Aon Hewitt Comments on Proposed Hybrid Pension Plan Regs

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Aon Hewitt Comments

Following are Aon Hewitt's comments on the proposed regulations. We first respond to the four questions posed to respondents in the preamble to the proposed regulations regarding plans that credit interest using an investment-based rate of return with an impermissible minimum annual or more frequent fixed or variable minimum rate. We then discuss some additional areas of concern regarding the proposed regulations, including:

• Interest crediting rates not satisfying timing rules;

• Interest crediting rates that must be limited to third corporate bond segment rate;

• Noncompliant cumulative minimum interest crediting rates;

• Greater of two or more variable investment-based interest crediting rates; and

• Pension equity plans with implicit interest crediting rates.

The preamble to the proposed regulations requested comments and responses to four specific questions. These questions related to plans crediting interest using a composite rate that is an investment-based rate of return with an impermissible annual (or more frequent) fixed or variable minimum rate, including such plans that apply a reduction to the investment-based rate of return in order to take into account the value provided by the minimum rate, and the plan amendments that should be required in order to bring such plans into compliance.

Question #1 -- Should the required amendment eliminate the minimum rate (and eliminate any reduction to the investment-based rate of return), so that the required rate after amendment is the unreduced investment-based rate of return?

Aon Hewitt believes that the regulations should permit the plan to be amended to eliminate the minimum rate and eliminate any reduction to the investment-based rate of return, so that the interest crediting rate after the amendment is the unreduced investment-based rate of return. However, we also believe that there are other alternative approaches that should be permissible. For example, a plan sponsor may believe that it is important to continue providing participants with an annual or more frequent minimum interest crediting rate in order to meet their plan design objectives and provide participants with reasonably predictable retirement benefits. In this situation, we believe it would be appropriate to permit the plan sponsor to change the basis for determining interest credits to a less volatile rate, such as the third corporate bond segment rate described in Treasury regulation Section 1.411(b)(5)-1(d)(3) with a fixed minimum interest rate of 4%.

Question #2 -- Should the required amendment change the interest crediting rate to another permitted rate that is less volatile than the unreduced investment-based rate (such as a rate described in § 1.411(b)(5)-1(d)(3) with a fixed minimum rate of 4 percent per year?

As noted in our response to Question #1, Aon Hewitt believes that a plan sponsor should be permitted to change the interest crediting rate to a permitted rate that is less volatile than the unreduced investment-based rate. However, we do not believe such a change should be required. Different plan sponsors may have different plan design and retirement benefit objectives. Some plan sponsors may prefer the variability in benefits and risk-management potential resulting from an investment-based rate, while other plan sponsors prefer the more predictable benefits provided by a bond-based rate with an annual or more frequent minimum. We believe it would be appropriate to permit plan sponsors a choice between these approaches based on their objectives and participant expectations.

Question #3 -- Should the required amendment depend on the level of the minimum rate and the extent of any reduction to the investment-based rate of return?

From a practical perspective, Aon Hewitt believes it would be difficult for the Service to identify different required amendments based on the level of the minimum rate and the extent of any reduction to the investment-based rate of return. For example, the appropriate level of reduction to an investment-based rate of return in order to compensate for a given minimum rate will vary based on the risk and return characteristics of the underlying investment-based rate, and may change over time based on market conditions. As a result, we believe it would be impractical to determine a comprehensive range of appropriate reductions and corresponding minimums. We believe the regulations should provide a consistent transition approach that plan sponsors can implement without undue difficulty or complexity.

Question #4 -- Should the plan sponsor have a choice among alternative required amendments to bring the plan into compliance?

As discussed in our responses to Question #1 and Question #2, Aon Hewitt believes that it is appropriate to provide plan sponsors with a choice among alternative required amendments to bring a plan into compliance with the 2014 final regulations, which specify permissible interest crediting rates that do not exceed a market rate of return. We believe the regulations should provide plan sponsors with sufficient flexibility to comply with the 2014 final regulations in the manner that is most consistent with those plan sponsors' design objectives while also protecting participants' interests. With such a choice, it is important to note that sponsors of collectively bargained plans will likely need to negotiate with the applicable collective bargaining unit to determine which approach will be followed. As a result, we believe the Service should consider tying the regulatory effective date for the proposed regulations to the expiration date of the collective bargaining agreement that is in place at the time the regulations are finalized. Note that this might also require a change to the regulatory effective date for the 2014 final regulations.

Additional Areas of Concern

Below, Aon Hewitt discusses some additional areas of concern regarding the proposed regulations.

Interest Crediting Rates Not Satisfying Timing Rules

Section 1.411(b)(5)-1(e)(3)(vi)(C)(1) of the proposed regulations provides that, if a plan does not satisfy the timing rules relating to how interest credits are determined and credited as set forth in Treasury regulation Section 1.411(b)(5)-1(d)(1)(iv), then the plan must be amended to correct the aspect of the plan's interest crediting rate that does not comply with those timing rules. However, the proposed regulations are unclear with respect to the flexibility available to the plan sponsor when making this change. For example, suppose that a plan credits interest for a given plan year based on a 12-month average of the 30-year Treasury rate for the preceding plan year. A 12-month average would not comply with the timing rules, as it would not satisfy the lookback requirements under Treasury regulation Section 1.417(e)-1(d)(4). While the proposed regulations would require that the plan be amended so that the interest crediting rate satisfies those requirements, there are multiple ways in which the plan could potentially be amended to accomplish this. The plan could be amended to credit the 30-year Treasury rate for a single permissible lookback month or an average of the 30-year Treasury rate for up to five consecutive permissible lookback months. Other choices exist as well. A similar issue exists with regard to a non-compliant stability period. It is unclear whether the proposed regulations would allow a noncompliant lookback or stability period to be changed to any permissible lookback or stability period, or whether there are limitations. We believe the proposed regulations should be clarified to explicitly state that a plan amendment to bring a plan's interest crediting rate into compliance with the timing rules can use any permissible lookback and stability period to determine interest credits following the amendment.

Interest Crediting Rates That Must Be Limited to Third Corporate Bond Segment Rate

In order to comply with the 2014 final regulations, the proposed regulations provide that plans crediting certain impermissible interest crediting rates -- e.g, a plan that credits the greater of two or more variable bond-based rates described in Treasury regulation Section 1.411(b)(5)-1(d)(3) or (d)(4) -- must be amended to credit the lesser of the composite rate and the third corporate bond segment rate described in Treasury regulation Section 1.411(b)(5)-1(d)(3). However, the proposed regulations are unclear as to whether the third corporate bond segment rate applied in this situation may use any permissible lookback and stability period, and whether any of the permissible third segment rates under Internal Revenue Code (Code) Sections 417(e)(3) and 430(h)(2), with or without interest rate stabilization under the Moving Ahead for Progress in the 21st Century Act and the Highway and Transportation Funding Act of 2014, may be used. We believe the proposed regulations should be clarified to explicitly state that this is the case.

Noncompliant Cumulative Minimum Interest Crediting Rates

The proposed regulations do not appear to address situations in which a plan provides for a cumulative minimum interest rate (rather than an annual or more frequent minimum) that is in excess of 3% as permitted by the 2014 final regulations. We believe the regulations should permit a plan crediting such a rate to be amended to reduce the cumulative minimum interest rate to 3%.

Greater of Two or More Variable Investment-Based Interest Crediting Rates

The proposed regulations do not appear to address situations' in which a plan may credit interest based on the greater of two or more variable investment-based interest crediting rates -- e.g., the greater of the return on a Registered Investment Company (RIC) designed to track the S&P 500 and the return on a RIC designed to track the Barclays Aggregate Bond Index. We believe the regulations should provide a reasonable transition approach for such plans. For example, the plan sponsor could be given a choice between eliminating one of the two variable investment-based interest crediting rates, or limiting the resulting crediting rate to the third corporate bond segment rate described in Treasury regulation Section 1.411(b)(5)-1(d)(3) in order to ensure that the resulting interest crediting rate does not exceed a market rate of return

Pension Equity Plans With Implicit Interest Crediting Rates

The issue of implicit interest crediting rates has arisen in reviews of pension equity plan (PEP) determination letter applications for those PEPs that do not explicitly credit interest beginning with a participant's termination of employment. According to recently released Service procedural guidelines, a PEP that determines the accrued benefit as an annuity commencing at normal retirement age by dividing the accumulated PEP benefit by a deferred annuity factor has the same effect as projecting interest to normal retirement age using the interest rate (and mortality rates, if applicable) embedded in the deferred annuity factor. The proposed regulations do not appear to address situations in which a PEP has an implicit interest crediting rate that does not satisfy the market rate of return rules. Aon Hewitt believes the Service should provide: 1) Clear guidance on how PEPs with implicit interest crediting rates should determine whether they comply with the final regulations; and 2) Express transition guidance and Code Section 411(d)(6) anti-cutback relief for PEPs with implicit interest crediting rates that do not comply with the final regulations, taking into account the fact that a change in the implicit interest crediting rate may mean a change in annuity conversion factors used to determine the accrued benefit. Because the Service has not yet issued specific guidance for PEPs, a delayed effective date for PEPs to comply would seem appropriate.

Closing

Aon Hewitt appreciates the opportunity to submit these comments regarding the proposed regulations. If you have any questions regarding these comments, please contact the undersigned at the telephone number or email address provided below.