What is Critical Status?
In 2006, Congress passed the Pension Protection Act of 2006 (PPA). The PPA created four classifications for multi-employer pension plans that relate to the plans funding status: critical (red), seriously endangered (orange), endangered (yellow), and reasonably healthy (green). The plan’s status is determined by an annual valuation of the plan’s assets and liabilities, conducted by the plan’s actuary. The PPA requires the plan’s actuary to submit a report, reflecting the plan’s funding status. There are several criteria that plans uses to determine critical status. However, in general multiemployer pension plans that are less than 65% funded (but not projected to be insolvent in the next 14 or 19 years) are considered to be in “critical status” (aka red zone).
How do Trustees Address a Plan in Critical Status?
The trustees for a plan in critical status are required to develop a Rehabilitation Plan (RP) to address the plan’s funding problem. This RP must be adopted within 240 days after the plan is certified to be in critical status. The RP must be reasonably expected to bring the plan out of critical status within 10 years and to keep the credit balance positive for at least an additional 10 years.
The RP consists of a schedule or set of schedules that revises the plan’s contribution rate and/or underlying benefit structure. The Plan sponsor will designate one of those schedules as the “default schedule” and provide that to the bargaining parties. The “default schedule” usually includes the maximum benefit decreases permitted under law and the minimum increase in contributions. This default schedule would then apply if the bargaining parties failed to adopt their own schedule within a certain period of time. Moreover, the law requires contributing employers to pay an automatic surcharge in addition to contributions required under the CBA. With some exceptions, the amount of the surcharge is equal to 5% of the required contributions in the initial critical year, and 10% of the required contributions for each subsequent year that the plan remains in critical status. Thus, the “default schedule” and automatic surcharge work to encourages the bargaining parties to reach a new agreement to address the plan’s funding deficiencies.
How is the Plan Revised?
As noted above, the trustees will address funding problems by either reducing benefits, increasing contributions, or some combination of both. When it comes to reducing benefits, the plan can only reduce what are called “adjustable benefits.” These are defined as a “benefit, right, and feature under the plan,” including post-retirement death benefits, 60-month guarantees, disability benefits not in pay status, and similar benefits. Importantly, the law prohibits reductions of benefits for retirees in payment status except in limited circumstances.
Often, plans will reduce early retiree subsidies, eliminate 5-year guarantees for unmarried participants, and reduce future accruals. Once an RP is adopted, a plan cannot increase benefits unless the plan actuary certifies that the increase is paid for out of additional contributions not contemplated by the rehabilitation plan and, after taking this increase into account, the plan is still reasonably expected to emerge from critical status by projected period. In other words, the benefit increases need to be paid from another source and cannot impact the rehabilitation plan’s projections.
Takeaways:
A plan in critical status is one in which the plan is projected be less than 65% funded. To address this funding problem, the trustees for the plan must adopt a Rehabilitation Plan, increasing employer contributions and/or reducing benefits. The trustees can either agree on the changes to the plan and adopt a schedule reflecting those changes, or a default schedule will be adopted if the trustees have not adopted a RP before the expiration of the CBA. If a default schedule is adopted, employer contributions will only be increased after benefits have been reduced.
Crafting and implementing a rehabilitation plan is a pain staking process and involves the plan’s actuaries and attorneys working with the Trustees to establish a plan that will (A) appeal to the bargaining committees and (B) help the plan emerge from critical status.