The recently enacted coronavirus economic relief package, the American Rescue Plan of 2021 (“ARPA”), contains the most significant changes in fifteen years to the funding rules of single employer pension plans.  These changes have largely has fallen under the radar of the national press – an outcome disappointing perhaps only to ERISA nerds.  The little press addressing the pension provisions of ARPA mostly has been focused on the financial relief the legislation provides to troubled multiemployer pension plans — which, as we discuss elsewhere, have major implications for employers that participate, or are considering whether to participate, in a multiemployer plan.

Nevertheless, the significant changes to the single-employer plan funding rules warrant the attention of any employer that sponsors a single-employer defined benefit plan.  While the new law may significantly reduce the amount of contributions to pension plans that are required by law, reducing contributions may have other consequences that employers may wish to weigh.

ARPA’s Methods for Reducing Minimum Required Contributions

The legislation may substantially reduce the amounts employers will need to contribute to their pension plans under the funding rules.  Two levers in the legislation yield this result:

1. Longer Time to Pay off Unfunded Liabilities. ARPA permits plans to fund their past plan liabilities over 15 years — more than double the time permitted under prior law.  By allowing plans to pay off liabilities over a longer time, employers’ funding requirements are reduced.
2. Higher Interest Rates to Value Future Benefit Obligations. The legislation includes provisions that increase the interest rate that plans use to calculate the value today of the plan’s future benefit obligations.  Higher interest rate assumptions mean less money today is expected to be needed to pay for future benefits.  By permitting use of a higher interest rate, projected liabilities are valued at a lower amount today, resulting in a corresponding decrease in the amount the employer is required to contribute to fulfill its funding obligations.

Considerations for Employers Impacted by this Legislation

While changes to the funding rules may significantly reduce the amounts employers are required to contribute to single employer pension plans, the question as to how much employers should contribute remains.  Prior to reducing their pension plan contributions, employers may wish to assess countervailing factors, including:

1. Impact on De-Risking Strategies. The legislation’s levers for reducing the amounts employers are required to contribute to pension plans do not alter the amounts of promised pension benefits to workers and retirees — or the actual amounts employers eventually need to fund to fulfill these obligations.  If an employer reduces pension contributions in reliance on the new legislation, certain pension plan de-risking strategies may become more difficult to execute as a result of this disconnect.  For example, it may become more expensive to complete a transaction to transfer obligations to pay pension liabilities to an insurance company in an annuity purchase.  Those liabilities need to be fully funded as determined by the insurer, and reducing contributions could result in larger amounts that need to be paid to complete the purchase.  In addition, reducing contributions may make it more difficult to sufficiently fund a plan to implement a liability-driven investment strategy of matching pension payment obligations with assets of similar maturity.
2. Impact on Variable Rate Premiums. Underfunded single-employer plans pay a variable-rate premium to the Pension Benefit Guaranty Corporation (“PBGC”) based on the amount of their unfunded benefits obligations (up to a cap based on the number of participants in the plan).  Importantly, the method of calculating unfunded benefits for purposes of variable rate premiums is not impacted by ARPA.  This means that if employers reduce their pension plan contributions in reliance on ARPA’s funding rule changes, their unfunded benefit obligations for purposes of calculating variable rate premiums will increase — potentially resulting in increased liabilities to the PBGC.

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The precise impact of the legislation — and any decision to reduce pension plan contributions — will vary by employer and could result in disparate results amongst different employers.  Given the magnitude of ARPA’s changes to funding rules, employers that sponsor pension plans may want to study the impact on their plans and analyze whether it may be advantageous to make changes to their funding strategies over the short- and long-term.