Memorandum Date: From: Subject:
December 1, 2006 Donald J. Segal, MAAA, FSA, FCA, EA Funding Reform Advisory Task Force Lookback funding measures
PPA requires qualified defined benefit plan sponsors to look back to the plan’s funded status in the 2007 plan year for purposes of determining whether, for the 2008 plan year: the plan is at risk; the credit balance may be used toward the minimum required contribution; quarterly contributions are required; or benefit restrictions apply during the first 9 months of the plan year (although the statute is unclear how such a measure is used for this purpose). At-risk status and credit balance use
PPA gives the IRS the authority to provide rules for estimating the plan’s 2007 funded status for at-risk and credit balance purposes. The Funding Reform Advisory Task Force recommends that these 2007 funded measures should be estimated from amounts reported on the 2007 Schedule B – no new asset smoothing or liability calculations should be required Liability measure. The PPA liability measure for at-risk, credit balance, and benefit restriction purposes is the not-at-risk funding target. We believe the 2007 gateway current liability is the most appropriate liability measure for these purposes, and should be used without further adjustment. Actuarial value of assets. PPA uses the actuarial value of assets for at-risk, credit balance, and benefit restriction purposes. But PPA changes the rules for determining the actuarial value of assets, limiting the averaging period to no more than 24 months and restricting the resulting actuarial value of assets to 90 percent – 110 percent of market value. The 2007 estimation rules should not require the recalculation of the actuarial value of assets using 2008 asset valuation rules. But the new corridor around market value may be readily applied to the 2007 actuarial value of assets. Thus, for 2008 look-back rules, the actuarial value of assets should be the value determined for the 2007 minimum required contribution, but no less than 90 percent of market value and no more than 110 percent of market value. Reduction for credit balance. The actuarial value of assets may be reduced by some or all of the credit balance, depending on the purpose of the measurement and the plan’s funded status. PPA also allows plan sponsors to waive credit balance and include it in plan assets for all purposes. The estimation rules should either: (i) provide a mechanism for irrevocably waiving credit balance at January 1, 2007, with the amount so waived reported on 2007 Schedule B or (ii) limit the required reduction for credit balances consistent with the PPA rules for the relevant measurement purpose, as follows:
Page 2 December 1, 2006 FRAT Force
At-risk status. PPA reduces the actuarial value of assets by the entire credit balance in determining at-risk status. If credit balance cannot be waived in 2007, the actuarial value of assets should be reduced by only that portion of the credit balance that is actually applied toward the 2007 minimum required contribution. The credit balance used during the 2007 plan year can be readily determined as the excess, if any, of (i) the credit balance at 2006 plan year-end, over (ii) the credit balance at 2007 plan year end, discounted for one year’s interest at the valuation rate.
Use of credit balance toward 2008 minimum required contribution. In determining whether the plan may apply the credit balance toward the minimum required contribution for the plan year, PPA reduces the actuarial value of assets by the prefunding balance. Because the prefunding balance is $0 in 2007, assets should not be reduced by the credit balance in estimating the 2007 funded status for this purpose.
Quarterly contribution requirement
PPA requires quarterly contributions if the plan had a funding shortfall in the prior plan year, i.e., the plan’s funding target – not-at-risk, at-risk, or phase-in at-risk, as applicable – is greater than the actuarial value of plan assets reduced by the entire credit balance. It is unclear to us whether PPA authorizes the IRS to provide estimation rules for determining whether the plan had a funding shortfall in 2008, but it is unreasonable to require plans to determine the 2007 funding shortfall using 2008 rules solely for this purpose. Consistent with the estimates described above, quarterly contributions should be required only if the actuarial value of assets (as determined for the 2007 minimum required contribution, but limited to 90 percent – 110 percent of market value), reduced by any portion of the credit balance that is actually applied toward the 2007 minimum required contribution (or the unwaived credit balance, if a mechanism for waiving credit balance is provided for 2007), is less than the gateway current liability. Benefit restrictions
PPA gives the IRS the authority to provide rules for estimating the plan’s 2007 adjusted funding target attainment percentage (FTAP) for 2008 benefit restriction purposes (new Code section 436(k), Special rule for 2008). However, it is unclear exactly how this estimated 2007 adjusted FTAP is intended to be used in practice. This is because the presumption-of-underfunding rules are stated in terms of the percentage that would have caused a restriction to apply in the preceeding plan year, and there is no such percentage before 2008. Consider Section 436(h)(3)(A) [emphasis added]: “a benefit limitation under subsection (b), (c), (d), or (e) did not apply to a plan with respect to the plan year preceding the current plan year, but the adjusted funding target attainment percentage of the plan for such preceding plan year was not more than 10 percentage points greater than the percentage which would have caused such subsection to apply to the plan with respect to such preceding plan year” There is no percentage that would cause the restriction to apply in 2007, so there is no risk of being within 10 percentage points of that threshold.
Page 3 December 1, 2006 FRAT Force
If plans must have some method for determining whether a benefit restriction applies at the start of the 2008 plan year (either because it is concluded PPA does directly require a lookback to 2007 or because, for purposes of estimating 2008 FTAPs prior to completing actual valuations, an estimation from the prior year is ultimately permitted), we suggest estimates consistent with the methods described above. A 2007 adjusted FTAP could be determined using the 2007 gateway current liability and the actuarial value of assets (as determined for the 2007 minimum required contribution, but limited to 90 percent – 110 percent of market value). Any reduction in assets for the credit balance should be consistent with the rules that apply in determining the 2008 adjusted FTAP: The actuarial value of assets is unreduced by the credit balance if the plan satisfies specified minimum funding thresholds (starting at 92 percent in 2008), but is reduced by the entire credit balance otherwise. Exemption from the deficit reduction contribution (DRC) requirements in 2007 (generally, assets are at least 90 percent of current liability) is consistent with the phase-in funding thresholds starting in 2008. Therefore, assets should be unreduced by the credit balance in determining the estimated 2007 adjusted FTAP if the plan had no DRC in 2007. If the plan had a DRC in 2007 and credit balance cannot be waived in 2007, assets should be reduced by only that portion of the credit balance that is actually applied toward the 2007 minimum required contribution, determined as described for At-risk status above. Summary
The table on the following page summarizes our proposed lookback calculation rules assuming the credit balance cannot be waived in 2007.
Page 4 October 11, 2006 Funding Reform Advisory Task Force Purpose
At-risk status
Use of credit balance
PPA measure for 2008 plan year
Plan is at-risk if, in 2007:
Credit balance may be used in Benefit restrictions for the first 2008 if, in 2007: 9 months of 2008 may be (Assets – prefunding balance) triggered depending on the adjusted FTAP for 2007: ≥ 80% of not-at-risk funding
(Assets – credit balance) < 65% of not-at-risk funding target
target
Benefit restrictions1
Quarterly contribution
Quarterly contributions are required for 2008 if, in 2007: (Assets – credit balance) < not-at-risk funding target2
If assets ≥ 92% of not-at-risk funding target, adjusted FTAP = assets ÷ not-at-risk funding target If assets < 92% of not-atrisk funding target, adjusted FTAP = (assets – credit balance) ÷ not-at-risk funding target
Recommended 2007 estimate
1
2
3
4
(Assets3 – credit balance used Assets3 ≥ 80% of gateway toward 2007 minimum current liability required contribution4) < 65% of gateway current liability
If no DRC in 2007, adjusted FTAP = assets3 ÷ gateway current liability If DRC required in 2007, adjusted FTAP = (assets3 – credit balance used toward 2007 minimum required contribution4) ÷ gateway current liability
(Assets3 – credit balance used toward 2007 minimum required contribution4) < gateway current liability
As discussed in the body of this memo, it is unclear how a 2007 lookback measure is intended to be used for 2008 benefit restrictions. Both assets and funding target are increased by the amount of any annuity purchases for nonhighly compensated employees in the two preceding plan years. The plan’s funding shortfall is determined on the basis of the funding target for the plan year – not-at-risk, at-risk, or phase-in at-risk, as appropriate. But because the phase-in of the at-risk funding target ignores years before 2008, the 2007 look-back funding measure would be the not-at-risk funding target. Actuarial value of assets as determined for the 2007 minimum required contribution, but limited to no less than 90% and no more than 110% of the market value of assets. If a mechanism is provided for irrevocably waiving credit balance on the 2007 Schedule B, assets should be instead reduced by the unwaived portion of the credit balance at the 2007 valuation date.
