The commonly accepted practice of considering a pension plan healthy using its funded ratio is not comprehensive enough, on its own, to determine the plan’s financial health, an actuarial organization said.
“Any realistic assessment of a pension plan should include several measures, not just one,” said Don Fuerst, a senior pension fellow at the American Academy of Actuaries, a 17,000-member organization. “Somehow 80% has become a perceived standard but that is a myth we need to replace with facts.”
The practice became an issue earlier this year when Sen.Orrin Hatch, ranking member of the Senate Finance Committee, issued a report on the health of local, state and federal defined benefit pension plans, which said “80% is generally considered the indicator of a sound government pension plan.”
A fuller set of criteria is necessary to determine the actuarial soundness, the academy said in a letter in response to Hatch’s report. Understanding a pension plan’s funding progress should not be reduced to a single measure or benchmark at any single point in time.
The group suggests that multiple funding ratios should be examined over several years to determine trends. Other factors should be considered as well, including the size of the pension obligation compared to the financial resources of the sponsor; the financial health of the plan sponsor; the funding or contribution policy of the plan; and the investment strategy and risk level of the plan assets.
“The 80% myth can lead to a dangerous slippery slope,” Fuerst said. “It could evolve into an inadequate target if not challenged. 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.”
