Pension contribution risk: Is it time for a review?

In our blog, we highlighted how pension plan sponsors may have to revisit contribution risk in the much nearer term than expected, thanks to a year of diminished market returns.

As plan sponsors head further into 2023, there a few things to consider when thinking about managing contribution risk.

Let’s take a look at a sample client’s daily funded ratios in 2022 for a plan with an 80% exposure to LDI. Throughout the year, there had been very little volatility in projected benefit obligations, due to the fact that LDI more closely matched the change in discount rates.

However, we saw a significant reduction in terms of Funding Target Attainment Percentage or FTAP funded status because that discount rate is not market-based.

The significant reduction in FTAP was attributed to market value losses, including losses in the LDI strategy due to rising rates. The market recovery towards year-end helped avoid accelerating the timing of contributions even further. Had the year ended with an FTAP ratio below 100%, as experienced around the October timeframe, contribution calculations could have been immediately triggered.

Clearly, asset allocation strategies managing accounting risks do not always manage contribution risks. Clients should ask themselves whether their plan’s asset allocation be based on accounting measures or cash contributions.

Ultimately, your key plan goals and objectives are what determines the appropriate strategy to limit both accounting and funding volatility, while supporting as high a return expectation as needed to fund plan liabilities and maintain the plan's financial health.

In our opinion, the current rate environment and its impact on funded status warrants a review and may require shifts in strategy going forward.