Fear of (Not) Dying

One of the downsides of being a pension actuary is that conversations can often turn a bit morbid.  Mortality is such a heavy subject that non-actuaries (also called “people”) consciously use more pleasant euphemisms like “longevity”. Others simply take a hiatus from their regular blog to avoid the topic. (By the way, I’m filling in for Scott Ruba while he runs our United Way campaign.)       

On the other hand, the Society of Actuaries (SOA) paradoxically lives for mortality. Just recently, the SOA recommended updating the standard mortality tables from 2000. (I always imagine these recommendations coming from secret SOA meetings resembling PG-rated versions of Eyes Wide Shut. They’re probably not, though.)

The good news is the new mortality tables reflect what you’ve probably heard already: despite our poor diets and sedentary behavior, Americans are living longer than ever! The bad news is factoring this added longevity to an average pension plan increases the liabilities by an estimated 5-7%. This increase could potentially be factored into IRS funding liabilities and lump sum calculations within two years, and audit firms may push for earlier recognition in accounting liabilities.

The actual implementation date of the new SOA mortality tables is still unclear. Just last week, the American Academy of Actuaries (AAA) expressed concerns about the quality of the data used by the SOA for their recommendation, setting the stage for a West Side Story-style actuarial dance fight the likes of which the world has never seen (probably with retractable pencils.)   

These questions haven’t prevented retirement consultants from feverishly inciting plan sponsors to take action before the mortality liability increases arrive, however. One popular suggestion is to offer lump sums to former employees now, before the extra longevity is included in the payments. (“Buy now!  Prices will never be this low again!”)

Remember though, mortality is only half of the actuarial equation. The mortality assumption tells us how many payments to expect. But the interest rate used to discount future payments tells us how much each payment is worth today. 

Are lump sums the answer?

Under current law, minimum lump sums are based on the yields of high-quality corporate bonds. Lump sum values move inversely to the rate, so lower rates mean higher lump sums and vice versa. These rates remain near historic lows, so higher future rates are not out of the question. 

The impact of higher future interest rates would be significant. The entire anticipated impact of the new mortality assumption would effectively be offset by a 0.5% increase in corporate bond rates. Greater rate increases would reduce lump sums by even more. 

So it is possible that rushing payment of lump sums to beat the mortality clock could actually cost more than waiting until rates are higher, even with the impact of increased longevity factored in. 

Unfortunately, even actuaries (some say especially actuaries) can’t guarantee future interest rates. This makes lump sum offerings a legitimate risk management strategy for defined benefit plans, and there are valid reasons for considering them sooner rather than later. However, the final decision should only be made after careful consideration of their impact on plan funding, accounting and administration. Rushing to a snap decision driven by fear of increased longevity (or fear of pensioners not dying) may ultimately prove to be counterproductive. 

Mike Clark is a fellow of the Society of Actuaries and a member of the American Academy of Actuaries, and is understandably quite conflicted about the potential dance fight between the two organizations.

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