Funding for DB Pension Plans in 2010 and 2011 Under Relief Proposals

While recent legislative and regulatory measures have given defined benefit (DB) plan sponsors some funding relief for 2009, required contributions for 2010 and 2011 have loomed large.¹ In this analysis, Watson Wyatt projects funded status and required contributions for single-employer DB plans using an updated version of its comprehensive and realistic model of plan funding.² It considers five scenarios: (1) the law prior to Sept. 24, 2009, including the Pension Protection Act of 2006 (PPA), the Worker, Retiree and Employer Recovery Act of 2008 (WRERA) and the March 2009 IRS guidance; (2) current law, including the IRS guidance released on Sept. 25, 2009; (3) House Education and Labor Committee bill (H.R. 2989) introduced in June 2009; (4) the main provisions of Representative Earl Pomeroy’s (D-N.D.) discussion draft released in August 2009; and (5) House Minority Leader John Boehner’s (R-Ohio) bill (H.R. 2021) introduced in April 2009.

Our results indicate that the most recent IRS guidance eases the DB funding schedule through 2010. The legislative relief proposals further lighten the funding schedule and extend it into 2011, freeing up financial resources — currently in short supply generally — for other corporate purposes, including jobs and investment in plant and equipment.

Relief proposals
Figure 1 summarizes the major provisions in current law and the relief proposals. The Sept. 25 IRS Employee Plans News confirms that “the final regulations will provide automatic approval for a new choice of interest rates for the first plan year beginning in 2010."³ Two of the legislative proposals also provide this relief. Many sponsors will likely switch from mark-to-market methods to smoothed-value methods for 2010 — the latter approaches are more advantageous for 2010 and 2011 plan years under the normal economic and financial conditions assumed.⁴

All three legislative proposals include a “2+7” rule, which allows sponsors to make up any 2009 and 2010 shortfalls with interest-only payments in the first two years, followed by normal seven-year amortization of the shortfall amount. Representative Pomeroy’s discussion draft additionally mandates that contributions for 2009, 2010 and 2011 must exceed 2008 minimum contributions by specified percentages increasing over time. A wider asset smoothing corridor in the proposals from Representatives Pomeroy and Boehner would make the smoothing method more attractive for asset valuation and cushion market losses.

Figure 1
Summary of funding relief proposals

Note: Representative Pomeroy’s discussion draft allows plan sponsors to choose between applying the 2+7 rule and amortizing the shortfalls over 15 years under various conditions. The latter is not modeled here. The draft also includes various “maintenance of effort” plan requirements, opposed by the employer community.

Source: Watson Wyatt summary and assumptions.

Funding model results
Average regulatory funded status is projected to decline from 96.4 percent in 2008 to 93.8 percent in 2009 (see Figure 2).⁵ The modest decline, despite dramatic investment losses, is attributable to the asset value smoothing provided under WRERA and use of the most favorable spot rate for liability valuation allowed by the March 2009 Employee Plans News (the composite corporate bond rate, CCBR, which is used as a proxy for the spot yield curve, peaked in October 2008). Without the Sept. 25, 2009, IRS guidance, average funded status, however, would have fallen to about 78 percent in 2010 and 77 percent in 2011, thereby driving required contributions up to roughly $121 billion in 2010 and to $145 billion in 2011. Moreover, some sponsors would contribute more to avoid benefit restrictions at the 80 percent funded threshold — the model conservatively projects another $7 billion and $12 billion extra contributions for 2010 and 2011, respectively.

The IRS’s automatic approval of interest rate elections in 2010 is projected to boost average funded status to nearly 84 percent in 2010 and 77 percent in 2011. This scenario lowers required contributions to $89 billion for the 2010 plan year but requires $147 billion of contributions for 2011.

The Education and Labor Committee bill would increase measured funded status in 2009, reduce required contributions in 2009 and 2010, and postpone a large part of the funding obligations to 2011. Compared with the Sept. 25 IRS guidance, the two-year interest-only rule here provides further funding relief in terms of lower contributions for the 2009-2011 plan years.

Representative Pomeroy’s discussion draft would afford the biggest gains in funded status for 2009 and 2010, both because the draft permits a wider asset smoothing corridor and because contributions for new plan years must exceed 2008 minimum contributions by certain margins. Note that contributions in 2009 exceed current law requirements. In this scenario, contributions for 2009-2011 jump from roughly $41 billion to $121 billion, the funded status of nearly 77 percent in 2011 remains close to the level produced by current law, and fewer plans face the 80 percent funding threshold for benefit restrictions.

Representative Boehner’s bill provides the greatest funding relief for 2009 — total contributions would be only around $10 billion. In later years, the bill results in higher contributions and funded status similar to the other legislative proposals.

Note that the interest rate elections and/or the proposed wider asset corridors reduce the shortfalls recognized for 2009 and 2010 plan years. This in turn would make the amortization payment significantly smaller than otherwise in 2011 when the 2+7 rule reached its seven-year amortization component for these specific shortfalls.

Figure 2
Measured funded status and contributions under current law and proposals

Notes: Contributions are the minimum required by law. Extra contributions by certain plans are to avoid benefit restrictions at the 80 percent funded status level.

Source: Watson Wyatt calculations.

These results indicate that the funding relief in the September 2009 IRS guidance enables DB plan sponsors to avoid burdensome contribution obligations for 2010. The 2011 funding obligations, however, remain large. These obligations could divert financial resources that companies would otherwise spend on hiring workers — or continuing to employ them — and on increasing their compensation and paying for other benefits,⁶ thus escalating the risk of a jobless economic recovery. The funding relief proposals would further alter the schedule and magnitude of DB contributions, in varying patterns. Like past relief actions, further relief would signify bipartisan congressional and administration support for keeping DB plans viable for American workers and employers.

Appendix: Methodology and assumptions
We use a comprehensive model to simulate the dynamics of DB plans. The model codes in the shortfall amortization schedules of the PPA, the provisions of WRERA and IRS guidance. It uses 2007 initial funded status, 2007 aggregate liabilities of $1.857 trillion, matrices of asset allocations by funded status and plan size for 2007-2009 as data allows, and market conditions as of Sept. 15, 2009. This analysis assumes that by the end of 2011, market interest rates will have reached year-end 2007 levels. The data sources include the IRS, Form 5500 and Global Financial Data. Average returns for equity and bond assets in 2010 and 2011 are based on the forward-looking projections of Watson Wyatt Investment Consulting (WWIC), which incorporates higher market volatilities in the near term and assumes a gradual convergence to equilibrium over a five-year period. Figure A-1 lists the basic economic and financial assumptions.

Figure A-1
Economic and financial assumptions at end of calendar year (%)

Notes:

1. The most favorable CCBR (as a proxy for spot yield curve) for the 2009 plan year was 7.90 percent in October 2008, while December 2008 had the highest segment rates.
2. CCBR and segment rates for 2009 are as of August and September 2009, respectively. The end-of-2011 CCBR is set to the year-end 2007 level, the 2nd and 3rd segment rates (assumed to be equal in 2010 and 2011) are correspondingly calculated as 24-month moving averages.
3. Asset returns for 2009 are based on S&P 500 and Dow Jones corporate bond total return indexes as of Sept. 15, 2009. Annual equity and bond returns for 2010 and 2011 are based on WWIC forward-looking (July 2009) projections. Monthly returns are log-linearly interpolated.

Source: Watson Wyatt calculations and assumptions.

¹  See “New Relief From IRS Reduces Required DB Plan Contributions for 2009, but Large Increase Looms for 2010,” Watson Wyatt Insider, 19(4), 1-3, April 2009.

²  For details of the original model, see “The Future of DB Plan Funding Under PPA, Recovery Act and Relief Proposals,” Watson Wyatt Insider, 19(1), 1-6, January 2009.

³  Employee Plans News, Special Edition, IRS, Sept. 25, 2009.

⁴  See the Appendix.

⁵  The Appendix gives a brief description of the methodology and assumptions.

⁶  One criticism of our model has been that, in the absence of data and plan-specific information, credit balances are ignored. Market value declines, past use and forfeitures (both voluntary and required) have likely significantly reduced credit balances outstanding. Moreover, from the perspective of employers making job decisions, credit balances are largely as valuable as cash, so reducing credit balances should have essentially the same economic impact as making cash contributions.