2012 – Mayan Apocalypse or Pension Plan Termination?

By Jesse M. Cox

As 2012 approaches, the time might be right to consider terminating your defined benefit (DB) pension plan.  Not because the Mayan calendar ends on December 21, 2012, but because the Pension Protection Act of 2006 (PPA) changed the interest rates that are used to calculate lump sum amounts.

Prior to PPA, lump sum interest rates were based on 30 year Treasury rates.  Post PPA, lump sums are based on yield rates for high quality corporate bonds (phased in over 2008, 2009, 2010 and 2011) – resulting in higher interest rates and smaller lump sum amounts.  In 2012, PPA lump sum interest rates will be fully phased in.  Combine this with an overall environment of potentially increasing interest rates (thank Standard & Poor for their recent downgrade of the United States’  credit rating) and 2012 might create the perfect time for a Pension Plan Apocalypse… err, Termination. 

It’s true.  Aside from the financial cost, terminating a pension plan is a very complicated process with lots of deadlines and administrative hurdles.  A trusted mentor (and well respected actuary) once told me – “the most onerous task related to a pension plan is that of its termination”.   While onerous indeed, the guidance of experienced actuaries and consultants – combined with the efficiencies of “today’s technology” – will help avoid the excessive costs and the many traps and pitfalls that often are encountered during the termination process.

The following steps provide an overview of the plan termination process for a single-employer DB plan that is insured by the Pension Benefit Guaranty Corporation (PBGC):

1)      Freeze Plan Benefit Accruals and Establish Plan Termination Date

A 204(h) Notice of Plan Freeze should be sent out 45 days before benefits freeze to inform the participants. Once this has occurred plan termination can commence and a plan termination date is established.

2)      Establish Short Term Investment Philosophy

With plan termination approaching, the investment strategy needs to be reassessed. In order to reduce risk, a short-term investment philosophy should be determined until all plan assets are distributed from the trust.

3)      Calculate Final Accrued Benefits

A final accrued benefit should be calculated for each participant as of freeze date. The Plan Document along with its amendments should provide sufficient information to do so.

4)      Annuity Provider Search

For participants who are not receiving or offered lump sum options, the plan sponsor must select an insurance company from which they will purchase annuity options.  

5)      IRS and PBGC Plan Termination Requirements

• PBGC Notice of Intent to Terminate (NOIT)

Informs participants of the plan sponsors intent to terminate. This should be filed 60-90 days prior to the termination date and is often combined with the 204(h) notice.

• IRS Notice of Interested Parties (NTIP)

Informs participants of plan sponsor’s intent to file for a plan termination with the IRS. Must be issued 7-21 days prior to filing IRS Form 5310.               

• IRS Form  5310 and 6088

IRS Form 5310 (Application for Determination for Terminating Plan) and IRS Form 6088 (Distributable Benefits from Employer Pension Benefit Plans) are required to be completed and filed as soon as possible after proposed plan termination date.

• PBGC Notice of Plan Benefit (NOPB)

Reports plan benefit information to participants. This should be filed no later than 180 days after termination date. NOPB is part of a formal plan termination election form package.

• PBGC Notice of Annuity Information (NOAI)

Provides participants with annuity information regarding the chosen insurance company or those that are being considered. Notice must be issued 45 days prior to annuity release. NOAI is often included with NOPB.

• PBGC Standard Termination Notice (Form 500)

Must be filed within 180 days of plan termination date (but after NOPB is provided).

• PBGC Post Distribution Certification (Form 501)

Plan sponsor certifies PBGC that all plan liabilities have been settled and that Notice of Annuity Information was distributed in a timely manner.

Don’t forget that the ongoing administration of your pension plan must continue – even during the plan termination process.  Participants receiving monthly benefit payments continue receiving monthly payments, participants requesting to retire should commence benefits in accordance with their elections and the Plan Document, minimum required and quarterly contributions must continue to be made and IRS and PBGC annual reporting must be continue to be filed.

GASB on Pension Accounting and Financial Reporting by Employers

By Jill Urdahl

The Preliminary Views of the GASB on Pension Accounting and Financial Reporting by Employers has been approved by the Board for issuance for public comment.  The document seeks to define the function of pension accounting and financial reporting more thoroughly, and entails methodology changes for pension, and eventually OPEB, valuations.  Discussions to date have been limited to what the Board believes is most fundamental relating to pensions by employers, but eventually, they expect this to result in a new statement(s).  Below is a brief summary of the objectives, timeline and changes proposed by GASB.

Objectives:

• Establish standards of accounting and financial reporting for postemployment benefits for Governmental entities.
  • Governmental entities differ from other financial reporting units due to their long-term nature. 
  • Reporting information should not focus on whether they are suitable to continue to exist, but rather, it should focus on the allocations of their services and provide a longer term view of their operations.
• Emphasize that the obligation an employer incurs is upon the creation of the “Employment Exchange”.
  • As a result of the Employment Exchange each year, the employer incurs a pension benefit obligation to its employees.
  • Entry-Age Actuarial Cost Method bears a more consistent relationship to the employee’s salary level, thus it better fits the above mentioned objective than other actuarial funding methods.
• Establish that the employer is primarily responsible for the unfunded liability, and obtains secondary responsibilities only upon full funding of the plan.
  • The old method of measuring Net Pension Obligation implies that the liability to the employees is transferred to the plan, and the annual funding requirements have been substituted for original liability.
  • The proposed new method of measurement for Net Pension Obligation (or Net Pension Liability) is much simpler (total pension liability less net plan assets). The basic formula intends to pattern this new objective of holding the employer primarily responsible for the unfunded liability.
• Further develop the understanding and measurement of financial resource outflow/inflow.
  • Focus on satisfying Interperiod Equity; the state at which current period inflows equals current period outflows.
  • Main goal is to harmonize the “short term” with the “long term.”

Timeline:

• GASB has solicited comments from individuals and employers in order to further develop thoughts and obtain public opinions on their questions raised in the Preliminary Views document. 
• By June 2011, the Board hopes to submit an Exposure Draft of a new GASB Statement for Pension Accounting and Financial Reporting by Employers.  The Board will again consider feedback from the Exposure Draft before producing a final Statement.
• June 2012 is the date targeted by the Board to release a new Statement.
• The similar process for OPEBs is expected to begin with Board conversations around August 2011.

Time to Revisit Pension Investment Strategies

by Bob Ryan

Liability Driven Investment (LDI) strategies are intended to reduce much of the volatility associated with the financial measurements of Defined Benefit retirement plans. The basic idea is to have the measurements of plan assets and liabilities, which change with long-term interest rate fluctuations, move in the same direction and magnitude. This synchronization would reduce balance sheet and income statement volatility associated with the defined benefit plan.

The earliest use of this strategy was to invest plan assets in a fixed income portfolio that matched income streams from those assets with the cash outflows expected from the pension plan. In theory this was a very simple solution but in actual practice, the time period of cash outflows expected for the pension plan were far longer than the payout stream expected for the pension benefits.

On a present value basis, this mismatch was usually immaterial. Interest rates were extremely high and most plans were overfunded.  In addition, if the duration of the assets and liabilities could be equalized, the mismatch could be resolved. This quickly became the standard practice.

Over the intervening 30 or so years, much more sophisticated investment practices have emerged and investment strategists have become more refined in their application. Efficient markets for the necessary long-term interest rate swaps or similar investment hedges have expanded to meet the need for those devices. As a result, what we could not execute thirty years ago has become achievable.

Current practices also overcome a major disadvantage of the original fixed income strategies. The use of hedging strategies means that not all investments must be held in fixed income instruments. Since the class of fixed income instruments usually has a significantly lower expected return relative to other asset classes, the total expected return of the pension assets is higher and the ultimate cost of the pension plan is lower. Less volatility with greater return!

Past perception has been that an LDI strategy might not be possible to implement for underfunded plans. Today that may not be true. So if you have previously rejected LDI for any reason, it may be time to revisit this alternative.

Happy Holidays from Pension Live

Pension Live was specifically formed to compete with the national actuarial service providers by bringing ingenuity, efficiency and dedication to our clients while consistently offering a substantial cost savings on each project we undertake.  By applying the most cutting-edge tools and techniques toward pension plan consulting and administration services, we clear the pathway to never-before-experienced levels of efficiencies and client satisfaction.  Our subject matter experts not only possess the experience and credentials to create accurate and usable analytic results, but also the drive to eliminate the layers of mystery from common actuarial reporting and impart to our clients the essential meaning behind the numbers.

Since our inception, Pension Live has quickly become the premier source for defined benefit plan sponsors seeking innovative and practical pension administration solutions via the web. Our cost-effective, fully customizable services and web applications radically reduce the time, expense and complexity associated with pension plan sponsorship.

We look forward to sharing our blogs with each of you during the coming year and appreciate the opportunity to be a valuable resource to you.

 Happy holidays from all of us at Pension Live.