Title: Pension Funding Reform Rationale and Financial Implications
1Pension Funding Reform Rationale and Financial
Implications
- Jerry Mingione
- Enrolled Actuaries Meeting
- March 27, 2006
2Plan Sponsors Would Like Maximum Contribution
Flexibility
- But plan sponsor decisions have entailed social
costs. - Business conditions change and organizations go
bankrupt. - Liability commitments are passed on to the PBGC
and then through to other plan sponsors. - Plan participants may forego benefits.
Thus, some restrictions on plan sponsors
contribution policy options seem necessary.
3 Range of Possible Contribution Policy
Outcomes
Always Fully Funded
Benefit Security
Range of Current And Proposed Funding
Requirements
Pay As You Go
Constraints on Contribution Policy
4Putting Pension Financial Commitments in
Perspective
Average for 78 Fortune 100
Average for 10 Fortune 100
Companies
Companies
Contributions Paid
440 million
904 million
- as of Operating Cash Flow
10
13
ABO
10.8 billion
34.4 billion
Unfunded ABO
0.6 billion
2.4 billion
- of Operating Cash Flow
14
34
- of Book Value
2
17
Add 10 to ABO
- of Operating Cash Flow
25
50
- of Book Value
4
25
Notes
- Companies included are those with defined
benefit pension plans.
- Information is from 2004 annual reports.
5Are Current Funding Requirements Effective?
- Two-tier approach multiple funding
targets to manage. - Deficit reduction triggers and contribution
amounts are inconsistent - 80/90 triggers vs. 100 funding target.
- The result is that plan sponsors essentially have
three (or more) funding targets to manage - and, none of these reflect a true solvency
measure.
Bottom High Contribution Volatility Line
Inadequate Benefit Security
6 How Alternative Funding Requirements Perform
Funding Reform
"Workable Balance"
Proposal
Current Rules
No Smoothing
3-Year Smoothing
Contributions
7.2
9.7
9.7
9.0
Average over time
10-90 percentile range
0 - 20
0 - 20
0 - 19
0 - 17
Probability of exceeding
10
11
7
5
20 of payroll
Funded Levels
90
104
104
99
Average over time
10-90 percentile range
72 - 112
85 - 122
85 - 125
81 - 121
Probability of falling
28
8
10
12
below 80
Assumptions - Reflects requirements after
transition period - Minimum contributions paid
each year - No initial credit balance.
7 An Efficient Frontier for Funding Reform
Options
Always Fully Funded
Current rules No smoothing approach 3-year
smoothing approach Workable balance approach
Benefit Security
Pay As You Go
Contribution Level and Volatility
8What Might Effective Contribution Requirements
Entail?
- A target set at the solvency level, on a basis
that reflects - market values
- A reasonable period to reach the funding target
- Two-sided amortization (gains/losses treated
equally) - Some degree of smoothing (sufficient to decouple
- funding requirements from the business cycle)
- Contribution flexibility over time
- Effective utilization of any surplus assets that
may arise
9Will Defined Benefit Plans Survive?
- A plan sponsors decision to maintain a defined
benefit plan is based on economic factors - perceived value to the employer and employees
- expected cost, cost volatility and linkage to
business cycles. - The costs and benefits of plan sponsorship must
be balanced effectively - or, sponsors will find other more effective
vehicles through which to compensate their
employees.