Case study: PPA poses pension funding challenge

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By Bret Linton | 22 December 2009

The challenge

The Pension Protection Act of 2006 (PPA) incorporated the most sweeping changes to the retirement arena since ERISA was enacted in 1974. Among those changes was a revamp of the funding requirements for qualified defined benefit pension plans.

At first, it seemed that PPA did not allow for many different funding policies for pension plans. However, while PPA did standardize the funding requirements, there still remain several different and important funding options that an employer may choose to meet its business needs. In addition, special funding relief was provided in 2009 by the IRS through Notices and the Worker, Retiree, and Employer Recovery Act of 2009 (WRERA). This funding relief gave plan sponsors a one-time election to change the asset and interest rate methodologies for valuing their pension plans, with automatic IRS approval.

This presented a good opportunity for our clients to choose a funding policy that best suited their business needs. One such example was a new client for Milliman. We were awarded the actuarial work for this client starting with the 2009 valuations. As part of transitioning the work, we were tasked with determining the final contribution for the 2008 plan year. Our client wanted to make a 2008 plan year contribution sufficient enough to fund its pension plans to 80%. Initially, the client decided to smooth assets and use 24-month average segment interest rates to value its plans. In order to determine the final 2008 contribution and help the client get the most out of its contribution, we developed a series of funding scenarios for it to consider.

The solution

Our first task was to help our client understand its funding options and the impact of any decisions. We developed five funding scenarios that we thought may be of most interest. The funding scenarios highlighted additional ramifications for the client to consider. The chart below displays the following five funding scenarios based on different combinations of asset and interest rate methodologies:

  • Base Case: Market Value of Assets and Segment Interest Rates
  • Scenario 1: Asset Smoothing and Segment Interest Rates
  • Scenario 2: Market Value of Assets and Yield Curve
  • Scenario 3: Smoothed Value of Assets and Yield Curve Rates
  • Scenario 4: Scenario 3 and Funding to 94%

Funding scenario details

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Again, its initial goal was to be 80% funded under any scenario.

The outcome

Each scenario allowed our client the opportunity to fund up to at least 80%. With each scenario, the final contribution varied in amount. We added Scenario 4 because it provided additional mileage given the size of the possible contribution the client was already considering. Ultimately, it saw that funding a similar level of contribution but selecting yield curve rates along with smoothed asset values allowed it to exceed the 94% funding threshold. This was of great interest because it provided many other benefits.

It was a clear decision for our client to fund based on Scenario 4, which provided the following additional advantages:

  • $600,000 savings in variable rate premiums paid to the PBGC
  • Ability to defer the AFTAP certification until September of 2010 (versus April 2010) without possibly triggering benefit restrictions
  • Preserve carryover balance to meet future funding requirements
  • Establish prefunding balance from excess contributions, if desired
  • Avoid a seven-year funding shortfall amortization by having a funding ratio of more than 94%

This is just one example of how understanding different funding scenarios can help an employer make the right decision. Pension funding rules and funding options are complex. Even more complex can be the ramifications of selecting a certain funding option. There are many different funding scenarios still available with PPA. By working closely with actuaries, clients can learn how to make the right funding decisions to meet their business needs.