Return to The Consulting Actuary Index

Session 602 - Modeling Future Costs After the PPA
Presenters: Bruce Cadenhead, Brian J. O’Neill
Recorder: Amy C. Sullivan

Forecasting future pension plan contributions has become more challenging due to the PPA.  Interest rate and credit balance utilization assumptions were two forecasting considerations explored during Session 602 of the 2008 Enrolled Actuaries Meeting as presented by Brian O’Neill, a consultant with Towers Perrin, and Bruce Cadenhead, a worldwide partner with Mercer.

The session began with a brief overview of the funding rule changes.  O’Neill noted that in the pre-PPA world, shocks would occur when current liability took over as the driver of minimum funding if the forecasting was completed based on accrued liability.  Post-PPA, there is only one liability measure but plan sponsors have both short and long term goals to consider that will affect contribution forecasting.  Plan sponsors need to evaluate the optimal use of their credit balance and the optimal use of company cash in light of their policies around avoiding benefit restrictions or at-risk status, minimizing volatility and avoiding PBGC premiums or filings.

Starting with the observation that funding strategy is really independent of minimum funding requirements, Cadenhead began a discussion of projecting liabilities for forecasting.  He remarked that we can still use the traditional approach for rolling forward liabilities but the new interest rate structure presents some challenges.  Options were presented for choosing the forecasting interest rate including using forward rates or using an adjustment to the results based on expected interest rate changes.  Alternatively, the yield curve could be projected and used with the underlying cash flows.  Audience members were reminded in projecting the yield curve that an economic expansion or recession will produce a different yield curve and that eventually the projected yield curve will flatten out.  Cadenhead noted that it would be prudent to make some downward adjustments to the early years as two forces are at work pulling yield curves down in the short term.  First, there is a term premium and second, the further you go out into the future the higher the default risk.   After a lengthy discussion of projecting the yield curve, a comment from the floor was raised suggesting that it might be better to just use the current yield curve.  Cadenhead remarked that he wouldn’t necessarily draw that conclusion and moved to a slide showing that the yield curve has changed quite a bit over the last 6 months.

The session continued with observations regarding additional adjustments that should be made for mortality improvements, lump sum payments and other plan specific items.  Then O’Neill moved on to a discussion of credit balance use.  He introduced key decision points for plan sponsors and how those decisions on credit balance use and funding policy can affect forecasting.  Under a sample funding policy, contributions and credit balances were modeled for the next decade looking at four different asset return environments.  Ideas for mitigating some of the funding spikes observed in the models were discussed as well as some of the issues that arise when funding is accelerated.

In a more lighthearted moment, Cadenhead commented that he was hopeful he had not left the impression with the audience that we should just give up because this is all so complicated.  Said O’Neill, “If we were all pessimists we’d probably tell our clients to terminate their plans and just not deal with this. Luckily we’re all optimists and trying to learn this stuff.”  He went on to note that the complexity is something we, as actuaries, need to own and it is clear that our expertise in this area is going to be very valuable as we move into the future.