The 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.