PPA and 2007 Pension Funding: What in the World Are We Waiting For?

Pension Section News – Number 64 | May 2007

PPA and 2007 Pension Funding: What in the World Are We Waiting For?

By Brian C. Donohue, FSA, EA

Concerning the Pension Protection Act (PPA) and certainty, there are two related misconceptions:

Misconception #1: Now that PPA is law, we finally have clarity on pension funding rules.

Misconception #2: PPA extends current rules through 2007. So, if we don’t have all the details of the new law, at least this year is clear enough.

There is no doubt that PPA has removed significant legislative uncertainty around pension funding rules. But there are lots of details. And, as discussed below, many unresolved issues relate to near-term funding decisions. In some ways, the rules for 2012 are clearer than for 2007.

Here's the problem: many PPA rules apply based on variants of the Funding Target Attainment Percentage (FTAP) as of January 1 (for calendar-year plans) of the prior year (the "lookback year"). For 2008, the lookback year–2007 –is a pre-PPA year. Here are the rules that may use a 2007 lookback year for 2008:

  2007 Funding Target Attainment Percentage (FTAP) 2008 Consequence  
< 60 percent funded* Hard benefit restrictions (hard freeze, no lump sum or shutdown benefits)
< 70 percent funded* Hard benefit restrictions (beginning April 1)
< 80 percent funded Credit balance restrictions
< 80 percent funded* Soft benefit restrictions (no benefit improvements, 50 percent lump sums)
< 90 percent funded* Soft benefit restrictions (beginning April 1)
< 100 percent funded Quarterly contributions

* PPA is unclear whether or not 2008 benefit restrictions (e.g., lump sums, improvements, accruals, shutdown benefits) will be subject to a 2007 lookback, let alone how the lookback rules would be applied to 2007. Collectively bargained plans enjoy up to two years delay in the effective date for these restrictions.

So, for example, in determining whether hard benefit restrictions apply to your plan in 2008, you look at your FTAP as of Jan. 1, 2007 (for calendar-year plans). In order to avoid hard benefit restrictions in 2008 (or, e.g., “at-risk status,” restrictions on lump sums, or funding of nonqualified deferred compensation plans), pension plans will need to hit certain funding targets as of Jan. 1, 2007 (for calendar-year plans). Contributions to hit these targets must be made by Sept. 15, 2007.

The problem is that there is no FTAP for 2007–the rules defining FTAP do not apply until 2008. There are similar percentages defined under current law, such as the "funded current liability percentage." But PPA does not adopt these measures as the basis for the lookback at 2007, but instead instructs IRS to issue guidance as to how the lookback rules apply for 2007.

So, just how will the FTAP be calculated for 2007? There are four areas of uncertainty.

    Old (2007) rule New (PPA) rule  
Mortality New table New table;Custom option for large employers
Interest rate Long-term rate/4-year smoothing 3-segment yield curve2-year smoothing
Assets Smoothing of prior 4-years' experience;80-120 percent corridor “Averaging” of prior 2-years' experience;90-110 percent corridor
Credit balance Included in assets Subtracted from assets

The key question in each case, in calculating the FTAP for the 2007 lookback year, in applying various restrictions that key off funded percentage, do you use the old rule (for mortality, interest rate, etc.) or the new one? The answer may be different for different items on our four-item list.


IRS recently issued regulations governing 2007 mortality. The preamble to the regulation includes the following comment: "The specifications for developing the mortality tables under [PPA] are the same as the specifications” under current law.” So, we can expect the 2007 table to be reasonably similar to what we’ll see under PPA.

The big unknown here relates to large employers that submit their own mortality tables for PPA. Will they be able to apply this table to the 2007 FTAP calculation?

Interest rate

Current law uses a long-term corporate bond rate, while PPA uses a three-segment yield curve. In view of the recent flattening of the yield curve, there may not be a lot of difference between using the old (single rate) rule or the new (yield curve) rule for the 2007 lookback year. Applying the yield curve (instead of a single long-term bond rate) to 2007 may result in a 2–3 percent increase in liability for a very short-duration plan, but may produce a slightly lower liability for other plans.

But, there's an (optional) transition rule for the yield curve. In year 1, you calculate interest rates using 1/3rd yield curve and 2/3rds single long-term bond rate. In year 2, you calculate interest rates using 2/3rds yield curve and 1/3rd single long-term bond rate. Is 2007 year 1 or year 0? If it's year 0, then presumably, you would use the old (single rate) rule to determine the plan's interest rate.


Current law allows smoothing of up to four years of prior asset returns within a corridor of 80-120 percent of market value. PPA reduces this to two years of prior experience “on the basis of the averaging of fair market values” within a 90-110 percent corridor. If this is interpreted as simple averaging rather than averaging of expected values in some fashion, it will produce a value that is biased below market value and will be unappealing to many, possibly most, plan sponsors.

Our immediate concern is: which rule do you apply for the 2007 lookback year? If anything, PPA methodology (market value or something closer to it) will produce a higher asset value than current rules for many plans in 2007, due to healthy asset returns over the past four years.

Credit balances

For many companies, the biggest issue will be, how are credit balances treated in determining the FTAP for 2007–are they included in (old rule) or subtracted from (new rule) assets? Sponsors with large credit balances will be especially interested in the resolution of this issue.

Beginning in 2008, plans can (and in some cases must) “burn” a portion of their credit balance to avoid adverse consequences. If lookbacks at 2007 are calculated by subtracting the credit balance from assets, it would be very troublesome to employers unless they had some ability to “burn,” or otherwise agree not to use, their credit balance during 2007.

Some Clarity

Amid all this uncertainty, there are some things we can lock on to for 2007. First, plans that wish to enjoy delayed impact of PPA funding rules will want to ensure they avoid the “deficit reduction contribution” (DRC) for 2007.

Secondly, plans that want to avoid lump sum restrictions to “top-25” employees will need to fund to 110 percent of their 2007 liability.

Both of these calculations will reflect the new mortality published for 2007.

Finally, plans will have one last bite at the “full funding exemption” apple (for the sake of avoiding PBGC variable premiums) during 2007 by ensuring that they fund at least up to the 2006 full funding limitation. This amount, which is based on 2006 valuation results, should be known already for most plans.

What’s next

The IRS and Treasury are aware of the urgent need for guidance around 2007 lookback issues and have made this one of their priorities in the months ahead. I am optimistic that plans will have the needed guidance in time to make intelligent September 15 funding decisions- maybe even with a few weeks to spare.

Brian Donohue is a vice president with CCA Strategies in Chicago, Illinois, and a member of the Pension Section Council.  He can be reached at brian.donohue@ccastrategies.com.