In 2016, the stars appeared to align for defined benefit (DB) pension plans. Interest rates rose. Stock market returns were robust. Employer contributions increased.
And yet, at year’s end, aggregate plan funded status remained largely unchanged. In a 2017 report titled Pension Plan De-Risking In North America 2017, Clear Path Analysis wrote the following:
“In our analysis of 10-K statements from U.S.-based public companies with $25 million or more in domestic [pension benefit obligations], the average funded status rose only 0.2 percent, from 78 percent to 78.2 percent, all due to contributions. Without contributions, average funded status would have dropped to 77.6 percent at year-end, due to the dip in discount rates, new pension accruals, and the effect of benefit payments on the ratio for underfunded plans. A “rising-rate environment” and strong equity market returns—seemingly a dream combination— required cash layouts just for funded status not to deteriorate.”
Since 2007, when the Pension Protection Act of 2006 focused the attention of the C-suite on pension plans by compelling companies to include plans’ funded status on corporate balance sheets, U.S. pension plans have adopted de-risking strategies and offloaded billions of dollars of risk. However, volatile asset markets, increasing longevity, and a mercurial legislative environment have impeded many plan sponsors’ efforts to improve funded status.
However, volatile asset markets, increasing longevity, and a mercurial legislative environment have impeded many plan sponsors’ efforts to improve funded status.
It doesn’t appear that the challenges DB plan sponsors are encountering will disappear anytime soon, and new matters may arise. Concerns that remain top-of-mind for DB plan sponsors include:
Escalating pension benefit guarantee premiums
Congress has raised flat-rate premiums for single-employer plans by 123 percent since 2007, and variable rate premiums by 278 percent. Flat rate premiums for multi-employer plans have increased by about 250 percent over the same period. Many in the industry believe the increases have little to do with retirement security and much to do with Congress counting increased PBGC premiums as general revenue for purposes of budgetary scorekeeping.
Ignoring industry objections, the most recent Bipartisan Budget Act sharply increased PBGC premiums. For the 2017 plan year, single-employer plans will be charged a flat rate premium of $69 per participant, and underfunded plans will pay an additional variable rate premium of $34 per participant/$1,000 of unfunded vested benefits up to $517 per participant.)
Sponsors of underfunded plans will need to determine whether it’s cost-effective to employ the funding-relief mechanisms that Congress has provided to minimize annual contributions and pay higher PBGC premiums, or increase voluntary funding and pay lower PBGC premiums.
Potential reform of the tax code
There are some good reasons for plan sponsors to accelerate pension contributions. One is the pending reform of the U.S. tax code. Currently, the Internal Revenue Service allows plan sponsors to deduct a portion of pension contributions based on a company’s tax rate.
While tax reform legislation has not been finalized, one proposal would lower corporate taxes from 35 percent to 15 percent. Such a change would reduce the economic benefits of employer contributions made in the future, making it more beneficial to increase contributions at the current tax rate.
Persistently low interest rates
The persistent low-interest-rate environment has negatively affected funding status for many DB plans. By one estimate, if interest rates were to return to 2007 levels, plans’ median funded status would increase to about 110% of projected benefit obligations.
The silver lining of low interest rates is that they make borrowing an attractive option for firms with access to capital markets. So far in 2017, several large firms, including Verizon and DuPont, have announced plans to issue debt to fund voluntary pension contributions.
C-suite executives and plan fiduciaries across the country have spent countless hours deciding what should be done to de-risk their plans, and when action should be taken. If your company or clients are requesting guidance, Deloitte suggests that decision-making best practices include:
- Involving key personnel from human resources, finance, and treasury to ensure different perspectives are considered.
- Understanding the scope and materiality of the pension plan to the organization as a whole, and how these may have changed over time.
- Reviewing ongoing plan governance activities to facilitate the decision-making process around pension de-risking.
In addition, it’s critical to address the challenges that often accompany de-risking, such as having accurate plan participant data. Firms like Millennium Trust Company offer solutions for missing and non-responsive participants that may make it easier for plan sponsors to reach their risk management goals.
When you consider the current and potential risks associated with pension plans, the reasons DB plans are disappearing and 401k plans have gained popularity is clear.
Terry Dunne is Senior Vice President and Managing Director of Retirement Services at Millennium Trust Company, LLC. Dunne has over 35 years of extensive consulting experience in the financial services industry. Millennium Trust Company performs the duties of a directed custodian, and as such, does not sell investments or provide investment, legal, or tax advice.