A recent issue brief by the American Academy of Actuaries calls the 80 percent funded ratio of pension plans a myth that keeps getting perpetuated by companies, governments and the news media.
According to the organization’s research there are many unchallenged references to 80 percent funding as a healthy level for pension plans. The Pension Committee of the American Academy of Actuaries found that while the funded ratio may be a useful measure, understanding a pension plan’s funding progress should not be reduced to a single measure or benchmark at a single point in time. Pension plans should have a strategy in place to attain or maintain a funded status of 100 percent or greater over a reasonable period of time, the report stated.
The funded ratio of a pension plan equals a value of assets in the plan divided by a measure of the pension obligation. But how is the pension obligation measured? According to the brief, actuaries use different methods to measure a pension obligation for different purposes.
“A plan with a funded ratio above 80 percent (or any specific level) might not be sustainable if the obligation is excessive relative to the financial resources of the sponsor, if the plan investments involve excessive risk, or if the sponsor fails to make the planned contributions,” the report said.
The brief’s authors also mentioned that just because a plan falls below the 80 percent funded ratio, doesn’t mean it is unhealthy. A plan’s actuarial funding method should have a built-in mechanism for moving the plan to the target of 100 percent funding. Provided the plan sponsor has the financial means and the commitment to make the necessary contributions, a particular funded ratio does not necessarily represent a significant problem.
The American Academy of Actuaries recommends assessing a plan’s other attributes before deciding it is healthy or unhealthy, like the size of its pension obligation relative to the financial size of the plan sponsor, financial health of the plan sponsor, funding or contribution policy and whether contributions actually are made according to the plan’s policy and investment strategy, including the level of investment volatility risk and the possible effect on contribution levels.