Treasury Rejects Central States Suspension Application: But Many Misunderstand Reasoning
The Department of the Treasury (Treasury) has denied the application submitted by the Central States, Southeast and Southwest Areas Pension Plan (Central States) to suspend (that is reduce) benefits under the Multiemployer Pension Reform Act of 2014 (MPRA 2014 or Kline-Miller). In a letter dated May 6, 2016, the Treasury notified Central States of the denial and the reasons for it. This notification letter can be found at this link. Many commentators on this denial have misunderstood a key aspect of Treasury's reasoning for the denial and have stated that the Treasury believes a 7.5% interest rate is not a reasonable actuarial assumption for funding a pension plan. The reasoning related to the 7.5% interest rate was much more specific, and this alert will address the misunderstanding.
Under MPRA 2014, a multiemployer pension plan that is in "critical and declining" status can apply to the Treasury for approval to reduce benefits so as to remain solvent. The reduction of benefits can apply even to those in pay status (with certain restrictions).1 Treasury has 225 days to review and act upon the application. Central States was the first plan to apply to reduce benefits under this provision and stated that the fund was expected to run out of money in about 10 years. Central States asserted that its projections showed that the fund was not expected to run out of money if the benefit reductions were allowed. In making its projections, Central States used an assumption that the annual investment return would be 7.5%.
In denying Central States's application, Treasury found that the proposed suspensions failed to satisfy the following three requirements:
- that the proposed benefit suspensions, in the aggregate, be reasonably estimated to achieve, but not materially exceed, the level that is necessary to avoid insolvency, because the investment return and entry age assumptions used for this purpose are not reasonable. Code § 432(e)(9)(D)(iv).
- that the proposed benefit suspensions be equitably distributed across the participant and beneficiary population. Code § 432(e)(9)(D)(vi).
- that the notices of proposed benefit suspensions be written so as to be understood by the average plan participant. Code § 432(e)(9)(F).
In discussing the failure of first requirement, Treasury determined that the use of the 7.5% interest rate by Central States was not reasonable for this specific purpose. Many commentators have concluded that Treasury was saying that 7.5% is not a reasonable long-term interest rate assumption for funding a pension plan.
What the Treasury actually stated was that the 7.5% interest rate:
- was not appropriate for the purpose of the measurement (cash flow projections relating to proposed benefit suspensions under Kline-Miller), taking into account the Plan's negative cash flows and other factors;
- does not adequately take into account relevant current economic data (that is, appropriate investment forecast data); and
- has a significant bias in that it is significantly optimistic.
The key point is that, for purposes of demonstrating that the Plan is expected to avoid insolvency with the benefit cuts, the 7.5% was not appropriate in the Treasury's view. With respect to that point, Treasury stated the following factors should have been taken into account in the selection of the investment return assumption2:
- "the timing of future expected contributions and benefit payments, which--when taken into account--results in the Plan having significant negative cash flow and therefore declining asset levels;
- the greater materiality of asset returns during the earlier years of the cash flow projections because, based on the anticipated pattern and magnitude of change in the level of Plan assets resulting from the timing of future expected contributions and benefit payments, asset levels are projected to be higher during the earlier years of the projections than they are projected to be during the later years (i.e., these projections are extremely sensitive to variations in asset returns in the near term because the same percentage gain or loss has a greater impact if it occurs earlier, when asset levels are higher, than in later years, when asset levels are lower);
- a participant's or beneficiary's loss of benefits (once reduced pursuant to a suspension) is permanent--amounts reduced will not be returned; and
- the fact that the amount of the suspension cannot easily be (and will not automatically be) increased or decreased in a later year if the plan's actual experience proves to be different than projected."
Treasury then stated3:
"Based on these factors, the investment return assumptions for purposes of these cash flow projections must be developed in a refined manner that reflects and gives appropriate weight to near-term expected rates of return. For this purpose, it is not appropriate to develop investment return assumptions based solely on the time-weighted average expected returns over the long term or based on the assumptions used for other purposes (such as for purposes of determining a plan's minimum funding requirement) if doing so produces materially different results than use of a refined assumption." (underlining added)
Treasury did say that an annual 7.5% investment return assumption was not appropriate for this purpose for Central States. However Treasury did not say that a 7.5% investment return assumption was inappropriate for purposes of determining a plan's minimum funding requirements (or for funding a public pension plan over the long term). Instead, Treasury recognized because of Central States's specific situation (with negative cash flow), there needed to be a focus on the near term when testing whether the Plan could avoid insolvency. In this regard, the returns expected by the investment community were significantly less than 7.5%, so that even if the long-term return averaged 7.5%, Central States's chances of avoiding insolvency were below the required threshold. This effect of lower anticipated near-term rates of return has apparently been overlooked or glossed over by many of the commentators.
Cheiron consultants would be happy to discuss the Treasury's findings with you in light of your specific plan.
Cheiron is an actuarial consulting firm that provides actuarial and consulting advice. However, we are neither attorneys nor accountants. Accordingly, we do not provide legal services or tax advice.
1 See the Cheiron Pension Alerts of December 22, 2014, February 20, 2015, May 15, 2015, June 22, 2015, and September 14, 2015, for a description of MPRA and the benefit suspensions for greater detail.
2 See page four of the notification letter.