In February the Retirement Plans Experience Committee (RPEC) of the Society of Actuaries released its Exposure Draft RP-2014 Mortality Tables, recommending new mortality tables for the valuation of defined benefit plan liabilities. The new tables significantly increase life expectancy assumptions and, if adopted by regulators and DB plan actuaries, will increase DB plan liabilities for purposes of funding and de-risking.
In this article we review the SOA RP-2014 report, focusing on its consequences for regulatory purposes (we do not, e.g., discuss the implications of the RP-2014 tables for purposes of financial disclosure). We begin with a discussion of the regulatory framework – the current mortality assumptions/methodology for funding and lump sum valuation – and then proceed to a discussion of the exposure draft and its implications.
Regulatory framework – funding and lump sums
We’re going to look at two issues, minimum funding and the calculation of lump sums. (The assumptions used to calculate lump sums are, of course, critical for de-risking transactions; we have written extensively about de-risking, most recently in our article 2014 pension de-risking: deferred vested liability.)
Currently, for funding, the applicable IRS regulation requires the use of mortality tables based on the SOA’s RP-2000 Mortality Tables Report. Under the regulation, mortality assumptions in those tables (which calculate life expectancies/mortality as of the year 2000) must be updated for mortality improvement since 2000 in one of two ways: (1) by the use of a ‘generational table,’ which generally calculates different life expectancies based on year of birth; or (2) a ‘static table’ that makes fixed and generally applicable projections of mortality improvements. In either case, the mortality improvements are based on the SOA’s Mortality Projection Scale AA.
Certain sponsors may use substitute tables, provided they meet certain requirements. Substitute tables might be appropriate where the sponsor’s workforce has, e.g., significantly higher mortality than the rates in RP-2000. Whether generational or static/projected scale tables are used, the mortality assumptions used for funding are sex-based.
For purposes of lump sums, IRS publishes a unisex table annually. The most recent tables, for years 2014 and 2015, were published in 2013 in IRS Notice 2013-49 (we discussed this mortality update in our September 2013 Pension Regulatory update). These tables are “based on a fixed blend of 50% of the static male combined mortality rates and 50% of the static female combined mortality rates.” Thus, and oversimplifying significantly, they are based on RP-2000 updated for mortality improvements using Scale AA, averaging mortality for males and females.
In Notice 2013-49, IRS requested comments on, among other things: whether it was necessary, for small plans, to continue to use a ‘combined’ annuitant/non-annuitant table; and whether all plans could use generational tables (instead of continuing the option to use the static/projected tables in the regulation).
Society of Actuaries exposure draft
The SOA RP-2014 exposure draft reviews changes in mortality, trends in mortality improvement and methodological issues and includes a new set of generational mortality tables.
Significantly improved mortality
The most significant piece of RP-2014 is the new set of generational mortality tables. These tables reflect significant improvement in mortality relative to the rates in the current regulatory framework (RP-2000 plus Mortality Improvement Scale AA). To put that in English: the conclusion of the SOA is that the current rules significantly understate how long DB plan participants will live because they do not reflect changes (improvements) in life expectancy that have happened since Scale AA was published.
We’re not going to go into the specific mortality numbers. Here’s the bottom line: the following table shows the financial impact of adopting the RP-2014 mortality tables — more or less, the increase in the liability value for participants at different ages in 2014.
There are a number of nuances here, but first let’s focus on the big picture. If RP-2014 were adopted tomorrow, liability valuations would go up significantly. E.g., for de-risking purposes, if you were to take the IRS approach of averaging male/female mortality 50/50, the lump sum value of a benefit for a 55 year old would increase by almost 5%.
In Notice 2013-49, the IRS seemed to indicate it wouldn’t be changing its RP-2000 plus Scale AA rule before 2016. Concerns over pension de-risking, however, may accelerate the review of RP-2000. We know that IRS and Treasury, along with the Department of Labor, are very uncomfortable with the current de-risking trend. One of the claims that those opposed to de-risking have made is that calculating lump sums on the basis of the current mortality table rules is unfair because the tables are out of date and overstate mortality. The RP-2014 report seems to support those claims.
On the other hand, the SOA February RP-2014 report is only an exposure draft. And the adoption of a new set of base tables by IRS would, in the ordinary course, involve a regulatory notice and comment process which would take some time.
Thus, the most that can be said now is that it is likely that, at some point, probably before 2016, IRS will begin the process of reviewing RP-2000 and the adoption of RP-2014.
As we noted, currently actuaries may use static tables plus projections rather than fully generational tables. Indeed, according to the SOA report, “[m]ost U.S. pension actuaries use IRS-published static tables (based on Scale AA projection) for minimum funding purposes ….” In Notice 2013-49 IRS asked for comments on whether this was still necessary. The SOA appears to believe that it is not:
So an outstanding question is, will IRS adopt this standard?
No more combined tables?
For small plans, IRS allows the use of combined annuitant/non-annuitant tables (apparently small plan actuaries have (or had) a hard time separately valuing annuitants and non-annuitants of the same age). The combined table issue is also relevant to large employers since such an approach is used to produce the lump sum tables.
With respect to combined tables, the RP-2014 report states:
How will IRS integrate this approach into their lump sum assumptions?
White collar groups
One of the unusual things about RP-2014 is its blue collar/white collar weighting. Blue collar plan participants generally have a shorter life expectancy/higher mortality rate than white collar participants. Overgeneralizing, the RP-2000 dataset has close to a 50/50 blue collar/white collar split; the RP-2014 dataset is more heavily weighted to blue collar participants. In this regard, the RP-2014 report states:
Translation: all- or mostly-white collar plans may have to use even lower mortality rates than the general ones in RP-2014, with a corresponding greater increase in liabilities.
Question: will IRS consider this feature of the RP-2014 dataset in developing its lump sum valuation rates? Will it be pressured by participant advocate groups to do so?