Art by Tim BowerOn October 27, 2014, the Society of Actuaries (SOA) issued the final version of new mortality tables (RP-2014) for use by defined benefit (DB) pension plans. The tables were also accompanied by new mortality improvement scales (MP-2014), which project the rates at which future mortality is expected to decrease. Below are questions relating to the consequences and anticipated effective date of these latest mortality rates.
Q: What will the general impact of these new mortality assumptions be once they are implemented by defined benefit plans?
A: The new assumptions, which are based on a study that began in 2009, confirm the intuitive observation that life expectancies in the United States have been increasing. This makes sense, because fewer people smoke cigarettes and medical care has improved. As a result, the assumptions underlying the new mortality tables show that, in comparison with the existing tables found in RP-2000, the life expectancy for 65-year-old males has risen from 19.6 years to 21.6 years—or 10.4%. For age-65 females, the corresponding increase has been from 21.4 years to 23.8 years—up 11.3%. As life expectancy increases, so does the cost of pension annuity payments. The SOA predicts that retirement liabilities could grow anywhere from 4% to 8%, while some actuarial firms estimate that overall cost increases will be at the high end of this range.
Q: What specific plan calculations are affected by RP-2014?
A: Tax rules require the use of specified mortality assumptions to calculate plan funding, as well as lump-sum conversions.
In the case of funding, Internal Revenue Service (IRS) regulations currently provide for sex-based mortality assumptions developed from the tables in RP-2000 and adjusted for mortality improvement in accordance with the improvement scales that preceded MP-2014. IRS Notice 2013-49 contains tables based on the old mortality tables (RP-2000) that incorporate these old-style adjustments and can be used in calculating a plan’s minimum required contribution for 2014 and 2015. When the new assumptions go into effect, required plan contributions are likely to increase, and funding ratios will go down. Of course, the magnitude of these changes will be affected by the age, sex and other characteristics of a particular plan’s participants.
The tax code mandates that the present value of certain pension benefits must not be less than the accrued benefits’ present value as determined by applicable interest rates and an approved mortality table. This includes the calculation of lump sums. However, for this purpose and in contrast to funding requirements, a unisex blend of male and female mortality assumptions is used. Notice 2013-49 specifies the unisex tables to be used for 2014 and 2015. When these tables are replaced, the longer life-expectancy assumptions reflected in the new tables will mean larger lump sums. Plan sponsors will have an incentive to encourage lump sums before RP-2014 becomes effective for tax purposes.
Q: What are the other consequences of the issuance of RP-2014 for plan sponsors?
A: There are several, starting with financial reporting. In valuing pension obligations, company auditors look to the plan sponsor’s best estimate with respect to mortality assumptions. So the issue becomes whether RP-2014 represents a best estimate and should then be favored over older tables. The SOA believes the new tables are needed to accurately measure pension obligations; therefore, there will be pressure from auditors to immediately adopt them for accounting purposes, notwithstanding the timing issues that would be involved if the tables were used for 2014 year-end measurements.
The updated mortality assumptions are also relevant with respect to meeting plan obligations to disclose to participants the relative value of optional forms of benefit. Plan sponsors should ensure that the assumptions used for this purpose remain reasonable in light of the SOA’s research on longevity trends.
Many plan sponsors that have defined benefit plans have adopted a de-risking investment strategy. For instance, sponsors are increasing their allocations of plan assets to fixed income as the plan’s funded status, determined on the basis of accounting liabilities, improves. If RP-2014 causes the plan’s funded status to drop, sponsors may need to re-evaluate scheduled allocations to fixed income.
An increase in funding liabilities can also result in higher Pension Benefit Guaranty Corp. (PBGC) variable rate premiums.
Q: When will the IRS adopt the new mortality assumptions?
A: The conventional wisdom is that the IRS will mandate use of the RP-2014 mortality tables for 2016, after the expiration of the term set in Notice 2013-49. Certain large corporate and public plans would be entitled to use plan-specific tables, even after 2015, due to their size.
This view on timing may be oversimplifying things, because the IRS cannot require use of the new tables merely by issuing a notice and will have to implement the changes by amending its regulations. The regulatory process, including publication of proposed regulations and a period for public comment, could delay adoption of the new tables until 2017 or 2018.
The IRS is under a statutory obligation to review applicable mortality rates for qualified plan funding purposes at least every 10 years, but this does not mean that adoption of the latest SOA tables is required, and some countervailing factors may apply. For example, the methodology and data of the SOA study that resulted in the new assumptions was criticized by other actuarial groups such as the Academy of Actuaries, which suggested that the SOA’s new tables might overstate life expectancy. This debate could be rejoined when proposed regulations for adoption of the new assumptions are opened to public comment.
Further, the end result of the SOA’s conclusions regarding improved life expectancy is an increase in required contributions, effectively contradicting the objective of recent legislation such as the Highway and Transportation Funding Act of 2014 (HATFA), which sought to reduce contribution requirements. This raises the possibility that Congress could act to delay the impact of the updated mortality assumptions on pension funding. It is important to realize that the SOA’s final report and updated tables do not constitute new rules and regulations.
Marcia Wagner is a specialist in pension and employee benefits law, and is the principal and founder of The Wagner Law Group, one of the nation’s largest boutique law firms specializing in the Employee Retirement Income Security Act (ERISA), employee benefits and executive compensation. A summa cum laude and Phi Beta Kappa graduate of Cornell University and a graduate of Harvard Law School, she has practiced law for more than 28 years, 19 with her own firm. She is recognized as an expert in a variety of employee matters, including qualified and nonqualified retirement plans, fiduciary issues, all forms of deferred compensation, and welfare benefit arrangements. Additionally, she has been inducted as a Fellow of the American College of Employee Benefits Counsel. Wagner is a frequent lecturer and has authored several books and numerous articles, as well as being a frequent guest on televised media outlets.