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Aug 03
2010

To amortize or not to amortize

Posted by SherylNash01 in defined benefit planscareer/managementamortization

SherylNash01

Employers with underfunded defined benefit (DB) pension plans can receive billions of dollars in temporary pension funding relief as a result of legislation recently signed into law, according to a new analysis by professional services company Towers Watson.

Under the Preservation to Access to Care for Medicare Beneficiaries and Pension Relief Act of 2010, employers can elect to amortize funding shortfalls for any two plan years between 2008 and 2011, over a 15-year period, or make interest-only payments for two years, followed by seven years of amortization.

The goal is to give pension plan sponsors temporary funding relief. Towers Watson estimates companies could save between $19 billion and $63 billion over five years, depending upon which of the two options they choose.

"The pension funding relief law significantly eases some of the financial pressures employers had been facing, at least for two years," says Mike Archer, senior consultant at Towers Watson in a statement. "However, the choices that employers make now will have an impact on the magnitude of their future pending obligations."

But an easing of pressure today may only delay the pain. After 2011, employers face potentially larger funding obligations, according to Towers Watson. "Basically - pay me now or pay me later.  If I have a liability that I need to fund over time, and I reduce my payments against that liability now, then I have to increase my payments later on," explains Archer.

In fact, some employers plan to pass on the opportunity. In a Towers Watson survey last month, only 25 percent of plans said they are likely to elect the relief. Why? Many employers have concerns about the application of the cash-flow rule and uncertainties around details of the new law. Others are pursuing aggressive funding policies, have good funded positions, or otherwise do not need relief.

For those likely to elect the relief, according to the survey, most employers intend to reflect it for plan years 2010 and 2011 and use the 15-year amortization option.

Archer highlights three action steps companies can take.

First, project required contributions to the employer's qualified defined benefit plans over the next 5-10 years, both without and with the relief provisions (and comparing both alternative amortization schedules under the various combinations of plan years).  It is important to understand not just the near-term savings created by the relief but how the effect of longer term increases in contributions fit with the employer's cash planning.

Second, analyze how the reduced contributions will affect the plan's funded ratio going forward and what that will mean to the funded status

Third, the employer should consider the implications of notifying their employees that they have elected this relief.  Will the reaction be positive or negative, and how important to the employer is that reaction. Generally, employees won't care about the issue, unless the company is in danger of going out of business.  After all, while the Pension Benefit Guaranty Corporation (PBGC) does provide for guarantees, not 100 percent of everyone's pension is guaranteed.  Large pension amounts can potentially be lost.

 

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