THE PENSION BENEFIT GUARANTY CORPORATION AND ITS PLAN INSURANCE

If an employer encounters financial difficulty and is forced to terminate or curtail a qualified defined-benefit plan, the ultimate payment of plan benefits is often jeopardized. If the plan uses an insurance company contract as the funding medium, the employee's benefit is usually to some extent guaranteed by the insurance company. However, the use of trust funds predominates in defined-benefit plans, and these funds usually involve no insurance company guarantees. Actuarial funding methods assume that plans will be in existence indefinitely. As a result, the plan fund in many cases is, at a given moment, inadequate to fund all of the benefits accrued under the plan if the plan terminates at that moment.

Recognizing this problem, Congress established a scheme of mandatory plan insurance for certain defined-benefit plans as part of ERISA (Title 4) in 1974. The insurance is administered by a quasi-governmental corporation called the Pension Benefit Guaranty Corporation (PBGC). Defined-contribution plans do not involve the same benefit security problems as defined-benefit plans because the participant's accrued benefit is always equal to the participant's account balance. Therefore, the PBGC plan insurance scheme does not apply to defined-contribution ("individual account") plans.

Plans Covered

PBGC coverage can be summarized by stating that, in general, all qualified defined-benefit plans are covered, while individual account (defined-contribution) plans are not covered. With respect to defined-benefit plans, the usual exclusions applicable to ERISA provisions apply: there is no PBGC coverage for federal, state, and local government plans; church plans (unless the plan elects coverage); plans with no employer contributions; plans for highly compensated individuals or substantial owners; plans frozen prior to ERISA; and various other exclusions.

Benefits Insured

The PBGC does not insure or guarantee all benefits provided under a qualified defined-benefit plan covered by PBGC insurance. A distinction is made between basic and nonbasic benefits. The PBGC is required under the terms of its federal charter to insure basic benefits. PBGC is allowed to extend coverage to nonbasic benefits, but it has not yet done so.

There are numerous conditions and limitations on what qualifies as a guaranteed basic benefit, set out in Part 2613 of the PBGC regulations. The most significant limitations are as follows:

• The benefit must be nonforfeitable or vested. This refers to vesting that existed under the terms of the plan immediately prior to plan termination, not to benefits that became vested solely on account of plan termination.

• The benefit must be a "pension benefit"-a benefit payable as an annuity to a retiring or terminating participant or surviving beneficiary, providing a substantially level retirement income to the recipient. Consequently, the PBGC generally does not insure a lump-sum benefit.

• There is a dollar limitation on the amount of monthly payment the PBGC will guarantee. Regardless of the plan provisions, the insured monthly benefit is limited to one-twelfth of the participant's average annual gross income from the employer during the highest paid five consecutive calendar years or lesser number of years of active participation. Furthermore, in no event will the insured benefit exceed a dollar limit, originally $750 monthly in 1974, which is subject to an indexation procedure. For plans terminated in 2000, the limit was $3,221.59 monthly. The dollar limitation applies to a benefit in the form of a straight-life annuity beginning at age 65 and payable monthly. The limit is adjusted actuarially for other forms of benefits.

• The participant must be "entitled" to the benefit as of the date of plan termination. Generally, this means that the recipient must have satisfied the conditions of the plan necessary to establish the right to receive the benefit (other than mere application for it or satisfying a waiting period) prior to the plan termination date. Also, the benefit must be payable to or for the benefit of a natural person (not, for example, a corporation).

PBGC Funding and Premiums

The PBGC has established several funds to provide benefit guarantees. It has the power to borrow up to $100 million from the U.S. Treasury if necessary. However, the PBGC is expected to be self-supporting and is therefore required to charge insurance premiums for its guarantees. For single employer plans, the basic annual premium for 2000 is $19 per participant. For certain underfunded plans, an additional annual premium may be required, depending on the amount of the plan's unfunded vested benefits. Congress has the authority through a joint resolution procedure to review and change PBGC rates from time to time, based on various factors set out in the law. Payment of the premiums is mandatory, and is enforced by various penalties.

Plan Termination Procedures

Reportable Events

The PBGC becomes involved with a plan that is terminating or encountering various difficulties in somewhat complex ways. First of all, the plan administrator is obligated to report to the PBGC certain events that could potentially cause financial difficulty. There is a long list of these reportable events; some significant ones are these:

• An IRS or Department of Labor disqualification of the plan

• A plan amendment decreasing retirement benefits

• A decrease in the number of active participants to less than 80 percent of the number at the beginning of the plan year or 75 percent of the number at the beginning of the previous plan year

• A determination by the IRS that there has been a termination or partial termination of the plan

• A failure to meet the minimum funding standards

• An inability by the plan to pay benefits when due

• Certain large distributions to a substantial owner

• A plan merger, consolidation, or transfer of its assets

• The occurrence of another event indicative of a need to terminate the plan-the regulations refer to such items as insolvency of the employer or a related employer and certain breakups of commonly controlled groups of employers

If the consequences of these reportable events are significant enough, the plan can be involuntarily terminated by the PBGC. Also, of course, a voluntary termination can be carried out by the plan administrator under one of the two procedures described below. In any event, the actual termination of a plan covered by PBGC guarantees is carried out under detailed procedures set out in the law.

Allocation of Plan Assets on Termination

The PBGC termination procedures revolve around the rules for allocation of the assets of a terminated defined-benefit plan under ERISA Section 4044. On termination, such plan assets must be allocated in descending order to the following categories:

• Benefits attributable to voluntary employee contributions.

• Benefits attributable to mandatory employee contributions.

• Annuity benefits attributable to employer contributions that were, or could have been, in "pay status" as of three years prior to termination. A benefit in "pay status" means a benefit being paid to a retired (nonactive) employee. The high priority reflects the fact that such employees are least able to protect themselves against a failure of the plan fund.

• All other PBGC guaranteed benefits.

• All other vested benefits.

• All other plan benefits.

Any amount remaining after these categories may revert to the employer, if the plan so provides.

Voluntary Plan Termination

ERISA Section 4041(a) provides for two types of voluntary termination procedures, the standard termination and the distress termination. A plan is eligible for the standard termination only if assets at the termination date are sufficient to provide for all benefit commitments as of the termination date. A benefit commitment to a participant or beneficiary means all benefits guaranteed by the PBGC as described earlier, but determined without certain limitations, such as the maximum dollar limit or the restriction on benefits in effect for less than 60 months before plan termination. Certain early retirement supplements and plant closing benefits also come within the definition of benefit commitments. If benefit commitments are not met, a voluntary termination must follow the distress termination procedures.

With a standard termination, the plan administrator must provide 60 days advance notice of intent to terminate to participants, beneficiaries, and other affected parties.

The plan administrator must begin distributing plan assets at the end of the 60-day determination period if the PBGC has not issued a notice of noncompliance and if the plan assets are sufficient to meet benefit commitments. The assets are distributed in accordance with the priorities of ERISA Section 4044 described above. Assets must be distributed either through the purchase of annuities from an insurance company to provide plan benefits or in some other manner providing adequate benefit security.

A distress termination is available only if one of three distress criteria is met:

1. Each contributing sponsor of the plan or substantial member of a controlled group sponsoring the plan must be in a liquidation proceeding under federal bankruptcy law or similar state law; or

2. The sponsor must be involved in a reorganization in bankruptcy or an insolvency proceeding; or

3. The plan administrator demonstrates to the PBGC that unless the termination occurs, the sponsor will not be able to pay its debts and will be unable to continue in business, or the cost of providing benefits under the pension plan has become unreasonably burdensome (for example, because of a declining work force).

On a distress termination, the plan administrator must submit to the PBGC information similar to that required under a standard termination, plus information related to the distress criteria. If the PBGC determines that there are sufficient plan assets to fulfill benefit commitments, the plan administrator may begin to distribute the assets in accordance with ERISA Section 4044.

Contingent Liability of Employer

In the event of a plan termination covered by PBGC insurance, the employer must reimburse the PBGC for the PBGC's liability for guaranteed benefits in excess of the plan's assets. However, under ERISA Section 4062, any amount of the employer's liability that exceeds 30 percent of the employer's net worth, can be deferred under "commercially reasonable" terms. This PBGC remedy may be of limited value for large bankrupt employers with no net worth or financial resources.

Multiemployer Plans

The previous discussion of termination procedures applies primarily to single employer plans or plans of controlled groups of employers. The termination problems are somewhat different where contributions to the plan are made by a number of unrelated employers-that is, a multiemployer plan such as a plan adopted under industrywide collective bargaining agreements. For such plans, there are different asset allocation provisions and somewhat different provisions for involuntary termination by the PBGC.

The most significant difference from single employer plans involves the withdrawal liability of an employer that completely or partially withdraws from a multiemployer plan. A sale of the employer's assets in an arm's-length transaction will not be treated as a withdrawal as long as the purchaser of the business continues the plan, the purchaser provides an acceptable surety bond or escrow deposit for five years after the sale, and the seller of the business remains secondarily liable for five years. If an employer withdraws from the plan, the employer's withdrawal liability is an amount based on the withdrawing employer's share of unfunded vested benefits under the plan. The withdrawing employer must pay all or a substantial portion of the withdrawal liability to the plan on a periodic basis over a number of years. The law provides for the PBGC to establish a supplemental fund to reimburse multiemployer plans for any uncollectible employer withdrawal liabilities.