Most Plan Sponsors Expect New Pension Protection Act's Impact on Contributions to Be Modest, Towers Perrin Finds.

Companies Are Considering a Variety of Plan Design and Financial Strategies to Address Pension Plan Costs and Risks

STAMFORD, Conn. -- A new Towers Perrin survey shows that most pension plan sponsors expect that the Pension Protection Act (PPA) of 2006 will require them to make larger pension contributions in the years ahead. Many, however, expect the impact on their pension plan contributions to be relatively modest, although one in 10 of the companies surveyed expect very significant increases of 26% or more.

"Despite the new law's more stringent funding requirements, most of the survey respondents continue to view the costs and financial risks associated with their pension plans as manageable," said Bill Gulliver, principal and chief actuary for Towers Perrin. "Many of these companies also expect that they will continue to offer the same level of pension benefits in this new funding environment as they have in the past, at least in the near term. Companies are considering a variety of plan design and financial strategies to address the costs and risks of their plans under the new law, but a clear consensus has yet to emerge."

The survey was conducted in August, immediately following the enactment of the PPA. A total of 126 corporate executives responded, primarily financial executives from midsize and larger organizations. The average company participating in the survey has annual revenues of just over $5 billion, almost 9,000 employees worldwide and more than four pension plans.

Expected Financial Impact

Under existing rules, plan sponsors have only been required to fund their plans up to a 90% funded ratio, as determined on a plan solvency basis. The new law increases that target to 100%. This represents a substantial increase in the near-term financial commitment for many plan sponsors.

In fact, two-thirds of the survey respondents expect that the new law will result in higher levels of required pension plan contributions for their organizations. For 10% of companies, very significant increases of 25% or more are expected, while 44% expect more modest increases of 10% or less. A small minority of companies expect the new rules to entail reduced contribution levels. (Exhibit 1)

"The relatively modest anticipated impact on required contribution levels for many companies probably helps explain why the vast majority of respondents continue to view the financial risks posed by their pension plans as manageable," Gulliver said.

When asked to choose among several alternative descriptions of those risks, almost two-thirds (63%) characterized the risk as "manageableC*like others that we are monitoring closely" and another 30% chose "acceptableC*and appropriate for the value we see in the program." Less than one in 10 of the surveyed financial executives view their pension plans as a "significant risk that consumes an excessive amount of staff resources."

Similarly, more than 90% of respondents seem at least moderately confident of their ability to manage their organizations' pension plans in the new PPA funding environment. Fully 39% of the financial executives surveyed believe their organizations are well prepared to handle the added complexity of the new funding rules, while more than half (53%) say they're at least somewhat prepared.

Interestingly, Towers Perrin's analysis of the PPA provisions suggests that required contributions under the new law may prove to be less volatile than many plan sponsors expect. That's because there are PPA provisions that can be expected to add volatility and others that may help in suppressing it. (See Towers Perrin's new white paper, "The Pension Protection Act of 2006: Expected Impact on Retirement Plan Financing -- and How Employers Are Likely to Respond," for more details of the analysis.)

Implications for Plan Design

Uncertainty about the funding rules and the legal status of cash balance plan designs have contributed to the movement away from defined benefit plans in recent years. The survey sample clearly reflects this trend. For example, over a third of the companies responding have already closed their largest pension plans to new hires, and a smaller segment (11%) have frozen plan benefits (i.e., no additional pension benefits accrue). However, almost two-thirds of the respondents continue to maintain pension plans that remain open to new hires and accrue benefits.

Will the new law -- together with expected changes in the U.S. accounting rules for pensions -- accelerate this trend, as some commentators predict? While companies are only beginning to analyze the law's impact on their specific situations, it seems clear from the survey responses that the movement away from defined benefit plans will continue. Still, many companies -- slightly more than half of the respondents with fully operating plans -- remain committed to offering pensions to current and future employees.

As Exhibit 2 shows, 17% of respondents with fully operating plans intend to close their plans to future hires as a result of the new PPA requirements, while 5% plan to freeze benefits for current participants. However, almost half (49%) of the these companies plan to continue their current pension plans with the same or similar benefits as are offered today, and another 9% plan to continue their plans while reducing future benefit accruals.

"This suggests that traditional defined benefit plans will likely continue to cover a significant minority of the country's workforce -- despite the changes in the regulatory environment," Gulliver said.

Interestingly, although the new law provides long-awaited clarity about the legal status of cash balance pension plan designs and new guidance about the requirements for future cash balance conversions, relatively few of the survey respondents seem inclined to consider converting to cash balance plans in this new environment. (Exhibit 3)

The new law also makes important changes in the rules for 401(k) and other defined contribution retirement plans, including provisions designed to encourage automatic enrollment and the provision of investment advice to plan participants. These changes are likely to be embraced by many employers and should lead to enhanced levels of participation in company-sponsored savings plans in the future. (Exhibit 4)

Impact on Companies' Retirement Financial Management Strategies

The survey results suggest that corporate financial executives have only begun to analyze the available financial strategies. For example, just over a quarter of respondents indicate that their companies are likely to increase the level of bonds in their pension asset mix. Investing more pension funds in bonds can help reduce the volatility of funding requirements by more closely matching plan assets to liabilities. A similar percentage of companies are likely to make greater use of derivatives, overlays or similar risk mitigation techniques. (Exhibit 5)

Similarly, relatively few respondents (5%) view annuities as a potentially viable funding approach, although 16% say their companies would consider transactions designed to transfer pension financial risks to third parties at prices more favorable than purchasing annuities. Half or more of the executives surveyed say they need to do more analysis of such approaches.

"Towers Perrin's analysis shows that the new PPA requirements are likely to affect different plan sponsors in dramatically different ways," Gulliver said. "Carefully analyzing plan costs and likely contribution requirements under a range of economic scenarios is critical in this new environment. Our survey confirms that companies have only begun the process of developing strategies for managing pension costs and risks in this new environment."

About Towers Perrin

Towers Perrin is a global professional services firm that helps organizations improve their performance through effective people, risk and financial management. The firm provides innovative solutions to client issues in three areas: Human Resource Services, which provides human resource consulting; Reinsurance which provides reinsurance intermediary services; and Tillinghast, which provides management and actuarial consulting to the financial services industry. Together these businesses have offices and business partner locations in the United States, Canada, Europe, Asia, Latin America, South Africa, Australia and New Zealand. More information about Towers Perrin is available at http://www.towersperrin.com/hrservices.