DB Plan Sponsors May Pay Later for Funding Relief

August 14, 2014 (PLANSPONSOR.com) – Although pension funding stabilization will ease financial constraints on defined benefit (DB) plan sponsors in the near term, it may place a heavier burden on them later.

An analysis from Towers Watson suggests minimum required contributions for DB plan sponsors will be reduced by about $69 billion for plan years 2013 to 2017 under the Highway and Transportation Funding Act signed into law by President Obama August 8. The bill extends relief provided in the Moving Ahead for Progress in the 21st Century Act (MAP-21)—passed in 2012—which allowed defined benefit plans to discount future benefit payments to a present value using a 25-year average of bond rates rather than a two-year average (see “DB Sponsors to See Extended Funding Relief”).

However, between plan years 2013 and 2021, total minimum required contributions will increase by about $32 billion, according to Towers Watson’s estimates. This reflects both the elimination of stabilization and the reduced capital accumulation in the pension plan resulting from lower contributions.

Towers Watson notes that historically, pension plan sponsors have often contributed significantly more than the required minimum. Its sample of single-employer plans contributed roughly $74 billion for 2012—$39 billion more than the required $35 billion (based on the latest Form 5500 data). The actual impact of the extension of pension interest rate smoothing is sensitive to these additional contributions.

The firm’s modeling and projections incorporated a gradual normalization process for interest rates. Considering a further 50-basis-point rise in spot interest rates relative to the baseline by the end of 2015, the legislation would still reduce pension plan funding obligations but by a smaller margin: an estimated $56 billion reduction through the 2017 plan year compared with $69 billion in the baseline.

When Towers Watson slowed the pace of interest rate normalization—50 basis points short of the mean projections by year-end 2015—it found the stabilization provided by the bill would have a larger effect: an estimated total decrease of $75 billion through 2017 versus $69 billion. “The key inference is that the Act’s impact will be weaker in an environment of faster-rising interest rates, because the general 24-month smoothed segment rates will more quickly supersede the 25-year average corridors,” Towers Watson explains. “On the contrary, if the low interest rates persist, the extension of corridors under the Act will ease funding obligations more significantly.”

Towers Watson’s article about its analysis is here.