Preparing Defined Benefit Plan Sponsors for 2010

It seems as though just a moment ago the world was worried about Y2K, and in the blink of an eye we’re closing in on 2010. For defined benefit plans, it has been a roller coaster ride through the last decade. Market losses in the early years of the decade wreaked havoc on pension funding, seemingly countless pieces of funding relief and ultimately funding "reform" legislation were put forth by Congress, new pension funding and benefit restriction rules and regulations created a whole new set of requirements, and in late 2008 the infamous market downturn left the retirement industry scrambling on all fronts.

2009 in review
As we look ahead to the 2010 plan year, several items are of note with respect to pension plan finances. The U.S. equity markets have performed well in 2009, yielding returns of approximately 20% through October 2009. Broad U.S. investment grade bond indices are also up, returning just over 6% through October. However this represents only a partial recovery from the losses in late 2008. For the typical plan that lost roughly 30% of its assets in 2008, these positive 2009 investment returns may only restore about half of the 2008 loss due to the lower starting asset base at the beginning of the year.

Increased bond prices equate to lower yields, which in turn produce higher pension plan benefit obligations. As of December 31, 2008 the average discount rate was approximately 6.5% for FAS 158 reporting. As of the end of October 2009, discount rates are tracking 50 to 75 basis points lower than 2008 year-end. As a result, many plans can expect an increase in pension liabilities of 5% to 10% going into 2010. Of particular note is the significant decline in short duration bonds producing a significant steepening of the yield curve from December 2008 to September 2009. Plans with short duration liabilities or significant benefit payments due in the next five years may see a more significant liability increase.

Interest rates for determining lump sum distributions from qualified plans have also declined throughout the year, and may be lower in 2010 than 2009 in spite of being an additional year into the PPA phase-in period (which would normally be expected to have the effect of increasing interest rates). As with accounting and funding liabilities, lower interest rates produce higher present values for lump sum purposes.

Lower 2009 fiscal year end discount rates combined with asset values that are still depressed from the 2008 investment losses are likely to produce higher year-end balance sheet liabilities as well as higher income statement expense in 2010. Funding percentages for benefit restrictions and determining minimum funding requirements may also be lower in 2010 as a result of the declining bond yields. Lump sum distributions will also be slightly more expensive as interest rates fall.

Regulatory guidance continues to evolve as well
The IRS recently issued PPA final regulations relating to the determination of plan assets and liabilities and funding-based restrictions. Among the changes made is an allowance for new valuation method and assumptions elections for 2010 and relief for plan sponsors to withdraw certain excess credit balance elections. Additional proposed and final regulations are still forthcoming and will undoubtedly continue the trend of change and evolution that has been the reality for 2008 and 2009.

What's a plan sponsor to do?
The key to managing change is being proactive and staying on top of the latest developments. As 2009 comes to a close, plan sponsors and plan administrators can prepare for 2010 by:

• Ensuring their PPA required amendments are in place,
• Working with their actuary to monitor the impact of a rapidly changing market environment on their accounting and funding results,
• Meeting with the key players (such as accountants, actuaries, and investment managers) to establish a game plan for 2009 year-end reporting and 2010 funding valuation updates so that once the 2009 year closes all that’s left to do is execute the plan,
• Assessing with their actuary the impact of 2009 investment results, 2010 projected interest rates, changes in participant demographics and the new final benefit restriction regulations on the plan’s Adjusted Funding Target Attainment Percentage for 2010 and the implications for plan administration, and
• Reviewing data for recent terminations and attempting to pay out any small lump sum payments under $5,000 before year-end to take advantage of more favorable present value rates for 2009.

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