Improved mortality assumptions to affect pension funding calculations from 2018
Last week, the IRS issued a notice finalizing the prescribed mortality assumptions to be used in calculating liabilities for minimum funding purposes, effective from the start of 2018.
The IRS decision to update the mortality assumptions has been choreographed for some time: the Pension Protection Act of 2006 requires the IRS revise mortality tables every 10 years, with said 10–year period set to expire in 2017 or 2018, and the IRS preliminarily released this update in December, 2016.
All in, the new mortality assumptions are more conservative than the current tables, projecting plan participants to live longer which increases pension liabilities. These liability increases will raise minimum required contributions, PBGC variable rate premiums, and lump sum distributions to plan participants.
As indicated by the IRS in a December 2016 announcement, the new assumptions utilize the Society of Actuaries' mortality table RP–2014 and improvement scale MP–2016. This will align the mortality assumption for funding purposes with the one used by many plan sponsors to calculate liabilities and pension expense in their corporate financial statements.
Unlike the adoption of the new assumptions for accounting purposes in 2015 (which came as an unpleasant surprise), plan sponsors have been anticipating the IRS's latest announcement for some time. Moreover, the latest improvement scale takes into account two additional years of data, which has resulted in a slower assumed rate of future improvement than was built into the original scale published in 2014.
There are two main liability values under PPA for which plan sponsors are closely monitoring the impact of this mortality change:
- Funding Target Liability — this liability affects funding ratios ("FTAP" and "AFTAP") which are used in determining contribution requirements and potential benefit restrictions
- PBGC Premium Funding Target Liability — this liability determines the shortfall for the purpose of calculating the variable rate premium
As a result of the new mortality assumptions funding target liabilities are expected to increase by roughly 2–4% while liabilities for PBGC variable rate premium purposes are expected to increase by a slightly larger amount. Any increase in funding liability will increase minimum required contributions — the Society of Actuaries estimates a cumulative increase of 11% on required contributions.
It is difficult to generalize about the near–term impact on contributions since many plan sponsors are fairly well–funded under PPA calculations and the impact is amortized over seven years. Further, some plan sponsors have been contributing more than the minimum required amounts in recent years, so an increase in the required minimum will not necessarily change the actual amount contributed.
Lump sum windows also affected
Additionally, a variation of these mortality tables will be required for determining lump sum values under ERISA section 417(e)(3) which will increase the size of lump sum payouts converted from annuity benefits. This is likely to reduce the popularity of offering lump sums to terminated vested (TV) participants, since they will become more expensive for plans. We have already seen a flurry of TV activity both last year and again this year, and would not be surprised if more plan sponsors initiate windows during the 4th quarter of 2017 because of this announcement.
One inclusion to the IRS notice, at the behest of the ERISA Industry Committee, provides plan sponsors the option to delay the application of the new mortality assumptions until 2019. A plan sponsor would have to show that using the new mortality tables "would be administratively impracticable or would result in an adverse business impact greater than de minimis". Given that actuarial firms have likely already included the mortality tables in their valuation software for recent accounting valuations, the administratively impracticable reason seems moot. Thus, to postpone the implementation of updated mortality assumptions, a plan sponsor would likely have to prove an adverse business impact for which the definition of de minimis is unclear.