SOA: 2021 Smoothing Stoppage Calls for Forward-Thinking Initiatives

Although smoothing rates suggest single-employer pension plans have been fine, future restrictions could cause issues.

The Society of Actuaries (SOA) last week released a document chronicling research on its US single-employer pension plan contribution indices, noting that the 2014 total funding liability for these plans of $1.9 trillion was 98% funded, with an unfunded liability of $30 billion as of 2014. The database was pulled in October 2016.

The above funding percentage was reflected by the smoothed bond rates. When assessed using unsmoothed, high-quality corporate bond rates, the liability is actually estimated to be $2.4 trillion, and when assessed using the market value of assets, the system was 91% funded, with an estimated liability of $218 billion. While this is mostly positive news for now, there are some looming signs of uncertainty come 2021, when the smoothing effect will become more restricted, eventually fading away completely. This will cause the discount rates to drop, increasing liability.

The Pension Protection Act, the initial law regarding the smoothing was passed in 2006 and implemented in 2008. There was little smoothing in the initial law, but in the wake of the financial crisis, congress allowed for more smoothing in a relief effort. “That was about the time when interest rates started to drop and everything tanked,” said Lisa Schilling, retirement research actuary with SOA. “As an effort to smooth out the extreme shock of the way it turned out, with the extra contributions at the same time that the economy was in a down surge, Congress put in this smoothing and it was intended to be phased away. At that time, people thought interest rates were going to come back up, and for whatever various reasons, they didn’t.”

Schilling says that the varying issues caused Congress to re-up the smoothing of those discounts rates three separate times.

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Although 2021 seems far away, Schilling suggests those that are not planning ahead already should begin working immediately with their actuaries to adjust their budget plans to avoid taking a big hit in the future.

“That’s probably the single-biggest thing to do,” she said. “Combine that with the tradeoff of the more money you put in, the better funded you are in the future. If a plan is being close to 100% funded or is 100% funded on the basis of the smoothed rates, but not so on the market rates, I could imagine that could well play into the kind of investment strategies one might want to undertake,” she said. “Each plan needs to be looked at on their own and get their actuaries on the investment. They need to look at the whole picture, not just one piece at a time.”

The research was conducted using the Department of Labor Form 5500 database. The full SOA report can be viewed here.

Photo by: Natee127

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Fitch Revises Down Public Pension Discount Rate, Cites Slow Growth

On average, 1% drop in investment return assumption will bring about 11% increase in total pension liabilities.

Fitch Ratings will be discounting pension liabilities of public pension systems at a 6% investment return rate, rather than the 7% the rating agency was using previously, based on its views relating to slow economic growth that does not justify the higher rate of investment return.

Douglas Offerman, senior director, Fitch Ratings, noted, “US growth has been slower and more incremental over the current economic expansion than over longer time horizons. There is little evidence to suggest the economy will accelerate to previous levels of growth in the near term. Fitch believes that pensions will be hard-pressed to achieve their long-term growth expectations in the current economic context.”  

Fitch believes “the 6% return assumption, and increased total pension liability, better reflect the magnitude of the burden posed by pensions.” The New York ratings agency will apply the change to its input for assessing the pension liabilities of state and local governments.

It seems that for the 1% drop in Fitch’s investment return assumption, on average, these entities will see about a 11% hike in their total pension liabilities. Most of them will see their pension liabilities increase in the 9% to 15% range. There will also be a small number of state and local governments that are outliers, whose pension liabilities will rise beyond this expected range, based on their individual pension system characteristics.

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US growth has been slow in recent years, and feeling the impact of an aging population, reduced participation in the workforce, productivity that hasn’t risen, and restrained growth in wages. The economy last went through this sort of slow growth in the 1970s and 1980s.

Fitch finds that challenged pension systems are investing more in “broader ranges” of equity, fixed-income, and alternative assets so as to preserve their long-term returns in today’s environment of low market interest rates. However, these investments are also more volatile and expose the systems to higher risk.

“Among some outliers, exposure to unusually risky asset classes is well beyond what is typical for pensions with very long-term liabilities, and ultimately raises the risk that pension sponsors and participating governments will have to absorb the heightened risk of return underperformance,” according to Fitch.

The ratings agency also expects that the lower 6% discount rate serves to better gauge other risks associated with a defined benefit pension plan. For instance, actuarial updates could make for upward revisions to mortality expectations, and government policies could impact hiring levels, benefits, and contribution trends. These sorts of changes could expose state and local governments to higher liabilities and contributions.

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