Companies sponsoring traditional defined benefit pension plans received some good news and some bad news from Washington last week. On July 6th, President Obama signed the Moving Ahead for Progress in the 21st Century Act (MAP-21) into law. The law focuses on highway funding but it includes some provisions that impact defined benefit pension plan sponsors.
First, the good news. MAP-21 includes a provision to smooth interest rates and essentially lower required minimum funding levels for the time this provision is in place. The law allows pension plan sponsors to choose between using the current two-year average of interest rates to calculate funding liabilities or opt for a "smoothed" interest rate that is within a percentage of a 25-year average interest rate. From 2012 to 2015, this interest rate will be within 10% of the 25-year average and, from 2016 onward, it will be within 30% of the 25-year average.
To give some idea of how much of an impact a lower interest rate can have on a company's pension plan funding requirements, take a look at the funding requirements of two companies that have announced that they will use the higher interest rates. AK Steel Holding Corp. has opted to use the higher interest rate and, as a result, announced that it would reduce its expected $300 million pension plan contribution by $100 million. Magnetek, Inc. released a statement detailing the potential reduction in contributions, pending further details being ironed out. Magnetek had previously disclosed $52 million in total expected pension plan contributions for 2013 and 2014. However, based on current calculations, using the higher interest rate allowed by MAP-21 could lower Magnetek's required pension plan contributions by $7 million in 2013 and $2 million in 2014. The company's expected $12 million contribution for 2012 will remain unchanged.
Now for the bad news. The MAP-21 law also increases the premiums pension plan sponsors must pay to the federal Pension Benefit Guaranty Corporation (PBGC). Moreover, if pension plan sponsors take advantage of the option to temporarily use higher interest rates to lower their minimum funding requirements, that move will increase the plan's unfunded liabilities, thereby increasing the PBGC premiums the company must pay.
Under the law, the flat-rate PBGC premium will increase from current $35 per-participant currently to $42 per participant next year and $49 per participant in 2014. The variable-rate premium, which increases as unfunded liabilities increase, will go up from $9 per $1,000 of unfunded vested benefits to $13 per $1,000 of unfunded vested benefits in 2014 and to $18 per $1,000 of unfunded vested benefits in 2015. The PBGC will continue to use the interest rates set under prior law to calculate these premiums.
Finally, for companies with overfunded pension plans, MAP-21 provides more flexibility to transfer those excess pension assets to fund retiree health benefits and expands current provisions that allow the use of excess pension assets to fund retiree life insurance.