Importance of Setting Funded Status Goals for DB Plans

March 27, 2014 ( – Setting specific funded status goals for defined benefit (DB) plans can help sponsors and investment committees improve performance, says a new research paper from Russell Investments.

The paper, “What Is Your Funded Status Goal?” points out that given the number of different funded status measures that can be calculated for a DB pension plan, sponsors may not be totally clear about what their funded status goal is or what funded level they should try to achieve. But clarity on these points can help sponsors and investment committees make better funding and investment policy decisions that are critical to effectively managing a pension plan, says the paper’s author, James Gannon, who is director of asset allocation and risk management for Russell Investments.

Given the differences in dollar values for the various possible liability measures, Gannon says, it is important for plan sponsors to take a close look at how they are measuring their plan’s projected liabilities. The method should be well documented and sponsors should be able to clearly explain the economic rationale underlying the liability measure they choose. Once a sponsor is confident it has chosen the appropriate liability measure, it can use the benchmark to better inform asset-allocation strategies. 

According to Gannon, having a clearly justified and documented funded status goal will make other plan management decisions much easier, both before and after the funded status goal has been reached.

The paper explains that the measure of liability on which a sponsor should base a pension plan’s funded status goal is related to the value of its accumulated benefit obligations, projected growth in benefit obligations, present value of future benefits, and economic or buyout liability. In addition, the paper looks at what can keep plans from wanting to be even better funded, how the funded status goal interacts with major policies of the plan, and what short-term thresholds related to funded status would create sensible intermediate funded status goals.

To convince more plan sponsors they need to clearly formulate these goals, Gannon tells PLANSPONSOR, “Plans need to think about the present value of future benefits. In other words, how much more in plan assets will be needed to achieve those funding status goals in the future. While this is not necessarily needed for government requirements or corporate financial statements, nonetheless, it is still important.”

Gannon adds, “Having goals also helps plan sponsors to know not only the amount needed to fund the plan right now, but the amount that may be needed in the future. It shows plan sponsors how much work there is still left to do to reach that future amount.”

Goals allow plan sponsors to “start planning for what their plan will look like” in the future and to consider what investment strategies may be best suited for achieving their goals, Gannon says. For example, a company that has a solid funded status that is strong enough to match both present and projected liabilities may decide that the best route is to get more involved in liability-driven investing (LDI).

Gannon says plan sponsors need to consider what benefits have been promised to participants, as well as what benefits have and have not been earned by participants, in setting funded status goals. Plan sponsors also need to consider how much to invest in certain asset classes to reach their “ultimate” funding goal (i.e., factoring in funding amounts that will be needed in the future).

“Not a lot of plans have scoped out their ultimate funding goal,” Gannon explains. He adds that establishing these goals can be helpful in working through various “what-if scenarios” and in determining what next steps can be taken to achieve the sponsor and investment committee objectives.

“The goals say, my portfolio is supposed to look like this, and then gives you steps for how to achieve that,” Gannon says.

A copy of Gannon’s research paper can be downloaded here.