Milliman today released its second annual Public Pension Funding Study, which consists of the nation’s 100 largest public defined benefit pension plans. The study offers an aggregate analysis of these 100 public pensions and their funded status. The study complements Milliman’s corporate Pension Funding Study, which is now in its 13th year.
The Milliman analysis of these 100 plans identified several significant trends. Twenty-nine of these plans lowered their interest rate assumptions, with the median interest rate used by these plans decreasing from 8.00% in 2012 to 7.75% in 2013. A reduction in interest rates increases accrued liabilities and decreases funded ratios. The average funded ratio across the 100 plans is down slightly from the 2012 study, which reflects both the lowered interest rate assumptions and market movements. Because this study is based on published reports that largely reflect 2012 valuation dates, much of 2013’s strong market performance is not reflected in this study’s results.
“This year’s study reflects a consensus move toward more conservative assumptions,” said Becky Sielman, author of the Milliman Public Pension Funding Study. “This is evident in the average reduction in interest rate assumptions since last year’s study. This year’s study also provides an objective view of funded status, independent of what the 100 plans self-report. As was the case last year, our independent analysis of these pension plans indicates that most of the plans are realistically approaching their funding calculations, with the Milliman analysis only 2.6% larger than the cumulative accrued liability reported by the plans. While that still leaves a sizeable funding hole—these plans are 70.6% funded—at least it offers a realistic view of the road ahead.”
The study provides insight into other aspects of these 100 plans, including investment allocations, liability and asset performance, and asset volatility ratios. Taken as a whole, the study allows for the ongoing, independent measurement of aggregate public pension funded status.
About the Milliman Public Pension Funding Study
The Milliman Public Pension Study is based on the most recently available Comprehensive Annual Financial Reports and actuarial valuation reports, which reflect valuation dates ranging from June 30, 2010, to December 31, 2012; about two-thirds are from June 30, 2012 or later. For the purposes of this study, the reported asset allocation of each of the included plans has been analyzed to determine an independent measure of the expected long-term annual geometric average rate of return on plan assets. The reported accrued liability for each plan has then been recalibrated to reflect this actuarially determined interest rate. This study therefore adjusts for differences between each plan’s assumed rate of investment return and a current market assessment of the expected return based on actual asset allocations. This study is not intended to price the plans’ liabilities for accounting purposes or to analyze the funding of individual plans.
The funded status of the 100 largest corporate defined benefit pension plans improved by $3 billion during October as measured by the Milliman 100 Pension Funding Index (PFI). The deficit declined modestly to $126 billion, which was due to a robust investment gain of almost 2.4%. The PFI funded ratio increased to 91.9%.
PFI co-author Zorast Wadia discusses the latest PFI results on our monthly Google+ Hangout.
Milliman today released the results of its latest Pension Funding Index, which consists of 100 of the nation’s largest defined benefit pension plans. In October, these plans experienced a $31 billion increase in asset value and a $28 billion increase in pension liabilities. The pension funding deficit decreased to $126 billion at the end of October.
We faced a frightening funded status at this time last year, with the discount rate reaching 3.96%, one of the lowest in the 13-year history of this study. Twelve months and $392 billion worth of improvement later, we are on track to end the year better than 90% funded.
Year-to-date, assets have improved by $107 billion and the projected benefit obligation has been reduced by $157 billion, resulting in a massive improvement in funded status and increasing the funded ratio to 91.9%.
Looking forward, if the Milliman 100 pension plans were to achieve the expected 7.5% median asset return for their pension portfolios, and if the current discount rate of 4.67% were maintained, funded status would improve, with the funded status deficit narrowing to $113 billion (92.7% funded ratio) by the end of 2013 and $27 billion (98.2% funded ratio) by the end of 2014.
Milliman’s latest Pension Funding Index (PFI) shows that the funded status of the 100 largest corporate defined benefit plans improved by $32 billion during September. The deficit dropped to $132 billion from $164 billion at the end of August, which was primarily due to a robust investment gain of more than 2% during September. The PFI funded ratio increased to 91.4% from 89.3% at the end of August.
PFI coauthor Zorast Wadia discusses the index’s latest results on this Google+ Hangout with Jeremy Engdahl-Johnson.
Milliman today released the results of its latest Pension Funding Index, which consists of 100 of the nation’s largest defined benefit pension plans. In September, the funded status of the 100 largest corporate defined benefit pension plans improved by $32 billion as measured by the Milliman 100 Pension Funding Index (PFI). The deficit dropped to $132 billion from $164 billion at the end of August, which was primarily due to a robust investment gain of more than 2% during September. The PFI funded ratio increased to 91.4% from 89.3% at the end of August. This marked the fourth consecutive quarter of improvement in funded status.
It looks like the good news surrounding pension funded status has returned, at least temporarily, after a slight reversal of direction in August. The market value of assets increased by $27 billion as a result of September’s investment gain of 2.10%.
Under an optimistic forecast with rising interest rates (reaching 4.95% by the end of 2013 and 5.55% by the end of 2014) and asset gains (11.5% annual returns), the funded ratio would climb to 95% by the end of 2013 and 113% by the end of 2014. Under a pessimistic forecast with similar interest rate and asset movements (4.65% discount rate at the end of 2013 and 4.05% by the end of 2014 and 3.5% annual returns), the funded ratio would decline to 90% by the end of 2013 and 84% by the end of 2014.
Based on some recent survey information, reports on the demise of pension plans have been greatly exaggerated. A survey that I conducted in 2012 on Milliman single employer defined benefit (DB) pension plans, showed that about 50% of the plans were still accruing benefits for at least some participants. In addition, a Bureau of Labor Statistics National Compensation Survey in March 2012 indicated that 68% of private industry DB plans covering nonunion workers are still accruing benefits. Even if these survey results are flawed, it is clear that not all DB plans have frozen benefit accruals. Therefore, for many plan sponsors, the decision of how to maintain an ongoing accrual DB plan is still relevant.
The four scenarios that the plan sponsor of an ongoing accrual DB plan would most likely be considering are:
1. Maintain the DB plan as is with no changes.
2. Freeze all benefit accruals followed by a plan termination.
3. Freeze all benefit accruals without an immediate plan termination.
4. Maintain ongoing accruals for only current participants with no new participants.
The advantages and disadvantages of each scenario from a plan sponsor perspective are summarized below.
Maintain DB plan as is: Advantages
A DB plan is the best vehicle for providing monthly lifetime income to participants because it is not subject to mortality and investment risk. With defined contribution (DC) plans, participants must figure out on their own how to make their account balances last a lifetime.
For active participants, DB plan benefits can automatically adjust for inflation under a final average pay benefit formula. For retired participants, that can be accomplished with an automatic cost-of-living feature.
In many ways DB plans are more flexible in design than DC plans. DB plans can offer features such as early retirement windows, ongoing subsidized early retirement benefits, and supplemental monthly benefits to Social Security or Medicare retirement age, providing participants the opportunity to retire early. DB plans can easily be amended to update past service benefit accruals by a benefit formula improvement.
As with DC plans, DB plans can be easily amended to reduce future benefit accruals.
Maintain DB plan as is: Disadvantages
Managing the cost volatility (funding and pension accounting) that is primarily related to unpredictable investment performance and liability interest rate changes remains the biggest challenge facing any DB plan. Plan sponsors should discuss possible policies and strategies with their actuaries and investment consultants to help reduce cost volatility.
Pension Benefit Guaranty Corporation (PBGC) premium rates, both flat and variable, will be increasing under the Moving Ahead for Progress in the 21st Century (MAP-21) legislation passed in 2012. This is a plan expense that only provides a benefit to the plan sponsor in the unlikely event of a distress plan termination.
Freeze all benefit accruals/plan termination: Advantages
The plan sponsor no longer needs to be concerned about cost volatility issues.
In a plan termination situation, unlike an ongoing plan situation, active participants can be offered immediate access to the lump sum value of their accrued benefit.
Freeze all benefit accruals/plan termination: Disadvantages
The plan sponsor must commit to the plan termination process, which has many steps and stringent deadlines. In conjunction with the plan termination, the plan sponsor will need to locate all terminated vested participants and may need to cleanse data to accurately determine accrued benefits for active and terminated vested participants.
The recent low interest rate environment has increased the cost of settling liabilities (lump sums and annuity purchases).
The plan sponsor in a “standard” plan termination will typically need to make a significant immediate contribution in order to fully fund plan termination liabilities.
Most plan sponsors decide to design some type of replacement for the frozen DB plan benefit accruals, typically through new DC plan contributions. This is a time-consuming process with lots of necessary participant communications. Many times, special transitional DC plan contributions are considered for long-service DB plan participants who are most adversely affected by the benefit freeze.
Special curtailment and settlement pension accounting calculations will be required, resulting in the immediate recognition of unrecognized pension accounting losses.
Freeze all benefit accruals/deferred plan termination: Advantages
In comparison to an immediate plan termination, the plan sponsor can hope for a prospective higher interest rate environment in order to reduce the cost of settling plan termination liabilities. In addition, the plan sponsor can start gradually funding for plan termination liability, rather than having to immediately make a large contribution, and special settlement accounting is deferred.
Freeze all benefit accruals/deferred plan termination: Disadvantages
In comparison to an immediate plan termination, communications to active participants will be more difficult because they will not have immediate access to their frozen DB plan benefits. In addition, the plan sponsor will still need to annually maintain the DB plan, which entails management of cost volatility and annual payment of PBGC premiums.
As with an immediate plan termination, the plan sponsor will still need to go through a process to determine a replacement for the frozen DB plan accruals and special curtailment accounting is still immediately required.
Maintain ongoing accruals for only current participants: Advantages
The plan sponsor is able to keep the “promise” made to current participants at their hire that they could count on receiving retirement income for all company service from a DB plan.
Maintain ongoing accruals for only current participants: Disadvantages
In comparison to maintaining a DB plan for both current and new participants, the plan sponsor will need to monitor minimum coverage nondiscrimination requirements because all employees will no longer be covered under the DB plan. In addition, as fewer and fewer current participants accrue benefits from the DB plan because of eventual termination or retirement, the plan sponsor will also need to monitor minimum participation nondiscrimination requirements.
In comparison to a freeze of all benefit accruals, it will take much longer to see any significant DB plan cost reductions.
In conclusion, the plan sponsor should give consideration to all of the above presented issues before deciding to make significant changes to its ongoing accrual single employer DB plan.
For years, low interest rates have resulted in higher pension plan liabilities. As the cost of funding defined benefit (DB) plans has increased, many plan sponsors have frozen their plans. Some sponsors have even considered terminating their pensions upon interest rates rising again. The time for that decision may be on the horizon as interest rates have increased by over 70 basis points since the start of 2013.
Instead of terminating DB plans, Milliman’s Bill Most and Zorast Wadia believe sponsors should consider restoring pensions back to a corporate asset. In their new article, “Rising interest rates redefine options for frozen DB plans,” the two actuaries examine the cost of plan termination. In addition, they discuss alternative de-risking strategies that can turn a pension into an ongoing asset that generates income on the balance sheet.
Here is an excerpt:
Here’s the key question for plan sponsors: After going to the trouble and expense of funding your DB plan at more than 100%, is there more value to the enterprise in unloading it to an insurance company or in keeping it as an ongoing asset that generates income on the balance sheet—at significantly reduced risk?
Sponsors can achieve this outcome—the creation of a lifetime income-generating asset—by transitioning to an LDI strategy. Typically, the pension plans buys a portfolio of high-quality bonds with durations matching those of plan liabilities. This way, the sensitivity of the market value of assets to interest rate changes closely matches that of the liabilities. The investments and liabilities move in tandem, and the net funded status stays relatively consistent from year to year.
Matching up the fund’s assets and liabilities effectively eliminates funded status risk and minimizes interest rate and investment risk. We can’t talk about eliminating investment risk, because the portfolio clearly has exposure to the bond market. In addition, LDI strategies generally maintain a small allocation to equities, since a perfect duration match between plan liabilities and investments is not possible to achieve in the real world. Sponsors wishing to control the risk of this remaining equity exposure can employ an equity hedge. For example, Milliman’s Managed Risk Strategy offers dynamic hedging capabilities. The Strategy showed its effectiveness for some of the world’s largest insurers during the 2008 market downturn. This leaves only mortality risk, which can also be addressed, if desired, with customized hedging techniques.
In addition to risk control, this approach provides another substantial benefit—surpluses. Even a moderately overfunded plan with an LDI strategy in place can produce pension income under US GAAP accounting as the expected return on assets will exceed the interest cost on frozen liabilities by more than anticipated plan expenses. Every year, the financial statement can show income from the pension plan; and every year, that surplus can show up directly on the balance sheet.
Pensions offer an effective solution for potential shortfalls in retirement savings and advantages to employers. For more perspective read Richard Pavley’s article “Why defined benefit plans are still relevant.”
Over the last couple decades, defined benefit (DB) plans have in some cases been replaced by simpler employee-funded 401(k) plans. But the fact is, for many people, 401(k) plans won’t provide a sustainable retirement income. And what happens if you outlive your savings? That’s when a few smart actuaries at a forward-thinking company called Milliman came up with a really good idea. (There’s a very good white paper by Danny Quant, Zorast Wadia, and Daniel Theodore here.)
Enter the “longevity plan!”
A longevity plan is a proposed new kind of DB plan, intended to provide lifetime income for retirees who live beyond their assumed life expectancies. The benefit would be calculated based on pay and service, like a traditional DB plan, but it would only pay benefits to people who live past 75. Longevity plans would be much less expensive for employers than traditional DB plans for several reasons:
• There would be no subsidized early retirement benefits
• There would be limited death benefits
• Annuities would only be paid to the half of retirees who live beyond their life expectancies
• Benefits would be paid over a shorter remaining lifetime
For participants, a longevity plan would provide them peace of mind because they could not outlive their savings, which in turn could allow them to be more risk-tolerant in investing their 401(k) contributions. It would also allow them to better plan how to live on their savings because they would know the longevity plan safety net would kick in at age 75.
Administration would also be simplified. Fewer options would be available and no early retirement or death benefits would be calculated.
There are a few aspects of the proposed longevity plans that are not compliant under current rules (such as plan entry at age 45 and payments beginning after age 70½), but the concept is sound. It would provide a lifetime income when retirees need it most and it would be much less costly and volatile for employers.
Milliman’s latest Pension Funding Index (PFI), which consists of 100 of the nation’s largest defined benefit pension plans, shows that these plans experienced a $14 billion decrease in asset value and an $8 billion decrease in pension liabilities. The pension funding deficit increased to $162 billion at the end of August.
Index co-author Zorast Wadia discusses the results on Milliman’s monthly PFI Google+ Hangout with Jeremy Engdahl-Johnson.