Over the past couple of weeks we’ve been previewing some issues that pension plan sponsors may encounter during 2011 (e.g., increases in Annual Funding Notice liabilities and PBGC variable rate premium increases). This post highlights several items that plan sponsors should be aware of as they gear up for their 2011 pension funding valuations. These changes, which could increase minimum required contributions, include:
– Funding segment interest rates. As mentioned in our previous posts, the current low interest rate environment is making life difficult for many pension plan sponsors. PPA funding segment rates are following the downward trend, and lower interest rates will cause higher liabilities and larger minimum funding requirements.
For example, the PPA funding segment rates at January 2010 were 4.60%, 6.65%, and 6.76%, while the January 2011 rates are 2.94%, 5.82%, and 6.46%. Since the largest decrease is in the first two segments, this means that the liabilities for mature pension plans (i.e., significant benefits payable within the next 20 years) will be most affected. Fortunately, the discounting period over which the lowest interest rates occur is fairly short.
– End of transition period for determining shortfall amortization liability. One component of the minimum required contribution under PPA is an amortization of a plan’s unfunded accrued liability. For the past several years, this amortization has reflected a transition factor (e.g., 94% in 2009, 96% in 2010) to lessen the funding burden. In 2011 this transition is complete and the factor jumps to 100%. This could surprise some plan sponsors by increasing the minimum required contribution more than expected.
Consider the following rough example for a frozen plan where there is a large contribution increase even though the actual funded status of the plan improves slightly. The contribution increase would be much lower if the transition factor remained at 96% in 2011.
End of “At-Risk” determination transition. Under PPA rules, an “At-Risk” pension plan faces accelerated funding requirements (i.e., higher minimum required contributions). A plan is “At-Risk” if it meets the following criteria:
1. More than 500 DB plan participants;
2. At the prior valuation date, the plan’s funded percent (assets minus credit balances, divided by not-at-risk funding target liability) is less than 80%; and
3. At the prior valuation date, the plan’s at-risk funded percent (assets minus credit balances, divided by at-risk funding target liability) is less than 70%.
Criteria #2 had a four-year transition period that is now fully phased-in at 80% for 2011. Thus, plan sponsors may now have additional funding requirements when they fall below 80% funded, in addition to mandated benefit restrictions
The funding news in 2011 isn’t all bad, however. Two factors could alleviate some funding burdens.
– Strong asset returns in 2010. Many pension plans experienced solid asset returns in 2010 which should improve their funded status and decrease their minimum funding requirements.
– Funding relief options. As mentioned in previous posts, funding relief legislation was passed in 2010 which should temporarily ease pension funding strains. However, there are strings attached to the funding relief, and it delays but does not eliminate PPA’s full funding requirements. Nevertheless, it could be a viable option for cash-strapped pension plan sponsors.
In order to adequately prepare for an increase in pension contributions, we recommend that plan sponsors contact their actuary early in the year to discuss how these funding considerations may affect your plan and options for mitigating their impact.