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Milliman infographic: Pension liabilities

May 18th, 2015 No comments

When the discount rate increases the projected benefit obligation (PBO), or pension liability, decreases, and vice versa. This relationship explains the volatile nature of pension liabilities and demonstrates why liabilities-driven investment strategies, which manage funded status and limit volatility of pension liabilities and asset returns, are useful.

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To read the entire 2015 Corporate Pension Funding Study, click here.

Pension funded status improves by $40 billion in April

May 7th, 2015 No comments

Milliman today released the results of its latest Pension Funding Index, which analyzes the 100 largest U.S. corporate pension plans. In April, these pension plans experienced a $40 billion increase in funded status based on a $2 billion decrease in asset values and a $42 billion decrease in pension liabilities. The funded status for these pensions increased from 80.9% to 82.6%.

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Someone once said April is the cruelest month, but for these pensions last month was less cruel than what happened over the course of the first quarter. We’re still a long ways away from full funded status, but the slight rise in interest rates at least moved things in the right direction to start the second quarter of 2015.

Looking forward, under an optimistic forecast with rising interest rates (reaching 4.22% by the end of 2015 and 4.82% by the end of 2016) and asset gains (11.3% annual returns), the funded ratio would climb to 91% by the end of 2015 and 105% by the end of 2016. Under a pessimistic forecast with similar interest rate and asset movements (3.42% discount rate at the end of 2015 and 2.82% by the end of 2016 and 3.3% annual returns), the funded ratio would decline to 78% by the end of 2015 and 70% by the end of 2016.

Pension funded status drops by $6 billion in March

April 23rd, 2015 No comments

Milliman today released the results of its latest Pension Funding Index, which analyzes the 100 largest U.S. corporate pension plans. In March, these pension plans experienced a $6 billion decrease in funded status based on decreases in asset values and increases in pension liabilities. This month’s analysis reflects the results of the 2015 Pension Funding Study, published on April 2nd.

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Last month these pensions continued to languish in the low-interest-rate doldrums. Whether or not rates climb between now and the end of the year will likely determine whether or not these pensions can meaningfully reduce the funded status deficit before year-end.

Looking forward, under an optimistic forecast with rising interest rates (reaching 4.10% by the end of 2015 and 4.70% by the end of 2016) and asset gains (11.3% annual returns), the funded ratio would climb to 90% by the end of 2015 and 104% by the end of 2016. Under a pessimistic forecast with similar interest rate and asset movements (3.20% discount rate at the end of 2015 and 2.6% by the end of 2016, with 3.3% annual returns), the funded ratio would decline to 75% by the end of 2015 and 68% by the end of 2016.

Projected funding rates for the next several plan years

April 10th, 2015 No comments

Kliternick-StuartThe assumptions actuaries use to calculate funding and accounting liabilities for defined benefit (DB) plans are in the process of undergoing revisions over the next several years. The Society of Actuaries recently released new mortality and mortality projection tables and, even though the Internal Revenue Service has yet to adopt the new mortality tables for funding purposes, several plans are using either these tables or a modification of the current standard tables when calculating their accounting disclosure liabilities. Actuarial Standards of Practice (ASOPs) will encourage actuaries to review other demographic assumptions (e.g., withdrawal) and economic assumptions, such as the consumer price index (CPI). And, as the Milliman Pension Funding Study shows, the discount rates used for accounting purposes have fluctuated.

However, because of recent law changes made by the Moving Ahead for Progress in the 21st Century Act (MAP-21) and the Highway and Transportation Funding Act of 2014 (HATFA), pension funding discount rates for plans that use segmented interest rates have been relatively stable for the past several years. In fact, the process used to determine the segment rates under HATFA is so stable that, absent additional funding rules changes, one can predict with reasonable accuracy the segment rates to be used for funding valuations for the next several plan years.

As an example of the stability of the process for calculating the HATFA rates, assume that the yield curve used to calculate the segment rates remains constant from February 2015 (the most recent yield curve released as of this blog post) through September 2015. The calculated rates used to establish the HATFA corridor would be 4.92%, 6.57%, and 7.39%. The low-end segment rates of the HATFA corridor, which make up 90% of those rates, are 4.43%, 5.91%, and 6.65%. They would be the rates used for 2016 plan year valuations. These rates do not change even if the yield curve used to calculate the segment rates were to increase by 42 basis points each month through September 2015 or decrease by 19 basis points each month.

We have calculated 5,000 stochastic simulations of the Pension Protection Act of 2006 (PPA) yield curve, assuming current funding laws remain in place throughout this calculation and using Milliman’s capital market assumptions. The table below shows the results for the next four years showing the 50th percentile of the 24-month average rates (assuming a calendar-year plan with no look back period), and a range using the 5th and 95th percentile rates as endpoints for 2015-2018.

Year 2015 2016 2017 2018
First Segment Rate 1.22% 1.48%(0.94%-2.11%) 1.89%(0.46%-3.71%) 2.30%(0.16%-5.11%)
Second Segment Rate 4.11% 3.94%(3.49%-4.42%) 4.04%(2.81%-5.37%) 4.36%(2.55%-6.50%)
Third Segment Rate 5.20% 4.96%(4.56%-5.37%) 5.04%(3.98%-6.17%) 5.40%(3.86%-7.08%)

As the table indicates, short term interest rates are projected to rise over the next several years, perhaps as much as over 100 basis points. Mid-term and long term rates are projected to initially fall and then rise about 20 to 25 basis points over the next several years. As such, the effective interest rate on this basis would rise by about 25 basis points depending on the plan’s payout streams.

Next, the following chart provides the 50th percentile of the stochastic simulations of the low end of the HATFA rates through the 2018 plan year, and a range using the 5th and 95th percentile rates as endpoints for each segment for 2015-2018. As a reminder, the segment rate to use when calculating liabilities is the greater of the 24-month average rate and the low-end HATFA corridor rate. Therefore, if the HATFA rate is lower than the 24-month average rate, the 24-month average rate will be used in the stochastic simulation.

Year 2015 2016 2017 2018
First Segment Rate 4.72% 4.43%(4.43%-4.44%) 4.16%(4.13%-4.19%) 3.71%(3.63%-5.10%)
Second Segment Rate 6.11% 5.91%(5.91%-5.91%) 5.72%(5.70%-5.74%) 5.23%(5.16%-6.50%)
Third Segment Rate 6.81% 6.65%(6.65%-6.65%) 6.48%(6.46%-6.50%) 5.96%(5.90%-7.08%)

As this table indicates, despite the rise in the 24-month average rates, the HATFA rates drop by 85 to 101 basis points. This would cause a typical plan’s effective interest rate for funding purposes to drop by 84 basis points from 2015 to 2018, which leads to an increase in the Target Liability by over 10.5%. The large drop in the HATFA rates from 2017 to 2018 is due to two reasons: the HATFA corridor widens by 5% starting in 2018 so the low end of the corridor is now 85% of the 25-year average used to calculate the HATFA rates; and the highest rates in the 25-year average used to calculate the HATFA rates are removed by 2018.

Based on the stochastic simulations, it would appear that the 2016 plan year HATFA segment rates have already been determined. The 5th to 95th percentile interval around the midpoint rate is the same except for an increase of one basis point in the first segment, and the 24-month average rates do not approach the HATFA rates. In addition, it can reasonably be predicted that the 2017 rates will be the HATFA rates based on these simulations. This is due to the 24-month average rates in the first table not approaching the HATFA corridor rates in the second table. Because the 5th to 95th percentile interval around each projected 2017 plan year HATFA rate is narrow, using the midpoint rates in projecting 2017 liabilities will result in a good estimate of the 2017 liability to be used for minimum funding purposes.

However, for 2018 the 5th to 95th percentile interval around the midpoint HATFA rate widens, especially going from the 50th percentile to the 95th percentile. This increase is due to the projected 24-month average being greater than the low-end HATFA corridor rate. The likelihood of the 24-month average rate falling inside the HATFA corridor increases in the next several plan years as the HATFA corridor widens to 70% to 130% of the 25-year average. Therefore it becomes harder trying to predict plan year segment rates starting in 2018.

Milliman Hangout: 2015 Pension Funding Study

April 3rd, 2015 No comments

The funded status of the largest 100 corporate defined benefit plans declined by $131.3 billion in 2014 as measured by the 2015 Milliman 100 Pension Funding Study (PFS). Plan liability increases overwhelmed robust asset investment gains and annual contributions declined to $39.8 billion from $44.2 billion in 2013. PFS coauthors John Ehrhardt and Zorast Wadia discuss the results of the study with Amy Resnick, executive editor of Pensions & Investments, in this Milliman Hangout.

To read Pensions & Investments’ coverage of the study, click here.
To download the 2015 Milliman 100 Pension Funding Study, click here.

Discount rates deepen pension funding deficit and make 2014 a banner year for liability-driven investing

April 2nd, 2015 No comments

Ehrhardt-JohnMilliman today released the results of its 2015 Pension Funding Study, which analyzes the 100 largest U.S. corporate pension plans. In 2014, these pension plans experienced a funded status decline despite a 10.9% investment return, with plan liabilities for these 100 plans increasing by $189.2 billion and assets increasing by $57.9 billion. This resulted in a $131.3 billion increase in the funded status deficit, representing a funding ratio decline of 6.1%.

Pension plan sponsors may be feeling whiplash after the last three years. In 2012, plans with the heaviest investment in fixed income experienced superior returns. In 2013, we saw the opposite: Plans with heavy equity allocations fared the best. Now with these latest results, we’ve again reversed ourselves, as plans with the highest fixed income allocation once again outpaced the field despite a strong year for equities. This whiplash is the result of discount rates that hit a record low this year, and continue to define pension funding status.

Study highlights include:

Asset allocations shift toward fixed income. Equity allocations in the pension portfolios dropped to 37.3% by the end of 2014, the lowest in the 15-year history of this study. The companies included in this study have generally shifted toward higher allocations in fixed income investments.

Risk transfer trend continues. Some plan sponsors engaged in pension risk transfer activities, including two well-publicized pension buyouts conducted for two of the Milliman 100 companies (Bristol-Myers Squibb and Motorola).

New mortality assumptions increase pension liabilities by 3.4%. The magnitude of these increases is contingent on age, gender, and other demographic characteristics of each plan’s participants. Based on the footnote disclosures at year-end 2014, the new Society of Actuaries mortality tables led companies to update mortality assumptions, increasing pension liabilities by approximately $38.3 billion, or 3.4%, at least among those plans that disclosed the impact.

Contributions decline during 2014. The $39.8 billion in contributions during 2014 were the lowest level since 2008 and marked a $4.4 billion decrease from 2013 contribution levels. The lower-than-expected contributions were likely due to plan sponsors changing their contribution strategies in light of the Highway and Transportation Funding Act of 2014 (HATFA) interest rate stabilization legislation, enacted in August 2014.

Pension expense increases. Robust investment gains in 2013 were partially offset by the impact of lower contributions and increasing discount rates during 2013, producing a net increase of $4.8 billion and resulting in a total of $37.1 billion in pension expense. Pension expense hit an all-time high at $56.1 billion in 2012.

What to expect in 2015. The passage of HATFA may result in lower contributions on par with those seen in 2014. However, for plans already engaged in liability-driven investing (LDI), higher contribution levels can be expected. The lower discount rates at the end of 2014 are expected to lead to significant 2015 pension expense increases because discount rates for the coming fiscal year are set at the start of the fiscal year. This does not factor in any possible plan de-risking activity.

2014 annual funding notice: Changes you need to know

March 31st, 2015 No comments

Moliterno-MariaThe Highway and Transportation Funding Act of 2014 (HATFA) modified some of the content to be included on the 2014 annual funding notice (AFN) for single-employer defined benefit (DB) plans. Pension law requires employers that sponsor defined benefit plans to share certain financial information about the plan‘s funded status with plan participants via the AFN. Because the AFN due date is approaching for 2014 calendar-year plans, actuaries and plan sponsors should be aware of the necessary changes. The U.S. Department of Labor issued Field Assistance Bulletin (FAB) 2015-01 addressing updates to the 2014 AFN to reflect the application of HATFA.

In general, the AFN must be distributed to pension plan participants 120 days after the end of the plan year. Therefore, for calendar-year plans, the AFN must be distributed by April 30.

If a plan sponsor did not opt out of HATFA for plan year 2013 (“opt out” refers to the selection of the interest rate used to calculate the plan’s funding target) and had previously issued a 2013 AFN without reflecting HATFA, the 2013 AFN does not need to be revised or reissued to reflect the updates addressed in FAB 2015-01. However, the plan year 2013 results reflecting HATFA will need to be disclosed on the 2014 AFN.

Throughout the AFN, any references to Moving Ahead for Progress in the 21st Century Act (MAP-21) interest rates must refer to interest rates as amended by HATFA. A temporary supplement section was added to the 2012 AFN to disclose the effect of the change that is due to the MAP-21. Prior to HATFA, the temporary supplement was only required for applicable plan years beginning before January 1, 2015. Subsequent to HATFA, this temporary supplement is required for applicable plan years beginning before January 1, 2020.

An applicable plan year is defined as any plan year within the period in which the following three requirements are met:

1. The funding target under adjusted interest rates is less than 95% of the funding target without regard to adjusted interest rates.
2. The plan’s funding shortfall determined without regard to adjusted interest rates is greater than $500,000.
3. The plan had 50 or more participants on any day during the preceding plan year.

Previously, the first two items above were calculated using MAP-21 interest rates. Subsequent to HATFA, these same calculations are determined using HATFA interest rates. The wording on the supplement section of the AFN has replaced any references to MAP-21 rates with “adjusted interest rates.”

Prior to HATFA, if the value of plan assets was determined without regard to the MAP-21 interest rates, the AFN was to include a statement with the asset value and an explanation of how it differs from the value of plan assets used for funding purposes. Subsequent to HATFA, the Department of Labor rescinded this requirement after recognizing that it may result in complex requirements.
While most of the changes required by FAB 2015-01 are modest, they will still need to be reflected in the 2014 AFN. Be sure to update your 2014 AFN accordingly.

Pension plan risks will dictate de-risking behavior

March 13th, 2015 No comments

The de-risking of defined benefit (DB) plans is not expected to cease despite a low interest rate environment. This de-risking activity will depend on how the options available to plan sponsors address their particular pension plan risks. In a recent Bloomberg BNA article, Milliman consultants Zorast Wadia and Stuart Silverman discussed the option of longevity hedging.

Here is an excerpt:

Another type of longevity risk-shifting is longevity hedging, also called longevity swaps, [Zorast] Wadia said.

With the release of the Society of Actuaries’ updated mortality tables, “I wouldn’t be surprised if there’s more interest in 2015 in longevity hedging for pension plans,” Wadia said.

The market for longevity hedging has been growing in Europe and the U.K., but has yet to develop in the U.S., Wadia said.

…Longevity swaps or longevity bonds are a “fairly low-cost approach” to de-risking a pension plan, said Stuart Silverman, also a principal and consulting actuary in Milliman’s New York office.

In a September 2014 Milliman report titled “Understanding Risks and Solutions: A Pension De-Risking Case Study,” co-authored by Silverman, longevity bonds are defined as “capital market instruments that can reduce the upper tail of pension plan costs that are due to life expectancy significantly higher than initially expected.”

“Essentially, the corporation would issue a bond, with the principal repayment contingent on the level of future life expectancies,” the report said.

If plan sponsors had been using longevity swaps since 2000, they would have locked into an economic payment stream based on mortality exposure, but would have reduced their longevity exposure, and therefore “would have saved a significant amount of pension liability, because they would have not had that exposure over that period of time,” Silverman said.

When a plan sponsor is considering its options—whether to maintain its plan or to move in the direction of de-risking—it should consider not only the risks to the plan, but also the company’s risk tolerance, Silverman said.

For Milliman’s perspective on the de-risking of DB plans, click here.

Funded status improves in February from rise in interest rates and investments

March 9th, 2015 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. The funded status of the 100 largest corporate defined benefit pension plans increased by $80 billion during February, as measured by the Milliman 100 Pension Funding Index (PFI). After a $90 billion decrease in funded status in January, this month’s increase leaves these pensions’ funded status in approximately the same spot as they began the year.

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An increase in the corporate bond discount rates was a big driver of last month’s gains. But that needs to be put in perspective. January’s discount rate was the lowest in the history of our study, and February’s discount rate was the second-lowest. Discount rates continue to define pension funded status, and upward movement in those rates will be necessary to eliminate the funding deficit.

Looking forward, under an optimistic forecast with rising interest rates (reaching 4.13% by the end of 2015 and 4.73% by the end of 2016) and asset gains (11.4% annual returns), the funded ratio would climb to 94% by the end of 2015 and 107% by the end of 2016. Under a pessimistic forecast with similar interest rate and asset movements (3.13% discount rate at the end of 2015 and 2.53% by the end of 2016, with 3.4% annual returns), the funded ratio would decline to 77% by the end of 2015 and 70% by the end of 2016.

Is 2015 the year of lump-sum sweeps?

February 27th, 2015 No comments

Sent-StephanieAt the beginning of each year, plan sponsors often ask if we see any retirement trends for the year ahead. One issue emerging in 2015 may be an increase in the number of lump-sum sweeps for defined benefit retirement plans. A lump-sum sweep is when a plan sponsor offers a lump sum temporarily to a group of terminated participants and settles all or a portion of the plan sponsor’s pension obligations. There are many reasons why a plan sponsor may (or may not) choose to perform a lump-sum sweep:

• The size of the plan has grown to a disproportionate size in comparison with the current size of the company. Lump-sum sweeps may be one tool to adjust that balance.
• Escalating Pension Benefit Guaranty Corporation (PBGC) premiums, especially for vested terminated participants with small benefits. The flat rate PBGC premium for 2015 is $57 per participant. Remember when they used to be $19 per participant? Lump-sum sweeps may be one solution to reduce those premiums.
• The plan sponsor is seeking to terminate the retirement plan or is on a de-risking glide path. Lump-sum sweeps may be one way to further the long-term objectives.

Of course, there are a number of factors why a plan sponsor may choose to not execute a lump-sum sweep as well, including:

• The missed opportunity cost for higher return on plan assets, since lump-sum sweeps reduce the plan assets as well as the plan liabilities.
• Depending on the interest rates used to value the lump sums versus the interest rates used for minimum funding requirements, the funded status of the plan may drop if more assets are paid out than liabilities are released.
• With interest rates at a historic low, lump sums are higher than they might be in the future if interest rates increase.
• The Government Accountability Office (GAO) has voiced concerns that plan participants have not received adequate information regarding lump sum distributions versus life-time annuities to make informed decisions.

Why 2015? The Internal Revenue Service (IRS) has published lump-sum mortality tables through 2015. Many expect changes for 2016 or 2017 mortality rates, so that they better reflect the fact that people are living longer. As a result, the lump-sum values of retirement benefits going forward could increase significantly, somewhere in the range of 5% to 10%. If this is the case, the timing of these forthcoming changes is important, because they could be published by the IRS as soon as the third or fourth quarter of 2015. Plan sponsors already contemplating a lump-sum sweep may want to do so in 2015 in order to avoid this increase. Of course, 2015 has just begun, so stay tuned.