1. It produces contribution rates that are more stable than those of traditional methods, and
2. It provides an immediate and significant financial reward to plan sponsors that adopt a new tier of reduced benefits or increased employee contributions for future hires.
The Governmental Accounting Standards Board is replacing current pension accounting statements 25 and 27 (which have been used as a funding standard) with new statements 67 and 68 (which do not address funding). Thus, subject to state and local laws, public plan sponsors will be free to adopt new funding methods if they so desire.
The method Buck has developed is an open-group forecasting method—it recognizes that new employees will come into the plan in future years. The method begins with a 75-year forecast of traditional actuarial valuations using the same methods and assumptions that plans currently use. The actuary must also make assumptions about future hires: their number, ages at hire and pay levels. The method calculates the present value of employer contributions over the 75-year period and then determines the level contribution rate that will produce the same present value. That rate, subject to one modification, is the contribution rate under the open-group method.
The one adjustment is an amortization of the differences in open-group and traditional contribution amounts. The adjustment increases open-group contribution rates gradually when they are lower than those of the traditional method, and reduces them when they exceed those of traditional methods. As a result, contribution rates under the open-group method increase slowly in the early years and decline slowly in the later years of the projection. On the whole, they are much more stable than those of traditional methods.The below graph shows a 30-year deterministic forecast of anticipated contributions and contribution rates under the open-group method and under the current traditional method.
The open-group method offers immediate relief to the plan sponsor when it commences in 2014—the contribution rate falls from 31% in 2013 to 17.9% in 2014. It stays in the range of 16% to 22% during the entire 30-year period, while the traditional method contribution rates fall from 31% to 9%.
Buck has tested the plan design in an environment of varying investment returns. The new method holds contribution rates more stable than traditional methods, but funded status declines more under the new method when the plan experiences periods of poor investment performance. Buck has also explored variations in the method that seek to prop up funded status percentages when necessary. These variations improve funded status, but also increase contribution rate volatility.
This open-group forecasting method may be of interest to public plan sponsors that have been struggling to make the contributions required under traditional methods and to those that have been reluctant to introduce a new tier of less costly benefits because the savings that traditional methods produce for such a change take too long to materialize.
A copy of the paper is here.
Charlie Chittenden, principal and consulting actuary with Buck Consultants in Pheonix
Joseph Son, senior consultant with Buck Consultants in Los Angeles
NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.