules have been established to foster transition into 2008. Prior to April 1, 2008, lump sum and accrual restrictions will not be imposed unless a plan’s actuary certifies the 2008 AFTAP early. Beginning on April 1, 2008, in the absence of a certified 2008 AFTAP, the presumed AFTAP will be set equal to the 2007 AFTAP minus 10%, or if no 2007 AFTAP has been certified, 60%. On October 1, 2008, the AFTAP will be assumed to be 60% unless a 2008 AFTAP has been certified. To avoid any unfavorable consequences from not having a certified 2008 AFTAP, a range (i.e., 60% - 80%, 80% - 100%, or over 100%) certification can be issued as a temporary solution. However, a final 2008 certification is needed by October 1, 2008 to avoid a plan freeze. The option for a range certification to cover up to the first nine months of a year will be available in future years, but the final certification should not be a “material change” from the range certification or else the plan risks disqualification.

Despite the benefit restrictions rules established by PPA, participants maintain certain rights. Plan sponsors are required to send notices to participants within 30 days of restrictions taking effect. Participants must have the option to defer restricted benefits during restriction periods. Plans may allow unrestricted benefits to commence during this window. Participants also must be allowed to bifurcate their benefit and take the restricted and unrestricted portions in different payment forms.

The benefit restriction rules imposed by PPA increase the importance of plans maintaining an adequate funded status. While they certainly bring added complexity and additional decision points to the table for sponsors of defined benefit plans, they also bring participant benefit security to the forefront. Furthermore, as the rules become fully phased in and better understood over the next couple of years, their true impact on the defined benefit arena will become clearer.

Return to the 2007 CCA Annual Meeting Session Summaries