June 23 -- The Internal Revenue Service (IRS), Treasury, issues a notice of proposed rulemaking and notice of public hearing. This document sets forth proposed regulations specifying the methodology for constructing the corporate bond yield curve that is used to derive the interest rates used in calculating present value and making other calculations under a defined benefit plan, as well as for discounting unpaid losses and estimated salvage recoverable of insurance companies. These regulations affect participants in, beneficiaries of, employers maintaining, and administrators of certain retirement plans, as well as insurance companies. Written or electronic comments must be received by August 22, 2023. A public hearing on this proposed regulation has been scheduled for August 30, 2023 at 10:00 a.m. ET.
Section 412 of the Internal Revenue Code (Code) prescribes minimum funding requirements for defined benefit pension plans. Section 430 specifies the minimum funding requirements that apply generally to defined benefit plans that are not multiemployer plans. For a plan subject to section 430, section 430(a) defines the minimum required contribution for a plan year by reference to the plan's funding target for the plan year. Under section 430(d)(1), a plan's funding target for a plan year generally is the present value of all benefits accrued or earned under the plan as of the first day of that plan year.
Section 430(h)(2) provides rules regarding the interest rates to be used under section 430. . . .
These proposed regulations specify the methodology used to develop the corporate bond yield curve. This methodology is generally the same as the methodology set forth in Notice 2007–81 but would include two refinements to take into account changes in the bond market since 2007. The proposed regulations would also amend the existing regulations under section 430(h)(2) to reflect the addition of the interest rate stabilization rules of section 430(h)(2)(C)(iv) and to eliminate transition rules that applied to plan years beginning before January 1, 2010.
Under these proposed regulations, as under Notice 2007–81, the monthly corporate bond yield curve for a month is defined as the set of spot rates at specified durations. The specified durations are at 6-month intervals ranging from 6 months through 100 years, and the spot rate at a duration is the yield (when compounded semiannually) for a bond that matures at that duration with a single payment at maturity. Each spot rate at a specified duration on the monthly corporate bond yield curve for a month is equal to the arithmetic average for each business day of that month of the spot rates at that duration on the daily corporate bond yield curves.
Under these proposed regulations, as under Notice 2007–81, each spot rate on the daily corporate bond yield curve is calculated using a discount function, which is derived from a forward interest rate function (that is, the projected instantaneous interest rate at each point in time). The forward interest rate function is defined by the selection of five coefficients of B-splines that are determined using the bond data and taking into account certain adjustment factors.
Two of those adjustment factors, which are included in the methodology set forth in Notice 2007–81, take into account the ratings of the bonds used to develop the daily corporate bond yield curve. The third adjustment factor, which was not included in the methodology set forth in that notice, is a hump adjustment variable that peaks at 20 years maturity and serves to capture the effects of the hump in spot rates that is often seen around 20 years maturity.
These proposed regulations generally adopt the specification for the bond data set for a month in Notice 2007–81 but modify an exclusion from that bond data set. Under Notice 2007–81 and the proposed regulations, subject to certain exclusions, the bonds that are used to construct the daily corporate bond yield curve for a business day are bonds with the following characteristics: (1) maturities longer than a 1/2 year, (2) at least two payment dates, (3) designated as corporate, (4) high quality ratings (that is, AAA, AA, or A) as of that business day from the nationally recognized statistical rating organizations, (5) at least $250 million in par amount outstanding on at least one day during the month, (6) payment of fixed nominal semiannual coupons and the principal amount at maturity, and (7) maturity not later than 30 years after that day.
Under Notice 2007–81 and these proposed regulations, the following categories of bonds are excluded from the bond data set: (1) bonds not denominated in U.S. dollars, (2) bonds not issued by U.S. corporations, (3) bonds that are capital securities (sometimes referred to as hybrid preferred stock), (4) bonds having variable coupon rates, (5) convertible bonds, (6) bonds issued by a government-sponsored enterprise (such as the Federal National Mortgage Association), (7) asset-backed bonds, (8) putable bonds, (9) bonds with sinking funds, and (10) bonds with a par amount outstanding below $250 million for the day for which the daily yield curve is constructed.
Notice 2007–81 also excluded callable bonds (unless the call feature is make-whole) from the bond data set used to construct the daily corporate bond yield curve. The proposed regulations generally retain this exclusion but narrow it. Under the proposed regulations, this exclusion does not apply if the call feature is exercisable only during the last year before maturity. This type of call feature has recently become more widely used, and the inclusion of bonds with this feature in the data set will result in a significantly larger pool of bonds that more accurately reflects the market for high quality corporate bonds.
Notice 2007-81:
https://home.treasury.gov/system/files/136/archive-documents/irsnotice200781.pdf
FRN:
https://www.federalregister.gov/d/2023-12693