To contribute, or not? It's a big question for plan sponsors. Our experience working with sponsors suggests that it's typically optimal for them to make some contributions — especially from an after-tax perspective. What’s more, there’s good reason to think that the economics of making contributions will become still more compelling over the next few years. Underfunded plans will face a large and growing cash penalty for deferring contributions. Because the economics are swinging strongly in favor of making contributions, plan sponsors with bond market access may even have an incentive to borrow to fund the plan.
Contribution Deferral Penalties to Rise Steeply
For several years following the Global Financial Crisis, plan sponsor contributions to corporate defined benefit plans of companies in the Russell 3000 Index ran at $80 billion to $90 billion per annum. Then, primarily as a result of the pension relief provisions incorporated in the MAP-21 highway bill passed in 2012, contributions fell to around $60 billion per annum, as cash was directed toward dividends, share buybacks and acquisitions. The MAP-21 interest rate stabilization provisions were extended by further legislation over the past two years.
Contributions should, however, start to pick up. In separate legislation, Congress has increased future incentives to make higher contributions. Recall that the Pension Benefit Guaranty Corporation (PBGC) charges an additional premium to cover underfunded plans, and, for PBGC premium purposes, interest rate stabilization does not apply to the calculation of underfunding. This premium was formerly 90 basis points and will rise to 300 basis points in 2016. By 2018, the premium will be 330 basis points, and 410 basis points in later years.
To read the entire white paper, “LDI and the Rising Rates Riddle,” download the PDF document.