Possible MAP-21 extension presents additional funding stabilization

April 16th, 2014 No comments

By Javier Sanabria

A provision appended to the Emergency Unemployment Compensation Extension Act of 2014 may offer defined benefit plan sponsors continued funding relief. The provision would extend the funding stabilization authorized under the Moving Ahead for Progress for the 21st Century Act (MAP-21) another five years.

In a recent Bloomberg BNA article, Zorast Wadia talks about the benefits of lengthening the MAP-21 provision. Here is an excerpt:

The MAP-21 provisions stabilize the discount rates used to calculate employers’ pension funding obligations by adjusting rates if they fall outside of an interest rate “corridor” tied to average rates over a 25-year period. Those corridors gradually widen through 2016, weakening their impact. The provisions were designed to raise revenue by lowering companies’ required pension contributions and thereby driving up taxable income and projected tax receipts.

As the MAP-21 smoothing provisions enter the midway point in 2014, plan sponsors are beginning to see the relief wear off, said Zorast Wadia, a principal and consulting actuary in the New York office of Milliman.

Interest rates continually declined from 2009 to 2012, and only began to rebound in 2013, so pension liabilities still remain at all-time highs, Wadia said. Lessening the relief could put many sponsors in a “tough situation again,” he said.

Under MAP-21, the corridor incrementally widens from 10 percent in 2012 to 30 percent in 2016. Under the unemployment insurance legislation, the corridor would remain at 10 percent through 2017 and incrementally widen to 30 percent after 2020.

There is a lot of incentive to fully fund plans more quickly, one reason being rising premiums set by the Pension Benefit Guaranty Corporation, Wadia said. “But those [plans] that are cash-strapped will probably welcome this opportunity, and continue to eke by, to do what they need to get on through,” he said.

Results from the 2014 Pension Funding Study (PFS) suggest that plan sponsors took advantage of MAP-21’s funding relief. Contributions declined significantly during 2013, according to the PFS.

The $44.1 billion in contributions during 2013 (down $18.1 billion from $62.2 billion in 2012) was the lowest level in five years. The lower-than-expected contributions were likely due to plan sponsors changing their contribution strategy in light of the MAP-21 interest rate stabilization legislation, passed in July of 2012. Seven companies decreased their contribution by more than $1 billion in 2013 compared with 2012, for a total of $13.3 billion….

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Pension funded status drops by $5 billion in March

April 15th, 2014 No comments

By John Ehrhardt

Milliman today released the results of its latest Pension Funding Index (PFI), which consists of 100 of the nation’s largest defined benefit pension plans. In March, these plans experienced a $5 billion increase in pension liabilities in a month with flat investment return, resulting in a $5 billion increase in the pension funded status deficit.

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It was a brutal first quarter, with the deficit for these 100 pensions climbing by $79 billion, which was due to a combination of asset underperformance and interest rate decreases. Funded status greatly improved during 2013 but things have changed course in the first quarter of 2014 as the funding ratio has dropped to 84%.

Looking forward, if the Milliman 100 pension plans were to achieve the expected 7.4% median asset return for their pension portfolios, and if the current discount rate of 4.30% were maintained, funded status would improve, with the funded status deficit shrinking to $232 billion (86.1% funded ratio) by the end of 2014 and to $182 billion (89.1% funded ratio) by the end of 2015.

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IRS issues retirement plan guidance under the Supreme Court’s same-sex marriage decision

April 15th, 2014 No comments

By Employee Benefit Research Group

Retirement plans must recognize the rights of an employee’s same-sex spouse as of the U.S. Supreme Court’s ruling of June 26, 2013, and are permitted to do so prior to that date, under IRS Notice 2014-19. The IRS’s April 4 guidance includes information on the deadline for plan sponsors to amend their plans. The IRS also separately issued a frequently asked questions (FAQ) document that includes related information and a discussion of specific concerns for 403(b) and multiemployer plans.

The guidance applies to tax-qualified retirement plans such as defined benefit (DB) pension plans and 401(k) plans that include survivor benefits, spousal consent, minimum required distributions, qualified domestic relations orders (QDROs), and other spousal rights and features.

The IRS’s newly released Notice 2014-19 for tax-qualified retirement plans provides the following:
• Plans must be operationally compliant as of June 26, 2013, and the IRS will not raise qualification issues for plans that fail to treat same-sex spouses as spouses before then. The IRS also will treat a plan as qualified if, from June 26, 2013, through September 15, 2013, the plan treated a same-sex spouse as a spouse only if the participant lived in a state that recognized same-sex marriages (i.e., under the “state of domicile” rule).
• Plans are permitted to recognize same-sex marriages retroactively to a date before June 26, 2013, and may apply the recognition for limited purposes, e.g., for qualified joint and survivor annuity (QJSA) and qualified preretirement survivor annuity (QPSA) requirements. Doing so, however, will require that the plan amendment complies with the tax code’s qualification requirements.
• Plan documents will have to be amended if current language defines “spouse” as a person of the opposite sex or if recognition of same-sex spouses will be applied prior to June 26, 2013.
• Plans must be amended, in general, by December 31, 2014, for calendar-year plans (or, if later, the tax filing deadline for the year the change is effective). Special deadlines apply to governmental plans and single-employer defined benefit plans that are restricted from increasing benefits because of funding-based limits (under tax code section 436[c]) that choose to recognize same-sex spouses before June 26, 2013.

The IRS’s related FAQ discusses: beneficiary designations for profit-sharing or stock bonus plans if a participant dies on or after June 26, 2013; using the Employee Plans Compliance Resolution System (EPCRS) to apply the same-sex marriage definition retroactively; amending the plan for additional rights; compliance by, and amendment deadlines for, 403(b) plans; and multiemployer plans in “endangered” or “critical” status (i.e., subject to the additional funding rules under tax code section 432).

For additional information about the IRS’s guidance and for assistance with plan amendments, please contact your Milliman consultant.

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Regulatory roundup

April 14th, 2014 No comments

By Employee Benefit Research Group

More retirement-related regulatory news for plan sponsors, including links to detailed information.

President signs cooperative and small employer charity pension funding bill
On April 7, the president signed the Cooperative and Small Employer Charity Pension Flexibility Act (H.R.4275), which establishes special funding rules for defined benefit (DB) retirement plans sponsored by nonprofit cooperative associations and small charitable organizations.

The bill applies to “cooperative and small employer charity” pension plans that were affected by certain provisions of the 2006 Pension Protection Act (PPA) or that were maintained—as of January 1, 2013—by more than one employer, all of which were tax-exempt charitable organizations. The bill calls for an effective date of years beginning after December 31, 2013. The bill is now P.L.113-97.

To read the entire bill, click here.

IRS posts chart of rollover-eligible retirement plans and IRA combinations
The Internal Revenue Service (IRS) posted a one-page summary, in the form of a table, listing the eight kinds of plans and individual retirement accounts (IRAs) that can make rollover-eligible distributions, and the corresponding eight kinds of plans and IRAs into which those distributions can, or cannot, be rolled over.

To view the entire chart, click here.

IRS issues guidance on applying Windsor decision to qualified retirement plans
In addition to releasing Notice 2014-19, the IRS issued a related frequently asked questions (FAQs) document, providing answers related to qualified retirement plans. The FAQs document is available here.

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What should pension sponsors include in their benefit statements?

April 9th, 2014 No comments

By Javier Sanabria

Pension sponsors await model benefit statements from the Department of Labor (DOL) as required by the Pension Protection Act (PPA). Until guidance is issued, sponsors are to comply with new disclosure requirements in good faith. In the latest issue of DB Digest, David Benbow explains what sponsors should include in their benefit statements pending DOL guidance:

Be sure your statements contain the following required items:

• Accrued benefit
• Vested benefit, or the date the participant is expected to become vested
• A description of permitted disparity or a floor-offset arrangement if they are used in your plan

Make sure your statement is understandable to your average participant. You should check with your legal counsel to ensure that you’re in good faith compliance with the interim guidance regarding your delivery method and frequency.

Issuing benefit statements provides sponsors the opportunity to communicate a plan’s value to participants. Milliman’s Lily Taino offers more perspective in her article “Defined benefit plan statements: Getting by or adding value?

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Can variable annuity pensions offer more retirement security?

April 4th, 2014 No comments

By Javier Sanabria

Senator Tom Harkin proposed the Universal, Secure, and Adaptable (USA) Retirement Funds Act intending to improve retirement security for individuals. In their article “Variable annuity pension plans: An emerging retirement plan design,” Milliman’s Kelly Coffing and Mark Olleman discuss how the variable annuity pension plan (VAPP) can address four principles Harkin proposes for reform.

Here’s an excerpt from the article:

The VAPP design responds to Harkin’s four principles as follows:

• Although not universal, the reallocation of risk allows more employers to maintain the “three-legged stool,” which includes pensions.
• By changing the focus from a “guaranteed” dollar benefit to a “lifelong” benefit, more people are able to have the certainty of a reliable stream of lifelong income without the fear of outliving their assets.
• Retirement risk is shared more evenly among participants. Risk is shifted from employers and active participants to all participants including retirees.
• Because retirement assets are pooled and professionally managed, larger benefits can be provided per dollar contributed.

In addition, some level of inflation protection may be provided.

So how exactly does this work? Figure 1 provides an example. The participant is hired on January 1, 2002 and enrolled in a VAPP with a 4% hurdle rate. For simplicity, the illustration shows the participant earning $30 per month of benefit each year, but benefits could be based on a percent of contributions or a percent of each year’s pay (a career average formula). The illustration uses actual historical returns based on a portfolio that is invested 60% in large company stocks (S&P 500) and 40% in long-term high-grade corporate bonds.

Figure 1 shows that at January 1, 2003 the participant has earned a benefit of $30 during 2002. The $30 earned in 2002 is adjusted at the end of 2003 for the trust’s investment return of 19.3% in 2003. The adjustment is 119.3%/104.0% = 114.7%, which increased the $30 to $34.41. Therefore, at January 1, 2004 the participant’s total accrued benefit is $34.41 plus another $30 earned in 2003, for a total of $64.41.

After 11 years, at January 1, 2013 the benefit accrued in 2002 has grown to $43.37, the benefit accrued in 2003 has grown to $37.82 and the total of the benefits accrued in all years has grown to $395.33. Although all benefits decreased by 21.8% after 2008, by January 1, 2013 the benefits earned in all years are larger than the original $30 accruals.

Figure 1 - VAPP benefit accrued example

Milliman consultant Grant Camp describes VAPP benefit features that can provide security for both retirement plan sponsors and participants in his blog “A balanced approach to retirement risk.” Ryan Hart also highlights the advantages that VAAPs may offer employers and employees in this blog.

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In 2013, corporate pension plans with the highest equity exposure were the biggest benefactors

April 2nd, 2014 No comments

By John Ehrhardt

Milliman today released the results of its 2014 Pension Funding Study (PFS), which analyzes the 100 largest U.S. corporate pension plans. In 2013, these pension plans experienced historic improvement, with plan liabilities decreasing by 7.5% and assets improving by an average of 9.9%. This resulted in a $198.3 billion improvement in the funded status deficit from year-end 2012. While it was a “win-win” year for most sponsors, those with higher equity allocations performed the best.

Last year was a great year for pension funded status and helped reduce much of the underfunding that has persisted since the global financial crisis. Plans that held off on de-risking their plans were the biggest benefactors of the strong equity performance. With 18 of the 100 plans in our study now fully funded, and more hopefully reaching full funding this year, the timing for de-risking activities that can lock in funded status may be optimal.

Study highlights include:

Interest rate increases evident in financial statements. The discount rates used to measure plan obligations increased from 4.04% to 4.75% in 2013. While these rates are still down from a high water mark of 7.63% in 1999, the improvement in 2013 went a long ways toward minimizing the pension funded status deficit.

Investment performance exceeded expectations. The weighted average actual investment return on pension assets for the Milliman 100 companies’ 2013 fiscal years was 9.9%, which compares favorably to the expected return of 7.4%.

Contributions decline significantly during 2013. The $44.1 billion in contributions during 2013 (down $18.1 billion from $62.2 billion in 2012) was the lowest level in five years. The lower-than-expected contributions were likely due to plan sponsors changing their contribution strategies in light of the Moving Ahead for Progress in the 21st Century Act (MAP-21) interest rate stabilization legislation, passed in July 2012.

Pension expense decreased. Favorable investment returns in 2012 offset the impact of declining discount rates in that year, leading to a reduced level of pension expense: a $32.1 billion charge to earnings. This is $23.7 billion lower than the record high pension expense in 2012.

Market capitalization of these plans up more than 20%. The favorable equity market performance during 2013 increased the total market capitalization for the Milliman 100 companies by 21.2%. When combined with the decrease in pension obligations, this resulted in a decrease in the unfunded pension liability as a percentage of market capitalization, from 7.3% at the end of 2012 to 3.0% at the end of 2013.

Asset allocations remain relatively stable. The trend toward implementing liability-driven investing (LDI) continued in 2013, but at a slower pace. Overall allocations to equities remained largely unchanged in 2013. With strong 2013 returns across most equity markets and losses in many fixed-income sectors, it is evident that many plans rebalanced during the year by moving money from equities, and possibly other asset classes, to fixed income.

What to expect in 2014. Given the funded status gains in 2013, 2014 contributions are expected to decrease compared to those made in 2013. Plans already at surplus at the end of 2013 will have reduced incentive to further fund their plans in 2014. For some plans that had already engaged in LDI or other funded status lock-in strategies, higher contribution levels can be expected.

Given the compound effect of favorable investment returns in 2013 and higher discount rates at year-end, we estimate that 2014 pension expense will decrease to $19 billion, a $13 billion decrease compared with 2013. We may see more than 30 of the Milliman 100 companies with pension income in 2014, a level not seen since 2002.

To read the entire study, click here.

Watch Milliman’s Google+ Hangout where Zorast Wadia and I discuss the results of this year’s PFS with Pensions & Investments Executive Editor Amy Resnick.

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Update on the Federal Reserve’s tapering and rate increases

March 28th, 2014 No comments

By Dorian Young

Young-DorianOn March 18 and 19, 2014, the Federal Reserve’s interest-rate-setting committee, the Federal Open Market Committee (FOMC), held its first meeting led by Janet Yellen, the new Federal Reserve chair. The outcome of this meeting in terms of the Federal Reserve’s plans for tapering and future increases in the federal funds rate provided more data points toward a base case that continues to increase in clarity.

This is an opportune moment to update you on this base case given the level of clarity, a level higher than we’ve seen since the global financial crisis.

FOMC schedule
The FOMC has eight scheduled meetings per year—two each quarter—one at the end of the first month of the quarter, and one in the middle of the third month of the quarter. During these two-day meetings, the FOMC has been providing increasingly longer-worded guidance on its thinking regarding any changes to the federal funds rate and its thinking regarding any changes to tapering its monthly purchases of bonds (Quantitative Easing 3, or QE3).

Tapering
The FOMC began tapering after its final meeting in 2013 by reducing its bond purchases from $85 billion per month to $75 billion per month, a reduction of $10 billion per month. In its first meeting of 2014 (January 28-29), the FOMC continued its tapering, down to $65 billion per month. In its second meeting of 2014 (March 18-19), the FOMC again continued its tapering, announcing it would decrease bond purchase to $55 billion per month commencing April 1, 2014.

If the FOMC continues to decrease its purchases over the remaining six meetings in 2014, as is widely anticipated, then in the eighth meeting of 2014 (in mid-December), the FOMC will reduce its purchases from $5 billion per month to $0 (i.e., tapering will come to an end) and QE3 will be complete.

The risks to this base case are that the FOMC could either accelerate or decelerate this rate of change. Should these risks be realized, there may be noticeable reactions in the market, albeit temporary, lasting no more than three to six months and similar in nature to the May-June 2013 and September 2013 market responses.

Federal funds rate
The FOMC continues to communicate that it plans to keep short-term interest rates “low” for a long time. These short-term interest rates are driven by the federal funds rate, which is traditionally increased or decreased in increments of 0.25%.

The federal funds rate base case is that the FOMC will keep the rate unchanged until mid- to late-2015, at which point the FOMC will begin to increase the rate slowly. From a calendar perspective, mid-2015 could be as early as the late-April meeting, while late-2015 could be as late as the mid-December meeting. In terms of the FOMC increasing the rate slowly, slowly may mean a 0.25% increase every other FOMC meeting. A back-of-the envelope analysis could show the first rate increase happening in mid-June 2015 and subsequent rate increases every three months, which would put the federal funds rate at 1.00% in mid-December 2015, going to 2.00% in mid-December 2016, and continuing until ultimately leveling out somewhere around 4.00% sometime in late 2018 or early 2019.

The risks to this base case are that the FOMC could either accelerate or decelerate either the commencement of rate increases and/or the speed of the rate increase. At this point, we have little clarity on exact timing, while we do have reasonable clarity on the range of start dates.

Communication
Heading into this second FOMC meeting of 2014, one of the key news items in the financial media was how Ms. Yellen was going to improve the FOMC policy statement’s communication. When communication is the key question heading into a FOMC meeting (instead of federal funds rate changes or the execution of tapering), then there is more clarity in the market.

In 2013, the FOMC had first communicated that, when the unemployment rate reached 6.5%, it would begin to increase the federal funds rate (or at least this was how it was widely interpreted). Then this 6.5% unemployment rate was subsequently reported as the point at which the FOMC would begin to “think about” increasing the federal funds rate. Now the communication is that there is no longer a direct connection between the unemployment rate and when the FOMC will commence the rate increases—which we interpret as a standard investment mosaic process where everything the FOMC feels is relevant is pieced together to form its overall picture.

Conclusion
Discussions about the timing of when the FOMC will begin to increase the federal funds rate have been going on for years, but we now believe there is meaningful clarity. As we move through 2014, we expect QE3 to be tapered to $0 near year-end. If this occurs, we expect the FOMC would make its first rate increase sometime around mid-2015 to late 2015. And at this point, we expect subsequent rate increases to be slow.

Should you like to discuss these topics further, please contact us at Milliman Investment Consulting.

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GASB 67/68: Depletion date projections

March 25th, 2014 No comments

By Javier Sanabria

New accounting rules for public pension plans in the United States are set to take effect beginning in 2014. Successful implementation of the new rules will require an understanding of a variety of technical concepts regarding the various newly required calculations.

This article authored by William Winningham explores the requirement to calculate a depletion date and how the depletion date impacts the plan’s total pension liability (TPL).

To read Milliman’s PERiScope series on technical and implementation issues surrounding GASB 67 and 68, click here.

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Regulatory roundup

March 24th, 2014 No comments

By Employee Benefit Research Group

More retirement-related regulatory news for plan sponsors, including links to detailed information.

IRS discuss current issues EP compliance unit is reviewing
The Internal Revenue Service (IRS) has posted a discussion with Monika Templeman, director of Employee Plans Examinations, regarding current issues that the Employee Plans Compliance Unit (EPCU) is reviewing. Topics discussed include:

• Confirming higher educational organizations’ compliance with the universal availability rule, which is one of the main errors found in 403(b) plan examinations.
• Form 5500 series returns that show no plan participants, yet the plan received employer contributions.
• Terminated plans that have assets remaining. This could be a violation of Revenue Ruling 89-87, which requires plan assets be distributed as soon as administratively feasible after the stated plan termination date.
• Form 5310 returns that had over a 20% drop in participants from one year to the next to determine if a partial termination occurred and, if so, whether affected plan participants were 100% vested. Because of this project, over 250 participants were 100% vested as required by Revenue Ruling 2007-43.
• Form 5500 Non-Filer Project. Plan sponsors are contacted if their latest Form 5500 returns were not marked ‘final’ and they have not filed a subsequent return. EPCU began by selecting returns that were due for the plan year ending January 31, 2010 (originally due August 31 if no extension was filed) and that have still not filed by February 2011.
• Qualifying Employer Securities Project contacted plan sponsors who reported over 10% of their plans’ net assets were invested in employer securities.
• Two projects focusing on improving international compliance.

To read the entire discussion, click here.

PBGC requests extension of collection of multiemployer plan information
The Pension Benefit Guaranty Corporation (PBGC) issued a notice asking the Office of Management and Budget (OMB) to extend approval of a collection of information under its regulations on multiemployer plans that expires March 31, 2014, April 30, 2014, or July 31, 2014. The collection of information for which PBGC is requesting approval includes various reporting requirements related to:

• Termination of multiemployer plans
• Extension of special withdrawal liability rules
• Variances for sale of assets
• Reduction or waiver of complete withdrawal liability
• Reduction or waiver of partial withdrawal liability
• Allocating unfunded vested benefits to withdrawing employers
• Notice, collection, and redetermination of withdrawal liability
• Procedures for PBGC approval of plan amendments
• Notice of insolvency

Comments should be submitted no later than 30 days after publication in the Federal Register. The notice was published on March 19, 2014. To read the entire notice, click here.

IRS posts guidance on withdrawal of Cycle C cash balance applications; provides FAQs on Cycle C
Cycle C determination letter applicants who intend to adopt a preapproved cash balance plan may withdraw their applications for individually designed cash balance plans by May 31, 2014, if they sign Form 8905, Certification of Intent to Adopt a Pre-approved Plan, by March 31, 2014.

Announcement 2014-4 extended the submission period for preapproved defined benefit (DB) pension plans from January 31, 2014, to February 2, 2015, to allow time for the IRS to expand the preapproved program to permit plans with cash balance features. The announcement also allowed Cycle C plan sponsors who want to adopt a preapproved cash balance plan to complete Form 8905 by March 31, 2014, instead of submitting determination letter applications for individually designed plans by the Cycle C deadline of January 31, 2014.

For more information, click here.

IRS updates posting on checking the status of determination, opinion, and advisory letters
The IRS has updated its posting titled “Determination, opinion, and advisory letter for retirement plans – check the status of your letter.” The posting provides a chart with information regarding receipt of an application and important links.

To view the updated posting, click here.

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