The Chairs of the two Senate committees that govern pensions sent a letter last week to the heads of government agencies overseeing pensions requesting additional guidance on pension de-risking. The letter was written by Senator Wyden (D-Or), as Chair of the Committee on Finance, and Senator Harkin (D-IA), as Chair of the Committee on Health, Education, Labor and Pensions, and the letter was directed to the heads of the Department of Treasury, Department of Labor, Pension Benefit Guaranty Corporation (PBGC), and the Consumer Financial Protection Bureau. Continue Reading
Treasury and the IRS recently issued long-awaited regulations governing cash balance and other hybrid pension plans. Final regulations implement the intent of Congress in the Pension Protection Act of 2006 (the “PPA”) to eliminate the so-called “whipsaw calculation” and permit more generous rates of return for employees and retirees. Proposed regulations issued at the same time set forth a path for non-compliant plans to become compliant. Private sector plans must adopt these changes before the first day of first plan year beginning in 2016. Most significantly, however, is that the regulations − for the first time − specify the way in which employers can marry the efficiency of delivering benefits under through a defined benefit plan with the reduced financial volatility of a defined contribution plan. In short, the regulations make possible a new design for retirement benefits that may prove attractive for employers and employees alike: the shared-risk pension plan.
Whipsaw Is Dead. The PPA eliminated the practice, known as “whipsaw,” of requiring hybrid plans to pay out lump sums in excess of the hypothetical account balance (or accumulated percentage of final pay) by projecting interest credits to normal retirement age and then discounting the resulting benefit to present value using statutory rates. Whipsaw was objectionable on a number of grounds, which is why Congress eliminated it. Perhaps its most objectionable feature is that it required affected hybrid plans to pay out larger lump sums to younger employees than to similarly situated older employees. The proposed regulations imposed numerous restrictions on Congress’s elimination of whipsaw that did not appear in the statute, and appeared to require affected hybrid plans to continue using the whipsaw calculation, for example, if they provided subsidized survivor or early retirement benefits. The final regulations remove these restrictions and eliminate any requirement for any hybrid plan to continue using the whipsaw calculation.
More Generous Fixed and Minimum Interest Credits. The PPA made clear that hybrid plans could periodically adjust a participant’s hypothetical account balance (or accumulated percentage of final average pay) for the time value of money—for example, by crediting interest—as long as the rate of adjustment does not exceed a market rate of return. A hybrid plan that credits interest has a number of options for doing so, including crediting only a single fixed rate of interest (e.g., 5%) or offering a variable rate of interest that is underpinned by a floor or minimum fixed rate of interest (e.g., the current yield on 30-year Treasury securities, but never less than 4%). The final regulations increase the fixed and minimum rates that may be used as follows:
Type of Rate Highest Rate Permitted
single fixed rate 6%
minimum annual rate
if using rates in Notice 96-8
(such as 30-year Treasuries) 5%
minimum annual rate
if using 1st, 2nd, or 3rd segments 4%
minimum cumulative rate 3%
Treasury and the IRS established these ceilings on minimum rates to ensure that the combination of the variable interest crediting rate and the fixed minimum rate would not, together, create an above-market rate.
More Flexible Investment Rates of Return. Another way for a hybrid plan to adjust a participant’s hypothetical account balance for the time value of money is to credit the account with the rate of return on an investment, be it a single security or a diversified investment portfolio. Prior regulations permitted a plan to credit an investment rate of return, but limited the choices to the return on (1) all the assets held by the plan, (2) a diversified regulated investment company (such as an S&P 500 mutual fund), or (3) an annuity contract issued by an insurance company. One drawback to this approach is that it appeared to limit plans to crediting the same investment rate of return to all participants in the plan, even though individual participants might have vastly different investment horizons and appetites for risk (for example, the new hire just out of college vs. a long-term employee on the verge of retirement). The recently released regulations address this shortcoming by permitting a plan to (1) subdivide the plan’s assets into separate pools with different asset mixes, (2) calculate the rate of return on each pool separately, and (3) credit participants with different rates of return by crediting them with the rate of return on one of the pools. To be eligible to do this, the each subset of plan assets must meet the following requirements: the subset of assets is diversified, no more than 10% of such assets are employer securities, and the assets approximate the liabilities for which the return is being credited.
However, certain limitations remain regarding investment rates of return:
Limit on age or service grading. Plans that credit an investment rate of return may apply the anti-backloading rules by projecting negative returns using a 0% interest rate. This projection might preclude a plan from providing pay credits (or similar principal-like credits) that increase with increased age or service.
Difficult to Replace a RIC. A plan that credits a rate of return on a regulated investment company (“RIC”) may replace the RIC with another RIC without violating the anti-cutback rule if the initial RIC ceases to exist and the replacement is the successor to the RIC (where a successor exists) or a RIC with similar characteristics. A rate of return based on a RIC may not be replaced with a different RIC merely because the first RIC begins to perform poorly or otherwise changes without ceasing to exist.
May Not Credit Based on an Index. A plan may not credit a rate of return based on an index, such as the S&P 500. Instead, the plan would need to credit the rate of return on a RIC that seeks to mirror an index, such as a specified S&P index mutual fund.
Opportunity for Shared-Risk Pension Plans. Traditional defined benefit plans require the employer to bear the risks associated with changes in interest rates, financial markets, and life expectancies: the benefits promised under traditional defined benefit plans do not vary based on these factors. In contrast, the benefits provided by defined contributions plans are based solely on the participant’s account balance, which the participant typically must manage to address changes in the market, interest rate fluctuations, and the participant’s life expectancy (which is not always easy to predict). A key feature of the final hybrid pension regulations permits a new type of plan design in which these risks are shared between the employer and the participant.
As noted above, the final regulations permit a hybrid plan to credit an investment rate of return. The benefits under a hybrid plan could therefore vary based on market experience. However, the plan would need to credit, at a minimum, a cumulative return of 0% interest (meaning that the participant receives, at a minimum, the sum of his or her pay credits without interest). In this manner, a participant would bear some investment risk, but would have some protection from the 0% cumulative floor. Furthermore, the plan would be required to offer an annuity form of benefit, providing a stream of payments for the life of the participant and, if married, his or her spouse. But, as described above, prior regulations required a one-size-fits all approach: the plan could credit a return based on an S&P 500 index fund, for example, but doing so for all participants, regardless of investment horizon, limited the attractiveness of this approach. The final regulations remedy this concern: different rates of return may be credited for different groups of participants based on separate subsets of plan assets. The regulations offer an example of how this might work: a subset of assets could be associated with participants based on years of service. For example, shorter service employees might be credited with a rate of return on a subset of plan assets that is invested less conservatively than a subset of assets associated with benefits for longer-service participants.
Most group health plans must apply to the Centers for Medicare & Medicaid Services by November 5 for a unique health plan identifying number (HPID). Although self-insured health plans must apply for HPIDs, the application process was not designed with these plans in mind.
In a post this summer, we identified several deficiencies in the HPID rules that will make the application process difficult for employers. CMS has recently fixed a few problems; but with the November 5 deadline fast approaching, the agency still has not addressed other fundamental shortcomings of the HPID rules. Continue Reading
Earlier today, Motorola Solutions announced that it is transferring $3 billion of pension liabilities to Prudential. The transfer covers approximately 30,000 plan participants who currently receive monthly pensions. In addition, former employees who have a vested benefit under the company’s pension plan but have not yet begun to receive benefits will be given a one-time offer to receive a lump sum. The company is limiting the total amount of lump sums to $1 billion.
The Motorola Solutions transaction is the third largest transfer of pension liabilities to an insurance company in the United States. In 2012, General Motors transferred approximately $25 billion of pension liabilities to Prudential and, in the same year, Verizon transferred approximately $7.5 billion of pension liabilities to Prudential. The magnitude of de-risking transactions decreased in 2013, but some large transactions continued to occur. For example, in 2013 SPX announced a transfer of $625 million to Massachusetts Mutual.
The Motorola Solutions transaction comes at a time when many companies that sponsor defined benefit plans are considering ways to reduce financial volatility associated with pension liabilities. As we previously noted, there has been some scrutiny of pension de-risking transactions in recent years. In 2013, the ERISA Advisory Council held hearings on pension de-risking, but, despite calls for a moratorium on pension settlements, the Council’s primary recommendation regarding pension transfers focused only on the standard for selecting an insurance company. In addition, Verizon’s pension transfer was challenged in court, but the district court dismissed those claims in their entirety. An appeal is pending.
Earlier this week, the PBGC issued a proposal to collect information from plan sponsors regarding certain pension de-risking activity. Under the proposal, plan sponsors would be required to report to the PBGC each year “undertakings to cash out or annuitize benefits for a specified group of former employees.”
We previously noted that the National Labor Relations Board (“NLRB”) takes the position that the National Labor Relations Act (“NLRA”) protects employees’ use of social media for certain purposes, and these protections apply regardless of whether the employees are covered by a collective bargaining agreement. Our colleagues at InsidePrivacy recently posted a blog post discussing new rulings from the NLRB concluding that two employees of a sports bar and restaurant were unlawfully discharged for their participation in a Facebook discussion criticizing their employer. For a discussion of these cases, see NLRB Finds Employee’s Facebook “Like” and Comment Protected By Labor Law.
When a defined contribution plan terminates, the plan administrator must distribute participants’ accounts as soon as administratively feasible. However, participants do not always update the plan administrator when their contact information changes, and some participants may not be responsive when the plan administrator requests directions on how to distribute their accounts.
On August 14, 2014, the DOL published guidance describing the plan administrator’s fiduciary obligations in such a situation. The guidance focuses on two questions. First, what steps must a plan administrator take to try to locate a missing participant? Second, if a plan administrator fails to locate a participant after taking any required search steps, what must the plan administrator do with the balance of the participant’s account? The DOL guidance does not directly address analogous situations under defined benefit plans or health and welfare plans, but is likely to have relevance to them as well. Continue Reading
Kodak recently announced that it is increasing the benefits provided under its defined benefit plan. Kodak will credit an additional 3% of pay each year under its cash balance pension plan instead of making a matching contribution of up to 3% of pay under its 401(k) plan. In connection with this change, Kodak announced that it is reducing its pension costs. Providing benefits under a defined benefit pension plan can be more efficient, allowing a company to provide a greater benefit for the same cost as a matching or nonelective contribution to its 401(k) plan. Covington is advising Kodak with respect to this pension change. For additional analysis, see Jerry Geisel’s article in Business Insurance.
One of the more obscure provisions of the Affordable Care Act says that a group health plan may not discriminate against “any health care provider who is acting within the scope of that provider’s license or certification under applicable State law.” What on earth does this provision mean? Apparently not even the federal government is sure. Continue Reading
Withholding and paying FICA tax on nonqualified deferred compensation can be a tricky business. Because special timing rules apply to FICA tax, employers can’t simply withhold and pay FICA tax when they pay deferred compensation to the employee. Instead, FICA tax is due when the deferred compensation vests (or, in some cases, when the amount of the deferred compensation can be determined).
It is not always easy to tell when these triggering events occur. In fact, it is sometimes hard to tell whether compensation is “deferred compensation” that is subject to the special timing rules. Employers faced with these complications often discover long after the fact that they have failed to withhold and pay FICA tax on deferred compensation when the tax was due. The additional 0.9% Medicare tax introduced in 2013 makes these errors much more difficult to correct. Continue Reading
Starting in 2015, the Affordable Care Act imposes burdensome new reporting requirements on employers and insurers that provide group health coverage. We described the reporting requirements in earlier posts, here and here.
Employers and other reporting entities have anxiously awaited the IRS forms on which these reports will be made, so that they can program and test their computer systems, develop administrative procedures, coordinate reporting responsibility with their affiliates, and make arrangements with their business partners to collect and report the necessary information. The IRS posted drafts of the reporting forms on its website yesterday. Unfortunately, however, the instructions to the forms—which are expected to provide much of the detail programmers will need—will not be available until August. Continue Reading