Cash-Balance Funding

[JAY21]

If your plan doc's actuarial equivalence uses say 5% for pre- and post retirement interest rates, interest credit on theoretical account balance is 6%, and valuation funding assumptions were 6% (assume same mortality table for both funding and plan doc), would your annuity benefit for unit credit funding be determined based upon:

1. Project acct bal at 6% to NRA; convert to annuity using funding assumptions of 6%

2. Project acct bal at 6% to NRA; convert to annuity using actuarial equiv. of 5%.

3. Something different (please share any alternate approach)

Any thoughts ? Is there a definite black-and-white approach or are there alternative approaches equally feasible ? Thanks for any input.

[Effen]

Speaking soley for funding, your document tells you how to convert the account balance to an annuity. In your example, you would accumulate at 6%, then convert to annuity at 5%. Once you have that annuity, if you are funding at 6%, you would value the annuity at 6%. This should result in a present value greater than the cash balance.

I assume you are doing an 07 val, since for 2008 you will need to value the annuity (determined using 6% accumulation and 5% conversion) using the segment rates and applicable mortality.

[JAY21]

Thanks Effen. I would agree with you. Takeover plan document uses "GATT" for all actuarial equivalence purposes (not greater of), prior year Val and actuary used 6% for all purposes (even for CB conversion purposes), resulting in virtually no funding whipsaw so pay credit almost exactly the same as normal cost. Plan's been around 3-4 years. I like the result, but I thought we need to convert on plan doc rates, presumably using GATT for this purpose even though those rates fluctuate from year-to-year. Wasn't sure if this alternative approach was viable. I realize that 2008 is a whole new ballgame.

[Effen]

Your first post you said "actuarial equivalence uses say 5% for pre- and post retirement interest rates", now you are saying "plan document uses "GATT" for all actuarial equivalence purposes". Which is it?

Either way, if it is 5%, then why not use 5% for your funding and assumed cash balance accumulation? If it is GATT, then use the GATT rate for both assumptions. Either way your liability should equal your cash balance accounts. (I am assuming this is a small plan.)

I haven't figured out how to make this work in 08 since we have 3 segment rates and only 1 accumulation rate. Anyone thought about using the segment rates as the assumed accumulation rate? Why can't I assume cash balance accounts will increase at x% for the next 5 years, y% for years 6-20, and z% for 21+? That might be a difficult arguement if they use the 3rd segment for the accumulation rate, but what if they stick with the 30-yr treasury?

[JAY21]

I used 5% in the initial post to keep the example simple but it is indeed GATT. Good suggestions. Thanks.

[Mike Preston]

Don't fight the tide. If we get the 150% multiplier on the TNC then just about anything will work, don't you think? Root for technical corrections.

[Effen]

I agree about rooting for "Ole TC", but from my "people" in DC are telling me "don't hold your breath". Election year politics could delay TC until after the elections and I'm not sure I can wait that long before I need to release some numbers. Maybe in the coming March Madness TC can squeek one through.

[SoCalActuary]

Much of the issue with cash balance plans created in 2008 is the arbitrage of interest rates.

The actuary makes an assumption of the future interest to be earned on cash balance accumulations, presumably related to the type of interest index used in the plan.

For existing accrued benefits, this is often based on the last known value of the index.

But for 2008, that cash balance projection will result in either a future lump sum value or a future monthly benefit payment that gets discounted at valuation interest rates on some tiered basis. This produces a target normal cost that is not the same as the hypothetical contribution. How to explain this to the client?

Now the actuary might have limited ability to suggest a lookback month for a new plan, instead of the rates for the beginning of the plan year. And the plan sponsor has the ability to select a market rate of interest among several safe harbor choices.

But this is not going to produce an identical interest rate between the forward projection and the valuation discount rate.

So, I ask, what interest rates will we be recommending for cash balance accumulations, now that we don't have to use 30 yr treasuries to avoid whipsaw?

The 3rd tier rate for the month prior to the beginning of the year? This will usually produce a cost above the allocation rate.

The average 3rd tier rate over a period of some months? Same.

The 30 year treasury rate as in the past? This will usually underfund the plan.

Is anyone using a more sophisticated projection model for the future interest credits?

Does anyone suggest a high-return index, like the tier 3 rates, or do you stay more conservative to keep the costs down?

[Guest mrsactuary]

My plan has a interest credit of 6% and we use a funding valuation rate of 5% (actuarial equivalence in our plan is GATT). Is this ok? Prior actuary set it up. I don't understand cash balance plans very well but whats the implication of using a funding rate that is consistently lower than the interest credit rate. Any help appreciated.

Your first post you said "actuarial equivalence uses say 5% for pre- and post retirement interest rates", now you are saying "plan document uses "GATT" for all actuarial equivalence purposes". Which is it?

Either way, if it is 5%, then why not use 5% for your funding and assumed cash balance accumulation? If it is GATT, then use the GATT rate for both assumptions. Either way your liability should equal your cash balance accounts. (I am assuming this is a small plan.)

I haven't figured out how to make this work in 08 since we have 3 segment rates and only 1 accumulation rate. Anyone thought about using the segment rates as the assumed accumulation rate? Why can't I assume cash balance accounts will increase at x% for the next 5 years, y% for years 6-20, and z% for 21+? That might be a difficult arguement if they use the 3rd segment for the accumulation rate, but what if they stick with the 30-yr treasury?

[Effen]

SoCal, I agree, but I look at it a little differently.

If my accumulation rate is lower than my segment (discount) rate, then my funding target will be less than my actual cash balance account. If I keep my assets equal to the cash balance account, then I think my plan should generally be 100% funded in reality, but overfunded for funding/benefit restriction purposes.

However, if the accumulation rate is higher than my segment (discount) rate, then my funding target will be greater than my actual cash balance accounts. So, if the assets equal the cash balance account, the plan will be underfunded for funding/benefit restriction purposes, but 100% funded in reality. If the assets equal the funding target, the plan would be 100% funded for funding/benefit restrictions, but overfunded in reality.

I'm thinking in general to stick with the 30-yr treasury since it seems like it works best if you want the plan to be 100% funded in reality, no more, no less, assuming I have room under the deduction rules to make contributions in excess of the minimum.

[SoCalActuary]

Effen, that is my take also, just staying with the 30 yr treasury accumulation rate. It only has a problem under the current 2008 rules for new CB plans. No cushion on the current year accruals.

I mention this because we do have such new CB plans for 2008. But I also advise that this is a one-year problem, because we will have cushion next year on the 2008 accruals.

[Mike Preston]

And if Technical Corrections passes, you'll have it FOR 2008, as well.