Case study: Addressing funding issues caused by a stock market downturn

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By Jeffrey R. Kamenir | 19 January 2010

The challenge

An organization (see below 4/14/2008 Case Study) had carefully developed a funding policy under the new Pension Protection Act (PPA) funding rules. However, the plan suffered tremendous losses during 2008 related to the stock market downturn. The asset return for the plan during 2008 was negative 23%. The organization now needed to adjust its funding policy to address the severe asset losses while at the same time maintaining its long-term goals of continuing to offer a plan with ongoing benefit accruals and having affordable level annual contributions. The organization also wanted to meet certain PPA funding targets to avoid undesirable short-term consequences.

The Milliman strategy

Milliman prepared a new long-term cost projection based on an eventual higher required annual level contribution amount that the organization indicated it could afford. Due to current business issues, the organization could not afford to increase annual contribution levels until mid-2010.

Milliman also incorporated into the analysis recent IRS guidance applicable to 2009 designed to provide plan sponsors with short-term funding relief. The relief included an option to change to a three-year asset smoothing method to defer full recognition of the severe 2008 asset losses until 2011 and an option to change to a higher but potentially more volatile interest rate assumption (from blended rate of 6.50% to blended rate of 8.17%) to value plan liabilities. The 8.17% rate was an extremely unusual, one-time event, and the organization understood that that there was some risk in electing the higher liability interest rate assumption for 2009 because the IRS had not indicated if plans could change back to a more stable interest rate assumption for 2010.

Without adoption of the IRS funding relief options for 2009, the plan's "credit balance" would have been depleted in order to satisfy 2009 minimum funding requirements. The plan also would have needed to keep its funded ratio above 70% in order to avoid freezing benefit accruals in 2010. A credit balance is established based on contributions greater than minimum funding requirements in prior years and can be used instead of cash to meet future contribution requirements. The organization desired to maintain its credit balance to provide some margin in the event of possible future poor investment performance.

The outcome

The organization elected both forms of IRS funding relief, which resulted in the plan not having short-term problems related to depletion of its credit balance and the possibility of a plan freeze. The organization will increase annual funding from $1.4 million to $2 million beginning in 2011, with a transition to higher funding in 2010. Late in 2009, the IRS announced that it would allow plans to change back to the more stable interest rate assumption for valuing liabilities in 2010 and the organization is planning on making this change.

The resulting adjusted estimated pattern of contributions is as follows:

Table 1
Level Annual Contribution
Plan Year*
Funded Percentage**
$ 1,400,000

$ 1,400,000

$ 700,000

$ 1,050,000

$ 1,700,000

$ 2,000,000

$ 2,000,000

$ 2,000,000

$ 2,000,000

* Contributions must be deposited by September 15 of subsequent plan year.

** Determined as of January 1 of subsequent plan year. Funded percentage shown is equal to market assets over liabilities. Funded percentage results as of January 1, 2009, reflect one-year IRS allowable change to higher interest rate assumption for valuing liabilities. Funded percentage results as of January 1, 2010, assume a 0% investment return for 2009. Funded percentage results for all later dates assume a 7.5%/year investment return.

*** $700,000 of contributions originally scheduled to be allocated to the 2008 plan year were allocated to the 2009 plan year. $1,050,000 of contributions originally scheduled to be allocated to the 2009 plan year will be allocated to the 2010 plan year.