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On December 29, 2016, IRS proposed a regulation adopting new mortality tables for defined benefit plan valuations, calculations of DB lump sums and Pension Benefit Guaranty Corporation premiums, applicable for 2018 plan years. As we discussed in our August 2017 Current outlook, on August 9, 2017, IRS sent a final regulation to the Office of Management and Budget. Presumably, the final regulation looks substantially like the regulation proposed in December, 2016.
In this article, we review where we are in the regulatory process, certain concerns raised by industry groups about IRS’s proposal, and (briefly) the effect of the new tables/rules on plan sponsors. We close with a review of the proposal’s rules for the use of substitute tables under the Bipartisan Budget Act of 2015 (BBA 2015).
Generally, OMB may only take 90 days to review an agency rule once it has received it (although this period may be extended in certain circumstances). So – unless something unusual happens – we can expect OMB action by November 2017. OMB may simply approve the regulation, it may ask IRS to make changes to it or, it may return the regulation to IRS for reconsideration.
When IRS sent the final regulation to OMB, it re-classified it as “economically significant.” Economically significant regulations are given heightened scrutiny under Executive Order 12866, including, e.g., a cost/benefit analysis. When the new mortality table regulation was proposed, however, IRS took the position that the regulation was not economically significant, and “[t]herefore, a regulatory assessment is not required.”
Some industry groups have asserted that – because, among other things, there was no EO 12866 analysis when the regulation was proposed – the regulation should be re-proposed. Alternatively, given that 2018 is only months away, they have suggested that the application of the new tables be delayed, to 2019 (or later).
There is broad agreement that current mortality tables (adopted in 2008 and based on the Society of Actuaries RP–2000 Mortality Tables) should be updated to reflect increases in life expectancy. IRS’s December, 2016, proposal was itself largely based on the Society of Actuaries’ RP-2014 Mortality Tables and Mortality Improvement Scale MP-2014 and related reports. The SOA process was criticized in a number of respects, MP-2014 was “updated” in 2015 and 2016, and those updates are reflected in the IRS proposal.
Some industry groups have expressed concerns about the IRS proposal that may be considered by OMB in its review of IRS’s final regulation. The critical area of focus is the proposal’s mortality improvement scale and rules related to it, particularly the requirement that plans “must reflect the mortality improvement rates contained in the Mortality Improvement Scale MP–2016 Report.”
Oversimplifying, a mortality improvement scale adjusts the base mortality table for improvements in mortality since the base table was developed. The current (RP-2000 plus amendments) mortality tables take into consideration mortality improvements, but in a more limited way than new MP-2016 improvement scale does. The MP-2016 improvement scale provides for a long-term “[f]lat 1.0% rate to age 85; decreasing linearly to 0.85% at age 95; then decreasing linearly to 0.0% at age 115.”
The industry groups are arguing that this assumption is higher than long-run historical rates and should not be the basis for IRS-mandated mortality tables.
To get a feel for the significance of this issue, if the new mortality tables/improvement scale as a whole will increase liabilities under an average plan by about 4 %, backing off of the proposed mortality improvement scale (with its “flat 1.0% rate to age 85” improvement assumption) to something like, e.g., Social Security’s 0.75% long-term rate would result in an increase of between 2%-3%. (These numbers are very rough estimates, and there will be plans that will be affected more or less by IRS’s proposal.)
With regard to the mortality improvement scale, the preamble to the proposed regulation states:
Treasury and the IRS understand that RPEC [the Society of Actuaries’ Retirement Plans Experience Committee] expects to issue updated mortality improvement rates that reflect new data for mortality improvement trends for the general population on an annual basis. Treasury and the IRS expect to take those updates into account in determining the mortality rates to be used … for valuation dates in years after 2018. Those rates will be specified in guidance to be published in the Internal Revenue Bulletin.
Some are arguing that this sort of annual updating of the mortality improvement scale will introduce a significant element of instability into the plan valuation process.
We do not know at this point whether OMB will take any action – it’s entirely possible that it will simply approve IRS’s work and, sometime before the end of the year, we will have a new set of mortality assumptions applicable beginning in 2018.
In addition to the issues raised by industry groups, discussed above, there are a couple of broader issues that might argue for modification of the IRS proposal. First, it’s a revenue-loser – the increase in plan liabilities resulting from adoption of IRS’s proposal will necessarily increase contributions and thus tax deductions. And, second, it will (at the margin) drain cash from some companies that are already cash-poor and will (again, at the margin) have some effect on hiring, production and investment in plant and equipment.
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Now let’s consider briefly the effect of the adoption of these new tables on sponsors.
The increase in liability valuations will affect three areas: funding, lump sums and PBGC premiums.
Most obviously, as the value of plan liabilities is increased, plan funding obligations will increase. From one point of view, this is not really a “change” – “in real life” participants will live as long as they live, and the plan (if it is paying, e.g., a life annuity) will have to pay them as long as they live, whatever the tables say. But sponsors of plans at the funding “margins” – plans that are, e.g., near the prior year funding shortfall trigger for quarterly contributions or the less-than-80%/60% funding trigger for benefit restrictions (including restrictions on lump sum payments) – may be significantly affected by the liability increase resulting from the adoption of the new tables/improvement scale.
Lump sum values will also increase about 4% for a typical participant under the proposed mortality table. This will increase the cost of, e.g., lump sum de-risking.
And, for many plans the increase in liabilities will result in an increase in PBGC variable-rate premiums. As we have discussed in the past, sponsors of plans paying variable-rate premiums may want to consider voluntary contributions (contributions above ERISA minimums) to reduce or eliminate those premiums and, if necessary, borrowing to finance that funding.
BBA 2015 made it easier for sponsors to use customized, “substitute mortality tables,” and IRS’s proposal included a process/rules for their adoption. BBA 2015 modified the treatment of substitute mortality tables under IRS’s 2008 regulation in two ways: (1) It required that the determination of what is “credible mortality experience” (justifying the use of a substitute table) be made based on “established actuarial credibility theory.” And (2) it permitted (as an alternative to a full substitute table) the use of mortality tables reflecting adjustments to the “generic” IRS tables to reflect actual plan experience.
The proposed rules implementing change (1) are quite technical. Generally, they bring IRS rules for “fully credible mortality information” into line with current actuarial practice. In that regard, they:
[R]equire a substitute mortality table to be constructed by multiplying the mortality rates from a projected version of the generally applicable base mortality table by a mortality ratio (that is, a ratio of the actual deaths for the plan population to expected deaths determined using the standard mortality tables for that population). Use of mortality ratios (rather than providing for the graduation of raw mortality rates as under the 2008 substitute mortality table regulations) should make it easier for plan sponsors to develop the substitute tables, because it would eliminate the need to apply a graduation technique. It would also make it easier for the IRS to review applications to use substitute mortality tables.
The calculation of the number of deaths needed for “full credibility” would now be the product of 1,082 and a “benefit dispersion factor” reflecting the value of benefits.
The proposed rules implementing change (2) generally allow plans with at least 100 deaths per gender during an “experience study period” (“partially credible mortality information”) to use a hybrid of the generic IRS table and a plan table:
In accordance with established actuarial credibility theory, such a plan would use a weighted average of the standard mortality table … and the mortality table that would be developed for the plan if it were to have fully credible mortality information.
IRS also tweaked the 2008 regulation’s substitute mortality table rules for the aggregation of plans and for transition where, because of a corporate transaction, a new plan is added to the control group.
Bottom line: IRS’s proposed process with respect to substitute tables appears to be generally workable. We will have to see if any changes are made to it in the final rule.
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We will continue to follow this issue.