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A new law that allows employers to use more stable projected interest rates when calculating pension-funding levels may save them millions of dollars.
Jeff Mamorsky, CFO.com | US
August 13, 2012
CFOs rejoice! Congress has given you an early Christmas present, in the form of legislation known as "Moving Ahead for Progress in the 21st Century" (MAP-21). The law permits employers that sponsor defined-benefit plans to decrease required contributions and improve plan funding attainment percentages (AFTAP) by using "stabilized" interest-rate assumptions for funding calculations over the next few years.
Interest rates have declined significantly since last year, so without the new law employers would be facing significant increases in projected contributions during the next five years. MAP-21 provides relief in reducing near-term contributions. It changes interest-rate assumptions used for funding calculations by taking into account average interest rates over the most recent 25 years (a higher rate on average) rather than rates drawn entirely from the most recent 24-month period, which was the rule prior to the new legislation.
The funding-relief provisions will provide substantial reductions in required contributions for 2012 and 2013 for most employer-plan sponsors, and declining reductions for a few years after that depending on trends in corporate-bond yields. Provisions of the new law will also help some plan sponsors avoid AFTAP benefit restrictions during those years.
It is estimated that the 2012 effective interest rate (EIR) for valuation purposes will be 125 to 150 basis points higher than without MAP-21, which will result in a much lower minimum required contribution for the 2012 plan year. It is estimated that in 2013, the EIR will be 100-plus basis points higher than pre-MAP-21. In future years, the effect of MAP-21 on interest rates will decline and then disappear.
For example, one large pension plan (assets of approximately $700 million) that this author is familiar with would have faced significant increases in contributions in the coming years ($100 million over five years). However, as a result of MAP-21, the plan's funding valuation discount rate was increased from 5.45% to 6.76% (an upward adjustment of 131 basis points).
An actuarial rule of thumb is that when you change the funding valuation discount rate by 1%, a pension plan's liability drops by approximately 10%. Accordingly, in the case of a pension plan with $700 million in assets, an upward adjustment of 131 basis points in the funding valuation rate would decrease the plan's liability by more than $100 million. That has a dramatic impact on an employer's required contribution, as can be seen by the forecast below of required contributions for this $700 million plan:
As you can see, the required contributions are lower by $182.6 million over five years. That is incredibly good news for employers suffering with a poor economy, limited cash flow, and a low-interest-rate environment. However, unless interest rates trend out to a more normal level, it is devastating for the proper and prudent funding of pension plans. Accordingly, employers concerned about the future stability of their plan may not want to take advantage of the full reduction of contributions resulting from the new law and rather may pass only a portion of the reduction (e.g., "split the difference") in contributions such that the projected funded status of the plan is not lowered.
Not All Good News
The pension-plan funding relief provided by MAP-21 has been diminished somewhat by significant increases in future annual PBGC premiums. For 2012 the current per-person annual premium for a single employer is $35, which will increase to $42 for 2013 and $49 in 2014, with indexing thereafter.
In addition, variable-rate PBGC premiums for unfunded vested benefits will be indexed for inflation after 2012, from $9 per $1,000 of underfunding for 2012 to at least $13 per $1,000 of underfunding for 2014 and at least $18 per $1,000 of underfunding for 2015. The exact increases will depend on interim inflation adjustments. However, a new cap will limit the per-participant variable-rate premium to $400 starting in 2013, with the cap to be adjusted for inflation after 2013.