SOA Releases Public Plan Mortality Tables (Pub-2010)

The first mortality tables specifically for public-sector retirement plans were released by the Society of Actuaries (SOA) in early 2019. Prior to 2019, there were no publicly available mortality tables for public sector plans despite the general consensus that mortality experience for public-sector retirement plans differs from those of private pension plans. The current mortality assumptions used by public plans vary considerably, and many plans must rely on tables that were created using data for private pension plans such as RP-2000 or RP-2014.

The Importance of Mortality Tables

Using the right mortality table for your plan, whether it’s one of the Pub-2010 tables or another table, is very important. As mortality improves, people live longer and receive benefits for a longer period of time which increases the cost of your plan. In order to measure this cost and to fund your plan enough to pay future benefits, you need to choose an appropriate mortality assumption that reflects expectations. If you are using an outdated mortality table or one that doesn’t fit your plan’s population, your liability could be much larger than you realize. Your future contributions could increase significantly, or your plan may be unable to pay future benefits.

SOA Releases Public Plan Mortality Tables

Pub-2010 Mortality Tables

The new mortality tables, referred to as “Pub-2010”, are not a single table but a set of 94 tables. The SOA analyzed multiple factors that affect mortality rates, and the published tables use combinations of these factors:

  • Gender (male/female)
  • Job category (teacher/public safety employee/general employee)
  • Employment status (active employee, deferred vested participant, retiree, survivor)
  • Health status (healthy/disabled)
  • Income level (above/below median)

Plan Characteristics to Consider

Job category and income level were the two most statistically significant factors. You should pay special attention to job categories when considering using these tables.

The SOA did not release a combined table using data from all job categories, because the experience varied significantly between the categories. If your plan covers multiple categories, your Findley consultant could help you consider either valuing the groups using separate mortality tables or constructing a combined table that reflects the demographic breakdown of your specific population.

Not all plans may be able to easily divide their participants into these categories. For example, a plan for a regional transit authority with primarily blue-collar workers such as bus drivers may not be able to use these tables, since their workers do not easily fit into any of these job categories. The below-median Pub-2010 table for general employees is an option, but the RP-2014 Blue Collar table may be more appropriate.

Impact of New Tables

Using these tables is likely to increase the measurement of your liability, depending on your current mortality table and the demographics of your plan. Based on the study, teachers have the longest expected lifespan; liabilities for teachers are expected to be higher using the Pub-2010 tables than using the RP-2014 White Collar table. General employees have mortality rates in the Pub-2010 tables similar to those of the RP-2014 White Collar table. As expected, public safety employees have the highest mortality of the three groups, more similar to the RP-2000 table projected with Scale BB.

Income level is also a big determinant of mortality. The study population showed that lower income people had higher mortality rates than higher income people and had a shorter lifespan. If your plan is primarily composed of lower or higher paid employees, you should consider using the below or above median tables, respectively.

Location, Location, Location

The SOA was also expected to release tables based on geographic region. Ultimately, data based on geographic region was not used, because it was much less statistically significant than other factors and the data was not uniform across the geographic regions. If you expect your plan to have mortality rates that differ greatly from the national average, your Findley consultant can use the mortality information from the Center for Disease Control (CDC) to help develop adjustment factor(s) for geography. The CDC has mortality rates by census region, state, and county. If most of your participants live in one county that has a much higher mortality rate than the national average, you could scale the Pub-2010 tables by a factor in order to more closely model your plan population’s expected mortality.

What Now

Now that there are public plan tables available, you and your actuary need to consider adopting them or have a sufficient explanation as to why they are not appropriate. Keep in mind that there’s a lot of flexibility to tailor the tables to best match your plan’s population. You should discuss this with your plan actuary and your auditor. For further information and questions, contact Catie Barger in the form below.

Published August 17, 2020

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Copyright © 2020 by Findley, Inc. All rights reserved.

Developing a Strategy for Moving from Pension to 401(k) Benefits

Budgeting for next year’s cost of employer-provided benefits can seem daunting, especially when an organization sponsors both a defined benefit pension plan and a 401(k) defined contribution plan. Is it time to consider moving away from the defined benefit pension plan to avoid the volatility and risk? If so, plan sponsors should develop a well-thought-out process for analyzing the alternatives and impact to both employer costs and participant benefits. The overall strategy and objectives should be reviewed.

Each year, an actuary provides projections for the defined benefit pension plan and the amount required to fund seems to be ever-increasing. It feels like there’s no end in sight. Becoming fully funded seems to be a dream instead of a reality. Even in years when the assets in the plan had double-digit returns, there was either a new mortality table that needed to be adopted or the required interest rates dropped – all increasing the plan’s liability. This can be very difficult to manage going forward.

Strategy for Moving from Pension to 401(k) Benefits

While it is challenging to deliver an equivalent benefit in a defined contribution plan at the same level of contribution, defined contribution plans provide a predictable level of employer contribution each year. If plan sponsors are considering a transition to a replacement 401(k) plan, an analysis should be conducted to:

  • Determine the level of benefit desired for employees
  • Set a budget that provides the desired level of benefit when considering a defined benefit pension plan freeze

Performing the Analysis

When performing this type of analysis, we encourage companies to start by thinking of both the defined benefit pension and defined contribution plans together as a total retirement benefit. This allows the plan sponsor to contemplate its philosophy and develop a strategy related to short- and long-term goals for the retirement program.

Pension to 401(k) Benefits Flowchart

Establish Guidelines

Plan sponsors should start with a well-defined and proven process, taking the time to establish guidelines and understand the financial strategy. Begin by discussing the organization’s philosophy and define objectives for the retirement program to guide decision-making. These guidelines should include how the plan sponsor feels about management/budgeting of retirement plan costs, willingness to take on risk, providing benefits based on the organization’s ability to fund – discretionary vs. mandatory, the level of employees’ retirement benefits, and the competitiveness of benefits.

Determine Affordability

By evaluating all the current retirement plans and the projected cost and benefits, organizations will better understand the current and projected state of the plans and be able to determine the affordability of current plans over the long-term. The evaluation also allows them to discuss acceptable benefit levels and a cost strategy. A thorough analysis of the current and projected costs should include an outline of the current state of the program, including five-year projections under three scenarios for the defined benefit pension plan:

  • Ongoing plan
  • Closed to new entrants
  • Frozen accruals

In addition, the termination liability estimate under agreed upon assumptions should be calculated.

Determine Competitive Position

The guidelines and budgets are then coordinated with competitive market benchmarking to identify relevant alternatives to evaluate. Benchmarking the retirement plan benefits with competitive norms relative to the market allows the organization to measure the competitive position of benefits and expenses compared to industry/geographic region/employer size based on revenue or number of employees. The benchmarking helps the plan sponsor make informed decisions on the:

  • Form of benefit to be provided
  • Desired level of benefit for new hires/newly eligible participants
  • Impact on total compensation and the benefits package
  • Desired contribution allocation structure – pro-rata on pay, position-based, or based on age and/or length of service

Evaluate Alternate Strategies

Potential plan design alternatives including utilizing the current defined contribution plan should be developed based on previous discussions related to the organization’s philosophy, objectives and strategic direction for the retirement program. Alternative strategies can be assessed to determine the final strategic direction of the retirement program, such as modifying the current level of pension benefits or reduction/elimination of the defined benefit pension plan by freezing pension benefit accruals for all participants and moving toward a defined contribution plan only strategy.

Other strategies such as grandfathering selected participants or providing participants a “choice” between defined benefit and enhanced defined contribution benefits should be considered. If providing enhanced defined contribution benefits, determination of how the benefit will be provided – either with matching contributions and/or non-elective contributions in a fixed amount, performance-based, or based on a tiered age and/or service allocation – should be evaluated as well.

Modeling different plan designs that include variations of both defined benefit pension and defined contribution structures helps the plan sponsor compare costs and benefits. Based on the guidelines set upfront, these plan designs reflect the organization’s philosophical principles for providing these benefits to employees. The results of this analysis and each alternative are compared to the current plan(s) to show the overall impact on the employer-provided cost and level of employee benefit. Be prepared to study supplemental alternatives at this point because the first set may provoke additional thoughts or refinements.

Plan sponsors must be aware of compliance testing restrictions and be sure that any alternative considered will satisfy compliance rules — there is no point in studying an alternative that cannot be adopted due to nondiscrimination or coverage issues.

Making and Implementing the Decision

When all alternatives are reviewed, a final recommendation that ultimately links the retirement strategy with the philosophy and desired objectives is presented. Any potential transition issues or challenges should be outlined and a communication strategy should be developed. Establishing a formal communication plan is very important.

Develop and Document the Retirement Plan Strategy and Implementation Plan

The end result of the review should include a proposed retirement plan strategy to be presented to the board of directors. The proposed strategy should document the findings and conclusions of the review process and identify the steps necessary to carry out the recommendations within the strategy.

Change Management: Communicating to Employees

After the decision is made to change retirement benefits, communication to those impacted is key. This is the perfect time to remind employees of the retirement program and its overall value. In addition to government-required notices, you should also consider proactively sending out an individualized statement outlining the changes and providing the impact on participant’s benefits. It is important to make sure the changes are communicated clearly and that each participant understands the changes. Sometimes plan sponsors will hold group or one-on-one meetings with those impacted.

In Perspective

A change in the retirement program is a significant decision that affects the organization and its employees significantly. A thoughtful approach to a change like this can lead to better alignment of the overall program with organizational philosophy and goals, while still providing employees with competitive benefits.

If you have any questions regarding your options with transitioning from pension to 401(k) benefits, please contact Amy Kennedy at amy.kennedy@findley.com or Kathy Soper at kathy.soper@findley.com.

Published May 14, 2020

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Impact of Historic Interest Rate Decline on Defined Benefit Plans

How will defined benefit pension plans be impacted by historic year-to-year interest rate declines? The U.S. has experienced over a 100 basis point decrease on 30-year treasury rates and significant decreases across treasury bonds of all durations from year-to-year. After a slight uptick in rates during the fourth quarter of 2019, interest rates have plummeted in the first quarter of 2020. The low interest rate environment, coupled with recent volatility in the market arising from concerns over the Coronavirus, has pension plan sponsors, CFOs, and actuaries alike, taking an in-depth look at the financial impact.

Historic Interest Rate Decline on Defined Benefit Plans and options to consider.

How Will Your Company be Impacted by Historic Interest Rate Decline?

Under U.S. GAAP and International Accounting Standards, pension liabilities are typically valued using a yield curve of corporate bond rates (which have a high correlation to Treasury bond rates) to discount projected benefit payments. Current analysis shows that the average discount rate has decreased approximately 100 basis points from the prior year using this methodology.

Due to the long-term benefit structure of pension plans, their liabilities produce higher duration values than other debt-like commitments, that are particularly sensitive to movement in long-term interest rates. The general rule of thumb is for each 1% decrease in interest rates, the liability increases by a percentage equal to the duration (and vice versa). The chart below, produced using Findley’s Liability Index, shows the percentage increase in liabilities for plan’s with varying duration values since the beginning of 2019.

Pension Liability Index Results - 2/29/2020

Assuming all other plan assumptions are realized, the larger liability value caused by the decrease in discount rates will drive up the pension expense and cause a significant increase in the company’s other comprehensive income, reflecting negatively on the company’s financial statements.

Considerable Growth in Lump Sum Payment Value and PBGC Liabilities

Additional consequences of low treasury bond rates include growth in the value of lump sum payments and PBGC liabilities. Minimum lump sum amounts must be computed using interest rates prescribed by the IRS in IRC 417(e)(3) which are based on current corporate bond yields. PBGC liabilities are also determined using these rates (standard method) or a 24-month average of those rates (alternative method). For calendar year plans, lump sums paid out during 2020 will likely be 10-20% higher for participants in the 60-65 age group, than those paid out in 2019. For younger participants, the increase will be even more prominent.

In addition, if the plan is using the standard method to determine their PBGC liability, there will be a corresponding increase in the liability used to compute the plan’s PBGC premium. In 2020, there will be a 4.5% fee for each dollar the plan is underfunded on a PBGC basis. Depending on the size and funding level of the plan, the spike in PBGC liability may correspond to a significant increase in the PBGC premium amount.

What If We Want to Terminate our Pension Plan in the Near Future?

For companies that are contemplating defined benefit pension plan termination, there will be a significant increase in the cost of annuity purchases from this time last year. The actual cost difference depends on plan-specific information; however, an increase of 15-25% from this time last year would not be out of line with the current market. This can be particularly problematic for companies who have already started the plan termination process. Due to the current regulatory structure of defined benefit pension plan terminations, companies must begin the process months before the annuity contract is purchased. The decision to terminate is based on estimated annuity prices which could be significantly different than those in effect at the time of purchase.

Actions You Can Take to Mitigate the Financial Impact

Contributions to the plan in excess of the mandatory required amount will help offset rising PBGC premiums since the premium is based on the underfunded amount, not the total liability. Additional contributions would also help offset the increase in pension expense.

The best advice we can offer at this time is to discuss these implications internally and with your service providers. Begin a dialogue with your investment advisors about the potential need to re-evaluate the current strategy due to market conditions. Contact your plan’s actuary to get estimated financial impacts so you can plan and budget accordingly. If your plan has recently begun the plan termination process, you may need to reconvene with decision-makers to make sure this strategy is still economically viable.

Questions? For more information, you can utilize Findley’s Pension Indicator to track the funded status of a variety of plan types each month. To learn more about how this historic interest rate decline may impact your plan specifically contact your Findley consultant, or Adam Russo at adam.russo@findley.com or 724.933.0639.

Published on March 3, 2020

© 2020 Findley. All Rights Reserved.

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GE pension changes: should my company be looking to do the same?

On October 7, General Electric (GE) announced a series of decisions around their salaried pension plan:

  • For participants continuing to accrue benefits, further accruals will be stopped at the end of 2020. (New employees hired after 2011 were not eligible for the pension plan.)
  • A lump sum buy-out proposal to 100,000 terminated but not yet retired participants will be offered.
  • Benefits in a supplemental plan for certain executives will also freeze.

Inevitably, whenever one of the largest pension plans in the country makes an announcement like this, it can cause executives at other companies to question if a similar decision makes sense for their plan.  The action item here most germane to other plan sponsors, and the focus of the remainder of this article, will be to focus on the middle bullet point.  Offering lump sums to non-retired, terminated participants has become a popular strategy among pension plan sponsors the last couple years as a way to reduce headcount without paying a premium to an insurance company to off-load the obligations.

Lump Sum Cashouts Defined

A Lump Sum Cashout program occurs when a defined benefit pension plan amends its plan to allow terminated vested participants to take a lump sum payment of their benefit and be cashed out of the plan entirely. The program is typically offered as a one-time window.  Plans generally may offer this type of program only if their IRS funded percentage is at least 80% both before and after the program is implemented.

Many pension plans have offered, or at least considered, Lump Sum Cashout programs over the last several years to minimize their financial risk. Plan sponsors that have implemented these programs have been rewarded with significant cash savings as well as risk reduction.

Advantages of Implementing Lump Sum Cashout Today

1. Improved Funded Status

An advantage of the current interest rate environment is that lump sums will be less than most other liability measurements related to the plan. Employers will be paying benefits to participants using a value less than the balance sheet entries being carried for those benefits in most cases. These lower lump sum payments will then help employers improve the funded status of the plan in addition to de-risking or reducing the future risk.

2. PBGC Premium Savings

The most significant benefit of offering a Lump Sum Cashout Program is the Pension Benefit Guaranty Corporation (PBGC) premium savings. The PBGC continues to increase the annual premiums that pension plans are required to pay to protect the benefits of their participants in the pension plan. The per participant portion of the premium (flat-rate) is now up to an $80 payment per participant in 2019. This is more than a 200% increase since 2012. The variable rate portion of the premium is up to $43 per $1,000 underfunded which is an increase of almost 500% since 2012.

These rates are expected to continue to grow with inflation each year. Therefore it is ideal for pension plan sponsors to reduce their participant count sooner rather than later so they can save on these future premiums. In total, some pension plan sponsors could see annual PBGC premium savings of over $600 for each participant who takes a lump sum distribution.

Other Considerations When Planning for a Lump Sum Cashout

There are some concerns that pension plan sponsors will also want to consider such as:

  • Potential increases to contribution requirements;
  • One-time accounting charges that could be triggered;
  • Potential increase to annuity purchase pricing upon pension plan termination. Note that a permanent lump sum feature may increase pension plan termination annuity pricing and cause some insurers to decline to bid.

The pension plan’s actuary should be consulted so they can properly evaluate the impact of offering such a program.

Some pension plan sponsors use lump sum cashouts as part of their pension plan termination preparation strategy. This Findley article provides tips to map your route to pension plan termination readiness. Already have a frozen plan and been considering a termination in the near future? For a complete A-Z walkthrough, check out our guide below.

Questions? Contact the Findley consultant you normally work with, or contact Amy Gentile at amy.gentile@findley.com, 216.875.1933 or Matt Klein at matt.klein@findley.com 216-875-1938.

Published on October 8, 2019

© 2019 Findley. All Rights Reserved.

Pension Financial Impact of Record Low Treasury Bond Rates

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How will defined benefit pension plans fare as a result of the 30-year U.S. Treasury bond rates falling below 2.00% for the first time in U.S. history? This 100 basis point drop from the beginning of the year and the fact that U.S. Treasury bond rates of all durations are down significantly from the beginning of the year, have pension plan sponsors, CFOs, and actuaries alike, taking an in-depth look at the financial impact.

How Will Record Low Treasury Bond Rates Impact Your Company’s Defined Benefit Plan?

Due to the long-term benefit structure of pension plans, their liabilities produce high duration values that are particularly sensitive to movement in long-term interest rates. For instance, a standard frozen pension plan may have a duration of 12 which indicates that a decrease in the discount rate of 100 basis points would produce a 12% increase in liabilities. 

Under U.S. GAAP and International Accounting Standards, pension liabilities are typically valued using a yield curve of corporate bond rates (which have high correlation to treasury bond rates) to discount projected benefit payments. Current analysis shows that the average discount rate has decreased over 100 basis points from the beginning of the year using this methodology. Assuming all other plan assumptions are realized, the larger liability value caused by the decrease in discount rates will drive up the pension expense and cause a significant increase in the company’s other comprehensive income, reflecting negatively on the company’s financial statements. 

Pension Financial Impact of Record Low Treasury Bond Rates

What If We Want to Terminate our Pension Plan in the Near Future?

For companies that are contemplating defined benefit pension plan termination, there will also be a significant increase in the cost of annuity purchases. The actual cost difference depends on plan-specific information; however, an increase of 10-20% from the beginning of the year would not be out of line with the current market. This can be particularly problematic for companies who have already started the plan termination process. Due to the current regulatory structure of defined benefit pension plan terminations, companies must begin the process months before the annuity contract is purchased. Their decision to terminate is based on estimated annuity prices which could be significantly different than those in effect at the time of purchase.

Consider Growth in Lump Sum Payment Value and PBGC Liabilities

Additional consequences of record low treasury bond rates include growth in the value of lump sum payments and PBGC liabilities. Minimum lump sum amounts must be computed using interest rates prescribed by the IRS in IRC 417(e)(3) which are based on current corporate bond yields. PBGC liabilities are also determined using these rates (standard method) or a 24-month average of those rates (alternative method). If current interest rates hold, lump sums paid out during 2020 will likely be 10-15% higher than those paid out in 2019 for similarly situated participants. In addition, there would be a corresponding increase in the liability used to compute the plan’s PBGC premium. In 2020, there will be an estimated 4.5% fee for each dollar the plan is underfunded on a PBGC basis. Depending on the size and funding level of the plan, the spike in PBGC liability may correspond to a significant increase in the PBGC premium amount.

Actions You Can Take to Mitigate the 2020 Financial Impact

There is potential to help mitigate the financial impact for 2020 by taking action now. Since lump sum payments are projected to increase significantly in 2020, offering a lump sum window to terminated vested or retired participants during 2019 could be a cost effective way to reduce the overall liability of the plan.

Contributions to the plan in excess of the mandatory required amount will help offset rising PBGC premiums since the premium is based on the underfunded amount, not the total liability. Additional contributions would also help offset the increase in pension expense.

The best advice we can offer at this time is to discuss these implications internally and with your service providers. Begin a dialogue with your investment advisors about the potential need to re-evaluate the current strategy due to market conditions. Contact your plan’s actuary to get estimated financial impacts so you can plan and budget accordingly. If your plan has recently begun the plan termination process, you may need to reconvene with decision-makers to make sure this strategy is still economically viable.

Questions? For more information, you can utilize Findley’s Pension Indicator to track the funded status of a variety of plan types each month. To learn more about how falling interest rates may impact your plan specifically contact your Findley consultant or Adam Russo at adam.russo@findley.com or 216-875-1949.

Published on August 22, 2019

© 2019 Findley. All Rights Reserved.

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AI Technology Transforming the Next Generation of HR

The right mix of technology, artificial intelligence and the human element is a differentiator.

With the coming of Artificial Intelligence (AI) and broader uses of technology, HR professionals will be challenged to manage and humanize HR systems to achieve their objectives. AI is the ability of a computer program or a machine to think and learn. Call it what you will, HR Technology (HRIS, HRMS, HCM) are here to stay.

Steven Hawking once said that “Unless we learn how to prepare for, and avoid, the potential risks, AI could be the worst event in the history of our civilization.”

HR is Already Using Artificial Intelligence and Leveraging Technology

Many experts predict that AI will replace jobs involving repetitive or basic problem-solving tasks, and even go beyond current human ability. AI systems will make HR decisions instead of professionals in industrial settings, customer service and other interactive roles. 

Likewise, Human Resources technology and AI are used increasingly in every facet of the organization’s employment lifecycle as listed below.

  • Employers use social media to brand their companies and attract candidates
  • Applicant Tracking Systems technology improves HR professional’s recruiting and hiring efficiency and productivity
  • Screening technologies, such as video interviews, assessments or automated scheduling/screening help to vet candidates
  • Technologies have automated several HR-related tasks such as employee onboard processing, employee benefit elections and processing retirements
  • Performance management systems track individual performance and link that performance to company results
  • Employee engagement surveys, and 360 feedback systems capture the employee perspective
  • Training modules are distributed to employees and their utilization tracked via learning management technology systems
  • Compensation data surveys and cloud-based technology tools are available to compensation professionals that subscribe to them

Today many employee or prospective employee interactions are not with a human being. Instead, leveraging AI in HR, candidates apply for a job to an automated HR system, have an initial online screening, interview via video and through conversational job matching, are assessed to determine if they are talent worthy of further consideration. The assumption is that these HR software solutions are faster, more accurate and cost-effective at selecting the best talent.

How has the Human Resources Professional’s Role Changed?

Businesses that are late adopters of technology will be left behind. In today’s competitive market your speed to attract, hire, manage, develop and reward your talent is a key success factor. As we have seen in the marketplace, organizations that are lacking in this space have higher employee turnover and lower productivity. They are not meeting the needs of today’s generation which require immediate capability to engage and transact certain activities. Organizations using traditional HR approaches and software solutions struggle to land and keep top talent.

Human Resources professionals will need to significantly adapt and add new skills beyond being people experts. HR teams will need to develop a stronger understanding of systems, process and data analytics). We see this movement in the world of professional sports where data analytics augments identifying top talent. Businesses are slowly following this AI trend and are beginning to reap the benefits.  

Building Your Next Generation HR Team

One of the best innovators in hiring today is a company called Catalyte. In fact, Catalyte’s mission states: “Catalyte advances human potential for the digital economy. We use artificial intelligence to identify individuals, regardless of background, who have the innate potential and cognitive ability to be great software developers.”

Catalyte uses AI to review candidates for pure ability – not experience – and then builds skills through a strong apprentice and training program. The organization looks for raw talent and molds that talent to develop the computer programming skills they need to succeed.

Is your HR team combining innovative technology with raw human skill to build your workforce for the future? What kind of HR talent do you need to create and lead this kind of approach?

In larger organizations, where resources may be more plentiful, the focus of systems, process and data analytics may be assigned to specific departments. In smaller organizations everyone shares the burden of addressing these AI areas. Irrespective of the size of the organization or the specific role, HR professionals will need to build their technical acumen and become the conduit to building a workforce for the future.

After all, even AI uses algorithms built off of desired outcomes, as identified and input by human experts. Therefore, HR teams today require a mix of both art and science.

Questions regarding how to develop an innovative HR strategy or assess your current HR function or talent, contact the Findley consultant you normally work with, or Dan Simovic at dan.simovic@findley.com, 216.875.1917.

Published August 14, 2019

© 2019 Findley. All Rights Reserved.

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Could You Be Supporting a Hidden Retiree Health Plan?

A retiree health plan is when ex-employees are provided for or allowed to purchase health care through their former employer. 

Sponsoring a hidden retiree health plan happens more often than you might think. Having even an informal policy of extending active health benefits to retirees and charging the “full” active premium or supplementing retiree health benefit coverage for some time are two examples of creating a retiree health benefit plan and incurring the accompanying plan liability for health benefits promised in the future.

Could You Be Supporting a Hidden Retiree Health Plan?

Examples

1) ABC Company has a fully insured medical plan for its active employees. ABC pays 60% of the premium. The employees pay the rest. The employee handbook has a paragraph that reads, “If you retire from active service after age 60 with 15 years of service, you may remain in the health insurance plan until age 65. You will pay the employer and employee portion of the premium.”

2) Ten years ago, XYZ Company had an executive retire at age 60. He had been with the company for 17 years. He was allowed to stay on the active medical plan until age 65. He had to pay the employer and employee portion of the premium. All staff received an email at the time stating that this was now available to all employees who retire after age 60 with 15 years of service. The language in the email never made it in the employee handbook, but it was a well-known policy.

3) MNO Corporation has a collective bargaining agreement with its union that provides $150 per month for medical coverage for anyone who retires before age 65. Coverage ends at age 65, and the participants must purchase the coverage from MNO.

ABC, XYZ, and MNO have retiree medical plans and might need to recognize a liability on their balance sheets and annual expense on their income statements for the promised benefits.

Why is There a Liability?

The question often asked in regards to ABC and XYZ is, “The retiree pays the full cost of the premium. It costs the company nothing. Why is there a liability?”

There are two parts to the answer. The first part is in the way the premium is calculated for the active health plan. The insurance company calculates the premium rates for the entire population, including retirees. Since these retirees are older, their premium amounts are higher than for younger employees in the plan. Without the retirees in the plan, the total premium would be lower, and thus, the employer portion would be lower.

Looked at another way, if you could calculate a hypothetical premium rate for just the retiree group, it would be much higher due to their ages. The difference between the hypothetical premium level and the “full” active premium charged for medical coverage is called a “hidden subsidy.”

The second part is from the accounting standard ASC 715-60-05-2 which states, “a postretirement benefit plan is an arrangement that is mutually understood by an employer and its employees whereby an employer undertakes to provide its current and former employees with benefits after they retire in exchange for the employees’ services over a specific period of time.”

This second part of the above answer also applies to the MNO Corporation example. Their annual cost for the retirees may seem minimal and recorded as an annual payroll and benefits cost along with the active medical plan. However, for all three companies, the retirees are not receiving benefits as a part of their compensation while working. The retiree benefits accrue while working but are paid after retirement.

This promise of future benefits can trigger a liability to recognize on the balance sheet and an annual expense that runs through the income statement.

How Does an Employer Know if They Need to Recognize a Liability?

The employer should discuss it with their auditors. Depending on the circumstances, an auditor could consider it de minimus or may request that an actuary measure the liability before providing an opinion about the impact on the company financials.

Options

If the auditor does not consider it de minimus, in arrangements like ABC’s or XYZ’s, a company could charge the retiree more than the active premium –something more like the above hypothetical premium. (An actuary or healthcare consultant can help you set a hypothetical rate.) The hypothetical rate would remove the “hidden subsidy” and reduce the costs to a de minimus level. Additionally, the increased cost of coverage may cause retirees to look elsewhere for more affordable coverage.

Alternatively, if the employer wants to keep an arrangement that is not de minimus, then it will need to engage an actuary to perform annual valuations for financial reporting purposes.

If you have questions or would like to discuss any formal or informal arrangements you have in place for your retirees, contact David Davala at 216.875.1923 or David.Davala@findley.com.

Published July 12, 2019

© 2019 Findley. All Rights Reserved.

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Terminating an Overfunded Pension Plan? Who Gets the Excess?

If a single employer overfunded pension plan is terminating and its participants and beneficiaries are on track to receive full benefits, the plan sponsor will likely ask if the excess is theirs. In other words, will the surplus revert to the plan sponsor? The answer is maybe.

To determine how excess plan funds can be exhausted, which may include a reversion to the plan sponsor, there are 7 possibilities to consider. As always, the place to start with any retirement plan issue is to answer the question: what does the plan say?

Terminating an Overfunded Pension Plan

Possibilities to Consider if the Terminating Plan Document does not Permit a Reversion

A plan document may state that no part of the plan’s assets can be diverted for any purpose other than for the exclusive benefit of participants and beneficiaries. The plan may also indicate that the plan cannot be amended to designate any part of the assets to become the employer’s property. If an overfunded pension plan has these provisions, it is tempting to assume the only choice is to allocate the excess among participants and beneficiaries. However, even in the face of these explicit provisions, there may be other provisions that permit an employer to recover or use a portion of the excess assets.

Possibilities 1 and 2 – Return of Mistaken and Nondeductible Contributions

Plan documents generally indicate that if an employer makes an excessive plan contribution due to a mistake, the employer can demand the surplus is returned. The employer is required to request this from the trustee within one year after the contribution was made to the trust. In addition, plans generally provide that a contribution is made on the condition that the employer receives a corresponding tax deduction. In the unlikely event that the deduction is not permitted by the IRS, the contribution can be returned to the employer within one year following the IRS’ final determination that the tax deduction was not allowed.

An example of a contribution mistake may be an actuarial calculation error. In a 2014 Private Letter Ruling, the IRS considered a surplus reversion when a terminating single employer plan purchased an annuity contract. The excess assets were created when the purchase price selected to fully fund plan benefits actually came in at a lower price than estimated. Using reasonable actuarial assumptions, the plan’s actuary had advised the employer to contribute a higher amount than was ultimately calculated as necessary by the insurance company. In this case, the IRS permitted the return of the mistaken excess contribution. 

Possibility 3 – Have all Reasonable Plan Expenses Been Paid from the Trust?

Many plan documents provide that plan expenses can be paid from the trust. In some instances, appropriate and reasonable plan termination expenses will go a long way to exhaust excess assets. Reasonable plan termination expenses include determination letter costs and fees, service provider termination charges and termination implementation charges such as those for the plan audit, preparing and filing annual reports, calculating benefits, and preparing benefit statements.

Possibilities to Consider if the Terminating Plan Document Permits a Reversion

The overfunded pension plan may explicitly state that excess assets, once all of the plan’s obligations to participants and beneficiaries have been satisfied, may revert to the plan sponsor. On the other hand, the plan may not explicitly permit a reversion. In that case, the plan sponsor may want to consider amending the plan to allow a reversion well ahead of the anticipated termination.

Possibilities 4 – Take a Reversion

If the first three possibilities do not work or are inadequate to exhaust the surplus, and the overfunded pension plan allows a reversion, there are three more possibilities. In the first, the employer takes all. The employer can take all of the excess funds back subject to a 50% excise tax, as well as applicable federal tax.  Notably, a not-for-profit organization may not be subject to the excise tax on the reversion at all if it has always been tax-exempt.

Possibility 5  – Transfer the Excess to a Qualified Replacement Plan

The opportunity to pay only a 20% excise tax (and any applicable federal tax) on part of the surplus is available where the remaining excess assets are transferred from the terminating pension plan to a newly implemented or preexisting qualified replacement plan (QRP). A QRP can be any type of qualified retirement plan including a profit sharing plan, 401(k) plan, or money purchase plan. For example, an employer’s or a parent company’s 401(k) plan, whether newly implemented or preexisting, may qualify as a qualified replacement plan.

Once an appropriate plan is chosen, the amount transferred into the QRP must be allocated directly into participant accounts within the year of the transfer or deposited into a suspense account and allocated over seven years, beginning with the year of the transfer.

There are additional requirements for a qualified replacement plan. At least 95% of the active participants from the terminated plan who remain as employees must participate in the QRP. In addition, the employer is required to transfer a minimum of 25% of the surplus into a qualified replacement plan prior to the reversion. If all of the QRP requirements are satisfied, then only the amounts reverted to the employer are subject to a 20% excise tax and federal tax, if applicable. 

Possibility 6 – Provide Pro Rata Benefit Increases

If the employer chooses not to use a QRP, it can still limit the excise tax if it takes back 80% or less of the surplus and provides pro rata or proportionate benefit increases in the accrued benefits of all qualified participants. The amendment to provide the benefit increases must take effect on the plan’s termination date and must benefit all qualified participants. A qualified participant is an active participant, a participant or beneficiary in pay status, or a terminated vested participant whose credited service under the plan ended during the period beginning 3 years before termination date and ending with the date of the final distribution of plan assets. In addition, certain other conditions apply including how much of the increases are allowed to go to participants who are not active.

A Possibility That’s Always Available

Possibility 7 – Allocate all of the Excess Among Participants and Beneficiaries

It is always possible to allocate all of the excess assets among participants in a nondiscriminatory way that meets all applicable law. A plan amendment is necessary to provide for these higher benefits.

You may know at the outset of terminating your plan that there will be excess assets. On the other hand, a surplus may come as a surprise. Even if a pension plan is underfunded at the time the termination process officially begins, it is possible that the plan becomes overfunded during the approximate 12 month time period to terminate the plan. In this scenario, the plan sponsor will have to address what to do with the excess assets.

Dealing with the excess assets in a terminating defined benefit plan can be a challenge. There are traps for the unwary, and considerations beyond the scope of this article. Plan sponsors need to determine first how the excess was created, because the answer to that question may determine what happens to it. If there is no obvious answer in how to deal with the surplus, then the plan sponsor needs to look at all of the possibilities. It may be that a combination of uses for the excess plan assets is best. If you think you will find yourself in this situation with your defined benefit plan, consult your trusted advisors at your earliest opportunity so that you know the possibilities available to you.

Questions? Contact the Findley consultant you normally work with, or contact Sheila Ninnenam at sheila.ninneman@findley.com, 216.875.1927.

Published July 10, 2019

© 2019 Findley. All Rights Reserved.

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More Pension Lump Sum Cashout De-risking Activity Expected in 2019

Pension plan sponsors looking for significant cash savings and de-risking opportunities have another favorable environment to pull the participants’ lump sum cashout lever this year. But that lever includes several options and considerations. In 2019, the interest rate environment is favorable which gives pension plan sponsors an opportunity to provide lump sum payments to participants while improving the funded status of the plan. So why wait to offer this cashout opportunity when you have this significant benefit staring you right in the face?

Lump Sum Cashout Opportunity in 2019

Lump Sum Cashouts Defined

A Lump Sum Cashout program occurs when a defined benefit pension plan amends its plan to allow terminated vested participants to take a lump sum payment of their benefit and be cashed out of the plan entirely. The program is typically offered as a one-time window but can also be made a permanent feature of the plan with potentially significant financial impact. Plans generally may offer this type of program only if their IRS funded percentage is at least 80% both before and after the program is implemented.

Many pension plans have offered, or at least considered, Lump Sum Cashout programs over the last several years to minimize their financial risk. Plan sponsors that have implemented these programs have been rewarded with significant cash savings as well as risk reduction

Advantages of Implementing Lump Sum Cashout Today

1. Favorable Lump Sum Interest Rate Environment

In 2019, the lump sum interest rate environment is favorable for most employers thanks to a significant interest rate increase during 2018 when lump sum interest rates are locked in for 2019 calendar year plans. These higher rates will result in smaller lump sum payments when compared to 2018 (15-20% decrease).

2. Improved Funded Status

Another advantage of the current interest rate environment is that lump sums will be less than most other liability measurements related to the plan. In other words, interest rates used for 2019 calendar year plans to determine accounting liabilities are lower than lump sum rates. Therefore employers will be paying benefits to participants using a value less than the balance sheet entries being carried for those benefits. These lower lump sum payments will then help employers improve the funded status of the plan in addition to de-risking or reducing the future risk. This interest rate arbitrage is not expected to exist in 2020 since defined benefit lump sum interest rates have continued to decrease since the beginning of 2019.

3. PBGC Premium Savings

The most significant benefit of offering a Lump Sum Cashout Program is the Pension Benefit Guaranty Corporation (PBGC) premium savings. The PBGC continues to increase the annual premiums that pension plans are required to pay to protect the benefits of their participants in the pension plan. The per participant portion of the premium (flat rate) is now up to an $80 payment per participant in 2019. This is more than a 200% increase since 2012. The variable rate portion of the premium is up to $43 per $1,000 underfunded which is an increase of almost 500% since 2012.

HOW TO CALCULATE THE PBGC PREMIUM
Flat Rate (per participant) + Variable Rate = PBGC Premium

These rates are expected to continue to grow with inflation each year. Therefore it is ideal for pension plan sponsors to reduce their participant count sooner rather than later so they can save on these future premiums. In total, some defined benefit plan sponsors could see annual PBGC premium savings of over $600 for each participant who takes a lump sum distribution.

Can You Offer a Lump Sum Cashout More than Once?

Employers that have previously offered a lump sum cashout to participants should be aware that this doesn’t exclude them from pursuing a de-risking program again. In general, as long as plan sponsors wait 3-4 years between similar programs, they can offer the same program to plan participants again. This gives participants who have terminated since the original program an opportunity to take their pension payment. A second round offering also gives participants from the first program a second chance to take a cashout while de-risking the plan for the plan sponsor.

Other Considerations When Planning for a Lump Sum Cashout

There are some concerns that plan sponsors will also want to consider such as:

  • Potential increases to contribution requirements;
  • One-time accounting charges that could be triggered;
  • Potential increase to annuity purchase pricing upon plan termination. Note that a permanent lump sum feature may increase pension plan termination annuity pricing and cause some insurers to decline to bid.

In summary, 2019 is an ideal year given the lump sum interest rates. The current interest rate arbitrage provides pension plan sponsors a low cost opportunity to de-risk the pension plan and save significantly on future PBGC premiums. As with any de-risking opportunity, there are several considerations that should also be discussed. The defined benefit plan’s actuary should be consulted so they can properly evaluate the impact of offering such a program.

Some plan sponsors use lump sum cashouts as part of their pension plan termination preparation strategy. This Findley white paper provides tips to map your route to pension plan termination readiness.

Questions? Contact the Findley consultant you normally work with, or contact Amy Gentile at amy.gentile@findley.com, 216.875.1933.

Published on June 7, 2019

© 2019 Findley. All Rights Reserved.

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Benefits Communications Shouldn’t Stop after Open Enrollment Ends

Open enrollment season is an opportunity to remind your associates about their benefits options and prepare them to maximize their choices for the year ahead. It is a unique opportunity where employees are expecting highly detailed information in a relatively short time span. During this annual event, employees probably read more articles, watch more videos, and hear more presentations about company benefits than they do at any other time.

The most experienced HR professionals would advise teaching and communicating about benefits all year round, not just during the open enrollment window. While that applies to many company messages, it’s particularly important with benefits because of the rapid pace of change and the investment that organizations make in benefits packages. With a broader approach to benefits communications, organizations can keep employees from feeling intimidated or confused when it actually comes time for them to select their benefits each year.

Prepare Targeted Communications

Sending the same message to every employee won’t allow you to create materials that are relevant and meaningful to your audience. It won’t be long until most employees start to tune out your messages. By segmenting communications— using the data that you have after open enrollment is complete— you can make your messages more applicable and valuable. For example, once you know who has enrolled in your High Deductible Health Plan, you can send highly technical pieces with instructions on setting up or accessing a Health Savings Account (HSA). You can also reinforce the tax advantages of the HSA as the deadline for filing tax returns approaches.

HR communicators can get creative in their targeted approach. One client used a lottery ticket communication to help employees who weren’t contributing to the 401(k) plan understand how much money they were leaving on the table. The personalized lottery ticket also showed projections, based on the individual’s salary, of retirement plan account balances in 5, 10, and 20 years if the employee started contributing and received matching contributions. This approach is high touch and requires extensive data testing and sophisticated fulfillment procedures, but the results can be worth it.

Circle Back on Any Outstanding Questions

During a typical open enrollment meeting, some employees will ask detailed personal questions that should be addressed one-on-one. While it’s important to address these questions in a private setting, other employees are disadvantaged by not learning about benefit issues through these scenarios. To solve this problem, document the questions that are raised outside the large group settings and reshape the language to fit a broader audience. For instance, an employee might want to discuss an unpaid claim from her daughter’s college campus clinic. This could easily translate to a broad Q&A about best practices for accessing care while traveling or attending school outside the state.

Publishing a post-enrollment Q&A can also reinforce the message that the HR team is listening. Employees want to be heard and sometimes their questions and ideas can help improve the company’s benefits package or streamline administration. By paying attention to trends that come through employee inquiries, the HR function can better meet the needs of the workforce.

Create Annual Personalized Statements that Promote Value

Most organizations strive to provide competitive pay and benefits through their total compensation program. Yet, the key to maximizing this significant investment is to communicate with employees in a way that gets noticed. This is particularly important if your organization is intensely competing for talent or struggling with turnover. Ensuring employees understand the competitiveness of pay and benefits is critical to retaining top talent.

To help every employee understand the value of their pay and benefits, top organizations provide an annual Total Rewards Statement to all benefits-eligible employees. The goals of a Total Rewards Statement often include that it’s cost-effective; it’s personalized with accurate information; and it’s tailored for the unique programs offered in each part of the organization. Most importantly, the communication must engage employees by helping them understand the competitiveness and value of their total rewards.

Questions? Please contact the Findley consultant you normally work with or Kimberlie England at  kimberlie.england@findley.com or 419.327.4109.

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