By Jane Meacham

The U.S. Pension Benefit Guaranty Corp. (PBGC) has added two more conditions to the list of early warning factors that it watches and believes may endanger the funding of single-employer defined benefit (DB) retirement plans.

The federal pension insurance agency has for more than 20 years monitored corporate transactions and events through its Early Warning Program (EWP). In December 2016, the PBGC updated the program’s overview on its website and added “credit deterioration” and a “downward trend in cash flow or other financial factors” to its watch list.

Existing Watch List

The EWP already included the following factors in its early warning signs for company DB plans:

• A change in the group of companies legally responsible for supporting a pension plan (known as a controlled group), including a spin-off of a subsidiary;
• A transfer of significantly underfunded pension liabilities related to the sale of a business;
• A major divestiture by an employer that retains significantly underfunded pension liabilities;
• A leveraged buyout involving the purchase of a company using a large amount of secured debt; or
• The payment of a very large dividend to shareholders.

The agency said its experience has shown that it can avoid terminating a pension plan by working with the plan sponsor to obtain protections before a business transaction significantly increases the risk of loss.

The new additions may lead to a PBGC inquiry, even if none of the other corporate transaction warning signs listed is present. “There are also concerns that these factors may result in more forcefully sought financial concessions from companies that can ill afford them,” said Human Resources consulting firm Willis Towers Watson in a February 1 client bulletin.

Previous guidance from the PBGC indicated that it focused on “financially troubled” companies but that the agency would not act on that basis alone.

The PBGC website said it identifies about 300 transactions, events, or trends each year that are potentially of concern and engages the plan sponsors to obtain additional information. It assesses the impact of these situations based on each employer’s financial and operational ability to support its pension promises. It then may follow the initial inquiry with a more in-depth review, amounting to an average of about 100 cases each year.

In recent years, of the 300 initial transactions or events, the PBGC said it entered into an average of five settlements each year, or less than 2% of identified events.

Underfunding Leads to Restrictions

Under the Pension Protection Act of 2006, benefit restrictions apply when a DB plan becomes underfunded to certain prescribed levels. Specifically, various benefit restrictions apply when a DB plan's adjusted funding target attainment percentage — or AFTAP — is under 80% (defined as at-risk plans).

The AFTAP is based on a plan's funding target attainment percentage, or FTAP. The FTAP is the ratio of the value of net plan assets for the plan year, reduced by prefunding and carryover balances, to the plan’s funding target for the plan year, as defined in Code Section 430(d).

The AFTAP is the FTAP, adjusted by adding to the plan’s assets and funding target the value of any annuities purchased for nonhighly compensated employees during the previous two plan years. (See ¶361 in the Pension Plan Fix-It Handbookfor more on this topic.)