Pension Funding Reform Rationale and Financial Implications

1
Pension Funding Reform Rationale and Financial
Implications

• Jerry Mingione
• Enrolled Actuaries Meeting
• March 27, 2006

2
Plan 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
4
Putting 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.
5
Are 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.
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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
8
What 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

9
Will 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.