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5500 Preparer's Manual for 2012 Plan Years
The premier resource in the field of Form 5500 preparation, 5500 Preparer's Manual will help you handle the required annual Form 5500 filings for both pension benefits and welfare benefit plans.
One in ten companies expect their required pension funding contributions to increase by more than 25% as a result of the funding changes enacted by the Pension Protection Act of 2006 (PPA; P.L. 109-280), according to a survey of 126 corporate executives conducted by Towers Perrin. However, 44% expect an increase of less than 10%, 13% expect an 11% to 25% increase in their pension contributions, and 29% do not know. The remaining 4% of respondents expect their pension contributions to decrease.
Under existing rules, plan sponsors are required to fund their plans up to a 90% funded ratio, as determined on a plan solvency basis. The new law increases that target to 100%. This represents a substantial increase in the near-term financial commitment for many plan sponsors.
"Despite the new law's more stringent funding requirements, most of the survey respondents continue to view the costs and financial risks associated with their pension plans as manageable," noted Bill Gulliver, principal and chief actuary for Towers Perrin. "Many of these companies also expect that they will continue to offer the same level of pension benefits in this new funding environment as they have in the past, at least in the near term. Companies are considering a variety of plan design and financial strategies to address the costs and risks of their plans under the new law, but a clear consensus has yet to emerge."
Many plan sponsors are concerned about the prospect that funding reform will entail added uncertainty and greater volatility in required contribution amounts. Factors adding to the volatility of contribution amounts include the following:
There will be a reduced period of years for smoothing assets and liabilities, making both amounts more variable and less predictable.
Accumulated credit balances can't be counted on as an offset to contribution requirements if a plan's funded status drops below the 80% threshold, adding another element of unpredictability for plan sponsors with credit balances.
Plans falling below the 80% threshold may be deemed at risk, which increases the effective funding target (and thus contribution amounts) over time.
Interestingly, Towers Perrin's analysis of the PPA provisions suggests that required contributions under the new law may prove to be less volatile than many plan sponsors expect. That's because, although there are PPA provisions that can be expected to add volatility, there are others that may help in suppressing it. Factors that may help reduce contribution volatility include:
The new law entails a reduced rate of amortization in many cases, particularly for amounts assessed in earlier years and those applicable to more poorly funded plans.
Under the new rules, each dollar of unfunded liability is amortized in level amounts over a fixed period. In contrast, under current law, a plan's exposure to deficit reduction requirements is less predictable and, once triggered, these requirements have greater implications for contribution amounts. The removal of this potential "cliff" will tend to stabilize contribution amounts over time.
The PPA allows plan sponsors an opportunity to develop more effective asset/liability matching strategies through the use of market values for assets and liabilities. The mandated use of averaged assumptions for determining liability amounts under current law has been a substantial barrier to the implementation of effective duration-matching strategies.
The new law provides more flexibility to pre-fund the plan during favorable economic periods, when cash may be more readily available.
The relative effects of these factors will vary based on each plan sponsor's particular situation, depending on plan funded status, investment strategy, contribution policy, plan design and the level of credit balance that is maintained.
Towers Perrin notes that the PPA provisions, along with the new accounting rules from the Financial Accounting Standards Board (FASB), will accelerate the trend away from defined benefit plans. Currently, 65% of the survey respondents maintain defined benefit plans that are open to new hires and continue to accrue benefits. The remaining 35% have either closed their plans to new hires or ceased all future benefit accruals. Of those "open" plans, 17% indicated that they plan to close their plans to new hires and 5% intend to both close their plans to new hires and freeze future accruals for current employees. Another 9% will continue their "open" plans, but intend to reduce future benefit accruals. Nearly half of the 65% of "open" plans (49%) will continue their current plans with the same or similar benefits, while 28% do not know what they will be doing with their pension plans.
Another pension plan change, conversion to a cash balance plan, is considered not likely at all or not very likely by 63% of the respondents. A few (3%) consider conversion to a cash balance plan as very likely and 11% consider conversion as somewhat likely. The remaining 23% do not know what they plan to do.
The Towers Perrin survey results "suggest that corporate financial executives have only begun to analyze the available financial strategies." For example, 8% of the respondents indicated that their companies are very likely to increase the level of bonds in their pension asset mix, while 24% are somewhat likely to increase their level of bonds. "Investing more pension funds in bonds can help reduce the volatility of funding requirements by more closely matching plan assets to liabilities," Towers Perrin noted. At this time, 31% of the respondents reported that shifting to a higher asset allocation in bonds was not very likely or not likely at all.
More than half of the executives surveyed reported that they need to do more analysis of transactions designed to transfer pension financial risks to third parties before committing to such things as derivatives, overlays, annuities, or similar risk migration techniques.
The 126 companies responding to the survey had average annual revenues of slightly more than $5 billion, an average of nearly 9,000 employees worldwide, and an average of more than four pension plans.
For more information on this and related topics, consult the CCH Pension Plan Guide.
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