How should a DB plan think about its funded status and its implications?

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AcadiFi · Accepted Answer

Funded status = Plan Assets − Projected Benefit Obligation (PBO). The ratio (assets/PBO) is the funded ratio. It is the single most important health metric for a DB plan. **Why it matters**: 1. **Contribution volatility** — PPA-style rules in the US require higher contributions when funded status falls below thresholds. Sponsor P&L risk rises. 2. **PBGC premiums** — underfunded plans pay variable premiums that escalate with shortfall. 3. **Accounting P&L** — pension expense includes the discount-rate effect on PBO; gains/losses run through OCI with amortization. 4. **Credit rating** — rating agencies treat net pension liability as debt-equivalent. Large underfunding hurts bond ratings. **Components of PBO**: - Current accrued benefits discounted at the liability rate (AA corporates for US GAAP). - Expected future pay growth for active participants. - Mortality assumptions (affecting duration). **Levers available to CIO**: - **Glidepath de-risking** — shift to liability-hedging bonds as funded ratio improves. - **Completion portfolios** — fixed income sleeve specifically sized to hedge interest-rate sensitivity of liabilities. - **Risk factor budget** — explicit allocation of active risk across equity, credit, rates, alternatives. - **Hibernation** — fully-funded plans can run low-risk portfolios until final buyout or termination. ```mermaid flowchart LR A[Assets] --> C{Funded
Ratio} B[PBO] --> C C --> D[Contribs] C --> E[Glidepath
Step] C --> F[Rating] ``` Example: a CIO named Basile Moreau runs a plan at 85% funded. His glidepath says: at 85% hold 40% return-seeking / 60% liability-hedging. At 95% shift to 30/70. At 100% shift to 20/80 and consider pension risk transfer to an insurer. Common mistakes: chasing yield when underfunded (raises risk exactly when the sponsor can least afford a loss), and celebrating funded-status improvements that came from rising discount rates (a false win because asset losses often exceed liability reductions).

How should a DB plan think about its funded status and its implications?

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