Thursday, March 24, 2016

The Pension Tale of the Cash and the Calendar

Once upon a time, there was a defined benefit (DB) pension plan. And, the plan was fully funded. And, that was good.

Well, at least, the plan's actuary told the plan sponsor that the plan was fully funded. And, then he said something else after that -- something about a HATFA basis. Oh, but it couldn't matter. That was clearly some foreign word. After all, the sponsor knew that the actuary was a really smart and he probably lapsed into foreign tongues once in a while. All that actuarial gibberish is pretty much a foreign language, anyway.

So, the plan sponsor, in this case represented by the Benefits Manager (Bob) and the Controller (Cliff), armed with the knowledge that its frozen plan was fully funded gleefully went off to see the CFO (Charlotte). It was time to tell her that the plan was fully funded and that the plan could be terminated.

Those of who work in the pension world know that this little story didn't end well. For those who don't work in that world, let's just say that being fully funded at the beginning of 2016 on a HATFA basis may mean that on a plan termination basis, assets may only be very roughly 2/3 of liabilities.

Our story goes on.

After understanding that they couldn't terminate the plan, the sponsor Craters R Yours (CRY), the world's largest manufacturer of inflatable moonwalks set about to continue managing their frozen DB plan. CRY had initially assumed that freezing the plan was an end to its pension worries, but it soon learned that was not the case.

They learned that frozen plan management can be a tale of volatility caused by cliffs and calendars. In year 1, we get funding relief. In year 2, it's gone and we revert to the old rules. We're 80.01% funded; all is well. We're 79.99% funded; life gets really tough. We make a contribution on March 31; a ratio gets better. We make it on April 2; there are things we have to tell the government.

Bob and Cliff learned that their jobs had become really difficult. Charlotte had roundly praised them when they found a new and inexpensive actuary, Numbers For Cheap. And, NFC always provided legally correct numbers. But, there was no strategy. NFC didn't tell Bob and Cliff that contributing $1,000,001 on March 31 was going to be much more valuable in the long run than contributing $999,999 on April 2. Because NFC really had no clue, CRY would up doing a lot of crying.

Bob and Cliff, and Charlotte, for that matter had been sure that when they froze CRY's pension plan that the actuarial work was a pure commodity. All the strategy was done. All that was left was to hire the cheapest actuary and get the plan terminated.

The moral of the story, of course, is that pension funding strategy doesn't end until the plan is gone. Until then, there is a difference, and you, as a plan sponsor need someone who can help you to find that optimal strategy. Let us help.

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