What Happens When Funding “Relief”… Isn’t?

Rising Rates Reverse Past Relief

It’s a fundamental law of nature that what goes up almost always comes back down. Whether it’s a ball thrown in the air that falls due to gravity, atmospheric moisture rising when heated only to cool and fall back to earth as rain or snow, or interest rates used for pension funding.

When interest rates dropped to “historically low levels” following the Great Recession, two-year smoothing was inadequate to prevent a significant spike in pension funding target liabilities and required contributions. To address this, Congress enacted funding relief by realigning interest rates to fall within a corridor around the 25-year average. These “stabilized” interest rates, which exceeded spot rates by up to 350 basis points, lowered the funding target liability and allowed employers more time to adjust their budgets for future contribution increases. This relief included a phase-out provision that would eventually return plans to use a funding target that reflects current market conditions, presumably at a time when interest rates were significantly higher. That time has come.

With spot corporate bond interest rates at 5% or higher, plan sponsors are poised to experience the flip side of funding relief. The March 2025 stabilized segment interest rates from the IRS indicate that some stabilized segment rates are lower than current spot rates, leading to a slightly higher funding target on a stabilized basis than would be used without relief.

We’ve known for over a decade that this situation could occur if interest rates rose. The possibility of triggering the upper end of the stabilization corridor was a tradeoff for short-term relief derived from the effect of the lower end of the corridor. Since 2012, employers have funded to a target reflecting higher than market rates that trended back toward current market rates. Now that market rates and stabilized rates have converged, we’re facing the awkward situation where the funding requirements may target funding to a liability that is subsidized relative to spot rates.

The alternatives available to plans vary depending on their circumstances.

Funded Percentage Using Spot Rates	Considerations for Funding Target Interest Rates
Below 100%	Continued funding using the stabilized interest rates moves the plan closer to 100% funded on a spot-rate basis. Any extra contributions due above those determined without respect to stabilization make up for the deferred funding derived from interest rates stabilization in prior years.
At or above 100% - frozen accruals	Switching to the full yield curve option for funding and implementing an LDI asset strategy can lock in the current funded status and avoid future gains or losses from investment return and interest rate fluctuations.
At or above 100% - ongoing accruals	While the full yield curve is an option for these plans, it may not be palatable since it also requires measuring the normal cost for benefit accruals at fluctuating spot interest rates (which introduces significant volatility). For these plans, continued use of the stabilized rates creates an additional funding cushion that protects against actuarial losses when interest rates fall.

The extent to which the statutory funding target appropriately represents a plan's “true cost” depends on factors beyond the alignment of funding interest rates with current market conditions, such as the relationship between the mandated mortality table and the plan’s unique demographic characteristics. Whatever your plan’s situation, now is a good time to consult with your actuary about the plan's funding strategy, the effects of the phase-out of stabilization, and how to coordinate your funding and investment policies to best manage asset and liability risks.

Interest Rate Stabilization Phase-Out Mar 2025.pdf

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