Good news/bad news redux: Longer lives, higher costs

Pension plan liabilities will increase meaningfully due to new mortality tables released Feb. 4 by the Society of Actuaries. These tables reflect the results of the society's Retirement Plans Experience Committee's recent “Pension Mortality Study” and include a new mortality table (RP-2014) and a new mortality improvement projection scale (Scale MP-2014). Compared to previous tables and projection scales, these tables highlight longer life expectancies and faster increases in mortality improvements.

The new tables and scale likely will become the basis of lump-sum calculations and pension funding valuations in the near future, as well as a standard for pension accounting measurements. The result will be a noticeable increase in costs for most pension plans in the years to come that makes 2014 the ideal time to start looking at “shrink-the-ball” opportunities such as vested term lump-sum cashout initiatives.

(Technical details: The RPEC's study was intended to result in proposed mortality tables and an improvement scale that will ultimately supersede the RP-2000 mortality table and associated improvement scales (AA, BB, & BB-2D). Data, consisting of more than 10 million life-years, initially was collected from over 120 private pension plans covering the years 2004 through 2008. The existing RP-2000 mortality table was based upon data from 1987 through 1992, and improvement scale AA was based upon data from 1977 through 1993. The updated mortality improvement scales BB and BB-2D were released in September 2012 by the SOA as interim scales for measuring improvement post-2000.)

The new mortality table likely will increase the cost of lump-sum payouts from pension plans, especially for younger employees. The current mortality assumptions for the calculation of these payouts are based on a unisex version of the RP-2000 mortality table. This methodology will remain in place through at least the 2015 plan year based on current regulations.

It is unclear how the required lump-sum assumptions will change for 2016 and beyond, but we would anticipate the new mortality table and projection scale eventually will be incorporated.

The table below estimates the impact on various lump-sum factors using two different scales from the MP-2014 table. Because of the uncertainty of how the IRS will ultimately incorporate the MP-2014 mortality improvements into the lump-sum calculation basis, we have provided a range of potential increases using both a conservative and aggressive approach to how the mortality improvements are incorporated.

(Technical details: It is not totally clear how the tables will be blended and what type of mortality improvement projection scale will be incorporated. We have attempted to estimate the potential impact on lump sums using a comparable projection methodology as is now used, but did so using RP-2014 and improvement scale MP-2014. We have used both the 2014 year and the ultimate 2027 year mortality improvement factors from MP-2014 to develop a range of increases in costs. For each scenario above, we have used the RP-2014 mortality table projected 15 years for non-annuitants and seven years for annuitants as a proxy for the current methodology used for lump-sum mortality tables.)

Accounting standards used in the U.S. do not mandate particular mortality tables, however, actuarial standards require the actuary to consider the likelihood and extent of mortality improvements as a factor in setting the mortality assumptions for accounting (and other) purposes. While there is no requirement to adopt a specific mortality table or improvement scale by a given date for accounting purposes, the release of RP-2014 and MP-2014 undoubtedly will have many plans adopting new assumptions for accounting purposes, perhaps as early as 2014 fiscal year-end.

Some plan executives already fielded questions from their financial auditors at the end of 2013 regarding mortality improvements that were likely to come in 2014 and their inclusion in the accounting results. We expect more questions to be raised from auditing firms in 2014 with the release of these new tables.

We have reviewed the potential impact of the new mortality table and projection scale on accounting results based on a discount rate of 5% for a sample plan (final-average earnings, open plan with ongoing accruals, 55% active, 30% retiree, 15% deferred inactive). The estimated impact on liabilities is shown in the table below for various combinations of mortality tables and projection scales. The resulting percentage in each table cell represents the percentage change of the RP-2014 generational mortality table based on scale MP-2014 over the stated mortality table and projection scale listed in the column heading.

While the sample plan is representative of an open pension plan with ongoing benefit accruals, our analysis on a comparable frozen plan produced similar results. The impact of the new mortality table will increase balance sheet liabilities and ongoing expense for just about every pension plan.

In addition to increasing the accounting costs for plans, the increase in plan liabilities will help to narrow the gap between a plan's liabilities and the cost for purchasing annuities to settle benefit obligations. Insurance companies already use a conservative mortality basis for their pricing and these new mortality tables will potentially help plans track closer to their potential termination liability.

Similar to the impact on lump sums, the impact on minimum funding is largely dependent upon the ultimate methodology required by statute. Currently, plans have been allowed the option of static mortality tables with fixed projections of mortality improvements built in, or fully generational mortality. The accounting results shown provide a proxy for the potential impact if new regulations were to require fully generational projections using RP-2014 and MP-2014. If new regulations allow for continued use of static projections using the new mortality and projections scales, the increases would mimic the analysis for lump sums shown (around 5%). As with lump sums, changes in the required mortality tables for funding are not expected to take effect until 2016 at the earliest.

The RPEC's study definitively revealed that pension plan participants are living longer, and that the improvements in mortality continue to get better. Once incorporated into lump-sum calculations and actuarial valuations, the new tables will increase pension costs for the majority of plans. Because of the anticipated delay in when the new mortality assumptions will be required for lump sums and funding valuations, plan executives should carefully analyze whether there is an opportunity to settle some of their pension obligations now using the current mortality basis.

These new tables represent the culmination of increased sophistication in how actuaries reflect current mortality experience and project future improvements. It could be about another decade before the next generation of tables is issued. While we cannot predict how practice and mortality experience will evolve, it does seem unlikely that the kind of profound increase in liabilities shown above will occur.

Dan Atkinson is a director and chief technical actuary in P-Solve's Boston office; Charlie Cahill is a managing director, also in P-Solve's Boston office and leads the firm's actuarial practice; and Michael Clark is a director in P-Solve's Denver office.