Many more defined benefit (DB) plans have an unfunded liability when using lower, unsmoothed discount rates than when using the higher, smoothed rates allowed under current law, a study from the Society of Actuaries (SOA) shows.
DB plans were given relief for funding calculations by the Highway and Transportation Funding Act of 2014 (HATFA). HATFA extended 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. MAP-21 created a “corridor” of rates on either side of a 25-year average that were permissible for discounting purposes. If the two-year average falls outside this corridor, a company can use the 25-year average that is closest to the two-year average in the corridor. HATFA reset the corridor’s boundaries.
The Bipartisan Budget Act of 2015 kept the corridor on interest rates at 10% through 2019, then increases it by 5% through 2023, and sets it at 30% beyond that. The SOA notes in its report that “in the current economic environment, smoothed discount rates are higher than the unsmoothed rates. Higher discount rates generate lesser liabilities and, hence, lesser unfunded liabilities, than unsmoothed rates.”
Using publicly available data from the Department of Labor as of November 14, 2017, the study provides results through the 2015 plan year, with preliminary results for the 2016 plan year based on a partial year of reporting. For 2015, about 11% of plans had an unfunded liability as computed using the smoothed corporate bond rates allowed under current law. The 11% is split between about 8% of plans that contributed at least enough to maintain unfunded liabilities and about 3% that failed to do so.
When computing liabilities for 2015 using unsmoothed corporate bond rates to discount liabilities, roughly 84% of plans had unfunded liabilities. About 25% of plans contributed at least enough to maintain the unfunded liability, while the remaining 59% fell short.
In general, using smoothed rates, results for 2015 are very similar to those for 2014. However, using unsmoothed corporate bond rates, results for 2015 are generally down from 2014, primarily because the unsmoothed rates for 2015 were significantly lower than for 2014, while the smoothed rates for 2015 were only somewhat lower than for 2014.
Plan sponsors contributed about $79 billion to their pension plans for 2015. Virtually all plan sponsors contributed at least the minimum amount required by law for 2015; preliminary data for 2016 indicate the same. Under current law, plan liabilities for 2015 totaled $2.0 trillion, 99% of which was funded.“Current law phases out the smoothing of discount rates over time. In the current economic environment, if all other items are equal, as smoothing lessens, liabilities will increase significantly, and contributions will tend to increase in order to pay down unfunded liabilities,” the SOA notes.
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