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.
Figure 1. CaMraData Prt index vs. PPa rates
Index + S.D.
Index - S. D.
Jan ‘ 11
Feb ‘ 11
M ar‘ 11
A pr ‘ 11
J u n ‘ 11
J ul‘ 11
Aug ‘ 11
Sep ‘ 11
O ct ‘ 11
N ov ‘ 11
M ay ‘ 11
F eb ‘ 12
Jan ‘ 12