Contributions on the horizon? Two areas corporate defined benefit plan sponsors may want to review in 2023.

Liability driven investing (LDI) strategies typically match to accounting measures, which use monthly average spot rates discounted on a full yield curve to determine the Projected Benefit Obligation (PBO).  However, the actuarial target – the funded status for contribution purposes – uses the Funding Target Attainment Percentage (FTAP). Actuaries typically calculate that percentage using 24-month average maturity segmented rates which are constrained by 25-year average maturity segmented rates. This means calculated liabilities are typically higher and the value loss in market returns for 2022 will create a greater funding deficit for contribution purposes. 

With that in mind, plan sponsors might want to consider the following two areas as they plan their ongoing strategy.

1. Consider actuarial changes
   If you are not currently using asset smoothing, now might be a time to review if that makes sense as an option. By using two year smoothing, asset values can be brought more in line with 24-month average maturity segment rates, though the constraints of the 25-year average maturity segment rates can add an element of mismatch. Asset smoothing could prove problematic, however, if a plan sponsor is not also smoothing liabilities and using yield curve discounting. If a plan is using yield curve discounting and planned on hedging the liabilities through asset allocation, smoothing would not be an appropriate strategy. 
   
   There is the material and consequential option to switch to using the full-yield curve (vs. segmented and smoothed rates) for determining minimum required contributions. However, once plan sponsors elect to make this change, it is permanent and they cannot change back. This would utilize discounts rates more closely tied to accounting standards. Using this methodology, FTAP liabilities (for contributions) can be more closely hedged using LDI strategies.
    
2. Adjust asset allocation
   Plan sponsors can consider adjusting their overall allocation to be more return seeking to help offset any difference between interest rate movements and portfolio returns. Many smoothing methods are codified under ERISA, which allow plan sponsors more time to generate returns. This approach would likely entail re-risking the glide-path, adjusting LDI allocations and increasing equity exposures. 
   
   Contrary, plan sponsors could choose to simply stay the course and hope for a market recovery. If markets improve and rates remain relatively flat, LDI is already in place and benefits would occur in that capital losses would be minimized on the accounting side.

These are two areas to review given the events of 2022 and do not require major shifts in strategy. Corporate defined benefit plan sponsors do not need to make decisions in haste and quite often the plans do not require drastic change. Any noise in the industry suggesting that is misleading. 

Year-end actuarial reviews often shed light on new information as the impact of the year’s markets are determined. Quite often, plan sponsors are encouraged to act quickly on this information. That is probably not necessary as the reality is nothing takes immediate effect. Plan sponsors have some time, should understand their various options, not rush to decisions, and if change is necessary, it should be calculated and aligned with the long-term strategy for the plan.