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.