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.
“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.
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.
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 and 3.4% annual returns), the funded ratio would decline to 77% by the end of 2015 and 70% by the end of 2016.
At 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.
The funded status of the 100 largest corporate defined benefit pension plans dropped by $90 billion during January as measured by the Milliman 100 Pension Funding Index (PFI). The $90 billion funded status decline was the eighth largest monthly drop in the 15-year history of the Milliman 100 PFI. The funded status deficit ballooned from $292 billion to $382 billion since December 2014, which was due to a decline of 42 basis points in the benchmark corporate bond interest rates used to value pension liabilities. Pension assets had a monthly above-expected return that was due to strong fixed income asset return and this helped to counter liability losses. The funded ratio decreased from 83.5% to 79.6%.
PFI co-author Zorast Wadia discusses the index’s latest results on this Milliman Hangout.
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 dropped by $90 billion during January, as measured by the Milliman 100 Pension Funding Index (PFI). The $90 billion funded status decline was the 8th largest monthly drop in the 15-year history of the Milliman 100 PFI. The funded status deficit ballooned to $382 billion from $292 billion at the end of December 2014, which was due to the decline of 42 basis points in the benchmark corporate bond interest rates used to value pension liabilities.
The projected benefit obligation (PBO), or pension liabilities, increased to $1.876 trillion from $1.775 trillion at the end of December 2014. The change resulted from a decrease of 42 basis points in the monthly discount rate to 3.38% for January from 3.80% for December 2014. January’s discount rate is the lowest in the history of the Milliman 100 PFI. The last time we observed a comparable discount rate change was in July 2012 when discount rates fell 40 basis points ending at 3.92%. January’s precipitous drop is even more impactful.
Looking forward, under an optimistic forecast with rising interest rates (reaching 3.93% by the end of 2015 and 4.53% by the end of 2016) and asset gains (11.4% annual returns), the funded ratio would climb to 91% by the end of 2015 and 104% by the end of 2016. Under a pessimistic forecast with similar interest rate and asset movements (2.83% discount rate at the end of 2015 and 2.23% by the end of 2016 and 3.4% annual returns), the funded ratio would decline to 73% by the end of 2015 and 66% by the end of 2016.
Reading this article from 1970 is like opening a time capsule. And, while Bill Halvorson didn’t predict everything that would happen to pensions, he did say a few things that ring very true nearly 50 years later.
Bill speculated that Social Security would spiral out of control and that if pensions integrated with Social Security, they would be diminished. This would lead to the emergence of savings plans, thrift plans, and profit-sharing plans as the only viable way to supplement expanding Social Security.
Bill also suggested that funding regulations would strangle private pensions…
DB plans are not dead. Not yet, anyway. And I, for one, hope that the pendulum will swing back toward the stability of some form of DB plan because as life expectancy increases, so does the likelihood of outliving your savings. The best solution is likely a combination of DB and DC plans in addition to Social Security. The DC balance could be designed to provide income for a fixed number of years, at which time the DB plan (or “longevity plan”) would kick in and provide lifetime income at later ages, while Social Security would provide inflation-adjusted lifetime income. Because DB benefits would be paid over shorter life expectancies, the funding would be much less volatile.
The funded status for the 100 largest corporate defined benefit plans decreased by $22 billion during December 2014, according to the Milliman 100 Pension Funding Index (PFI). Historically low interest rates were the dominant factor in the $105 billion deficit increase during 2014. While higher than expected investment returns produced a solid $81 billion gain, pension liabilities increased by $186 billion. The funded ratio was 83.6% as of December 31, 2014, down compared with the ratio on December 31, 2013, of 88.3%.
For more perspective on January’s PFI, watch our latest Milliman Hangout featuring coauthor Zorast Wadia.
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 December, these plans experienced a $19 billion increase in pension liabilities and a $3 billion decrease in asset value, resulting in a $22 billion increase in the pension funded status deficit and a funded ratio of 83.6%. For the year, despite market returns of $81 billion, these pensions experienced a $105 billion increase in the pension funded status deficit, fueled by a $186 billion increase in liabilities as interest rates fell to a historic low at year end.
What a difference a year makes. Last year at this time we were celebrating a historic rally for these pensions, thanks to—surprise surprise—cooperative interest rates. This year it’s the opposite story, with interest rates falling to 3.80%, the lowest rate we’ve ever seen in the 14-year history of this study. With rates this low, the liability increase for these pensions outstripped strong asset performance by more than $100 billion.
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 3.80% were maintained, funded status would improve, with the funded status deficit shrinking to $255 billion (85%.7 funded ratio) by the end of 2015 and to $217 billion (87.9% 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.
The 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.
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, which was 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.