DEFINED BENEFIT PLAN WORKSHOP: Guide Your Frozen Plan to Termination

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Michael Hampton
6 years ago
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Markley Actuarial and BDO USA, LLP BDO USA, LLP, a

member of BDO International Limited, a UK company

international BDO network of independent member firms.

1 DEFINED BENEFIT PLAN WORKSHOP: Guide Your Frozen Plan to Termination PRESENTED BY: Principal Financial Group, Markley Actuarial and BDO USA, LLP BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.

2 Strategy to Date with Frozen Defined Benefit Plans Wait for future rise in interest rates Stock Market returns will exceed increase in liabilities This strategy has not worked and there are new developments! Page 2

3 New Developments Increase in PBGC Premiums Recent Federal Budget would further increase premiums to $80 per participant and rate per $1,000 UVBs to $41 Page 3

4 New Developments Society of Actuaries issued updated Mortality Tables in late October 2014, RP 2014 and MP 2014, now MP 2015 New Tables would increase liability New Tables are not yet applicable for funding, lump sum distributions Could be effective as early as 2017 Page 4

5 Status of Plan Termination Unfunded Liability May 31, 2016 Page 5

6 Analysis with New Developments ABC Company Pension Plan Annual Pension Plan Expenses for 2015: PBGC Premium $ 135,000 Actuary $ 20,000 CPA for Audit $ 25,000 Investment Expenses $ 35,000 Total $ 215,000 Expenses are 2% of Plan Assets! Page 6

7 Proposed New Strategy Terminate the Plan in early 2016 so that payouts could be made in 2016 Strategy would eliminate administration of the Plan, PBGC premiums and new mortality! If decision is to delay: Get frequent updates of unfunded liability (quarterly) Adopt glide path strategy Page 7

8 Proposed New Strategy Why Not? New Laws Impacting Minimum Funding for Pension Plans MAP-21 HATFA Reduced required contributions to Pension Plans Page 8

9 Terminating a Pension Plan Page 9

10 Terminating a Pension Plan 2013 SURVEY RESULTS Nearly 60% of companies Frozen accruals for all participants Closed the defined benefit (DB) plan to new entrants Results are expected to continue over the next 2 years 2015 SURVEY RESULTS Evolution of de-risking Over 80% of plan sponsors have implemented a derisking strategy or are currently considering a strategy 88% are satisfied with their de-risking strategy Page 10

11 Types of Terminations DISTRESS If a Company is reorganizing in bankruptcy Financial distress test with 4 parts Need to satisfy at least 1 part INVOLUNTARY The Plan has not met the minimum funding requirements The Plan cannot pay current benefits when due STANDARD If the Plan can pay all of the benefits it owes Page 11

12 Types of Terminations Pension Benefit Guaranty Corporation (PBGC) becomes responsible to pay retirees the benefits they are owed, up to legal limits Distress & Involuntary $60,000 for a retiree aged 65 PBGC does not become responsible for benefit payments Standard Page 12

13 Types of Terminations DISTRESS INVOLUNTARY STANDARD Page 13

14 PBGC Update Standard Terminations during the PBGC s 2015 fiscal year end October 1, 2014 to September 30, 2015 Almost 1,350 plans Covering approximately 250,000 participants Minimal effect on PBGC s premium income Consistent with past years, more large plans filed in H.J. Heinz - Sunoco - Hannaford Brothers Page 14

15 Pre-termination checklist PLAN AHEAD Standard termination: 4 to 6 months Larger plans: 6 to 18 months Applying to the IRS for a determination letter Notify the Pension Benefit Guaranty Corporation (PBGC) BUILD A GOOD TEAM ERISA Attorney Financial Advisor Actuary Accountant Page 15

16 Pre-termination checklist (continued) PAPERWORK WHO NEEDS TO KNOW? IRS Pension Benefit Guaranty Corp (PBGC) DOL Unions KNOW YOUR FUNDING LEVEL Fully funded, underfunded or overfunded Impacts termination timeline DO THE MATH RE-EXAMINE YOUR INVESTMENT STRATEGY Page 16

17 Pre-termination checklist (continued) PLAN TERMINATION TIMELINE REPLACEMENT PLAN? 401(k) Plan or other option RETAIN THE PAPERWORK For at least 2 years Valuations, trust reports, participant distribution documentation PBGC audit Up to 2 years after the termination More than 300 participants will trigger an audit Less than 300 participants audit at random Page 17

18 Standard Termination Audits Conducted over 260 audits 1,500 individuals will receive an additional $5.8 million in benefits Audit findings can be contested Page 18

19 What Should You Do? DOCUMENT, DOCUMENT & DOCUMENT!!! Memorialize all decisions In working through procedures, use checklists; Retain minutes from meetings of committees; Page 19

20 Accounting and Tax Implications FINANCIAL STATEMENT IMPACT: Termination could result in significant book loss Straightforward accounting entry TAX CONSIDERATIONS: Cash payment deductible Deferred tax issues Entity-specific facts and circumstances Page 20

21 Dynamic Decision TAX IMPACT Full contribution is tax deductible? ACCOUNTING IMPACT Likely a significant loss on Financial Statements, but no impact Book Value Cash available to fund Plan at termination? Page 21

22 Example: Account DR CR Plan Liability Eliminate at Termination $5,353,820 Accumulated Other Comprehensive Income Cash (contribution to terminate the Plan) $8,375,663 $4,846,915 Settlement Loss $7,868,758 Page 22

23 Reducing Risk Until Payments Are Made Investment of Plan Assets, a fixed income approach Plan Termination Schedule Risk of non-in-pay participants electing an annuity Page 23

24 What if my Plan isn t Frozen? If the Plan is continuing, Glide path to reduce risk Asset liability matching Page 24

25 Potential Solutions Should I Change My Asset Allocation? For illustrative purposes only. Page 25

26 Potential Solutions Dynamic Asset Allocation Strategy DAA Glide path de-risks as funded status improves Bond Real Assets/Other Equity 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 52% 50% 48% 10% 40% 40% 10% 50% 30% 10% 60% 20% 10% 70% 10% 10% 80% 5% 5% 90% 100% The glide path presented above is hypothetical and is not reflective of any particular plan. Please consult with your investment adviser to determine the appropriate strategy and glide path for your particular plan. Asset allocation/ diversification does not guarantee a profit or protect against a loss. Use of DAA and/or any glide path does not guarantee improvement in plan funding status nor the timing of any improvement. 0% Current < 63% 63% - 72% 72% - 80% 80% - 88% 88% - 96% 96% - 104% > 104% Liability Funded Status For illustrative purposes only. Page 26

27 Potential Solutions Winding Down a Hard-Frozen DB Plan Effective Execution of Strategy Page 27

28 Potential Solutions DAA vs. Total-Return Definitions and assumptions: Funded status = Market value of assets as a percent of funding liabilities under PPA DB plan is frozen with duration of 13 years and Total Cost = Present value of annual contributions discounted at 6% 70% funded status as of January 1, Historical Scenario assumes actual asset returns (using broad market indices) from 1995 through 2005, Citigroup corporate bond yield curve to calculate modified IRS curve under PPA, minimum funding policy under PPA. Total-return portfolio uses 60% exposure to equities and 40% fixed income investment in core bond, and DAA is based on funded status. Under DAA : Present Value of Contributions almost 25% less Less Funded Status Volatility Better Funded Status in most years Page 28 This chart is for illustrative purposes only. It is hypothetical and does not guarantee any specific returns on any investment options. Results shown are not indicative of future results. Results will vary based on retirement plan characteristics.

29 Potential Solutions Provider Arrangement Page 29

30 Case Studies #1 Funded Status Can Change Rapidly PA Manufacturing Company (amounts in millions) Date Assets Liabilities Funded Status 1/1/1998 $3 $5 <$2> 1/1/1999 $4 $5 <$1> 1/1/2000 $5 $5 $0 On March 31, 2000, employer turned portfolio into cash and successfully completed termination in A few months later would have changed the funded status back to 1/1/98 levels. Quarterly updates are critical! Page 30

31 Case Studies #2 Importance of Asset/Liability Matching Ohio based Bank In 2007, Pension Plan had $40 million in assets and $60 million liability. Bank decided to contribute $20 million to fully fund the Plan. 2008/09 crisis occurred, Plan returned to $20 million underfunded! When a Plan s funded status improves, asset/liability strategies should be implemented to reduce volatility. Bank could have maintained their funded status with asset/liability matching when the Plan became 100% funded Page 31

32 Case Studies #3 Having a Threshold to Proceed with Termination PA based Manufacturer At the end of 2012, Plan was $7 million underfunded. During 2013, strong asset returns plus interest rates increasing 100 basis points resulted in an unfunded liability of $2 million. Plan terminated in 2014, before interest rates returned to end of 2012 levels. Page 32

33 Case Studies #4 Having a Threshold to Proceed with Termination PA based Food Processor Plan was $14 million underfunded at the end of A combination of significant contributions and strong asset returns resulted in the Plan being $5 million underfunded at the end of The Plan is now being terminated during Page 33

34 QUESTIONS? Bob Lavenberg, CPA, JD, LL.M Executive and HR Services Partner Joanne Szupka, CPA Executive and HR Services Director Dave Sandstead VP Retirement Plan Sales- Philadelphia Region (610) John Markley (717) , x109 Page 34

Regulatory Brief: Pension provisions in MAP-21

Regulatory Brief: Pension provisions in MAP-21 Vanguard Strategic Retirement Counsulting September 2012 Charles J. Klose Nathan C. Zahm Executive summary On July 6, 2012, President Obama signed into law