Case study: Milliman tools communicate financial impact of PPA options

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By John B. Wukitsch | 22 December 2009

For more than 10 years, Milliman has provided actuarial and consulting services for a defined benefit retirement system. The members of the system consist of approximately 25 community banks, where each plan is considered a single-employer defined benefit plan.

Recent regulatory and accounting changes resulting from the Pension Protection Act (PPA) and Statement of Financial Accounting Standards No. 158 (FAS 158) have both provided numerous scenarios for plan sponsors to consider. Each scenario has different future funding and accounting implications for plan sponsors.

Communicating the financial impact of the new options was especially challenging for this group because of the number of plan sponsors involved and the tight timeframe in which Milliman was expected to issue reports.

A special challenge

From a cash funding perspective, the provisions of the PPA became effective with the 2008 plan year. The new regulations introduced many new concepts and required that plan sponsors now take a much more active role in the selection of several key assumptions used for determining the funding requirements for their plan.

New concepts used to determine a plan's target liability (also a new concept under the PPA) include segment rates, with or without transition, and a yield-curve basis. Plan sponsors also now have the ability to use a look-back period in the selection of the assumption for valuing plan liabilities. Plan assets may now be smoothed or valued at market value.

Another new area of focus for plan sponsors is the overall funding level of their plans and whether benefit restrictions might impact future benefit accruals or certain payment options.

From an accounting perspective, additional provisions of FAS 158 also became effective in 2008, primarily the elimination of the "three-month look-back rule" used to measure a plan's assets and obligations. Under the prior rule, a plan sponsor was permitted to measure plan assets and obligations as of any date that was not more than three months prior to the sponsor’s fiscal year end, as long as the measurement date was used consistently from year to year. Plan sponsors using the "three-month rule" were now required to transition their measurement date to coincide with their fiscal year using one of two transitional methods.

In addition to the sweeping regulatory changes and changes in accounting requirements, plan sponsors also experienced extreme market volatility and extreme volatility in the various liability indexes in 2008. This made it very difficult to monitor year-end results and project budgets for 2009.

All of these regulatory and accounting changes, economic conditions, and client expectations combined to make 2008 a very challenging year. All 25 plan sponsors expected us to:

  • Quickly and accurately measure the impact of various decisions regarding funding assumption options
  • Present and discuss the results of our analysis
  • Obtain appropriate plan sponsor elections
  • Issue required funding certifications (Adjusted Funding Target Attainment Percentage certification) and actuarial valuation reports within three months
  • Assess the impact of the FAS 158 measurement date transition options
  • Determine the impact of additional contributions on year-end financial disclosures
  • Issue FAS 158 year end disclosures and subsequent year expense within seven business days after the fiscal year end

The solution

In order to help each member bank make an informed decision, we needed to develop several tools that would quickly assess the impact of each decision required by the plan sponsor. In 2007, we had reviewed each plan for the PPA and issued PPA compliance reports. Therefore, we had an overall blueprint for each plan and plan sponsors had a basic understanding of potential PPA issues that might impact their plans. We had also been in contact with each bank throughout the year so they had an expectation of the decisions that would be required at the end of the year.

The tools that we developed allowed us to present timely, customized reports (for each member bank) that showed the impact of the various funding options that required a plan sponsor election.

We worked with each member bank to help ensure that they understand the available alternatives and financial implications for their plans. We developed a similar tool to assess the impact (for each bank) of the change in the measurement date under the two transitional methods permitted under FAS 158, and provided an estimate of 2009 Net Periodic Pension Cost. Finally, our tools allowed us to quickly assess the funding and financial impact of making additional contributions by December 31.

The outcome

The goals for most of the member banks were very similar:

  • They wanted to reduce volatility (to the extent possible), so the majority chose the segment rate option (no transition) over the yield curve option.
  • They wanted to improve the funded status, so most made additional pension contributions.
  • The were able to:
  • Improve the funded status of their plan at year end
  • Reduce the impact of negative 2008 market performance on financial statements
  • Lower their 2009 Net Periodic Pension Cost

Milliman consultants were able to meet member bank expectations and provide the financial information that they needed to make informed decisions that aligned with their goals.

Future plan years will present additional challenges; however, the tools that we have developed will allow us to quickly asses the financial impact of various plan sponsor options.