DB Sponsors Should Consider Borrowing to Fund Contributions

November 21, 2012 (PLANSPONSOR.com) - Choosing to accelerate plan contributions, financed through borrowing, could benefit many defined benefit (DB) plan sponsors.

A research paper from Towers Watson contends borrowing to fund can lessen the risk of near-term interest rate movements and provide more security for sponsors during the continued turbulence of global financial markets. In addition, taking action now to reduce risk exposure can alleviate some of the worry about future volatility and allow sponsors to focus more attention on their core business operations.  

Many plan sponsors are looking to manage plan costs, and the idea of accelerating cash contributions may seem counterintuitive, especially with the passage of funding relief (also known as the Moving Ahead for Progress in the 21st Century Act, or MAP-21), which lowers near-term cash contribution requirements, Towers Watson concedes. However, many plan sponsors are no longer willing or able to bear annual cost volatility—cash or accounting. 

De-risking actions can reduce this volatility, but often this can only be done at a point of relatively strong funded status, the report noted. As a result, sponsors have considered accelerating contributions beyond required minimum levels—sourced from current resources or capital markets—to help reduce the ongoing risk exposure of the plan and increase the predictability of plan costs.

According to the report, “Accelerating contributions can help sponsors get to the point of being able to significantly lessen the ongoing financial impact of the pension plan on the organization’s performance.”  

Once the decision to accelerate contributions is made, borrowing has appealed to sponsors because of historically low interest rates and, as a result, much lower borrowing costs, Towers Watson said. Falling interest rates have served to increase plan size and deficits. In what many continue to consider an artificially low interest rate environment, taking de-risking actions has been compared with buying when prices are highest. Lower borrowing cost is one protection against this concern.   

Borrowing to fund and de-risk a pension makes a sponsor less susceptible to regret should rates rise. If rates rise, the debt value (assuming a fixed rate) is lessened; if they do not, pension costs stabilize.  

Plan sponsors have unique situations, so several issues must be considered when deciding whether to borrow to fund, Towers Watson notes.  

The report can be downloaded from http://www.towerswatson.com/research/8395.