Conference of Consulting Actuaries

1
Pension Reform Now That We Have It, How Does It
Work?

• Conference of Consulting Actuaries

Heidi Rackley Brian Donohue Martin
Pippins Mercer Human Resource Consulting CCA
Strategies LLC Internal Revenue
Service Washington Resource Group Chicago
IL Washington DC
2
Todays agenda

• The road to reform
• Single-employer pension funding rules
• Provisions effective now
• New funding rules effective in 2008
• Benefit restrictions
• Other key DB provisions
• New life for cash balance plans?
• Does PPA meet the challenges?

3
The road to reform

• Fallout from 2000-02 perfect storm of falling
  interest rates and equities
• Many underfunded plans
• Volatile contribution requirements under DRC
  rules
• 2 rounds of temporary funding relief
• 2002-3 current liability rate 120 of average
  30-year Treasury rate
• 2004-5 current liability rate 100 of average
  composite corporate rate
• Record PBGC deficits and very visible takeovers
• Severe participant benefit cuts when plans
  terminated in bankruptcy
• Unpleasant investor and participant surprises
  make lack of transparency in disclosures
  apparent

4
The road to reform

• Challenges
• Keeping employers in the defined benefit system
• Improving PBGCs financial health
• Protecting participants from severe, unexpected
  benefit cuts when underfunded plans terminate

5
The road to reform
House passes Pension Protection bill different
concessions to employers (more smoothing, but
credit balances more restricted), fewer
participant protections

• Bush administration unveils proposal driven
  primarily by PBGC financial condition
• Contribution determined from short-term solvency
  measure
• Higher deductible contribution limits
• Benefit restrictions on poorly funded plans
  (including NQDC prefunding restrictions)
• Higher PBGC premiums

Senate passes NESTEG bill mirrors
Administrations proposal but with modest
concessions to employers (some smoothing, credit
balances retained), added participant protections
Conferees named
7/20 Conferees reach preliminary agreement on
pension issues 7/27 Conference breaks down over
non-pension tax issues 7/28 House passes HR 4
a new bill reflecting conference
agreement 8/03 Senate passes HR 4 8/17 Pres. Bush
signs HR 4 into law
2007
2004
2005
2006
7/20 8/17
3/8
1/10
11/16 12/15
6
Single-employer pension funding rules Key
messages

• Contribution volatility can be managed
• but requires thoughtful analysis and careful
  coordination of benefit, contribution and
  investment policies
• new funding policy drivers avoiding at-risk
  status and benefit restrictions
• Credit balance treatment is complex optimal
  contribution and credit balance strategy requires
  careful analysis
• important for 2006-7 as well as 2008 and later
• Plan now but be prepared to refine preliminary
  decisions
• evolving IRS guidance
• capital market conditions
• calendar-year plans have until September 2008 to
  make 2007 plan year contributions for optimal
  transition
• guidance on lookback rules needed for final
  September 2007 contribution decisions

7
Single-employer pension funding rules Key
milestones
2006 2007 2008
2009 2010 2011
2012
8
Single-employer pension funding rules Key
provisions effective now (2006-7 plan years)

• Now have guidance needed to wrap up 2006
  valuations
• funding relief extended
• current liability interest rate (5.19 - 5.77
  for calendar-year plans)
• higher limit on maximum tax deductible
  contributions
• but if DC contributions gt 6 of pay, 25 of pay
  limit overrides
• Variable-rate PBGC premium relief extended
• 85 of composite corporate rate
• will increase to 100 if IRS issues new 2007
  current liability mortality tables
• full funding limit exemption continues through
  2007

Comparison of 2006 contribution ranges
Old law with 30-yr. Treasury rate New law with
150 CL deduction
Poorlyfunded(66)
Wellfunded(93)
Over funded(105)
9
Single-employer pension funding rules 2008
Minimum contribution components

• Funding target
• 100 of present value of accrued benefits
• mandated discount rate based on corporate bond
  yield curve
• mandated mortality tables
• probability of lump sum payments
• higher target for at-risk plans
• Target normal cost
• present value of benefits expected to be accrued
  in current plan year
• including effect of salary increases
• same assumptions as funding target
• Actuarial value of assets (AVA)
• IRS prescribed methods
• up to 24-month smoothing
• 90 - 110 of market
• Funding shortfall
• funding target (AVA credit balance)
• Funding target attainment percent (FTAP)
• (AVA credit balance)/not-at-risk funding target

Normal cost
Normal cost
7-yr amortization
Fundingtarget
Actuarial valueof assets net ofcredit balance
Funded Position
PreliminaryMinimum Contribution
10
Single-employer pension funding rules 2008
Funding target assumptions
All plans

• Discount rate based on high quality (AAA, AA, A)
  corporate bonds 3 choices
• 24-month-average segmented yield curve without
  phase in
• 24-month-average segmented yield curve with
  3-year phase-in
• 1-month-average full yield curve without phase-in
• Additional choice up to 4-month look-back

IRS-mandated mortality table or Plan-specific
mortality table (large plans only) approved by IRS
At-risk plans
Not-at-risk plans
Other assumptions (including lump sum
utilization) are individually reasonable IRS must
approve assumption changes that reduce funding
target if unfunded vested benefits gt 50 million
Participants eligible to retire in next 11 yrs
retire at earliest time all participants elect
most-valuable payment form

• Mandated expense load if at-risk 2 out of last 4
  years (4 700/participant)

Other assumptions are individually reasonable
11
Single-employer pension funding rules 2008At
risk status

• What happens if a plan is at risk?
• Higher liabilities and hence higher
  contributions, phased in over 5 years at risk
• Higher PBGC premiums, phased in over 5 years at
  risk
• No additional rabbi trust funding of nonqualified
  plans for top executives, immediately upon
  becoming at risk
• Other benefit restrictions likely also triggered
• When is a plan at risk?
• gt 500 participants in all controlled group DB
  plans, and
• At prior valuation date, assets minus credit
  balance lt 80 of not-at-risk funding target
• 80 threshold phased in over 4 years (65 for
  2007, 70 for 2008, 75 for 2009, 80 in 2010 and
  later), and
• At prior valuation date, assets minus credit
  balance lt 70 of the at-risk funding target
  determined without expense load

12
Single-employer pension funding rules 2008
Minimum required contribution calculation
Determine at-risk status based on last years
valuation waive prior credit balance to avoid
at-risk status or avoid benefit restrictions?
Calculate adjusted funded percentage (assets
generally unreducedby credit balance)
100, or no DRC in 2007, and 92 in 2008,
and 94 in 2009, and 96 in 2010
Calculate initial funding target,funding
shortfall, and FTAP (assets credit balance)
No
FTAP 100
No
Preliminary minimum normal cost ?old
shortfall installments new shortfall
installment New shortfall installment 7-year
amortization of(shortfall ?PV
remaininginstallments on old bases)
Yes
Yes
Preliminary minimum normal cost ?old
shortfall installments No new shortfall base
establishedbut old bases are not eliminated
Preliminary minimum normal cost (assets
credit balance funding target) Eliminate old
shortfall bases
Can use credit balance to pay preliminary minimum
if, at prior valuation, assets minus prefunding
balance 80 of funding target
13
Single-employer pension funding rules 2008
Minimum contribution illustrations
Old law with relief (corporate bond rate) PPA
14
Single-employer pension funding rules 2008
Credit balance past future
Careful analysis required to determine advantages
of maintaining credit balance
15
Single-employer pension funding rules 2008
Quarterly contributions still required

• Required if, at prior valuation date, assets
  minus credit balance lt funding target
• More severe penalties than old law
• late interest charged at the effective rate 5
• Unclear how credit balance will be applied to
  quarterly contributions
• credit balance earns interest at actual plan rate
• will quarterlies draw down old carryover balance,
  while 9/15 contribution creates new more
  restricted prefunding balance?
• Additional liquidity contributions required in
  some cases

Calendar plan year
4/15 7/15 10/15
1/15
9/15 final contribution
16
Single-employer pension funding rules 2008 Rifle
shots

• Airlines and airline catering companies
• 17 years to fund frozen plans using 8.75
  interest, or
• 10 years to fund 2008 funding shortfall
• Greyhound bus
• mortality table
• 5-year phase-in of shortfall amortization bases
• no quarterly contributions
• Auto companies and certain auto parts
  manufacturers
• special rules for determining whether plans are
  at risk
• Delayed effective date for new minimum funding
  rules (after 2007, current liability rate 3rd
  segment rate) and benefit restrictions
• rural cooperative multiple employer plans (2017)
• large defense contractors (2011 or when CAS rules
  updated, if earlier)
• PBGC settlement plans (2014)

17
Single-employer pension funding rules 2008
Maximum deductible contribution

• Old law DB deduction limit
• generally 100 of unfunded current liability
• New law DB deduction limit
• normal cost, plus
• 150 of funding target, plus
• pay or benefit increase allowance (including
  401(a)(17) compensation limit increases), minus
• assets (unreduced by credit balance)
• DB/DC combined plan limit
• doesnt apply to PBGC insured plans

Poorly Funded
Well Funded
Old law with relief (corporate bond rate) PPA
18
Single-employer pension funding rules 2008
Benefit restrictions based on plans funded status

• Adjusted FTAP
• Assets
• reduced by credit balance
• unless 100 funded before reduction
• phased in over 4 years 92, 94, 96
• must waive credit balance if that avoids
• restriction on accelerated payments (e.g. lump
  sums)
• any restriction for a bargained plan
• increased by security outside plan
• Funding target is not-at-risk funding target
• Assets and funding target both increased by NHCE
  annuity purchases in last 2 years
• Restrictions based on current year's funded
  percentage until certified
• if any restriction applied for prior year
• same as prior year for first 9 months of plan
  year
• lt 60 thereafter
• if no restriction applied for prior year
• same as prior year for first 3 months of plan
  year
• prior year - 10 for next 6 months
• lt 60 thereafter

• Triggered by bankruptcy, distress termination

80 - 100

• Benefit increases must be funded immediately
• Lump sums limited to 50

60 - 80

• Benefit increases must be funded immediately
• Shutdown benefits must be funded immediately
• No lump sums
• No accruals
• Vesting and eligibility service continue

lt 60
Restrictions based on adjusted FTAP
19
Single-employer pension funding rules 2008
Benefit restrictions based on plans funded status

• Funding restrictions for nonqualified plans
• Effective NOW
• DB plan sponsor cannot prefund NQDC for top
  officers in a rabbi trust or similar arrangement
  when
• plan sponsor is in bankruptcy
• 6 months before or after distress termination
• qualified DB plan is at risk
• this trigger apparently isnt intended to apply
  before 2008
• Top officers
• those reported on proxy
• SEC 16(a) insiders
• former executive in either category at
  termination
• Violation triggers onerous tax penalties on
  executive

20
Single-employer pension funding rules 2008 PBGC
premiums

• Flat rate premiums
• Deficit Reduction Act of 2005 increased flat-rate
  premiums to 30 in 2006, indexed to national
  average wages
• Variable-rate premium 9/1,000 of unfunded
  vested benefits (UVB)
• 2006-7 plan years
• UVB based on actuarial value of assets, 85 of
  composite corporate bond rate
• if IRS issues new current liability mortality
  table, changes to market value of assets and 100
  of composite corporate rate full funding limit
  exemption
• for 2007, if 25 employees in controlled group,
  max 5 ( of participants)2
• full funding exception
• 2008 and later plan years
• UVB determined using market value of assets,
  segmented yield curve at snapshot date (not
  24-month average), funding target assumptions
• no full funding limit exemption
• if 25 employees in controlled group, max 5
  ( of participants)2
• Distress termination premium of
  1,250/participant for 3 years
• enacted in Deficit Reduction Act of 2005 (2005
  2010 terminations)
• made permanent by PPA

21
Single-employer pension funding rules 2008 New
funding drivers
Subject to 4-year phase-in (65 in 2008, 70
in 2009, 75 in 2010, 80 in 2011) Subject to
4-year phase-in (92 in 2008, 94 in 2009, 96 in
2010, 100 in 2011)
22
Other key DB provisions Minimum lump sums (2008)
Estimated PPA lump sum as percent of GATT lump
sum

• Segmented yield curve without 24-month average
• phased in over 5 years beginning in 2008
• Mortality based on mandated table for funding
• Reduces deferred-to-65 lump sums
• 30 50 at younger ages
• 0 15 at retirement ages 55 - 70
• Reduces immediate lump sums
• 10 15 at younger ages
• 0 - 10 at retirement ages 55 - 70
• Assumptions
• 30-year Treasury rate 5
• typical relationship between Treasury and
  corporate bonds
• typical shaped yield curve
• 50/50 unisex blend of IRS proposed 2007 current
  liability mortality tables, updated annually

23
Other key DB provisions Participant
communication (effective date)

• Benefit statements (2007)
• employed participants with nonforfeitable
  benefits, at least once every 3 years (or
  annually advise how to request statements)
• all participants and beneficiaries upon written
  request, but no more than once in 12 months
• Distribution consent, QJSA notice (2007)
• Annual funding notice replaces current PBGC
  participant notice and Summary Annual Report
  (2008)
• Electronic display of Form 5500 information
  (2008)
• Benefit restriction notice within 30 days after
  restriction is triggered (2008)

24
Other key DB provisions (effective date)

• 415 limits for lump sums and other 417(e) payment
  forms (retroactive for 2006 limitation years)
• EGTRRA rules made permanent (enactment)
• Phased retirement actives who have attained age
  62 (2007)
• New rollover rules nonspouse beneficiaries
  (2007)
• New QJSA requirements, QOSA (2008)
• New multiemployer plan rules (2008)

25
New life for cash balance (and other hybrid)
plans?

• New law provisions
• hybrid plans not age discriminatory
• applies to cash balance, pension equity and other
  hybrid plans
• retroactive to June 29, 2005 no inference re
  prior law
• interest credit can't exceed a market rate of
  return (2008 for plans in existence on June 29,
  2005)
• minimum 3-year cliff vesting (2008 for plans in
  existence on June 29, 2005)
• whipsaw protection (distributions after
  enactment)
• upon plan termination, variable interest and
  annuity conversion factors are fixed at average
  of last 5 years (terminations after June 29,
  2005)
• restrictions on new conversions to hybrid plans
  (conversions after June 29, 2005)
• Cash balance litigation risk - how important is
  the recent IBM court decision?

26
Does PPA meet the challenges?