DB Plan Sponsors Using Different Strategies for Cost, Funding Measures

PwC finds some DB plan sponsors are using multiple discount rates, and some have moved to mark-to-market accounting.

For defined benefit (DB) plans included in a PwC study, the 2016 median discount rate decreased 20 basis points since 2015 (from 4.30% to 4.10%) and has decreased more than two full percentage points since 2007 (from 6.25%), reflecting the low interest rate environment of the past decade.

PwC’s Pension/OPEB 2017 Assumption and Disclosure Study, which represents an analysis of the 2016 year-end assumptions and disclosures of DB plans and analyzed data for 100 companies, comprising Fortune 100 and other large and established companies with a December 31 fiscal year-end, also found the 2016 median expected long-term rate of return on pension plan assets decreased 25 basis points since 2015 (from 7.25% to 7.00%) and 130 basis points since 2007 (from 8.30%), reflecting less optimistic capital markets outlooks of investment professionals.

The 2016 median salary scale assumption decreased 17 basis points since 2015 (from 3.97% to 3.80%) and has decreased 45 basis points since 2007 (from 4.25%).

Median plan funding levels remained unchanged from 2015, with pension plan assets equal to approximately 82% of the projected benefit obligation (PBO) in 2016 and 2015. In 2007, the median funded ratio was 100%. If interest rates were to return to 2007 levels, PwC estimates the median funded ratio would increase to roughly 110%.

Median deferred losses for pension plans in the study remained unchanged at 33% of the projected benefit obligation at the end of both 2015 and 2016. Of the 89 companies that defer recognition of gains/losses, 87 were in a loss position at 12/31/2016.

Median 2016 asset allocations for pension plans in the study were generally consistent with 2015 allocations at 40% equity, 39% debt/fixed income, and 16% other in 2016, compared to 39% equity, 40% debt/fixed income, and 15% other in 2015. In 2007, the median values were 64% equity, 29% debt/fixed income, and 5% other.

NEXT: Changing trends in DB plan measurements

According to the study report, until recently, most companies used a single discount rate approach—a single weighted average discount rate determined from measurement of the projected benefit obligation was also used to measure the interest cost and service cost components of benefit cost. However, beginning in 2015, many companies adopted an alternative approach, with separate measurement of the projected benefit obligation, interest cost, and service cost. Under this approach, individual spot rates from a yield curve are matched with the respective future cash flows. This results in different weighted average discount rates for the projected benefit obligation, interest cost and service cost.

Of the 100 companies in the study, 36 disclosed adopting a multiple discount rate method at year-end 2016, an increase from year-end 2015 when 25 companies disclosed using such method.

PwC says another key component of net benefit cost is the gain or loss resulting from changes in assumptions or actual experience different from assumptions (for example, mortality, returns on plan assets, discount rates). Most companies defer recognition of these gains and losses through accumulated other comprehensive income and amortize them to income over future periods.

However, PwC found over the last few years, some companies have elected instead to immediately recognize these gains and losses in income (sometimes referred to as a mark-to-market approach). Of the 100 study companies, eight disclosed using a full mark-to-market approach, in which all gains or losses are recognized in income in the year they occur. Further, three companies disclosed using a partial mark-to-market approach, in which gains or losses only in excess of a corridor (10% of the greater of beginning of year PBO and asset values) are recognized immediately. The number of companies using a mark-to-market approach is consistent with the prior year.

The study also found the number of companies that had frozen their funded pension plans has been increasing each year. Based on information disclosed in the study data collected, in 2007 only one company had disclosed a frozen plan or plans, compared to 20 companies in 2015 and 21 companies in 2016. PwC concedes that these numbers may be understated, since for some companies in the study it was unable to determine based on their disclosures whether the company had frozen one or more pension plans.