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Click to edit Master title style,Click to edit Master text styles,Second level,Third level,*,Pension Funding Targets and Strategies,Brian Donohue,Chicago Consulting Actuaries,Jerry Mingione,Towers Perrin,May 12,2004,Historyof Funding Rules,In the beginningoftime(post-ERISA),.,actuaries had considerable control overtheassumptions,andmethodsusedfordeterminingfundingrequirements.,Financial assumptions were set to bereasonableon along-term basis.,Actuarial methods were selected,essentiallyright fromthetextbook,withconsiderablefreedom.,Unfundedliabilitieswere fundedover 10-30yearperiods,basedon levelpayments.,Historyof Funding Rules,Thenthingschangedlegislatively.,In 1987,OBRA institutedtheconceptofcurrentliability,in orderto bringa solvency/terminationbasis perspective tofundingrequirements(and tax deductionallowances).,Basically,planswere required to maintain afundinglevel of 90%ofcurrentliability.,If theyfellbelow thislevel,theywould berequired tocontributeadditional amounts to recover theirfunded positionover(essentially)3-5 years.,Currentliability-basedfundingrequirementswere made morestringent in1994:,maximumCL interestratereducedfrom 110%to 105%,updatedmortality table,increased required funding%,s for deficit reductioncontributions.,Historyof Funding Rules,Andcapitalmarket changes upsetthedynamics.,Initially interest rateswere high enough that the termination basiscalculations did not override the long-termfundingbasis thatplans had traditionallyusedforfunding.,Theninterest ratesdeclinedinthe90s,asdidequitymarketsin the earlyyears of this decade creatingthedoomsday scenario for pension plans.,Actuary-setlongterm-basedfinancial assumptions did not reactmuch.,Thus,the dynamics of pension funding requirements changed dramatically.,Treasurycutback the issuance of 30-year bondsin 1998,andthen eliminatedthem entirely in 2001.,Yields on 30-year T-bonds declined and the credit spreadwidened.,It became apparent thata legislative remedywasrequired.,Temporary reliefwasgrantedfor2002-2003 by raising the interest ratecapto 120%.,CurrentSituation,Lets compare assumptions inthelate 1980svs.today:,*,Potentiallyincreases toabout 6.4%withinterest rate relief.,1988,2004,averagecontribution,interestrate,8.4%,8.3%,30-yearTreasuryyield,9.0%,5.1%,maximumcurrent,liability rate,10.1%,5.5%*,CurrentSituation,Here,s whatthose changes implyin termsofvaluation results and,contributionrequirements:,1988,2004,2004,withoutrelief,withrelief,valuation interest rate,8.4%,8.3%,8.3%,currentliability rate,10.1%,5.5%,6.4%,AALfunded ratio,84%,83%,83%,CL funded ratio,115%,73%,81%,regularminimum,$47.3,$49.2,$49.2,addtl.funding charge,0.0,75.6,34.7,minimumwithDRC,124.9,83.9,CurrentSituation,Thetypicalpensionplantoday has acurrentliability funded,status in the rangeof 80-90%.Many,ofcourse,arewell,below this level.,Contributionrequirements tend to spikedramaticallyasfunded levels fall below90%.,However,contribution requirements in most caseslagemerging financialexperience by roughly 2-3 years,duetotheeffectsof:,volatility relief,four-year averagingof interestrates,asset smoothing,allowable contribution timing delays.,CurrentSituation,Plansponsors have typicallynotbeen proactivein addressing their,declining fundedpositions with afewnotableexceptions.,Why?,Theycountedonsmoothing toavoid the worsteffectsofthecapitalmarket situation,and that the capital market situationwould improve over time.,Theycountedonlegislated solutionstomitigatecontribution requirements.,Theimplicationsinterms offuturecontributionrequirements were not always made clear.,Thenumber of alternative funding measures madeit hardto monitor results and determine/prioritizefundingtargets.,LessonsLearned,Poorly funded plansentail anumberof adverse,consequences,inaddition tospikesin future,contributionrequirements:,quarterly contribution requirements,PBGCvariable premiums,participantnoticesre underfunding,PBGCunderfunding notice,additional minimum liability/chargestoshareholderequity.,LessonsLearned,Recent experience has exposed aneedtobetter monitor,CL funding,andpotentiallyadjust funding overtimesoas,to maintaina targetfundinglevel:,60%to avoidrestrictions onbenefitimprovements,80%/90%to avoid additionalfundingcharge+participantnotice,100%toavoidquarterly contributions.,110%toavoidlump sum restrictionsto top25.,125%toallowsection420 transfersto fund retiree medical benefits(based on OBRACL).,LessonsLearned,Other possiblefunding targets:,FFL toavoid variablepremium,ABO toavoid additional balance sheet liability.,LessonsLearned,While 2003 results were strong,they weren,t a panacea.,Plan sponsorsstill have theafter-effectsof smoothingmethodologiesto dealwith.,Most plans nowrealize thata minimum funding strategy is not optimal.,There is alsoconsiderable legislative uncertainty remaining:,short-term interest rate andDRC-related relief,long-term funding reform.,Proactive Strategies,Push back quarterly contributions,requires,minor,acceleration of contributiontiming,improves CL funded%,reducesPBG
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