Employer Contributions Aid in DB Plan Funding Progress

An analysis from the Society of Actuaries suggests the majority of defined benefit (DB) plan sponsors are doing a good job of making contributions that help reduce unfunded liabilities.

The study compares employer contributions to single-employer DB plans to benchmarks for measuring whether pension plan contributions—absent other influences—reduced unfunded liabilities or met other benchmarks, such as regulatory requirements. The study considers five benchmarks that represent the contribution needed to:

• Satisfy the minimum required contribution (MRC) as defined by Internal Revenue Code Section 430 after reflecting all allowable offsets;
• Reduce the unfunded liability (normal cost plus interest on the unfunded liability) using smoothed discount rates allowed by current law; contributions must exceed this level to reduce the unfunded liability;
• Eliminate the unfunded liability in seven years (normal cost plus seven-year amortization of the unfunded liability) using smoothed discount rates allowed by current law;
• Reduce the unfunded liability using unsmoothed discount rates; and
• Eliminate the unfunded liability in seven years using unsmoothed discount rates.

Lisa Schilling, retirement research actuary with the Society of Actuaries in Schaumburg, Illinois, and co-author of the study report, tells PLANSPONSOR the results show plans are doing well as far as funding. More than 70% do not have unfunded liabilities. In 2016, 27% of plan liabilities were in plans that had an unfunded liability when computed with the smoothed discount rates allowed under federal law. She notes that because a lot of plans do not have an unfunded liability, the do not have an MRC.

The study found only 21% of plan liabilities were associated with plans that had a 2016 MRC under federal law. Of the 21%, more than 20% was attributable to plans that contributed at least as much as the MRC, and less than 1% was associated with plans that contributed less than the MRC.

Of the 27% of plan liabilities associated with plans that had an unfunded liability in 2016, 16% (or nearly six in 10) is attributable to plans that contributed enough to reduce their unfunded liabilities, while 11% fell short.

When assessed using a seven-year funding pace, of the 27% of plan liabilities that had a benchmark, about 13% (nearly half) is from plans with contributions that exceeded their benchmarks and the remaining 14% is from plans that fell short.

Using unsmoothed rates, 78% of liabilities in 2016 were associated with plans with an unfunded liability. The 78% was split between about 32% of liabilities associated with plans whose contributions exceeded their benchmarks for reducing their unfunded liability and 46% of liabilities associated with plans whose contributions fell short of preventing their unfunded liability from growing. In addition, the 78% was split between about 23% of liabilities attributable to plans that contributed enough to eliminate their unfunded liability within seven years and 55% of liabilities associated with plans that fell short of the seven-year funding pace benchmark.

The report points out that the smoothed interest rates allowed under current law are averaged over 25 years. During the period studied (2009–2016 plan years) and the 25 preceding years, interest rates were generally falling. During economic periods of generally falling interest rates, averaging historical interest rates to compute a rate for discounting liabilities results in a discount rate that is higher than the current market rate. When averaging over a period of generally rising interest rates, the opposite would be true. All else equal, higher discount rates produce lesser liabilities, hence lesser unfunded liabilities.

“Single-employer DB plans in general are in good shape and heading in right direction in terms of funding progress,” Shilling says.