The full impact of mortality improvement hasn't been felt yet by DB sponsors

In 2014 DB sponsors were jolted with the reality that their participants were living longer. This is good news, of course, but had serious implications for their pension plans. Longer lives means more annuity payments. Within a few months of their release, the new death rates took their toll on balance sheets, increasing PBO by as much as 8% and doubling down on the liability loss from falling discount rates that same year. Adoption of new mortality rates for accounting purposes has now been almost universal among DB sponsors.

Changes on the horizon

Although almost two years have passed since their release, some of the most meaningful consequences of the new tables have not taken place. Specifically, the IRS has still not offered guidance on new mortality assumptions for funding-related purposes.

This could be a big deal for sponsors. Once the IRS updates their prescriptive tables (the exact form of which we do not know), sponsors can expect funded ratios (“FTAP” and “AFTAP” in IRS nomenclature) to drop, which will trigger higher contributions requirements (due to a larger funding shortfall to fill), and could push some sponsors into “benefit restriction” or “at-risk” territory below 80%. The relief offered by BBA 2015 and its predecessors will help dampen this effect for now, but over time the effects of that relief should phase out.

In addition, new mortality will likely mean that lump sum payments will increase (as most lump sums are just the present value of annuities), making lump sum offers less attractive to sponsors. The new mortality will also apply to PBGC liabilities, boosting PBGC variable rate premiums (the portion of the premium tied to funded status) for those that have not reached their “premium cap".

When is this change happening?

The code put into law by the Pension Protection Act of 2006 requires the IRS revise tables every 10 years to reflect actual experience and trends. The 10-year period ends in either 2017 or 2018, depending on your interpretation of the code. We do not know what version of the tables the IRS will choose (a topic of debate in the actuarial world right now), but sponsors are allowed to develop their own tables if they can generate enough credibility with their plan data.

At this point 2018 seems like the most likely implementation year from a logistical perspective, but 2017 in still possible. We expect the IRS to make an announcement one way or the other in the next couple of months. Until then, sponsors can re-evaluate their funding policies (funding up now could lessen the load later and potentially reduce PBGC premiums) and help protect their downside through LDI strategies. Whether the change occurs in 2017 or 2018, the effects are the same—higher contributions and PBGC premiums, less attractive lump sum offers, and other negative impacts related to lower funded ratios.

Please note: Content for the Fiduciary Matters blog is being provided by guest authors while Bob Collie is on sabbatical.