Pension Funding Reform

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Pension Funding Reform

• SOA/CCA Employee Benefits Spring Meeting
• May 19, 2006

Tonya Manning, FSA, EA Aon Consulting Brian
Donohue, FSA, EA CCA strategies
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History of Pension Funding Rules
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Trends in Pension Funding Rules

• Movement toward solvency - PBGC perspective
• PBGC has amassed a 23 billion deficit
• Current funding rules are to blame
• Could increase substantially if additional
  airline or auto companies fail

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Trends in Pension Funding Rules

• Reduced discretion in assumptions
• Interest rates
• Mortality (updated table may add 2-5 to
  liability)
• Further restrictions for at risk plans

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Trends in Pension Funding Rules

• Less smoothing / more transparency and
  volatility
• Interest rates
• Assets
• Amortization

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Trends in Pension Funding Rules

• Protection against significant underfunding
• Limitations on credit balances
• Benefit based restrictions (benefit
  improvements, lump sums, accruals)
• At risk classification

7

• The more things change,
• the more they remaininsane.

Michael Fry and T. Lewis Over the Hedge, 05-09-04
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The Political Context

• Budget deficit
• Consideration of legislative costs
• Partisan standoffs
• Philosophical differences
• 2006 midterm elections
• Senate vs. House perspectives

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Other Agenda Priorities

• Appropriations
• Immigration
• Iraq
• Tax bill

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Pension Environment
11

• Even God cannot change the past.

Agathon (448 BC 400 BC)
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Pension Reform

• This is the 800 lb. gorilla
• Congressional state-of-play
• Conference Committee try to reconcile
  House/Senate bills
• Progress still slow
• Numerous points of conflict
• Still hoping to complete by Memorial Day
• No action means back to 30-year Treas., not
  corporate bonds

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Common Elements in Both Bills

• Existing funding rules scrapped
• PBGC premiums raised substantially
• Spending reconciliation bill raised flat-rate
  premiums
• Lump-sum benefits calculation changed
• Deduction limits increased
• Additional reporting and disclosure mandated

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Major Changes Under Discussion

• New funding target
• Yield curve
• Credit balances
• Limitations on at-risk plans
• Use of company credit ratings
• Lump sums, amendments, new accruals
• Impact on payment of nonqualified deferred
  compensation
• Smoothing of assets and liabilities to minimize
  volatility

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Other Major Changes Under Discussion

• Hybrid plans retroactive and/or prospective
  relief
• Conversion rules
• New rules for multiemployer plans
• Funding relief for airlines
• Effective date 2007 or 2008?
• Transition rules

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Other Bill Provisions

• EGTRRA permanence
• 401(k) auto enrollment and investment selection
• FSA rollovers
• Investment advice

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Areas of Significant Controversy

• Credit ratings for at risk plans
• Degree of smoothing
• Recognition/use of credit balances
• Transition duration
• Hybrids
• Retroactive re existing plans
• Prior conversions
• New conversion mandates
• Plans in litigation
• Costs of EGTRRA and FSA rollover provisions

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• If we dont change direction soon, well end up
  where were going.

Professor Irwin Corey (1914 -)
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Pension Reform- Stepping Off
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Yield Curve
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How Steep is Steep?
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Pension Reform Other Items that Smooth the
Transition

• Solid asset returns lessen impact of reduced
  asset smoothing
• Phase-in of
• interest rate changes (3 years)
• 100 funding target (0-5 years)
• mortality changes (3-5 yearsmaybe)

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Pension Reform Funding-based Benefit
Restrictions

• lt 80 funded
• No benefit improvements
• restriction applies to pay increases under House
  bill
• Restrictions on credit balance
• No lump sums (House bill)
• lt 60 funded
• Restrictions on lump sums (Senate bill, limited
  to 50 of total or PBGC guarantee)
• At risk classification (House bill)
• All accruals cease
• Presumption of underfunding
• Accelerated valuation needed to remove
  restrictions
• Accelerated valuation needed to avoid
  presumptive deterioration (House bill)
• Assets reduced by credit balance in calculating
  funded ratio (House)
• Incentive to burn credit balance

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Pension Reform At-Risk Plans

• Definition of At Risk
• Plans lt 60 funded (House bill)
• Employers in poor financial health lt 93 funded
  (Senate bill)
• Required assumptions
• Conservative retirement and turnover assumptions
• Loads to estimate annuity purchase rate
• Transition and phase-in
• Multi-year phase-in with no impact before 2009

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Pension Reform New Minimum Lump Sum

• Based on corporate bond yield curve
• House
• 3-segment, unsmoothed yield curve
• 5-year phase-in, 2007-2011
• Mortality follows funding rules (unisex)
• Senate
• Full yield curve with 3-month smoothing
• 4-year phase-in, 2007-2010
• Impact
• Lower required lump sums (5 or more) for
  younger participants
• Older employees may be a couple lower or higher

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Pension Reform PBGC Premiums

• 30 headcount premium for 2006
• Indexed to national average wage after 2006
• Liability measure for variable premium
• Reflects At risk status
• No asset or interest rate smoothing
• Vested benefits only (House bill)

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Pension Reform- Plain Vanilla Example

• Assumed return on assets 8.00
• Liability discount rate 5.75
• If asset return exceeds discount rate
• the plan will attain full funding in less than 7
  years
• ultimately, funding will run somewhat below the
  "target normal cost."

28

• "I guess that it's true
• for me and for you
• that time changes everything

Johnny Cash Time Changes Everything