Actuaries Weigh in on Best Way to Stabilize Pension Plan Funding After Two Years of Low Interest Rates

WASHINGTON (May 2, 2012)—The American Academy of Actuaries today asked members of the U.S. House of Representatives and Senate to take the actuarial perspective into account as they consider measures to stabilize required pension plan contributions based on funding targets established by the Pension Protection Act (PPA).

In letters to House and Senate conferees specifically appointed to the conference committee for S. 1813, Sec. 40312, Pension Funding Stabilization, the Academy’s Pension Practice Council suggests that the best way to create stability in pension funding is to smooth contributions directly.

“To the extent the conference committee chooses to include in its conference agreement pension funding changes to create more stability in contributions,” Vice President for Pensions John H. Moore and Academy Senior Pension Fellow Don Fuerst said in the letters, “the Pension Practice Council believes this could be accomplished better by smoothing outputs rather than inputs.”

The methodology proposed in the Senate-adopted bill would effectively raise interest rates used to determine plan liabilities by 100 to 150 basis points.

“Higher interest rates mean lower reported liabilities and the appearance of a plan being better funded than it would appear under the current rules,” said Fuerst. “Lower reported liabilities also mean lower contributions by plan sponsors.”

Under PPA, interest rates are based on a 24-month average of corporate bond rates. Although current interest rates are historically low, these are the market rates at which liabilities can be settled, or low-risk portfolios can be designed to fund these benefits. The actuaries recommend keeping the current method for determining funding targets and participant disclosures, and instead directly provide a reduction in contributions.

Several methods are available to directly reduce contribution requirements, including changing amortization periods or methods, reducing contribution requirements by specific percentages or adopting a “stabilization collar” around the minimum contribution.

“These direct measures to reduce contributions preserve the meaningfulness and consistency of funded status levels that are disclosed to participants and used for multiple purposes under the Pension Protection Act,” said Fuerst. “Direct measures also enable Congress to be more specific in the degree of contribution reduction permissible.”