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5500 Preparer's Manual for 2012 Plan Years
The premier resource in the field of Form 5500 preparation, 5500 Preparer's Manual will help you handle the required annual Form 5500 filings for both pension benefits and welfare benefit plans.
Due to a better economic climate, the financial health of the PBGC has improved since the 2002-2005 period of record losses, according to a report by the Congressional Research Service (CRS), but underfunding in plans sponsored by financially weak entities continues to present a unknown level of risk to the PBGC. New funding rules contained in the Pension Protection Act of 2006 (PPA; P.L. 109-280) are not effective until plan years after 2007, with some rules phased in over a longer period, so the full impact of the PPA on the PBGC's financial condition also remains an unknown, according to the CRS. However, the CRS opined, pension plans of commercial airlines, which were given special treatment under the PPA funding rules, continue to threaten the PBGC's financial condition.
The CRS report recapped the PBGC's financial difficulties during the past few years. The PBGC's net position (assets minus liabilities) fell by $31 billion during the period of 2001 to 2004, when it posted an all-time high deficit of $23 billion. CRS attributed this decline to record-setting claims caused by the termination of several large underfunded pension plans in the steel and airline industries. Eight of the PBGC's ten largest claims since 1975 occurred during this period, the CRS stated, further noting that more than one-third the PBGC's nearly $30 billion in total net claims since its inception were attributable to terminations in 2005 alone.
Plans terminated by just two airlines, United Airlines and US Airways, accounted for most of the PBGC's record claims in 2005. The CRS acknowledged that the airlines' financial condition had been adversely affected by the "perfect storm" of the drop in airline traffic after September 11, 2001, an underperforming stock market and falling interest rates. However, the CRS noted, plan underfunding could not have reached such levels were it not for pre-PPA rules which enabled sponsors of underfunded plans to forego contributions to their plans if certain conditions applied. The CRS stated that this practice exacerbated plan underfunding and increased the level of claims made on the PBGC.
The CRS also attributed the complexity of pension funding rules to an "ad-hoc" approach to pension reform from 1975 until the passage of the PPA in 2006. Under the pre-PPA rules, the CRS noted, a plan could be considered fully-funded even if only 90% of the plan's liabilities were funded. Other plans that had contributed more than required in prior years could use these credit balances to offset subsequent required contributions to the plan. And the effect of the full funding limit on plan contributions prevented additional contributions to a fully funded plan even if the accrued liability of the plan was greater than the plan assets. Because years of low or no contributions by financially weak sponsors, often leading to plan terminations, threatened the financial condition of the PBGC and raised the likelihood of a taxpayer bailout, the General Accountability Office (GAO) has categorized the PBGC as high-risk since July 2003. All of these factors led to the passage of new funding rules as part of the PPA.
The most visible funding change under the PPA, the CRS states, is the increase in the fully funded level from 90% to 100%, to be fully phased-in by 2011. Amortization rules have been simplified, which is expected to eliminate plans' unfunded liabilities more quickly.
Premiums. The PBGC collects flat-rate premiums ($30 per participant in 2006) from all plan sponsors and variable-rate premiums (VRPs) from sponsors of underfunded plans ($9 per $1,000 of underfunding). With fewer exemptions from the VRP requirement due to the PPA, the CRS expects the PBGC's revenue from VRPs to increase starting in 2008.
At-risk plans. The PPA establishes an at risk category for plans that are, generally, less than 80% funded on a standard basis, making such plans subject to a higher funding target and a higher target normal cost, and consequently requiring larger funding contributions.
Credit balances. Under the PPA funding rules, credit balances still exist, but are limited to plans that are at least 80% funded, and they will have to be adjusted for subsequent investment gains and losses, the CRS states. Maximums on contributions also remain, but are redefined so as to permit underfunded plans to make larger contributions without exceeding the limit.
Benefit limitations and surcharges. In order to prevent plan sponsors who are in bankruptcy, or plans underfunded below certain thresholds, from offering benefits which have the effect of "raiding" pension funds prior to termination, the PPA prohibits shutdown benefits, benefit increases or lump-sum benefits for such plans, the CRS states. The PPA makes permanent a surcharge premium of $1,250 per participant assessed for three years against any firm that terminates an underfunded pension plan during bankruptcy and later emerges from bankruptcy.
Smoothing. When financial markets underperformed for several consecutive years, asset values that had undergone smoothing exceeded market asset values for a number of years. As a result, plan underfunding was understated, and contributions calculated using these values were inadequate, which further exacerbated underfunding, the CRS stated. The PPA retains smoothing but shortens the period from 4 years to 2 years.
Interest rates. The PPA makes permanent the replacement of 30-year Treasury bond rates with corporate bond rates for use in the determination of a plan's liabilities (the present value of future benefits promised by the plan), the CRS noted. The PPA uses a yield curve which applies three different rates, depending on how far in the future payments are expected, based upon corporate bonds with similar maturities.
Highlighting the fluctuations inherent in pension financing, and thus the difficulty in making projections, the CRS noted that the PBGC's net position improved by $529 million in 2005, despite more than $10 billion in claims. This improvement was attributed to rising interest rates, which lowered liabilities, and positive investment gains. Similarly, the funding status of private-sector plans has improved due to improving financial conditions. The CRS cautioned, however, that the PBGC's projections of future net claims, using its Pension Insurance Modeling System (PIMS), has resulted in a substantial underestimation of the number of claims received. For example, PIMS projected total claims of $1.7 billion annually from 2006 to 2015, but actual claims in 2005 alone were more than $10 billion. Congressional Budget Office (CBO) projections, in its September 2005 report, are much higher, assuming average claims of $4.87 billion from 2004 to 2013. As of January 2007, the PBGC remains on the GAO's high-risk list, despite passage of the PPA. The CRS cited the GAO's assessment of the PPA, stating that it addressed many prior concerns, but the gradual phase-in of many reforms postponed their potentially positive effect on plan funding, leaving the ultimate impact of the new law unclear.
For more information on this and related topics, consult the CCH Pension Plan Guide.
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