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Considerations in deciding whether or not to terminate a frozen pension plan during 2015

December 11th, 2014 No comments

Kamenir-JeffThe recent issuance by the Society of Actuaries of a new mortality table for possible use in valuing pension liabilities has some plan sponsors thinking they should consider terminating their frozen pension plans by the end of 2015. The plan termination consideration is due to speculation that the Internal Revenue Service (IRS) may require the use of the new mortality table for calculating lump-sum distributions of pension benefits beginning in 2016, which would increase lump-sum amounts. There are many other considerations beyond the possible timing of the new mortality table that a plan sponsor should take into account before deciding to terminate a frozen pension plan by the end of 2015, which are summarized below.

In support of 2015 plan termination:

1. Avoidance of scheduled increases to Premium Benefit Guaranty Corporation (PBGC) premium rates after 2015.
2. No prospective concerns about trying to annually manage pension cost volatility.
3. Elimination of annual administration costs.
4. If a lump-sum distribution is offered, active participants have the opportunity to have immediate access to the value of their frozen benefits.

Disadvantages of 2015 plan termination:

1. Lump-sum and annuity purchase liability interest rates are currently very low, which results in higher plan termination liabilities.
2. A large one-time pension settlement accounting loss may be incurred on the company’s financial statements.
3. A very large pension contribution may be necessary to fully fund plan termination liabilities, which in part is due to the low interest rate environment.
4. A plan termination is a time-consuming process with various steps required, including trying to locate missing participants.
5. Recent funding relief legislation may result in lower minimum required contributions over the next several years.

In order to accomplish a plan termination by the end of 2015, a plan sponsor will need to make a decision to terminate early in 2015 to account for the entire plan termination process. The decision process should include discussing with the plan’s legal counsel whether or not it is advisable to distribute plan assets following PBGC approval but prior to IRS approval of the plan termination.

Google Hangout: Pension Funding Index, December 2014

December 5th, 2014 No comments

The funded status of the 100 largest corporate defined benefit pension plans fell by $8 billion during November as measured by the Milliman 100 Pension Funding Index (PFI). The deficit widened from $263 billion to $271 billion, primarily due to another decrease in the benchmark corporate bond interest rates used to value pension liabilities. The funded ratio declined from 84.8% to 84.6% at the end of November.

PFI co-author Zorast Wadia offers some perspective on the latest results in this Milliman Google+ Hangout.

Corporate pension funded status drops another $8 billion in November

December 4th, 2014 No comments

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 November, these plans experienced a $26 billion increase in pension liabilities and an $18 billion increase in asset value, resulting in an $8 billion increase in the pension funded status deficit.

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The story this year seems to be the same month after month, and in November it’s exactly the same as it was in October—an $8 billion increase in the funded status deficit, with liabilities exceeding positive asset performance. For the year, interest rates have dropped by 79 basis points, driving a $167 billion liability increase.

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 3.89% were maintained, funded status would improve, with the funded status deficit shrinking to $230 billion (87% funded ratio) by the end of 2015 and to $191 billion (89.2% funded ratio) by the end of 2016. This forecast assumes 2014 aggregate contributions of $44 billion and 2015 and 2016 aggregate contributions of $31 billion.

Fund pensions and reduce PBGC premiums by borrowing cash

December 4th, 2014 No comments

Pension Benefit Guaranty Corporation (PBGC) premium rates are going to rise threefold by 2016. Consequently, companies sponsoring underfunded defined benefit plans will have to pay higher annual premiums. A solution that could lower or eliminate PBGC premiums is to borrow cash to fund a pension. This Plan Sponsor article authored by Milliman’s Will Clark-Shim offers perspective.

Here’s an excerpt:

Plan sponsors may not have the cash to contribute to their plans; another option is to borrow money to fund the pension plan.

This may sound like leverage, but plan sponsors already owe the pensions. The PBGC values those pensions as if they were AA-rated corporate debt. If a plan sponsor borrows money, funds the pension plan, and invests the borrowed proceeds in AA-rated corporate debt, it has roughly swapped one type of debt for another. The goal here is not to beat the market; the goal is to avoid paying a “tax” of 2.9% per year…

How much can plan sponsors save? Illustratively, if a plan sponsor pays 6% interest on its debt, invests the proceeds at 4% in long-duration corporate bonds, and forgoes 2.9% PBGC premiums, it saves 0.9% per year. On $20 million, that would be $180,000 per year, prior to taxes.

In addition, the pension contributions and the interest on the plan sponsor’s debt are generally tax-deductible. That may mean some tax relief above and beyond the PBGC premium savings. The higher the company’s taxes, the greater the potential tax advantages.

To learn more about this pension risk management solution, read Clark-Shim and Chris Jasperson’s article “Borrowing money to reduce PBGC premiums.”

GASB 67/68: Proportionate share allocation

November 19th, 2014 No comments

This PERiScope article in Milliman’s Governmental Accounting Standards Board (GASB) Statements No. 67 and 68 miniseries discusses the allocation of financial reporting liabilities for cost-sharing multiple employer plans.

Under the new GASB 67/68 rules, a cost-sharing multiple-employer pension plan is a plan that is used to provide pensions to employees of more than one employer, and plan assets are pooled such that they can be used to pay the benefits of the employees of any employer. Other plan types defined under the new GASB statements include single employer plans (where a plan involves only one employer), and agent employer plans (where assets of one employer may not legally be used to pay the benefits of the employees of any other employer). For cost-sharing plans, a “proportionate share” for each employer must be developed to distribute the aggregate plan liability and expense among the employers’ financial statements. An individual employer’s proportionate share will almost certainly change from measurement date to measurement date, and the financial impact of this change must be quantified. In addition, to the extent that an employer makes actual contributions during the year that are different from its allocated proportionate share of contributions, this difference must also be tracked and accounted.

Google+ Hangout: Pension Funding Index, November 2014

November 17th, 2014 No comments

The funded status of the 100 largest corporate defined benefit pension plans fell by $8 billion during October as measured by the Milliman 100 Pension Funding Index (PFI). The deficit widened from $255 billion to $263 billion at the end of October, which was primarily due to a decrease in the benchmark corporate bond interest rates used to value pension liabilities. As of October 31, the funded ratio declined from 85.1% to 84.8%.

PFI co-author Zorast Wadia discusses the index’s latest results on this Milliman Google+ Hangout.

Nondiscrimination testing: Minimum allocation gateway

November 11th, 2014 No comments

Peatrowsky-MikeA defined contribution (DC) plan can test on a benefits basis if it meets any of the following criteria:

• Provides broadly available allocation rates
• Provides age-based allocations
• Provides a minimum allocation gateway to non-highly compensated employees (NHCE)

A plan satisfies the minimum allocation gateway test if each NHCE has an allocation rate, which is determined using Internal Revenue Code (IRC) Section 414(s) compensation, that is at least one-third of the highest allocation rate of any highly compensated employee (HCE) participating in the plan.

Alternatively, a plan is deemed to satisfy the gateway test if each NHCE receives an allocation of at least 5% of the employee’s IRC Section 415 compensation. Therefore, a DC plan designed to provide a minimum allocation of at least 5% to NHCEs will always be eligible to be cross-tested for nondiscrimination testing.

Aggregated DB/DC plans
To satisfy the minimum gateway for an aggregated defined benefit (DB)/DC plan, each NHCE must have an aggregate normal allocation rate (ANAR) that meets the following requirements:

Nondiscrimination testing graph

Instead of using each NHCE’s equivalent allocation rate under a DB plan in calculating the aggregate allocation rate, it is permissible to use the average of the equivalent allocation rates of all NHCEs benefiting under the DB plan.

Who must receive the minimum allocation gateway?
Employees who receive a safe harbor nonelective contribution, a top-heavy minimum contribution, or a qualified nonelective contribution (QNEC) must receive a minimum allocation gateway contribution, unless they are separately tested under 401(a) as part of a disaggregated group.

If you have questions regarding the minimum allocation gateway, please contact your Milliman consultant.

Corporate pension funded status drops by $8 billion in October

November 10th, 2014 No comments

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 October, these plans experienced a $22 billion increase in pension liabilities and a $14 billion increase in asset value, resulting in an $8 billion increase in the pension funded status deficit.

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These pensions have had a great year from an asset perspective, with $65 billion of improvement since the start of the year. But over the same time, interest rate decreases have ballooned the liabilities for these pensions by $141 billion. Low interest rates continue to drive this funding deficit.

Liabilities may be further influenced by the introduction of new mortality tables. The latest PFI has not been adjusted to estimate for the impact of possibly moving to the mortality tables recently finalized by the Society of Actuaries, but preliminary estimates indicate a possible increase in liabilities of between 6% to 8%.

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 4.00% were maintained, funded status would improve, with the funded status deficit shrinking to $255 billion (85.3% funded ratio) by the end of 2014 and to $219 billion (87.4% funded ratio) by the end of 2015.

Milliman issues third annual Public Pension Funding Study, provides objective analysis of funded status for 100 largest plans

November 5th, 2014 No comments

Sielman-BeckyMilliman today released its third annual Public Pension Funding Study, which consists of the nation’s 100 largest public defined benefit pension plans and analyzes these plans from both a market value and an actuarial value perspective. Strong market conditions have propelled improvement in the market value of plan assets, and that improvement has exceeded the increase in accrued liabilities. However, the market losses suffered during the financial crisis continue to cause a drag on the actuarial value of plan assets, resulting in a slight decrease in the funding ratio when analyzed from that perspective. The two asset measures are converging and funded ratios have crept upward as these plans have continued to distance themselves from the financial crisis. Meanwhile, investment return assumptions were level from the prior year but remain higher than current long-term market return expectations, causing concern that accrued liabilities may be modestly underreported.

Our study provides an independent investment return assumption, which we use to recalibrate the liabilities for these 100 plans. While the investment return assumptions and funded ratios remain fairly level from last year, the gap between Milliman’s recalibrated accrued liability and the plan-reported accrued liability widened from 2.6% in 2013 to 3.8% in this year’s study. While Milliman lowered our median investment return assumption from 7.47% in 2013 to 7.34% this year, only 13 of the 100 plans in our study reported a reduction in their investment return assumption this year. We expect more plans will consider lowering return assumptions in coming years in response to market conditions.

This year’s study revealed a number of other developments. The number of retired/inactive members in these 100 plans grew from 11.8 million members to 12.1 million. In the aggregate, the plans currently have sufficient assets to cover 100% of the sponsor-reported accrued liability for retirees and inactive members, but beyond that would cover only 29% of the liability for active plan members.

This year’s study explores whether poorly funded public plans are more apt to use unrealistically high investment return assumptions or invest disproportionately in risky investments. Contrary to common perception, the study finds that there is in fact very little correlation between a plan’s funded status and the use of high interest rates or riskier investments.

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A thought out approach to borrowing funds may ease PBGC premiums

October 30th, 2014 No comments

Congress has increased the PBGC premium rates that plan sponsors of underfunded defined benefit (DB) plans will have to pay in the coming years. Sponsors should consider borrowing money to fully fund their plans to eliminate these premiums. In the latest issue of Pension Risk Perspective, Milliman consultants Will Clark-Shim and Chris Jasperson discuss how to structure this kind of lending transaction.

Here is an excerpt from their article:

Factors to consider when borrowing funds include:

• Method of borrowing: Two primary options are a direct loan from a financial institution or issuing bonds. Plan sponsors should consider whether accounting treatment may vary depending upon the method of borrowing.

• Structure of repayment: Two common approaches are amortizing payments like a mortgage or issuing a bond with periodic interest payments and full principal repayment at maturity.

o Amortizing the debt over seven years may allow plan sponsors to somewhat replace the IRS minimum required contributions prior to issuing debt, but this may not be a readily available payment structure.

o Using a traditional bond structure with repayment occurring over 10, 20, or 30 years would give plan sponsors more cash-flow flexibility in the short term, but would not settle the outstanding liability until the debt is paid off at maturity.

o The longer the debt repayment period, the less attractive the transaction may become. If the plan sponsor intends to roll over the debt, that should be modeled at the outset.

• What is the interest rate on the debt? The lower the rate, the more attractive the transaction becomes.

• What is the plan sponsor’s marginal tax rate? The higher the tax rate, the more attractive the transaction may become.

For more Milliman perspective on pension risk management, click here.