Today in 2006: The Pension Protection Act is signed into law

August 17, 2012

Today in Legal HistoryPerhaps one of the greatest fears of a retiree is having his or her pension plan default.

Of course, that isn’t going to affect the retiree that much anymore, thanks to the Pension Benefit Guaranty Corporation (PBGC) that guarantees pension benefits to participants of failed funds.

The PBGC was established by 1974’s Employee Retirement Income Security Act (ERISA), but the corporation has seen its share of modifications since.

These modifications became necessary as more companies defaulted on their defined benefit pension plans, which, in turn, caused the PBGC to run up an ever increasing deficit.

These defaults and the PBGC’s associated deficit became more pronounced in the mid-2000s, and, in early 2005 in response, President George W. Bush proposed a set of pension funding reforms.

These proposed reforms were largely codified as the Pension Protection Act (PPA), signed into law by President Bush on August 17, 2006.

The PPA was no small modification; instead, it was the most significant federal pension legislation since the passage of ERISA 32 years earlier.

The bulk of these changes centered on ensuring that pension plans were sufficiently funded.

To determine whether a pension is adequately funded, the plan’s present value of its liabilities is compared against the value of the plan’s assets.

The present value of a plan’s liabilities is calculated by converting a future stream of pension payments into the amount that would be needed at the time of the calculation to pay off those liabilities all at once.

The “assets” of a plan are just that: various assets set aside specifically to fund the pension plan.

When the value of the plan’s assets is less than the present value of its liabilities by more than the percentage allowed under law, the plan is considered “underfunded” and the plan’s sponsor (typically, the employer) faces increased PBGC premiums.

Before the PPA, a plan was not considered “underfunded” as long as it was at least 90% funded.

The PPA raised this number to 100% over several incremental steps from 2008 through 2011.

In addition, the PPA changed the calculation to determine the present value of a plan’s liabilities in several ways that resulted in a higher resulting number in almost all circumstances.

These changes increased in varying degrees the costs to sponsors of maintaining pension plans.

As a result, both the premium costs to participants and the rate of plan freezes increased.

The causes of pension freezes are difficult to pinpoint with any level of certainty, but they are always a cost-cutting measure.

What are “freezes?”

There are several different kinds of freezes:

  1. The plan is closed to new entrants, but those participants who are already in the plan continue to accrue benefits.
  2. Employees are completely barred from earning any further benefits under the plan.
  3. Employees are prevented from getting pension credit for future years of work under the plan, but their benefits are allowed to be figured on their pay at the time they leave the plan (instead of at the date of the freeze).

In any case, the pension plan is effectively shut down – but not “terminated,” a process which is far more regulated and carries several negative consequences for the plan’s sponsor.

Despite its unintended consequence of increasing pension freezes, many argue the PPA saved the PBGC from insolvency, which itself saved numerous other pension plans from default.

However, because of increased costs, some unrelated to the PPA, fewer and fewer employers participate in pension plans.

If the pension system in the U.S. is to be salvaged, future pension reforms need to take an approach different from the PPA’s – one that doesn’t shift the economic burdens of pension onto such a narrow group as pension sponsors.