Pension Fund Heading Into the ‘Red Zone’ – but don’t panic: Here’s what the law means and how it protects you

The following article first appeared in the April 2010 edition of Allegro, the newspaper of the New York City musicians’ union (AFM Local 802). It is reprinted with permission. For more information, see www.Local802afm.org.

The devil’s in the details. On Feb. 17, former Local 802 President Bill Moriarty attended our membership meeting to discuss the current status of the AFM Pension fund. Moriarty is uniquely qualified to discuss this issue, having served both as a fund trustee and fund committee member for many years.

It would be fair to say that there was great interest in this subject among the membership, and Moriarity’s presentation was well received. He was both thorough and incisive, and was able to break down a very complex subject matter into fairly understandable terms.

For those who missed the meeting, I thought it would be useful for me to highlight here some of the points made at the meeting.

Two Kinds of Plans

Generally, pension plans fall into two basic varieties: defined benefit plans and defined contributions plans. Defined contributions plans are those that have a specific contribution rate to be made on behalf of covered employees. Contributions are then invested and when the employee comes of retirement age, he or she will receive a pension benefit based upon the return on the invested contributions. Whatever the invested contributions garner will be the total pension available to the participant. In this respect, defined contribution plans will always be 100 percent funded.

A defined benefit plan involves an entirely different concept. In this type of plan, the fund determines the level of pension benefits a retiree will receive. Employer contributions are then invested to achieve this benchmark pension level. Investment advisers and actuaries are utilized to ascertain the funding level of the plan. If funding levels are either too high or too low, contribution rates or benefit amounts may be adjusted.

With a defined benefit plan, the possibility looms that “vested liability” (the amount of liability the fund would have if everyone who vested a pension retired at the same time) may exceed the present funding of the plan. If that is the case, the fund is considered underfunded.

Pension Protection Act

In 2006, Congress passed the Pension Protection Act (“PPA”), to assist underfunded defined benefit pension plans to decrease liability and minimize the risk that they one day will become insolvent.

Insolvency occurs if the fund is unable to pay its present liabilities. In the case when a plan becomes insolvent, a government agency known as the Pension Guaranty Cooperation (“PBGC”) will guarantee that the pension or a portion of the pension will be paid.

For those interested in the maximum pension the PBGC will pay, I refer you to www.TinyURL.com/PBGCmaximum. (Note that the maximum benefit the PBGC will guarantee for 2010 is actually $54,000 for an individual who retires at age 65.) Under the PPA, a plan must certify its funding level to the Secretary of the US Treasury.

Three funding categories were established by the statute: fully funded (green); endangered underfunded (yellow), and critically underfunded (red).

A fund will be in the red zone if it is less than 65 percent funded, meaning that it only had less than 65 percent of the funds available to satisfy vested benefits. At present only 20 percent of this country’s defined benefit pension plans are in the green zone due to substantial losses caused by the recent economic downturn.

When a fund is in critical status, it is legally required by the PPA to develop a rehabilitation plan. The statute mandates some of the features of the plan.

For instance, a fund in critical status is required to impose a 5 percent surcharge on contributing employers. The surcharge will increase to 10 percent in the second year if the employer fails to enter into a successor collective bargaining agreement that provides for additional rehabilitation.

Furthermore, a fund will be permitted, upon notice to plan participants, to decrease subsidized or adjustable benefits such as disability or early retirement benefits.

Finally, the fund must prohibit decreases in contribution rates presently contained in collective bargaining agreements. Subsidized/adjustable benefits may be decreased only for individuals who are scheduled to receive benefits after the benefit reduction notification has been submitted.

Persons receiving the subsidized/adjustable benefit prior to the thirty day notice submission will not have their benefits reduced.

The PPA provides that “the sponsor of a plan in critical status shall not reduce adjustable benefits of any participant or beneficiary whose benefit commencement date is before the date on which the plan provides notice to the participants.”

We’re in ‘Critical Status’

Congress enacted the Worker, Retiree and Employer Recovery Act of 2008 (“WRERA”) to provide additional relief for multi-employer pension funds in endangered or critical status.

Under this statute, a fund in endangered or critical status may freeze its status at the previous year’s level and obtain an additional year to impose a rehabilitation plan.

This provides additional time for the fund to improve its funding levels. It also permits pension funds to implement some rehabilitation efforts without being locked into all of the components the PPA requires.

Moriarity advised the membership that the AFM Pension fund, like a great many pension plans in this country, was presently in critical status and that it has exercised its deferral right under the WRERA.

The fund expects to be in the “red zone” beginning in its next fiscal year, which starts April 1. Therefore, it will almost certainly be implementing a rehabilitation plan.

In fact, the fund has already taken steps towards that end, such as decreasing the pension multiplier to 1, and freezing employer contribution levels.

It should be emphasized that individuals already receiving pensions are fully protected under Employee Retirement Income Security Act (“ERISA”) and will continue to be paid as they have in the past.

Further, the benefits multipliers from prior to Jan. 1, 2010 remain in effect for those time periods, and benefits will be paid in accordance with those percentages.

(Those multipliers are $4.65 for work done before 2004; $3.50 for work between Jan. 1, 2004 and March 31, 2007; $3.25 for work done between April 1, 2007 and April 30, 2009; and $2 for work done between May 1, 2009 and Dec. 31, 2009.)

On March 1, 2010, the fund disclosed several features of its rehabilitation plan. These benefit reductions will apply to any application for a subsidized annuity benefit postmarked or received by the fund office on or after Feb. 25.

Applicants whose applications were postmarked or received prior to Feb. 24 will not be subject to any benefits reductions. Reductions in plan benefits include the termination of single annuity benefits upon the participant’s death; early retirement benefits will no longer be subsidized; and joint and survivor annuities will no longer convert to a single life annuity benefit if the joint annuitant dies within five years of the annuity starting date, or include a 60 month payment guarantee.

Finally, employers will not be charged the statutory surcharge if they agree to percentage increases in contribution rates. At the conclusion of the meeting, Moriarity expressed confidence that even though the AFM Pension Fund was in some distress, it was in extremely capable hands.

Participants in the AFM pension fund should trust that the long term picture is not bleak and that panic is entirely unjustified.

Nonetheless, musicians, to the extent that they are able, may look to supplement pension benefits with other vehicles such as 401(k) and 403(b) plans.

Postscript

Several members have pointed out to me that the $54,000.00 maximum annual benefit referred to in my prior months’ Allegro article only applies to single employer plans. The PBGC in fact maintains separate programs for single employer and multi-employer plans.

Under the Multiemployer Pension Plan Amendments Act (MPPAA), the PBGC makes loans to insolvent multi-employer funds so that they can continue to pay vested benefits as required under the plan if they become insolvent. These loans are required to be repaid if and when the fund has the financial capacity to do so. The PBGC does not actually pay benefits directly to multi-employer fund participants. The statutory limit on a PBGC loan is the product of the participant’s years of service multiplied by the sum of (1) 100 percent of the first $11.00 of the monthly benefit accrual rate and (2) 75 percent of the next $33.00 of the monthly benefit accrual rate. (For someone with 30 years of service, the loan limit would be $12,870). Benefit increases that have been in effect for less than 60 months are not guaranteed by the PBGC and are considered an adjustable benefit for critical plans.

Withdrawal liability assessments against withdrawing employers are also intended by MPPAA to assist distressed funds in paying vested benefits.

Concern about the solvency of the AFM-Employer Pension Fund, however, is not warranted at this point in time. Even in its current state, the Fund can continue to pay vested benefits for at least the next 40 years. With the implementation of its rehabilitation plan, it is reasonable to expect the Fund’s situation to improve.