Although many employers have been shifting away from traditional defined benefit (DB) pension plans and retiree medical plans in favor of defined contribution plans, such as 401(k) or 403(b) plans, their DB plans for legacy employees are generally significant to their financials.
One of the key actuarial assumptions used in the valuation of DB plans is the mortality assumption, which estimates the life expectancy of plan participants. In recent years there have been comprehensive mortality studies prepared by the Society of Actuaries (SOA) which have been publicly released and generally accepted in actuarial practice. The IRS now requires recent SOA mortality tables for use in calculating plan liabilities and cash contribution requirements. Implementing these prescribed mortality assumptions resulted in an increase in liabilities for most plans due to projected longer life expectancies.
As a result of financial statement and cash contribution volatility, employers continue to seek “de-risking” strategies, which are strategies to better manage pension plan risks or transfer them to insurance companies. Earlier this year the IRS issued a notice that reversed itself on a key pension plan liability de-risking strategy.
On a separate matter, accounting standards will be changing for the valuation of insurance contracts on an international reporting basis for global insurance companies. The implementation of such changes is expected to be quite onerous, leading to a delay from the initial proposed implementation date.
In 2014, the SOA released sets of mortality rates that were developed by the SOA’s Retirement Plans Experience Committee (RPEC), which were based on a comprehensive study of mortality experience for private retirement plans in the United States. This study produced base tables (called RP-2014, where RP stands for “retirement plans”) and mortality improvement scales (called MP-2014, where MP stands for “mortality projection”). For many plan sponsors, these tables became the basis for their year-end financial statement disclosures, which generally increased liabilities due to the increase in projected life expectancy compared to the mortality tables that had been in use. In the fall of each subsequent year, the SOA released updated MP improvement scales, which (all other things being equal) generally resulted in slight decreases in actuarial liabilities from the prior year due to reductions in projected life expectancies based on additional data obtained and analyzed for each subsequent MP table.
As noted above, implementing these new mortality tables as now prescribed by the IRS generally resulted in increased actuarial liabilities and contribution requirements which, in turn, put pressure on other key funding measures that could affect the administration of the plan and the level of premiums owed to the Pension Benefit Guaranty Corporation.
Earlier this month the SOA released another MP improvement scale (MP-2019), and similar to mortality improvement updates in prior years, when compared to last year’s scale this latest release will generally result in a slight liability decrease, roughly 0.3% to 1.0%.
Additionally, on Oct. 23, the SOA released another set of base mortality tables, the Pri-2012 Private Retirement Plans Mortality Tables. The dataset is approximately 50% larger than that used in the RP-2014 study and was collected from private sector plans across the country, and it includes a substantial amount of data from multi-employer plans (excluded from RP-2014). Compared to the RP-2014 dataset, Pri-2012 generally will result in an increase of 0.3% to 1.0% in liabilities for ages 65 and younger, while decreases of approximately 1.0% to 2.5% for ages greater than 65.
In January 2019, the SOA/RPEC released the Pub-2010 Public Retirement Plans Mortality Tables Report. These tables were developed based on mortality experience of public retirement plans in the United States and are based on job categories of teachers, public safety and general employees. As this is the first public sector table developed by the SOA, the liability impact will vary depending on which tables are currently being used. While these new tables are not mandated, there will likely be parallels to future requirements for use, similar to what was seen on the private sector side -- namely to use these new tables unless the plan’s own credible experience shows otherwise.
Pension plan de-risking
Due to a number of factors that impact the balance sheet and income statement, such as interest rate and investment return volatility, many plans sponsors in recent years have undertaken an approach to minimize or eliminate a portion of that volatility. Common approaches have been to freeze the plan, offer a lump-sum window to deferred vested participants, purchase annuities from insurance companies and consider liability-driven investments.
For the first nine months of 2019, interest rates have decreased by over 100 basis points (based on the FTSE pension liability index) which, if they remain unchanged for the rest of the year, will result in significant increases in actuarial liabilities that will likely not be offset by asset returns.
In March 2019 the IRS announced in Notice 2019-18 that it would no longer take the position that offering a lump sum to current retirees (those already in-receipt of benefits) would violate certain sections of the IRC. While other requirements would still have to be met, this notice opened the door for another de-risking strategy. This option may be more appealing to plan sponsors as the cost may be less expensive than purchasing annuities for retirees, but other possible issues, such as anti-selection insurance costs, should be assessed.
IFRS 17 for global insurance companies
The International Financial Reporting Standards (IFRS) has proposed changes for the accounting of insurance contracts of global insurers that will impact both the balance sheet and the income statement, and the implementation of such changes was delayed until Jan. 1, 2022. On a high level, the purpose of IFRS 17 is to standardize the reporting of insurance accounting so readers of financial statements can more easily compare the financial positions and certain risk exposures of insurers. Actuarial calculations will need to be performed with the disclosure of the underlying assumptions and methods.
Significant changes have been communicated by the IRS, SOA and IFRS that have been in the works for several years, some of which are quite complicated and require the engagement of certain specialists. What all of the above have in common is that actions taken will affect balance sheets and income statements, and quite possibly actual cash outlays. As such, it is important to understand the key issues and possible impacts of the changes required.
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