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Session 502 - PPA Funding IV: Strategies for Underfunded or Overfunded Plans
Presenters: R. Evan Inglis, Ellen L. Kleinstuber
Recorder: Amy C. Sullivan

The Pension Protection Act (PPA) has taken away much actuarial flexibility in determining methods and assumptions for funding measurements. However, as discussed in Session 502 of this year’s Enrolled Actuaries Meeting, there is still a great deal of consulting left to do. In this fourth session of the PPA series, Evan Inglis of Watson Wyatt Worldwide and Ellen Kleinstuber of Aon Consulting presented some basic strategies related to funding and credit balance use for both overfunded and underfunded plans. Also included in the session was a discussion of plan sponsors’ PPA election options and early thoughts on plan-sponsor decisions.

Inglis began by noting that the new rules will drive plans toward 100 percent funding, causing plan sponsors to rethink their asset mix and turn their focus to funding policy. Four basic funding policy strategies were discussed:

• Minimum requirement—a reasonable method in which volatility will be dependent on the mismatch between liabilities and investments;
• Fixed percent of pay—a method that may not be feasible because of the difficulty of its long-term application and the unnecessary acceleration of funding;
• Setting investment risk to cover normal cost—a method that would match assets and liabilities with an additional return potential intended to equal the normal cost of the plan;
• Funding to 100 percent immediately—a strategy that would minimize PBGC premiums but could add to the carryover balance (COB) for 2007.

Following the discussion of alternative funding policy strategies, contribution illustrations were presented for three different scenarios. The first focused on how much, if any, COB a sponsor could waive and how such a decision could affect total contributions, PBGC premiums, and the pattern of contributions. The second illustration introduced the concept of making contributions at a value that recognizes the plan sponsor’s cost of capital. The last set of illustrations showed how low asset returns can affect the ability of both well-funded and poorly-funded plans to stay “above water” (i.e., having no shortfall amortization). The discussion turned to whether or not it is important to stay above water since the net cost of doing so in a low return environment is greater than the cost experienced for falling below. Therefore, Inglis noted, it is not clear that staying above water is the best approach.

After reviewing these cash contribution strategies, Kleinstuber pointed out that there are tactical considerations in determining contributions. Among these considerations were the avoidance of benefit restrictions, quarterly contributions, disclosing at-risk status, PBGC 4010 reporting, and triggering debt-covenant requirements. Kleinstuber then walked through four examples that showed the effects of waiving credit balances and making small contributions. One example showed how an overfunded plan can actually be at-risk. A question was raised from the floor regarding the ability to provide a cover letter explanation with the notice to participants that shows at-risk status. The speakers commented that communication will be very important going forward under PPA and that consultants should be discussing these matters with their clients’ human resources and finance departments. Discussion then moved to reasons for and against advance funding and possible uses for a plan’s surplus assets. Inglis cautioned against funding such that sponsor ends up with too much surplus.

The remainder of the session discussed upcoming election options. When asked how many consultants were using the full spot yield curve, only a few raised their hands.  The speakers referred to the ASOPs when discussing appropriate mortality assumption decisions. Although we have a free pass, so to speak, on the prescribed table, it may not be the appropriate table to use. When the discussion turned to actuarial asset values, only four audience members raised their hands to indicate they have clients that would be using the averaging method.  One said that the client simply likes smoothing, and another noted that the plan was well funded so the plan sponsor was interested in protecting against a drop in asset values.

As was discussed throughout the session, actuaries now have a set of funding calculations that are one-size-fits-all. Kleinstuber said that this just provides a framework to begin discussions with plan sponsors about what makes sense for their individual plans.