Health of Defined Benefit Pension Plan

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bhughes1001
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Joined: Sat Aug 18, 2012 10:07 am

Health of Defined Benefit Pension Plan

Post by bhughes1001 »

My current employer still offers a defined benefit pension. I am now within one year of the five year vesting period, and I am interested in better understanding the nuances of interpreting the annual funding notice for the program. Is the Funding Target Attainment Percentage the most relevant piece of information?
That percentage is nearly 100%, but appears to have been helped significantly by a changeover in 2012 to MAP-21, which changed some of the methodology. Without that modification, the Funding Target Attainment Percentage is a little over 80%.

There is also an effective interest rate, not sure if that represents a real expected return on investments, a nominal return, or something different.

Any information is appreciated regarding how people interpret or assess the health of a defined benefit plan.

Thanks

BH
Grt2bOutdoors
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Re: Health of Defined Benefit Pension Plan

Post by Grt2bOutdoors »

3 ways: 1) Projected Benefit Obligation less Accumulated Benefit Obligation. If the Projected Benefit exceeds the Accumulated Benefit, then you have a pension funding deficit. 2) If funding contributions are 50% or less of current benefits paid and the fund is only funded 75%, that raises a red flag. 3) If the expected rate of return is more than 15% above the general consensus for returns based on stated asset allocation of pension plan. This takes about 20 minutes of one's time to calculate.

If you're plan is 80% or more funded, chances are it will be able to meet it's obligations going forward. What is the financial condition of the company sponsoring it?
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions
asif408
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Re: Health of Defined Benefit Pension Plan

Post by asif408 »

BH,

Here is a good recent article you might find relevant: http://www.wilshire.com/media/23548/wil ... 130226.pdf. Overall, state pension plan liabilities are still increasing (though at a slower rate than in the past), and more money is moving into less efficient asset spaces and leveraged strategies (I would assume to increase returns).

I assess the health of the defined benefits plan by the unfunded liabilities and what the state's plan is to meet those liabilities. I also have a defined benefit pension and am in the 2nd year of the 8 year vesting period. I am paying close attention to legislation in the works in my state (Florida). They are considering a law which would automatically move new employees into a 401(k) type plan in lieu of the defined benefits plan unless they select the defined plan. Right now the default is the defined benefits plan. If the legislation does not pass, I may consider making my one time change to the 401(k) type investment plan or use a third hybrid option available. I just don't see how they will be able to afford to pay out full benefits when I retire in 30 years if there is not a major change in the works.
Topic Author
bhughes1001
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Re: Health of Defined Benefit Pension Plan

Post by bhughes1001 »

Thanks to you both for the helpful information. This is a non-governmental company that appears to be financially sound, but trying to manage in a challenging environment going forward. My sense is that once vested the benefits will probably be secure. I don't see any red flags at this time.
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Frugal Al
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Re: Health of Defined Benefit Pension Plan

Post by Frugal Al »

asif408 wrote:Here is a good recent article you might find relevant: http://www.wilshire.com/media/23548/wil ... 130226.pdf. Overall, state pension plan liabilities are still increasing (though at a slower rate than in the past), and more money is moving into less efficient asset spaces and leveraged strategies (I would assume to increase returns).
Given that the OP's plan is covered by MAP-21, it's safe to say they are not in a state pension plan.
The 80% funding level is probably adequate. The fact that the plan is nearly 100% funded under MAP-21 means they won't pay much if any penalty for inadequate funding.
bhughes1001 wrote:There is also an effective interest rate, not sure if that represents a real expected return on investments, a nominal return, or something different.

The ''effective interest rate" is not what some would think it is. It is a composite discount rate derived as a function of the bond segment rates applicable to the plan, and their duration, which is based on the plan participant's ages. It really has nothing to do with the rate of return the plan is actually achieving, but is the theoretical rate needed, under current law and mandated segment rates, for the plan to fulfill future liabilities.
ubermax
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Re: Health of Defined Benefit Pension Plan

Post by ubermax »

Good responses so far - DB plans typically get two major reports each year from their consultant or actuary , an accounting report and a funding report - since you mentioned the annual funding notice it sounds like you're concerned about the funding aspects whereas response #1 is talking accounting talk and response #2 is aimed at funding but for state or municipal plans which are not required to comply with the funding rules that began with ERISA and continue to evolve - since you got an annual funding notice I'm assuming you're not in a muni plan.

The Pension Protection Act of 2006 changed a lot of things for DB plans and created new terminology - an over 80% Adjusted Funding Target Attainment Percentage (AFTAP), a close kin to the FTAP which you mentioned is a sign of health for your plan unless your employer is undergoing bankruptcy and over 100% is very healthy - when it goes below 80% the IRS gets worried and imposes restrictions on the plan.

You didn't say but if your plan is covered by the Pension Benefit Guaranty Corporation (PBGC) then there's a partial safety net if the plan terminates .

But as the other poster mentioned the financial health of your employer is equally important .

Frugal Al is going in the right directions but the effective rate is not a theoretical rate - it's real - and is the one rate that is equivalent in a present value sense to the result of applying the funding segment rates - it's not something you need to be concerned with regards the health of your plan .

This topic could fill a book but that's my two cents :happy
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bhughes1001
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Re: Health of Defined Benefit Pension Plan

Post by bhughes1001 »

Thanks for the additional information, ubermax and Frugal Al.
Very helpful. I believe the company is financially healthy, and the plan is covered by PBGC.

BH
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Frugal Al
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Re: Health of Defined Benefit Pension Plan

Post by Frugal Al »

ubermax wrote:Frugal Al is going in the right directions but the effective rate is not a theoretical rate - it's real - and is the one rate that is equivalent in a present value sense to the result of applying the funding segment rates - it's not something you need to be concerned with regards the health of your plan .
Good point, uber. Yes, the rate itself isn't theoretical, but it's not really an indicator of anything for the pension annuitant.
Harold
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Re: Health of Defined Benefit Pension Plan

Post by Harold »

bhughes1001 wrote:Is the Funding Target Attainment Percentage the most relevant piece of information?
Quite honestly, the fact that your benefit is insured by the PBGC is the most relevant piece of information. Your plan sponsor is holding the risk of providing your benefit, and the PBGC is insuring that risk.

To some extent, the funded status of the plan may be able to suggest whether the plan may be frozen or terminated in the future (very underfunded may indicate a plan sponsor who views the plan as an unfavorable cost, very overfunded may indicate a plan sponsor who views the plan as a valuable benefit and tax shelter)-- most plans are somewhere in the middle range where you couldn't even read that either way. Probably can't fully read either way anyway, way underfunded plans can be quickly funded, and way overfunded plans can be quickly terminated. The policies listed in your notice will give some indication of their official approach.

Liabilities can't be exactly known, so will always be estimated based on prevailing interest rates. The rates illustrated without MAP-21 are as good a set of recent corporate bond rates as any, and the rates under MAP-21 are intended to reflect something closer to a historical average. Since the pension is a corporate obligation, it makes sense to use corporate bond rates to determine the present value (the effective rate is simply a single rate that gives the same discounted value as the three segment rates). The end of year liabilities listed in a different section will be on the most recent unaveraged corporate bond basis.

Assets are what they are, and most likely most of the assets illustrated will be an actuarial value (probably averaged over two years). There's a fairly unhelpful exhibit of how the assets are allocated (unhelpful because it's divided by types, not asset classes). The end of year assets will be actual market value.

Contact information that you may not already have is provided, and is there for any of your requests or concerns.

It's a fairly boilerplate document, and most probably look about the same since the DOL provided a template for companies to use. Might be worth paying attention to whether your employer added any additional commentary or cover letter, since that's serving as a message they are looking to communicate.
magazinewriter
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Re: Health of Defined Benefit Pension Plan

Post by magazinewriter »

Does the PBGC take over only if a company files bankruptcy or are there other instances?

My company's pension is underfunded, 68% MAP21, and I see in a statement I received today that two of the quarterly contribution payments were "not made in their entirety."
ubermax
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Re: Health of Defined Benefit Pension Plan

Post by ubermax »

magazinewriter wrote:Does the PBGC take over only if a company files bankruptcy or are there other instances?

My company's pension is underfunded, 68% MAP21, and I see in a statement I received today that two of the quarterly contribution payments were "not made in their entirety."
http://www.pbgc.gov/prac/terminations/s ... tions.html

check this out - describes a standard termination ; bankruptcy termination is called "distress"

missing quarterlies could be a "reportable event" to the PBGC - do a search to find out more - some of this stuff just isn't fresh anymore and there's a lot of it - missing quarterlies is not a good sign - is your company struggling financially that you know of ?
magazinewriter
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Re: Health of Defined Benefit Pension Plan

Post by magazinewriter »

ubermax wrote:
magazinewriter wrote:Does the PBGC take over only if a company files bankruptcy or are there other instances?

My company's pension is underfunded, 68% MAP21, and I see in a statement I received today that two of the quarterly contribution payments were "not made in their entirety."
http://www.pbgc.gov/prac/terminations/s ... tions.html

check this out - describes a standard termination ; bankruptcy termination is called "distress"

missing quarterlies could be a "reportable event" to the PBGC - do a search to find out more - some of this stuff just isn't fresh anymore and there's a lot of it - missing quarterlies is not a good sign - is your company struggling financially that you know of ?
Thanks. The payments not made in their entirety were reported to the PBGC according to the report. Yes, the company is struggling and is quietly doing early buyouts and layoffs. I'm quite sure they would not have the money for a standard termination as described in the link. I'm an early retiree already collecting but thankfully my pension is only a small part of my income. I have a close friend still working who is counting on it for a significant part of his retirement income.
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