BNA Pension and Benefits Blog

A New Year’s Wish: Why Not Try More Beneficial Benefit Planning?

As the mountain of new-year, new-law, alerts and warnings mounts, wouldn’t it be nice if sponsors and their advisors paid a little more attention to the beneficial purposes of a benefit plan?

Of course, lawyers and actuaries cannot be expected to ignore the potential for problem-discovering, alert-related, problem-solving, business-generating, fee-generating professional work growing out of the new law, new FASB rules, new SEC rules, new regulations, and the like. The profit opportunities are too great to ignore.

But wouldn’t it be nice if we also helped our clients to remember the serious needs of their employees and the benefit-planning opportunities that are the real reason why these plans developed in the first place?

What, exactly, does that mean?

How about some of these now-controversial ideas: Maybe considering how NOT to terminate, or NOT to freeze? Or at least how NOT to completely freeze a defined benefit plan? Or how about even perhaps doing the unthinkable and establishing new (but modest) DB plans, while diminishing the cash-flow risks (e.g., using more conservative actuarial assumptions, methods, and benefit definitions, and eschewing unpredictable contingent event benefits, limiting new unfunded past service credits)? After all, the "normal cost" of DB plans is not often the land-mine or booby-trap – it’s the present value of unfunded accrued liability where the risk lies, and, with care, that risk can be diminished or even avoided.

And how about combining modest DB plans with 401(k) supplements (many proponents’ original idea behind 401(k) plans in the first place)?

And how about putting some new restraints on DC plan cashouts, so that lower-paid employees (those who need pensions the most) are not the ones with the most cashouts? After all, 401(k) plans were invented to be retirement plans, not mere receptacles for short-term savings.

And so on.

This isn’t rocket science. It’s a question of role definition(s). The temptation to view plan sponsorship and "settlor functions" as a cash opportunity for employers (stockholders) may be real and substantial. But in a world in which outside advisers have taken on such a large role, perhaps we professional should remember, at least, the advice of a famous lawyer and outside general counsel who once wrote that he considered one of the primary responsibilities of outside counsel to be this: on an appropriate occasion, when asked to opine on a proposal that would be lawful but perhaps completely shortsighted, to look your client in the eye and say (what inside lawyers might not feel free to say): "You are damned fools and should stop." (Sol Linowitz, The Betrayed Profession, p. 4 (New York, Charles Scribner’s Sons, 1994), p. 4, quoting lawyer, cabinet member, diplomat, and Nobel Prize winner Elihu Root, ).

It takes some guts for a professional to say it, and it takes some character for a client to pay heed to it, but what a New Year that would be.

     A little-noted feature of the Pension Protection Act is its provision extending to multiemployer pension plans the opportunity to transfer "excess" assets to fund retiree health benefits.  Until now, only single employer pension plan sponsors were permitted to make such transfers. 

     The fact that the effort was made to include such a provision in the PPA suggests that there are at least some well-funded multiemployer pension plans that are in a position to transfer such "excess" assets to a more financially stressed affiliated health benefits plan.  The question arises, however, as to whether this provision will really prove workable or attractive for multiemployer plans.

     The amendment to Section 420 of the Code takes account of the fact that this section was originally written for single employer plans, by stating that it shall be applied to multiemployer plans in accordance with such modifications as Treasury determines appropriate to reflect the fact that the plan is not maintained by a single employer. 

     Presumably, regulations to implement this directive will not have a claim on Treasury's most immediate attention.  Yet they would seem essential.  For example, Section 420's definition of "excess" assets is now cast in terms of funding rules that apply only to single employer plans.  (Here there is a further problem for all plans - - single or multiemployer - - that might wish to utilize Section 420.  BNA, on September 13, quoted Nell Hennessy as pointing to "an incredible typo" in the amended Section 420, which mistakenly defines "excess" in terms of assets that exceed the "funding shortfall" rather than assets that exceed the "funding target."  In all likelihood this will require an eventual legislative fix.)

     In addition, there are other existing provisions of Section 420 that may prove particularly difficult for multiemployer plans to work with.  Section 420(b)(2) states that only one transfer a year may be made to pay for retiree health benefits that are provided during that year, which seemingly imposes an impossibly tricky forecasting problem.  If more assets are transferred than are necessary to pay for the retiree health benefits that are provided during that year, then the excess must be returned to the pension plan, subject to a 20% excise tax.  If, on the other hand, the single transfer turns out to be insufficient there may be no practical way to precisely adjust employer contributions to make up the shortfall, as Section 420(d)(2) states that an employer may not contribute any amount to a welfare benefit fund with respect to health liabilities for which transferred assets are required to be used.

     Other rules that must be taken into account are Section 420(c)(3)'s requirement that if there is a transfer of pension assets, health benefits may not be significantly reduced for a period of five years - - which may limit a health benefit plan's options in searching for ways to cut costs, such as by increasing deductibles and co-payments.  And Section 420(c)(2)(A) requires that for a transfer to be "qualified," all accrued benefits under the pension plan must be fully vested - - thereby imposing an additional cost that some multiemployer plan sponsors may be reluctant to incur. 

     All in all, I strongly suspect that without modifications that Treasury is unlikely to adopt, Section 420 transfers will probably not prove sufficiently attractive for multiemployer plan sponsors to pursue.  Does anyone have a different assessment?

Employers are being inundated with a press of new guidance issued by government agencies on many new employee benefit requirements with which the failure to comply can result in some fairly stiff penalties.  Guidance such as that issued by Treasury at the beginning of this month on section 901 of the Pension Protection Act of 2006 (the Act) which establishes participant diversification rights for publicly traded employer securities held in defined contribution retirement plans (other than certain ESOPs).  While the guidance is certainly welcomed because it fills some "need to know" gaps in the short run, the Notice raises some immediate significant areas of concern for employers.

The Act establishes as a new plan qualification requirement (new Code section 401(a)(35)) for investment diversification applicable to publicly traded employer securities held by defined contribution plans and certain ESOPs.  IRS Notice 2006-107, provides guidance on the new Act diversification rules, one of which requires 30 days advance notice to participants before the first day that participants are eligible to direct diversification of their accounts out of employer securities.  The Notice provides employers with some breathing space and advises employers that the new participant notice requirement can be satisfied as late as January 1, 2007, for calendar year plans.  This still means, however, that employers have to figure out who must get the notice and what the notice should say and send it by year end. 

One issue is whether employers that already allow participants to diversify out of employer stock (i.e., their plans already contain full diversification rights), have to advise participants by January 1, 2007, of their right to do so, which likely would be duplicative especially if the information already is contained in an SPD).  The Notice contains a model notice (requiring customization), but the IRS has requested comments on ways to improve the model notice.

While the reason for the new statutory provision is to ensure that participants in defined contribution plans (sponsored by publicly traded employers) receive diversification rights where the employer's plan invests in comapny stock, has a company stock fund or matches employee contributions with company stock, as a result of ENRON and the spate of litigation that followed in its wake, many employers already have modified their plans to allow employees to diversify out of employer stock.  What is hitting many employers who have already provided for diversification out of employer stock in their defined contribution plans is how to comply with these notice requirements.  Does it make sense for an employer to send out 50,000 notices to employees in its 401(k) plan by the end of the year telling them about a right they already have (and presumably already know about)?

Some government representatives at Treasury and the IRS have pointed to an alternative purpose of the employee notice -- to educate employees concerning the importance of diversifying their investments.  When asked whether an employer needs to send notices (by year end) to employees in plans that already contain the required diversification, these representatives have suggested that notices may still be required.

Should publicly traded employers with defined contribution plans holding company stock send out notices before the end of the year even if their defined contribution plans satisfy the diversification requirements of the statute?  Although some practitioners think this is absurd, this practitioner thinks it is better to be safe than sorry.  Any thoughts?

On Dec. 14, BNA will host an audioconference with J. Mark Poerio, partner, Paul Hastings Janofsky & Walker; David G. Johnson, national practice leader-Compensation Strategy & Design, at Ernst & Young; and Richard L. Alpern, a principal at Frederic W. Cook & Co., titled "Getting Started With Writing the 2007 CD&A."  In the audioconference, our panel will provide practical guidance in drafting the Compensation Discussion and Analysis.  Registration information is available at http://legaledge.bna.com, or by calling 800-952-2477.

In the year 2005 we saw a national debate on the nation's most important defined benefit plan, Social Security. The nation overwhelmingly expressed its sentiment that the system of work-related, guaranteed lifetime benefits provided the security that people wanted for themselves, members of their family, and the nation as a whole.

But the private defined benefit plan system has been withering away without any great public debate. Whether for reasons of cost, competition, volatility or other business reason, employers have been steadily and increasingly choosing to move away from defined benefit plans. The recently enacted Pension Protection Act is not likely to reverse this trend, and in combination with new accounting rules, we are likely to see this trend accelerate. In their place, we have defined contribution plans that place the risk on the individual. These risks include the risk of not contributing, of not investing well, of prematurely tapping funds, and of taking a distribution that does not last a lifetime. These risks will affect millions of families, and my guess is that many more will have retirement incomes lower than previous generations.

Had this trend been brought up for public debate, how would the American public have responded? And should we change course, or is it too late? Perhaps more importantly, is the choice simply between retaining the old defined benefit plan system, and moving to 401(k)-type plans?

Most benefit professionals seem to believe that 401(k) plans simply shift too much risk onto employees, and simply are not going to provide the retirement security of the old defined benefit plan. But employers do not want to assume all the cost and risk associated with traditional defined benefit plans. But must a plan have the risk assumed entirely by the employer OR the employee? Are there not arrangements where part of the investment and volatility risk and/or longevity risk are better shared? Is there a next generation of pension plan on the horizon, one that better meets the needs of both employers and employees?

Unfortunately, these changes are happening largely outside the great public debate. We will need to address these private pension plan issues in the larger context of long-term retirement security if we are to get a better handle on the direction we want for this country.

And in the meantime, long live Social Security -- it may increasingly be all that most people have.