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In this regulatory update, we briefly review ERISA Advisory Council recommendations for rule changes to encourage the inclusion of lifetime income options in QDIAs, the effect of the new Society of Actuaries MP-2018 mortality improvement scale on liability valuations, and a recent IRS “Program Letter” identifying qualified plan distributions as a compliance target.
The ERISA Advisory Council consists of 15 members appointed by the Secretary of Labor, representing labor, employers and the general public and the fields of insurance, corporate trust, actuarial counseling, investment counseling, investment management, and accounting. Each year it considers and hears testimony on selected issues and then makes recommendations to DOL. The EAC has for at least 10 years been considering and making recommendations with respect to lifetime income issues in defined contribution plans.
In their November 2018 recommendations, the EAC focused on the issue of the inclusion of lifetime income options in qualified default investment alternatives (QDIAs). Under current DOL regulations, a QDIA is (generally) a safe harbor investment for participants who have not made an affirmative investment election. Target date funds, balanced funds and managed accounts that meet certain conditions may function as QDIAs.
The executive summary describing the EAC’s recommendations begins by noting that the QDIA regulations do not address “the use of annuities as investment components within a default fund, or [w]hether a qualified default fund may have distribution features.” The EAC makes three sets of recommendations in this regard:
Recommendation #1 – include lifetime income options in QDIAs: DOL should amend the QDIA regulations to: (1) allow the inclusion of annuities, living benefits and other lifetime income (LTI) options in QDIAs; (2) accommodate these options within current QDIA transferability and liquidity requirements; and (3) address the issue of charges with respect to these options that may have the effect of limiting liquidity or transferability.
Recommendation #2 – allow outsourcing of fiduciary obligations with respect to lifetime income options: DOL “should publish guidance confirming that a named plan fiduciary may appoint a 3(38) investment manager to select and monitor annuity and other LTI options for DC plan decumulation, as well as accumulation.” This would be a significant step towards clarifying the extent to which a plan sponsor may outsource this responsibility and may even provide a possible solution to the fiduciary issues raised by the use of in-plan annuities in a DC plan.
Recommendation #3 – encourage inclusion of lifetime income options: DOL should “encourage plan sponsors to adopt plan design features that facilitate LTI.”
These are very interesting recommendations. DOL action on them would allay some sponsor fiduciary concerns about the use of annuity products in DC plans. Thus far, however, many believe DOL has been slow to act decisively on such recommendations.
In October 2018, the Society of Actuaries published its new Mortality Improvement Scale MP-2018, showing mortality improvement rates that are “slightly lower than the corresponding Scale MP-2017 rates.” This decrement in mortality improvement will result in a reduction in life expectancy assumptions and a (marginal) reduction in defined benefit plan liability valuations. Quoting the SOA: “most 2018 pension obligations calculated using Scale MP-2018 (with a discount rate of 4.0%) are anticipated to be 0.2% to 0.4% lower for females, and 0.3% to 0.6% lower for males, relative to their Scale MP-2017 counterparts.”
In early October 2017, IRS finalized a regulation adopting mortality tables/assumptions based on (among other things) SOA mortality improvement scale MP-2016. Those rates were generally effective beginning in 2018, although sponsors were, under certain conditions, permitted to defer adoption to 2019 for all purposes other than calculation of lump sums.
In late October 2017, the SOA came out with MP-2017, showing a year-over-year increase in the age-adjusted U.S. mortality rates of 1.2%. That increase would result in a reduction in liability valuations vs. the MP-2016 scale currently being used by IRS. Quoting the SOA: “most 2017 pension obligations calculated using Scale MP-2017 (with a discount rate of 4.0%) are anticipated to be approximately 0.7% to 1.0% lower than those calculated using Scale MP-2016.”
In the preamble to its 2017 regulation, IRS said that, “to minimize the discontinuities in mortality rates that could arise from infrequent updates, Treasury and the IRS contemplate that generally the rates will be updated annually.” In December 2017, IRS issued Notice 2018-02, updating mortality improvement rates and static mortality tables to reflect SOA’s MP-2017 mortality improvement scale for purposes of funding, the determination of Pension Benefit Guaranty Corporation variable-rate premiums and lump sum valuations in 2019.
Presumably, IRS will not take into account the new SOA MP-2018 scale until sometime later this year or next, for purposes of 2020 valuations.
Interestingly, MP-2018 also proposes an alternative, “smoother” mortality improvement model:
Section 4 [“Alternative Model Based on Smoother Historical Graduation”] includes analysis of an alternative mortality improvement model based on the same methodological underpinnings as RPEC_2014 (the model used to produce Scale MP-2018), but with rates projected from a smoother graduation of historical U.S. population mortality improvement. In particular, the model introduced in Section 4 is anticipated to reduce volatility resulting from incorporating updated mortality experience each year, though its fit to historical mortality improvement rates is diminished relative to that of the RPEC_2014 model.
It is conceivable (although not necessarily likely) that IRS may adopt this smoother model in order to reduce volatility in mortality assumptions.
On October 3, 2018, the Commissioners of IRS’s Tax Exempt & Government Entities Division published a “Program Letter” describing “where we are heading in the new fiscal year” that included a discussion on “executing compliance strategies.” One of the compliance strategies with respect to employee plans the letter identified for 2019 was:
Distributions: verify that plans are following correct distribution processes and procedures and that participants are receiving correct distribution amounts.
As we have noted, distributions to “missing participants” has been a Department of Labor audit target for several years now. Sponsor organizations have requested that DOL provide guidance as to how missing participants in non-terminated plans should be handled – guidance that DOL has, to this point, not been willing to provide. And there is a bipartisan proposal in Congress to (1) address the issue of the extent of a sponsor’s duty to search for a missing participant and (2) create a missing participant “lost and found.”
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We will continue to follow these issues.