The Consulting Actuary

Session 704 - Top Ten Unresolved Issues in PPA
Presenters: David R. Godofsky, Kent A. Mason
Recorder: Briana S. Summers

The session at the EA Meeting titled “Top Ten Unresolved Issues in PPA” brought to light some of the areas in which Enrolled Actuaries still express concern almost two years after the passage of the Pension Protection Act. Panelists expressed their opinions about where the solutions to these issues may end up.

What is an actuarial certification?

There are many questions surrounding actuarial certifications. What information must be included for it to be considered a certification? What form must it take? When does informal communication rise to the level of a certification? There could be times where an actuary certifies an adjusted funding target attainment percentage (AFTAP) calculation and doesn’t even know it. If any information is conveyed and permanently recorded, whether written, electronic or verbal, that directly or indirectly specifies the AFTAP, then that could possibly be considered a certification. This includes voicemails left to clients, or a signed report that has enough information in it to calculate the AFTAP. Once an AFTAP is “certified” there is an immediate impact on the benefits that can and must (or must not) be provided. Because of this, certifiers need to be aware of their communications.

Does the Funding Target include shutdown benefits? How do you calculate the liability?

This question applies not only to shutdown benefits, but really to any unpredictable contingent event benefit. Before PPA, there was an explicit rule that these benefits were not part of the Current Liability until the event occurred. The Post-PPA Treasury regulations state that one should include all benefits “earned or accrued.” The Treasury has orally said that these types of benefits should be included in the liabilities used to calculate the funding target, reflecting the probability of such event occurring. However, does this really make sense? A shutdown either happens or it does not happen. Is it efficient to apply a probability to a single event that is unlike other decrements such as death or termination of individual participants? Also, it may be inconsistent to include these event benefits since some of these events may be restricted should the AFTAP fall below 60%. As an update: at a more recent conference, an IRS representative made the point that most shutdown benefits would not be “earned” before the shutdown, and could be excluded for that reason.

What is a “market rate of return” for a cash balance plan? How does the minimum rate affect the market rate of return? What is a “safe harbor” rate of return and when do you have to pay whipsaw if you had a minimum rate of return? Is there such a thing as whipsaw now for past distributions? (Questions related to Notice 96-8)

When we think of a market rate of return in a cash balance plan, we all think of stock or bond indices, etc. What if you apply a minimum rate of return like 4%? Is that still a market rate? The Treasury states that you must have something less than an index to implement a minimum. The IRS is still reviewing determination letters with flat minimum rates of return. For example, IRS’s position is that a rate equal to the greater of 4% or the 30-year Treasury rate is not a “safe harbor.” Does that make sense when the 30-year Treasury rate has never fallen below 4% in its history of over 50 years? The Treasury would say the above formula is not a safe harbor rate since it is not just the 30-year Treasury. In addition, many are hopeful that if the minimum rate never applies, then whipsaw calculations are not necessary.

What is the interplay between interest crediting rates and in a cash balance plan and the backloading rules? Do market rates of return violate the backloading rules in years in which the returns are negative? Are rates that might be negative prohibited by the backloading rules?

Some believe there is an obvious glitch in the backloading rules regarding negative market rates of return. If a cash balance plan states a flat pay credit of 5%, there should be no backloading involved. However, if there is a negative rates of return in any one year, the pay credits, on a projected basis, get diminished year after year. Another case where backloading may unnecessarily apply is for plans with increasing pay credits that are counting on a positive rate of return to offset any backloading. The rate of return may drop in one year to create backloading. Most are hopeful that new regulations will avoid backloading problems for those plans with long-term expected positive rates of return that happen to be negative in a single year.

What is a “conversion” to a cash balance plan?

Statutes and regulations require that a plan sponsor must draft a “conversion amendment” for their plans with an “A + B” approach (those whose prior formula will be frozen - A, and a cash balance formula will be implemented – B). But what exactly is a “conversion amendment?” What if a plan was converted years ago with wearaway, and now the plan sponsor wishes to change the pay definition to exclude bonuses? Looking at the definition of a “conversion amendment” in the proposed regulations, this plan sponsor would need to provide the A+B benefit. Sponsors of plans with a “greater of” formula need to pay close attention to their plans, as there may be serious consequences related to now meeting the definition of a true “A + B” plan. For plans with temporary “greater of” provisions, the regulations state that the plan is considered to be “A + B” at the sunset of the “greater of” provision. There are many other situations where the A+B requirement may be an issue under the proposed regulations, including acquisitions, multiple plans, treatment of transfers, etc.

Can a plan offer choice only to participants over a certain age and have a safe harbor exemption to the age discrimination rule?

Many were happy with the new age discrimination safe harbor rules in PPA. If everyone is given a 5% pay credit, then that is not age discriminatory. But a special condition was mentioned in the proposed regulations – when are employees similarly situated? Under the proposed regulations, if a plan offers a choice only to employees over a certain age (say, age 55) but not to employees under that age, the plan would not meet the safe harbor because some older employees might make the wrong choice. Panelists argued that giving older employees more choices than younger employees could not reasonably be considered discrimination against older workers, but it remains to be seen if the final regulations will take the approach in the proposed regulations.

How do you determine whether a plan is age discriminatory under ERISA Section 204(b)(1)(H)? Do you compare two employees, or do you compare an employee to his younger self?

The statute clearly reads that a plan cannot reduce a benefit accrual solely because a participant attained a certain age. For the past 31 years, actuaries and plan sponsors used the “individual test,” where a person is compared to his or her younger self. However, court decisions seem to be changing the rule to become a 2-person test, where a person can be compared to an otherwise “similarly situated” younger individual in the plan. This becomes an issue for 401(l)-type offset plans, where older participants will receive a lower benefit due a Social Security offset. If the plan meets the 401(l) definition, it will have no issues, but if a plan is set-up similarly to 401(l), but does not meet all the requirements, then it will see issues when the two-person test is used. Another problematic example: A plan may have a disability offset where the definition of disability does not mirror the Social Security disability definition.

Over what period do you accrue and fund disability benefits?

The proposed regulations indicate that a disability benefit should be accrued over the period needed to accrue eligibility. In the case of a benefit that requires a certain age and service amount (example: age 50 with 10 years of service), should the benefit be accrued over the 10 years of service from date of hire, or over the amount of years from date of hire to age 50? If someone is hired at Age 30, and the plan provides a disability benefit when the participant becomes disabled after attaining age 50 with 10 years of service, should the benefit be accrued over 10 years, or over 20 years?

You may have noticed only 8 issues have been mentioned here. Some issues have been addressed since this list was originated. But other issues, while not discussed in this session are still worth mentioning here:

How do we determine when to restrict lump sum payments to the Top 25 restricted employees, since there is no longer a true definition of “current liability?”

How do you calculate actuarial equivalence in a contributory DB plan?