The challenge in a low interest rate environment like

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The challenge in a low-interest rate environment, like the one in which America finds itself today, is that interest rates will move higher sometime in the not so distant future. When interest rates do move higher, fixed income investors will lose value, which would defeat the normal purpose of rotating into fixed income. Many pension asset managers in this market are forgoing the normal rotation into fixed income for this reason. Q: A plan has liabilities of $100 million and assets of $85 million. What would this plan be called? A: Under-funded Q: A plan has liabilities of $100 million and assets of $75 million. What would this plan be called? A: at-risk. This plan is both under-funded and at-risk. Technically, it is an at-risk under-funded plan. In this case, the best answer is at-risk because this is the worst-case scenario. Q: A plan has liabilities of $100 million and assets of $75 million. Can this fund use the 7-year smoothing method for funded status recovery? A: No. This is an at-risk plan, which means that the 7-year smoothing method is off the table. This sponsor will need to get caught up with their liabilities at a more accelerated rate.
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DB Plans: Where are we? We just discussed what funded status means. A logical question would be, "Where are we right now?" The image below uses 2016 figures to show the funded status for all state pension funds. There is way more red here than green. The green is for a funded status that is not in peril. Anything in red is technically at-risk. A few states did not report their status. California is the biggest concern because they have a huge state-run pension system. This image clearly shows that most states are in dire straits. This is not just bad news for the pension participants. These are states, which means that the taxpayers in each state could eventually be on the hook to fund the shortfalls. You might be thinking...what about corporate-run pension plans. I'm glad that you asked. The table below shows the top 25 under-funded DB plans in the S&P 500 Index. This is not good either.
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Fully Insured Plans Companies with a defined benefit plan can alleviate the uncertainty of unknown cash flow volatility by purchasing an insurance-based product. You can think of this as the sleep-at-night factor. With an insurance-based alternative, the risk gets shifted to the insurance company and the employer could have fairly reliable cash outflows for an otherwise uncertain cash demand. The way this alternative works is that an employer can purchase an annuity contract where the employer makes level periodic payments to an insurance company and then the insurance company is responsible for making the ultimate payments to participants once they retire. The risk of actuarial assumptions will then reside with the insurance company and not the plan sponsor.
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  • Spring '14
  • VOSS,JAMESA
  • Cash balance plan, HCES

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