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Help DB Plan Clients See How Funding Affects Bottom Line

Putting more into pensions cuts into plan sponsors' operating cash, which should be considered for their DB funding and investment strategies.

By Rebecca Moore | August 28, 2017
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Methods for reducing underfunded defined benefit (DB) plans should be looked at holistically, not in a vacuum, and they should be considered within a corporate financial context to avoid negative surprises to a company’s executive team, board of directors and shareholders, according to a white paper from Northern Trust Asset Management.

How DB Plans Got Here 

Most corporate pensions have yet to recover to the funded levels they had before the 2008 financial crisis even though the market has done well because low interest rates have caused them to remain significantly underfunded. Northern Trust’s analysis of the 340 companies in the S&P 500 with pension obligations at the end of 2016 found the average asset value increased from $3.4 billion in 2008 to $4.9 billion in 2016 (44% growth).  However, in 2008 average liabilities were $4.3 billion and in 2016 liabilities were $6.1 billion (42% growth)—almost the same growth rate.

The reason for the growth in liabilities is partially due to participant accruals, but the primary cause is the drop in interest rates used to determine pension liabilities from 2008 to 2016 from 6.25% to 3.61%. Northern Trust explains that pension liabilities are determined by discounting expected benefit payments using the interest rate in effect, so as the interest rate drops, the liability climbs.

In 2012, the Moving Ahead for Progress in the 21st Century Act (MAP-21) changed the corridor of interest rates that could be used to calculate funded ratios. In 2014, the Highway and Transportation Funding Act (HATFA) extended provisions of MAP-21. And, finally, in 2015, the Bipartisan Budget Act further extended MAP-21 provisions, but it also increased Pension Benefit Guaranty Corporation (PGBC) premiums.

Segal Consulting Retirement Practice Leader Stewart Lawrence, based in New York City, says funding relief helped a little. “The first time it created a corridor, it did a lot of good for mitigating large increases in employer [contributions]. The second time was not as good but helped mitigate the volatility of contributions,” he explains.

According to Northern Trust, some DB plan sponsors have been waiting for higher interest rates to no avail. Dan Kutliroff, head of Solutions Strategy at Northern Trust Asset Management in Chicago, and co-author of the white paper, says, “We expect [interest rates] to rise slightly, but not to the point of helping underfunding.”

NEXT: Increasing Contributions and the Effect on the Bottom Line