As far as determining the funded status of a defined benefit (DB) pension plan, many factors are out of the control of the plan actuary, such as investment performance, liability interest rates, and how much a plan sponsor is able to contribute to the plan. However, the actuary can discuss with the plan sponsor possible funding strategies and policies designed to maintain the funded status of a fully funded plan or to improve the funded status of an underfunded plan.
In general, the discussion can be broken down into three possible scenarios. If a plan is fully funded, the plan sponsor should consider ways to stabilize annual costs to avoid the possibility of becoming an underfunded plan. If a plan is underfunded, the plan sponsor can consider ways to stabilize annual costs and then commit to making contributions gradually over time to bring the plan to fully funded status. Alternatively, a plan sponsor can subject an underfunded plan to annual cost volatility with an equity-based investment allocation in the hope of bringing the plan to fully funded status through a combination of favorable investment performance and contributions.
Some cost stabilization strategies that can be considered are liability-driven investment (LDI) tactics or a change to a more conservative investment allocation that is much less based on equities. In an LDI strategy, the plan’s investment allocation is changed to primarily fixed income with the objective of plan assets and plan liabilities moving in tandem as liability interest rates rise and fall. In a more conservative investment strategy (e.g., an allocation of 35% equities and 65% fixed income), annual costs are more stable, which is due to less investment risk related to a low equity allocation.
One possible funding policy to consider is annual contributions in the amount needed to hit a given Pension Protection Act of 2006 (PPA) funding target (e.g., at least 80% to avoid benefit restrictions for the current year). Another funding policy to consider is having the actuary determine an annual contribution amount projected to meet a plan sponsor’s funded status goal (e.g., become 100% funded by the year 2017).
A plan sponsor can choose to combine any of the above strategies and policies to meet its goals. Reviewing long-term cost projections is suggested when considering any new strategy and/or policy.
Finally, plan sponsors need to be careful about taking full advantage of any type of legislative funding relief—e.g., Moving Ahead for Progress in the 21st Century (MAP-21) funding relief legislation passed during 2012—because later this may result in much higher minimum funding requirements. Therefore, plan sponsors should consider making higher-than-required contributions despite the availability of funding relief.