Modified DB funding calculations take back seat to premium hike
New mortality tables from the Internal Revenue Service will keep plan sponsors busy adjusting calculations and putting more money into their defined benefit plans, but the bigger impact could be higher premiums owed to the Pension Benefit Guaranty Corp.
As people live longer, the updated, more conservative mortality tables released Oct. 4 mean that funding liabilities used to determine contributions to pension funds will go up by as much as 5%.
That in turn means that variable-rate premiums that sponsors pay to the PBGC for underfunded plans could also spike. Sponsors offering — or considering an offer of — lump-sum distributions to plan participants also will see those costs increase, beginning with the 2018 plan year when the tables take effect, and sponsors' ability to offer lump sums could be derailed.
While the tables will affect funding calculations, "that's just a sideline for what's going to happen with PBGC premiums," said Robert Collie, chief research strategist, Americas institutional with Russell Investments in Seattle. "That's going to be much more directly painful. It is more equivalent to another change to PBGC premiums, and that's just real money (sponsors) are not going to get back."
Many plan sponsors are making higher pension contributions to boost their funding ratio to avoid those variable premiums — and even borrowing the cash to do so, said Justin Owens, Seattle-based director of client strategy and research at Russell Investments, in the same interview. "We expect a meaningful uptick in contributions to avoid PBGC premiums, and this is just one more reason why they should do it sooner or later."
Under the new mortality tables, funding-target liabilities that affect funding ratios used to determine contributions and to set benefit restrictions, including when lump sums can be offered, are expected to increase as much as 4% or 5%, and liabilities used to calculate PBGC variable rate premiums will be higher.
The Society of Actuaries estimated that in 2018, minimum required contributions will increase 11% and liabilities for estimated aggregate funding targets could increase 2.9%, or $65 billion. Variable PBGC premiums based on plan funding levels could increase 12% to $9.6 billion, the SOA projects. For lump sums, the new IRS tables, which combine male and female tables, are expected to increase costs up to 5%.
Plan sponsors were not surprised that the IRS refreshed mortality tables, which were last updated for 2008. The Pension Protection Act of 2006 requires updates every 10 years, and companies have been using newer mortality tables issued in 2014 by the Society of Actuaries for their financial reporting since then, to show investors their pension expenses on corporate balance sheets. Waiting for the IRS to update the tables used for funding calculations with the SOA information was the missing piece.
What caught plan sponsors off guard was how late in the year it happened. The IRS proposed the updates in December 2016, but as 2017 entered the fourth quarter, plan sponsors and their advocates in Washington urged the IRS to hold off on issuing them until 2019 to allow enough time to adjust.
"The bigger deal is the timing," said Alan Glickstein, Dallas-based senior retirement consultant at Willis Towers Watson PLC. "For many plan sponsors, it's a very legitimate concern."
At an IRS hearing on the proposal, Bruce Cadenhead, Mercer LLC partner and chief actuary, testified on behalf of the ERISA Industry Committee that plan sponsors needed at least 18 months.
One small victory was that the IRS will allow a potential one-year delay if plan sponsors can prove an administrative hardship or a potentially significant business impact.
"That appears to be a very generous opt-out for funding (calculations) for 2018," said Mr. Cadenhead in an interview. With what appears to be a relatively simple self-certification process, "I expect a lot of sponsors to take advantage of it," he said.
Plans that do not elect a one-year delay will have to pay PBGC premiums that are due 9.5 months into the plan year, and file 5500 reports one year later.
Ability to customize
Plan sponsors also appreciate that the IRS made it easier for them to use their own mortality tables in cases where a company's demographics might show different mortality experiences. Where that once was an option for only a few of the largest companies, hundreds of plan sponsors may be able to take advantage of that now, experts say.
But timing is still an issue for those wanting to do so starting in 2018 because of a February deadline for approval, and unless IRS officials can approve those quickly, plan sponsors may have to play it safe by using the standard tables.
"We have seen some interest from sponsors," said Mr. Owens with Russell, but it "is a long process to generate your own tables. It will take some time to see those start to get implemented."
A race for the door?
Since the one-year delay option only applies for calculating funding demands and not lump-sum values, consultants are expecting to see more lump-sum activity in the final months of 2017, before costs rise.
Deciding whether to offer lump sums to participants could also get more complicated with the new tables. As under the existing tables, if a plan falls below 80% funded, its ability to offer lump sums will be partially restricted, and if it falls below 60%, it is fully restricted.
The expectation of new tables were a large driver in lump-sum offers in 2017, said Mr. Glickstein of Towers Watson, who anticipates less activity in 2018.
Russell's Mr. Owens does not expect lump-sum offers to stop in 2018, "even if they cost 3% or 4% more," he said.
"We would view this as one more reason why plans need to focus on funding up their plans and derisking their plans," said Mr. Collie.
Mr. Cadenhead of Mercer notes that "if interest rates go up, that works in the opposite direction.
"On the other hand, plan sponsors are very conscious of managing risk. One way to reduce that is by reducing the size. I think sponsors are going to keep looking at that on the other hand a lot," said Mr. Cadenhead.
While sponsors and their consultants resign themselves to the new reality, they take some comfort that future updates won't be so dramatic. With future improvements for the first time built into the tables, "instead of waiting 10 years, they now will be making smaller change every year," said Mr. Collie of Russell.
Society of Actuaries officials, sensitive to the controversy that arose when its 2014 mortality tables were released after a 14-year gap, are collecting data from sponsors to release the next updates on a more frequent basis, and the next version is expected in a matter of weeks.
With mortality improvements slowing down instead of the rapid increases in the previous decade, Mr. Cadenhead thinks that could reduce funding liability increases by as much as 1% in subsequent years.