Corporate pension plan sponsors often face difficult decisions associated with the management of their defined benefit plans. Many factors that determine the projected benefit obligation are out of management’s control and can cause uncertainty during the annual budgeting process. This has led corporate sponsors to consider strategies such as freezing plan participation, freezing benefit accruals, and partial or full plan termination.
Here are current trends in the major assumptions used to determine a plan’s projected benefit obligation.
Since the beginning of 2014, the Citigroup Pension Liability Index and the Moody’s Long-Term AA Corporate Bond Rates have decreased by over 100 basis points, or 1 percent. This downward trend has led to an increase in the projected benefit obligation, since an inverse relationship exists. Plan sponsors should consider formally documenting their discount rate methodology to ensure it is consistent from year-to-year.
Stock market performance
Wild stock market swings can be the largest variable for pension plans. The funded status of mature pension plans that depend on investment returns to fully cover annual benefit payments can be significantly impacted, resulting in increased required minimum contributions or possible reductions to participant benefits.
Updated mortality tables
Corporate plan sponsors may use the new mortality table (RP-2014) and mortality improvement scale (MP-2014) to calculate their liability for 2014 year-end disclosures. The tables were published by the Society of Actuaries in late October 2014 and reflect improved life expectancies, a trend that is expected to continue. Pension liabilities are expected to increase from 5 to 15 percent, depending on population demographics. Since there are several versions of the mortality tables, options should be discussed with your accountant or actuary.
Many plans have implemented some type of plan freeze related to participation, benefit accruals, or both. Plan sponsors are also wrestling with whether to partially or fully terminate their plans in order to gain more control over budgeting and financial projections. Cash-out options to vested terminated participants have increased and some plan sponsors have moved toward full plan termination, either through cash-out or annuitizing vested participant benefits. Plan terminations may take up to eighteen months and require IRS approval and participant notices. Corporate sponsors with excess cash or investments, or those that are not highly leveraged, are most likely to find the termination strategy more attractive. With the availability of today’s low interest rates, financing the plan’s termination strategy enables the entity to convert a variable liability and expense into a consistent manageable obligation.
Defined benefit plan sponsors have a fiduciary responsibility to protect vested benefits of plan participants, regardless of the current plan situation. We recommend that you discuss the issues presented above with your accountant or actuary to determine what changes to your defined benefit plan should be considered.
Information contained in this alert should not be construed as the rendering of specific accounting, tax, or other advice. Material may become outdated and anyone using this should research and update to ensure accuracy. In no event will the publisher be liable for any damages, direct, indirect, or consequential, claimed to result from use of the material contained in this alert. Readers are encouraged to consult with their advisors before making any decisions.