Life after receiving special financial assistance: Plan merger

For many trustees of financially distressed multiemployer pension plans that receive funds under the government’s special financial assistance (SFA) program, one of the first questions is “can we merge into a more secure plan now?” As with most pension plan questions, the answer is “maybe.” SFA is intended to help the plan delay or avoid insolvency over the next 30 years, giving trustees the opportunity to consider options going forward that were not feasible before receiving SFA, such as a plan merger.

This article reviews how SFA may impact a merger analysis, as well as the mechanics and operational requirements if a plan’s trustees decide to pursue a merger.

Best time for a pension plan merger

The best time to pursue a merger may be soon after receiving SFA, because the SFA plan’s funded percentage on a market value basis will be at its highest expected point. In some cases, the SFA plan’s funded percentage may even be higher than that of the plan it is seeking to merge with.

SFA plans that are small relative to a potential merger partner may find more success with a merger because their immediate impact on the merged plan’s financial status is less significant.

A merger that benefits both pension plans

Depending on the relationship between the SFA plan and its potential merger partner, there could be synergies between them that may support the plan post-merger. Some examples are provided below.

• Common employers participating in both plans may reduce reciprocity tracking and strengthen the bond these employers have with the plan.
• Participants who earned benefits under both plans would have their benefits combined, making it easier for them to collect their benefits and reducing the chance they become missing participants. Also, a merger of plans with common participants can realize an overall reduction in Pension Benefit Guaranty Corporation (PBGC) premiums that would not be the case for a merger between two plans with unrelated participant populations.
• The geographic area of the plan may be expanded following a merger, offering the opportunity to increase employee and employer participation. More active members will result in a larger contribution base, which could help strengthen the merged plan’s overall financial position. In addition, the SFA plan may have struggled to add new employers due to its poor financial position, and joining a more secure plan could increase the chances of expanding the area’s signatory employer base.

Certainly, any merger analysis will review the impact on the plans’ actuarial measurements, and one plan will be better funded on a current and/or projected basis. There are many factors to compare, such as each plan’s size, contribution base, and maturity metrics (e.g., number of inactive participants to active participants, contributions compared to benefit payments and expenses). The decision to merge is not solely about the immediate impact on a plan’s funding measurements, and trustees should assess all the potential advantages a merger could provide.

Addressing ERISA minimum funding challenges

While the SFA plan’s market value funded percentage immediately improves following receipt of SFA, the SFA assets are segregated from the rest of the plan’s assets and must be excluded for ERISA minimum funding purposes. This means the SFA plan’s actuarial value of assets, Pension Protection Act (PPA) funded percentage, and credit balance measurements will not see an immediate improvement.

Many SFA plans have a funding deficiency rather than a credit balance, meaning that contributions coming in each year are less than what is needed to satisfy ERISA minimum funding requirements. If there is a merger, the SFA plan’s funding deficiency will immediately reduce the ongoing plan's credit balance. However, the SFA assets that are used to pay benefits and expenses will create actuarial gains that are amortized over 15 years, which will help to offset the initial negative impact gradually over time. In addition, benefits for the merged plan can be paid for with SFA assets, accelerating the recognition of the actuarial gains.

The contributions in an SFA plan are likely far greater than the cost of the accruing benefits, the excess of which is going to general plan funding. If they merge with a better funded plan and this contribution-to-benefit relationship is maintained, the long-term impact of the merger may be positive despite the potential negative impact initially.

Could the plan obtain a funding deficiency waiver?

Maybe, but it may be a challenge. Prior to PPA, employers participating in plans with a funding deficiency were imposed an excise tax based on the funding deficiency amount and were required to eliminate the funding deficiency within a specified period of time. Such plans could have applied to the IRS for a funding waiver by demonstrating that at least 10% of employers contributing to the plan were unable to satisfy the ERISA minimum funding requirement without a substantial business hardship.

Since PPA went into effect back in 2008, red zone plans are generally not penalized for having a funding deficiency. Applying to the IRS for a waiver of any funding deficiency to facilitate a merger may require a demonstration that at least 10% of employers contributing to the merged plan are unable to satisfy the ERISA minimum funding requirement without a substantial business hardship. This may be difficult to satisfy if the plan which the SFA plan seeks to merge with has been meeting their ERISA minimum funding requirements. Every merger is unique, so a conversation with the IRS may be needed to know whether this is a viable option.

Amortization extensions

Some SFA plans may have received approval from the IRS for amortization extensions under Internal Revenue Code (IRC) 431(d), providing them an extra five to 10 years to pay down some of the unfunded actuarial liability. Similar to the funding waiver, amortization extensions may be lost if an amendment increasing benefits is adopted. Loss of the amortization extensions means the amortization period will be shortened to its original period, increasing the ERISA minimum funding requirement.

An ongoing plan that merges with an SFA plan that has a funding waiver or amortization extensions in place will inherit the associated benefit improvement restrictions. While these restrictions do not prohibit plan amendments increasing benefits, it is important the trustees review funding projections to understand how the plan amendment may impact the projected credit balance.

Post-merger conditions and restrictions

An SFA plan is subject to certain conditions and restrictions, which are discussed here. The following conditions continue after a merger of an SFA plan and a plan that did not receive SFA (non-SFA plan):

• Segregation of SFA assets from non-SFA assets.
• How the SFA assets are used and invested.
• PBGC approval for any future mergers.
• PBGC approval for certain withdrawal liability settlements.
• Filing an annual compliance statement with the PBGC through the plan year ending in 2051. The merged plan may also be subject to periodic compliance audits by the PBGC.

The plan may apply to the PBGC for a waiver of the following conditions if the assets of the SFA plan premerger is 25% or less of the total assets of the premerger plans combined, the current liability of the SFA plan premerger is 25% or less of the total current liability of the premerger plans combined, and the status of the non-SFA plan was in the green zone and not projected to be in critical status in the next five plan years from the date of request. The conditions that may be waived are:

• Restrictions on retroactive benefit increases for participants in the SFA plan prior to the merger.
• Restrictions on contribution decreases for employers that had an obligation to contribute to the SFA plan prior to the merger.
• Restrictions on allocating contributions and other income relative to the SFA plan prior to the merger.

The SFA conditions that will not apply to the merged plan are:

• Restrictions on prospective benefit increases.
• Restrictions on the allocation of plan assets and expenses.
• PPA zone status. In general, an SFA plan is deemed to be in critical status through the plan year ending in 2051. However, if it merges with a non-SFA plan, and the non-SFA plan is designated as the ongoing plan after the merger, then IRS Revenue Ruling 2022-13 provides the merged plan is not deemed to be in critical status solely because of the merger.

PBGC approval is required

During the SFA coverage period,¹ a merger between an SFA plan and another plan must be approved by the PBGC. The merger must meet the general merger requirements under ERISA Section 4231 and the approval request to the PBGC needs to describe how the merger “does not unreasonably increase PBGC’s risk of loss with respect to any plan involved in the transaction and is not reasonably expected to be adverse to the overall interests of the participants and beneficiaries of any of the plans involved in the transaction.” The application to the PBGC must be submitted at least 120 days prior to the effective date of the merger.

Fiduciary concerns for pension plan trustees

Trustees of plans considering a merger with an SFA plan may ask themselves whether they are doing their fiduciary duty if they approve a merger with a plan with a lower funded position. On the surface, the merger may not appear prudent or in the interest of their participants and beneficiaries (e.g., the ongoing plan’s funding metrics may be negatively impacted initially, the SFA plan may bring additional restrictions and conditions that continue to apply post-merger, etc.). However, the PBGC’s approval of the merger could help mitigate this apprehension. In addition, as discussed above, there are many factors when considering the impact of a merger, such as the expected benefits of geographical expansion, the impact on administrative expenses, the practical impact of any SFA plan restrictions on the merged plan, and the long-term expected impact of the merger on the plan’s funding and zone status measurements.

In addition, a merger transaction may be considered a settlor function, which is not subject to the fiduciary standards under ERISA. Trustees should review the transaction with plan legal counsel to understand their fiduciary obligations as they consider the merger.

Facilitated mergers still possible

The Multiemployer Pension Reform Act of 2014 (MPRA) added facilitated mergers as another option to help financially distressed plans. The plans seeking a merger may request the PBGC to facilitate a merger, which could include financial assistance necessary for one or more of the plans to avoid becoming insolvent. At least one of the plans involved in the merger must be in critical and declining status.

In general, SFA plans are deemed to be in critical status through the plan year ending in 2051. The IRS has informally confirmed that critical and declining status is a subcategory of critical status. Therefore, if an SFA plan is projected to become insolvent within 15 to 20 years, it could be certified in critical and declining status prior to 2051, and a facilitated merger could be another option for the trustees to pursue.

Please contact your Milliman consultant to discuss how a merger may impact your plan(s).

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¹ The SFA coverage period is the period beginning on the plan’s SFA measurement date and ending on the last day of the plan year ending in 2051.