Unforeseen consequences one legacy of the Pension Protection Act

Like many pension-related laws, the Pension Protection Act that passed a decade ago was designed to address a crisis.

At the time, underfunded pension plans were threatening the financial stability of the Pension Benefit Guaranty Corp. But while the act did help strengthen the federal agency, it also had the unintended effect of discouraging defined benefit plan sponsors and hastening the switch to defined contribution plans, observers say.

“It was sold on the basis that we were going to shore up funding to protect workers,” but most people involved in passing the PPA didn't understand the impact that new funding rules would have on the cost and volatility of funding plans, and how that would scare away “thousands” of plan sponsors, said Earl Pomeroy, a former North Dakota Democratic representative and House Ways and Means Committee member who now works with the Washington law firm Alston & Bird LLP.

By the time lawmakers sat down to hammer out the details in 2006, the PBGC was reeling after absorbing nine of the 10 largest pension plan claims in the five-year period preceding the act's passage.

The size of those claims sparked concerns about the agency's solvency as well as about how to protect taxpayers from having to cover its deficits.

Additionally, alarm over the number of poorly funded pension plans, a changing workforce and retirement adequacy in general convinced lawmakers that it was time to undertake the most comprehensive pension law reform since enactment of the Employee Retirement Income Security Act of 1974.

“It was eye-opening for me,” recalled Rep. John Kline, R-Minn., who at the time was a new member of the House Education and the Workforce Committee and now is its chairman. “I could see pretty quickly this was a big problem.”

To improve funding levels of defined benefit plans, the PPA established new funding requirements and shorter time frames and called for plan assets and liabilities to be measured the same way.

Sponsors of underfunded plans saw more demands from the legislation to improve funding levels, and sponsors of cash balance plans received some legal clarity along with more rules aimed at preventing age discrimination and other abuses. Sponsors of well-funded plans gained more flexibility in their funding decisions, but moderately funded plans saw a significant increase in funding requirements, and poorly funded plans saw tighter amortization rates and higher PBGC premiums.

For the multiemployer plans, also experiencing underfunding problems, the PPA gave trustees a new color-coded zone system and funding requirements based on plan funding levels, with green for healthy plans funded at 80% or better, yellow for endangered plans funded between 65% and 79%, and red for critical plans funded less than 65%.

Yellow- and red-zone plan trustees had to adopt funding improvement or rehabilitation plans, respectively.

Perhaps the biggest impact of PPA was on defined contribution plans.

The law created the legal framework for automatic enrollment and automatic escalation of contributions. On the investment side, it created qualified default investment alternatives, allowing plan sponsors to steer assets toward age- and risk-appropriate choices when participants do not make their own choices

“It was intended to provide an offset to lethargy” that had kept people from participating in defined contribution plans in the first place, said Dallas Salisbury, president emeritus of the Employee Benefit Research Institute in Washington.

“PPA accomplished what it set out to do, in large measure,” said Mr. Kline. In addition to shoring up the PBGC, “it prevented plans from promising benefits they couldn't provide.”

Furthermore, Mr. Kline said, “it set the example for how you can do bipartisan pension reform.”

On the multiemployer plan side, “we accomplished what we set out to do,” agreed Randy DeFrehn, executive director of the National Coordinating Committee for Multiemployer Plans in Washington. “PPA changed the rules so employers would have to put in more money,” he said, and the zone system led to more funding discipline — at least in theory, until the financial crisis on top of the dot-com bubble changed it all, with assets shrinking faster than any additional contributions or benefit reductions could compensate for.

“Had that not happened, if those eight years would have been normal markets, these plans would have been extremely well funded,” said Mr. DeFrehn. “Timing is everything.”

Despite the boost to defined contribution plans, critics say the PPA's big mistake was not specifying default contribution rates, which made skittish employers reluctant to venture higher than the 3% example given in subsequent regulations.

For Thomas Harkin, an Iowa Democrat and chairman of the Senate Health, Education, Labor and Pension Committee from 2009 until his retirement in 2014, the PPA's emphasis on defined contribution plans “was the wrong basis,” and as a result, “I don't think it accomplished much.”

Mr. Pomeroy of Alston & Bird is even more critical of what he calls “the Pension Prevention Act.”

“I felt it was intentionally designed to encourage employers to end their DB system,” Mr. Pomeroy said.

Mr. Pomeroy, who as a former North Dakota insurance commissioner was one of the few congressional negotiators who knew what pension amortization meant. “Expense, volatility and uncertainty all came from PPA,” said Mr. Pomeroy, who points to the six subsequent legislative changes to funding rules “if there's any doubt that Congress got it wrong.”

Karen Friedman, executive vice president and policy director of the Pension Rights Center in Washington, acknowledges the PPA's tougher funding rules “may have possibly driven some employers out of the DB system. I think a lot of employers thought the funding rules were too tight.”

One “really bad” part of PPA, she said, was the new multiemployer zone rules that allowed trustees of troubled plans to trim future benefits.

“I think there's a clear line from the PPA to MPRA,” the Kline-Miller Multiemployer Pension Reform Act of 2014, which allowed deeply troubled plans to more widely cut benefits even for retirees, she said.

“Did PPA solve all the problems? We'd say no,” said Ms. Friedman. “You still have abysmal savings rates. We are still seeing companies breaking promises to workers (by freezing plans or cutting back on contributions) and we still have a private workforce where 50% don't have any savings. We think there needs to be all the stakeholders coming together to find a universal system.”

Ideas for new approaches continue to bubble up from many quarters, including think tanks, the private sector, and legislators such as Rep. Joe Crowley, D-N.Y., vice chairman of the House Democratic Caucus who introduced a bill creating universal retirement accounts for American workers in July.

At Pensions & Investments' Global Future of Retirement Conference in Washington in June, prominent speakers all presented options for national savings programs. Those speakers included Blackstone Group LP's Hamilton E. “Tony” James, New School economist Teresa Ghilarducci, State Street Global Advisors' Ronald O'Hanley, Bipartisan Policy Center's Co-Chairman James B. Lockhart III and Kent Conrad, and Mr. Harkin (P&I, June 27).

Aliya Wong, executive director of retirement policy for the U.S. Chamber of Commerce, thinks that while PPA took a broader look at the retirement system at the time, “I think what we need now is more of a precision focus.''

“We have a successful system but not everybody participates,'' Ms. Wong said.

“I do think we need to start focusing on solutions,” added Ms. Wong, who also said policymakers need to “really listen to plan sponsors and to what requirements they say are overly burdensome. Remember, they have businesses to run.”