Guest Article

(From the March 21, 2011 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

New Rule Is Proposed on Phase-In of Guaranteed Benefits Arising from Unpredictable Contingent Events

The Pension Protection Act of 2006 (PPA) modified the guarantee of benefits that are payable on account of an unpredictable contingent event (UCE) such as a plant shut down or reduction in force. The guarantee is phased-in over five years, beginning with the date the UCE occurs. Newly proposed regulations by the Pension Benefit Guaranty Corporation (PBGC) clarify how the phase-in is to be applied effective for UCEs that occur after July 26, 2005. Comments are requested by May 10.

Goal Is to Align the PBGC Guarantee and Plan Funding

The proposed rule discusses the historical background to the change regarding the PBGC's guarantee of UCE benefits. This helps to understand the purpose of the change, which is to better align the plan funding of UCE benefits with the PBGC's guarantee of those benefits. ERISA § 4022(b)(1) & (7) generally provide that the PBGC's guarantee of new benefits (or benefit increases) is phased-in over five years, beginning on the date the new benefit or increase is adopted or effective, whichever is later. The PPA added a new paragraph (8) to that ERISA section to require - in the case of UCE benefits - that the date of the UCE be treated as the date the benefit was adopted. Essentially, this prohibits the phase-in of the PBGC guarantee from beginning any earlier than the date of the UCE.

Prior to the PPA, many UCE benefits were fully guaranteed because they had been included in the plan document for years before the event occurred. Sponsors typically did not make contributions to fund the UCE benefits until the UCE occurred, and often the event (e.g., plant shutdown) was followed within a few years by a plan termination, resulting in increased losses to the PBGC. While the Omnibus Budget Reconciliation Act of 1987 imposed accelerated funding of UCE benefits (i.e., generally within five to seven years beginning with the occurrence of the UCE), it did not address the mismatch between the PBGC guarantee and the plan's funding of the UCE benefits. The PPA attempted to remedy this mismatch by beginning the PBGC's five-year phase-in at the same time the accelerated funding was triggered: the date of the UCE.

Clarification in Proposed Regulations: Uniform Definition

By starting the phase-in of the PBGC guarantee at the time the UCE occurs, new ERISA § 4022(b)(8) better aligns the guarantee with the funding of UCE benefits (UCEBs). The proposed regulations incorporate the definition of UCEBs that was included in the final regulations on Benefit Restrictions for Underfunded Pension Plans issued in October 2009. UCEBs are defined to include only benefits (or benefit increases) that would not be payable but for the occurrence of a UCE, and include:

UCE Date to Be Determined by PBGC on Plan-Wide or Individual Basis

The proposed rule provides for the PBGC to determine the date of the UCE based on the plan provisions and the relevant facts and circumstances (e.g., level of activity at the plant that is closing, the date the event was planned or conceived). The PBGC phase-in may be applied plan-wide or on a participant-by-participant basis, depending on the plan provisions. For example, the guarantee of UCEBs triggered by a reduction in force would typically be determined on an individual basis depending on the particular layoff date of the participant, while the guarantee of UCEBs payable only on the complete shutdown of the employer's operation would generally be determined on a plan-wide basis.

Phase-In Begins No Earlier than the UCE Date

Under the proposed rule, the date the PBGC guarantee begins to be phased in is the latest of the date: (1) the UCEB plan provision is adopted, (2) the UCEB plan provision is effective, or (3) the UCE occurs. This requires the phase-in to begin after the UCE in the atypical case where the additional benefit is adopted or made effective after the event occurs. The PBGC guarantee is generally phased in at 20 percent per year, with a full phase-in of the guarantee after five years. The proposed regulations include examples of how these phase-in rules would apply to:

No Change to UCEBs as Priority Category 3 Benefits

The preamble notes that no changes were made to the treatment of UCEBs as priority category 3 benefits . even though the UCEBs are not guaranteed by the PBGC under the PPA changes. Priority category 3 includes only those benefits that were in pay status (or would have been in pay status if the participant retired) for three years before the plan termination. Where the PBGC becomes trustee of a plan that terminated without sufficient assets to pay benefits, the benefits in priority category 3 may be paid by the PBGC even though they are not guaranteed, depending the plan's funded status. As explained in the preamble, because the PPA did not make any reference to the priority categories in connection with its amendment of ERISA § 4022(b), the PBGC concluded that no changes were intended. This means that, as a result, participants will be more likely to receive UCEBs that are not guaranteed (and plan assets will be less likely to reach other benefits that are guaranteed).

UCEBs in Plans that Terminate During Bankruptcy

The PPA also implemented a rule regarding underfunded pension plans that are terminated while the sponsor is in bankruptcy: the PBGC guaranteed benefit is determined as of the date the plan sponsor enters bankruptcy. In terms of UCEBs, the proposed rule clarifies that if a UCE occurs after the bankruptcy filing date the UCEBs are not guaranteed because the benefits are not vested as of the bankruptcy filing date. Similarly, if the UCE occurs before the filing date, the PBGC five-year phase-in will end as of the bankruptcy filing date (not the plan termination date).

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations. If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Erinn Madden 202.220.2692, Bart Massey 202.220.2104, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Deborah Walker 202.879.4955. Copyright 2011, Deloitte.