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Sessions 202 & 401 - PPA Funding – II:
The New Rules
Presenters: Bruce C. Gaffney and Laura M. Camisa
Recorder: Gregg M. Burk

At the 2008 Enrolled Actuaries Meeting, Bruce Gaffney of Ropes & Gray LLP and Laura Camisa of Watson Wyatt Worldwide gave a high level review of the PPA funding rules for single-employer plans. As Bruce and Laura highlighted, the new rules take many old and familiar concepts and recast them with both new terminology and some additional wrinkles. Given the level of attendee interaction during the session, these wrinkles require some serious study to avoid any pitfalls.

Building Blocks

Many of the basic building blocks of the PPA calculations are well-known actuarial concepts with a twist. For example, the current liability under the old law becomes the funding target under PPA.  As was true with current liability, the funding target measures plan liabilities for accrued benefits based on mandated interest rates and mortality assumptions. Rather than using a single interest rate, however, PPA calculations require more a complex structure of segment rates derived from a corporate bond yield curve.

Another familiar concept for pension actuaries is normal cost.  As one might expect, PPA’s target normal cost is the present value of benefits expected to accrue during the plan year, which includes benefit increases due to compensation growth as well as continued service.  But in addition to pay and service increases, target normal cost, as well as the funding target, may reflect changes from plan amendments; increases in liability due to plan amendments are no longer separately tracked and amortized.

Similarly, valuation assets are now called plan assets. Like the old rules, plan assets continue to be based on market value, and PPA continues to allow for some smoothing.  Under PPA’s new rules, asset smoothing is limited to a 24-month period (rather than a five-year period) and the market value corridor is decreased from 20% to 10%. 

PPA maintained the credit balance concept but not without some alterations. For example, PPA renamed and bifurcated the credit balance into carryover balance and prefunding balance.  Going forward, the prefunding balance will increase when contributions exceed the minimum required amount, and both balances can be used to satisfy future funding requirements. In addition, PPA provides more options to the plan sponsors: now plans are not required to maintain any credit balance, but instead they may waive any or all of the balances they have.  However, PPA also comes with new credit balance restrictions. Primarily, the credit balance may not be used to satisfy the minimum required contribution when plan assets for the prior plan year (after subtracting the prefunding balance) do not exceed 80% of the funding target for the prior plan year.  These new options and restrictions can create some interesting situations and decision points, as Bruce and Laura outlined.

Minimum Basics

At its core, the PPA attempts to bring defined benefit plans to a 100% funded level over a seven year period using a traditional unit credit funding method. 

Bruce and Laura discussed the fundamental components driving the new funding requirements. As they explained, in its most basic form, the PPA minimum funding requirement is the sum of the following components:

·         Target Normal Cost 

·         Shortfall Amortization Charge

·         Waiver Amortization

But be careful: this calculation can change depending on the plan’s funding level. For example, the components are tweaked for plans that are well funded, while poorly funded plans deemed “at-risk” have altered liability calculations. Also, there are many steps to consider when setting up the shortfall amortization charge.

Counting Contributions

The way in which defined benefit plans count contributions hasn’t changed much with PPA, but there are some new twists here too. Consistent with the old ERISA rules, contributions for a plan year can be considered during a 20 ½ month period.  This period includes the plan year and a period of up to 8 ½ months after the plan year ends. 

As with the prior rules this can lead to situations where plan assets at year-end include receivable contributions.  As Bruce described, plan contributions under PPA are “normalized.” This has many interesting consequences. As an example, when determining plan assets, any receivable contributions are now included on a discounted basis rather than full value.

Maximum Deductible Contribution

Of course PPA is not just about the minimum required contribution. Bruce and Laura also discussed the maximum deductible contribution at a high level.  The rules for calculating the maximum deductible contribution also saw a major overhaul.

The maximum deduction calculations are complex, but as a starting point they are made up of the following components:

Funding Target + Target Normal Cost +“Cushion Amount”
Minus
Plan Assets not reduced by any credit balance

The cushion amount is a new PPA concept. Essentially, the cushion amount equals 50% of funding target and the amount the funding target would increase if future compensation growth were taken into account (i.e. the difference between projected unit credit and traditional unit credit cost methods).

Of course, PPA’s redesign is very complex, and based on the lively discussions at the meeting, many actuaries are still just getting comfortable with the new rules.