The Pension Protection Act of 2006 (PPA) defined specifically how defined benefit (DB) plans should measure funded status—using high-quality corporate bond interest rates and a specific mortality table. It also prescribed a calculation for minimum required contributions each year, and plan sponsors had seven years to get their plans fully funded.
However, since the passage of the PPA, there have been six efforts to give funding relief to DB plan sponsors.
Currently, funding relief is available until 2020. What happens if no further funding relief is provided?
Jodan Ledford, head of U.S. Solutions at Legal & General Investment Management America (LGIMA), who is based in Chicago, notes that while some DB plan sponsors are using the funding relief, there are several factors which may impact their funding strategies: an increase in Pension Benefit Guaranty Corporation (PBGC) premiums that will cost less-funded plans more; recording deficits on their balance sheets; and the potential that funding more offers more tax relief on the heels of potential corporate income tax relief.
For those that use funding relief, assuming the interest rate environment will stay the same their discount rate could fall as much as 1.5%, Ledford says. Considering a duration of 12 or 13 years, they could see a 19% increase in funding liability, and conceivably will have to contribute more to their plans annually as a result.
John Lowell, partner and retirement actuary with October Three, who is based in Atlanta, notes that in 2012, $100 billion was contributed to DB plans—that was before passage of the Highway and Transportation Funding Act (HAFTA). Over the last few years that’s decreased to as low as $44 billion. Lowell says October Three’s projections are, that in 2020, plan sponsors may need to make contributions of $150 billion, even given the number of plans that are frozen. “Not necessarily a rule of thumb, but in aggregate, DB plan sponsors are looking at contributions 50% higher than before HAFTA,” he says.
While Ledford and Lowell both concede there is no way to project what will happen in the stock and bond market, they don’t anticipate that higher interest rates and positive investment returns will mitigate the effect on losing DB funding relief. According to Ledford, if interest rates rise to closer to the 25-year average, they would be harmonizing to the relief provided anyway.
Lowell says higher interest rates and positive returns may dampen the effects of losing funding relief, but that said, “How much do we really think interest rates will go up between now and then?” he queries. He speculates that interest rates will not get to the point they were pre-funding relief. In addition, he says, if investment returns are large enough, it could help, but many think the market is overvalued right now and we won’t see those returns in the future. NEXT: What should DB plan sponsors do?