As pension plan administrators wrestled with the new funding mandates and the mark-to-market requirements imposed by the Pension Protection Act (PPA), the bottom dropped out of the financial markets, pummeling asset returns. As a result, many employers froze existing plans and adjusted asset allocations on the fly.
Now that officials have granted employers a brief reprieve from PPA funding mandates and the financial markets have rebounded from their 2008 lows, embattled plan administrators have a brief window of opportunity to revisit the fundamentals and craft a comprehensive pension strategy that reduces volatility and risk and increases asset levels to meet future funding targets.
“Although the calamity has abated to some degree, the risk of market volatility persists, the government has not backed away from its original funding targets and current investment strategies may not be appropriate for a post-PPA world,” says Pete Neuwirth, senior consultant for the retirement practice at Watson Wyatt Worldwide. “Employers should use this time to prepare for future crises.”
Smart Business spoke to Neuwirth about the challenges facing employers offering defined benefit pension plans and the elements they should revisit during this brief respite.
How can employers mitigate escalating pension costs?
Many employers have opted to pay the least amount possible into their plans, without considering how those decisions might impact required contributions down the road. This strategy may ease short-term cash flow, but even companies with currently well funded or frozen plans need to manage their risks. If assets are currently sufficient, plan liabilities will still likely grow faster than assets as future benefits accrue, and even for frozen plans, the value of accrued benefits will continue to grow as employees near retirement. Since the ultimate cost of a pension plan is the cost of benefits paid minus investment income and contributions, the best ways to mitigate increasing costs are through plan redesign and improved asset performance. Employers should use this breathing space to reassess their liabilities and asset allocations to reduce income volatility and control costs.
How has PPA impacted funding policies?
PPA drives employers toward 100 percent funding for pension liabilities and most have been well below that target. This means that many employers will have to pay normal costs plus a seven-year amortization payment on any unfunded liability. Additionally, PPA curtails an employer’s ability to pay more in good years and draw against those credit balances in bad times. When reviewing existing funding policies, employers need to know their funding target date and be cognizant of credit balances, so they can make informed decisions on whether and when to use or give them up. On the positive side, PPA gives employers some limited flexibility to use spot market rates or 24 month average rates in their funding assumptions, but those decisions need to be calibrated with the company’s investment strategy, because each option has advantages and disadvantages and one solution will not fit all.