On October 27, 2014, the Society of Actuaries published its (new) RP-2014 Mortality Tables and Mortality Improvement Scale MP-2014, related reports, and two documents responding to comments on its exposure draft from earlier this year. We will refer to this group of documents as the SOA Report.
The base mortality tables/improvement scale are unchanged from the exposure draft, which we discussed in this article. The Society did, however, in response to comments, amend its report to allow pension actuaries more flexibility in the development of tables and mortality improvement scales.
Defined benefit plan sponsors will want to consult their actuary as to the application of the new tables to their plan. In this article we briefly 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 brief discussion of the regulatory framework.
Regulatory framework – funding and lump sums
We’re going to look at two issues, minimum funding and the calculation of lump sums. The assumptions – interest rate and mortality – used to calculate lump sums are, of course, critical for de-risking transactions.
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, e.g. where the sponsor’s workforce has significantly higher mortality than the rates in RP-2000.
In Notice 2013-49, IRS published updated static mortality tables for use in funding for 2014 and 2015.
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 unisex tables based on RP-2000 updated for mortality improvements using Scale AA. Those 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.” Notice 2013-49 includes unisex tables to be used in 2014 and 2015 in calculating lump sums.
Since we already have mortality tables for 2014 and 2015 for funding and lump sum calculations, as the SOA stated, “[t]he earliest calendar year that any new basis for ‘applicable mortality tables’ [under Tax Code rules] could be prescribed is 2016.”
The RP-2014 tables/improvement scale reflect significant increases in mortality improvement relative to the current regulatory regime (RP-2000 plus mortality improvement Scale AA projection).
If (as most believe) IRS adopts the RP-2014 tables/MP-2014 improvement scale, then the cost of funding and lump sums will go up. The following table estimates the increase in annuity values for minimum funding purposes that would result from the adoption of the RP-2014 mortality tables/MP-2014 improvement scale by IRS for 2016.
In response to comments, the SOA amended language in the exposure draft to allow for greater flexibility in the adoption of RP-2014. In its Response to Comments the SOA stated that the language “provides pension actuaries with the flexibility needed for all varieties of plan populations and applications.”
Recognizing the subjective nature of estimates of mortality improvement, the SOA also amended the language with respect to the “Recommended Application” of the mortality improvement scale. In its Response to Comments the SOA stated that the amended language “makes it clear that reasonable alternate assumption sets can be used by a pension actuary.”
As we noted, currently actuaries may use static tables reflecting a fixed projection 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.
As noted, the SOA softened its language on this issue. In its exposure draft, it stated that the SOA:
In the final report this language was changed to read that the SOA:
What position IRS takes on this issue may be significant.
Blue and 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 those in the base RP-2014 tables, with a corresponding greater increase in liabilities.
Whether IRS will consider this issue in revising its mortality tables is unclear.
Overall, however, the message is clear: participants are living longer, and that means DB funding costs and lump sum valuations are going up.