PLANSPONSOR - March 2012

Breaking Down the Expense Barrier

Until recently, the barrier to completely divest a DB plan has been formidable to plan sponsors [except for smaller plans]. A standard plan termination involved a large one-time expense relative to the plan’s full funding position. The cost of an insurance group annuity contract to take over the plan’s liabilities (a “buy-out”) was routinely cited as being at least 20% higher than a plan’s Accrued Benefit Obligation (“ABO”), which is the fully vested portion of the liabilities that must be covered by a buy-out. And attempts to find a way around using insurers were in effect quashed by IRS Revenue Ruling 2008-45.

In actuality, however, the price barrier (i.e., the difference between the cost of a buy-out and a plan’s
full funding position) is becoming lower than most plan sponsors realize.
STANDING ON HIGHER FUNDING GROUND

The Pension Protection Act of 2006 (“PPA”) mandated a new basis for plans to determine their full-funding target. Plan actuaries must use prescribed corporate bond rates for discounting future benefits and generally use the RP-2000 Annuity Table with Projection Scale AA for mortality. They must amortize their funding shortfall over a relatively short 7 years, with no remaining corridor; and asset gains and losses must be fully recognized within 3 years. “Fully funded” now in essence means fully funded. From the perspective of a plan sponsor who is or soon will be investing primarily in bonds, this PPA funding basis is the appropriate vantage point from which to view the additional cost of a buy-out. Standing on higher funding ground, the pricing of insurers – who also happen to invest primarily in bonds—no longer appears as daunting.