DB Plan Funding Update: Extending the Analysis Period Shows the Need for Smoother Funding Relief

In a series of studies since the global financial crisis began, Watson Wyatt has projected the regulatory funded status and minimum required contributions for single-employer defined benefit (DB) plans, in the aggregate.¹ It has serially updated the analysis to reflect changing market conditions, new regulations and enacted or proposed temporary legislative relief. The studies have contributed to fruitful discussions with sponsors, regulators and legislative staff in the pension community; indeed, the article published in the October 2009 Insider underlay Mark Warshawsky's Oct. 1 testimony to the House Ways and Means Committee. This new study continues that effort by incorporating market conditions to Oct. 15, 2009, adding two proposed legislative relief provisions and extending the funding horizon out to 2013.²

Updated and extended funding model
The new results are shown in Figure 1 below. The column labeled "Pomeroy/Tiberi bill (15-year)" shows the impact on funded status and contributions of the alternate provision in the bill allowing sponsors to select a 15-year amortization period for shortfalls in the 2009 and 2010 plan years. The final column illustrates an idea to extend to the 2011 plan year the widely proposed "2+7" temporary rule, which would allow two years of interest-only payments followed by regular seven-year amortization on the shortfalls of the three plan years.

Figure 1
Measured funded status and minimum required 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.

Updating the analysis by a month does not change the results much. But extending the analysis by another two years affords important insight into the longer-run consequences of current law and alternative proposals. Under current law, required contributions peak at almost $145 billion in 2011 and remain high through 2013. While Representative Boehner's bill provides for the largest and most immediate relief from current law requirements, eventually the "piper must be paid" and contributions are high in 2012. The same can essentially be said of the Education and Labor Committee bill and the 2+7 provision proposed by Representatives Pomeroy and Tiberi.

But the 15-year amortization provision smoothes out contributions in the "out" years — even as it increases them somewhat in 2010 and 2011 — compared with the other proposals. It should be noted, however, that the bill would impose "maintenance of effort" plan and benefit requirements for eight years for the relief, as opposed to only two years for the 2+7 relief.

The new idea of extending the 2+7 relief to the 2011 plan year also smoothes out the increase in contributions more effectively than the Pomeroy/Tiberi proposal, giving more time for sponsors to plan and budget, and perhaps for the financial markets to recover more fully. A downside of the last proposal is that funded status takes longer to recover, so some plan sponsors might feel the necessity to make extra contributions to avoid benefit restrictions imposed by current law.

Appendix: Assumptions

• Composite corporate bond rate (CCBR) as of September 2009; CCBR at end of 2011 is set equal to the end-of-2007 level, then remains constant in 2012-2013
• Segment rates as of October 2009; future rates calculated as 24-month moving average
• Equity and bond market conditions through 2009 as of Oct. 15, 2009, and Watson Wyatt Investment Consulting average equity and bond returns for 2010-2013
• No contribution floors assumed in the Pomeroy/Tiberi bill in 2012 and beyond

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

Source: Watson Wyatt.

¹ See Funding for DB Pension Plans in 2010 and 2011 Under Relief Proposals, Watson Wyatt Insider, October 2009; New Relief From IRS Reduces Required DB Plan Contributions for 2009, but Large Increase Looms for 2010, Watson Wyatt Insider, April 2009; The Future of DB Plan Funding Under PPA, the Recovery Act and Relief Proposals, January 2009.

² The various legislative proposals are explained more fully in the October Insider article.