The Retirement Report, Fall 2019

Variable Annuity Plans Practice Note—a Deep Dive

CadenheadThe Pension Committee released a public policy practice note in early November to provide information to actuaries on current and emerging practices for measuring obligations of defined benefit pension plans that include variable annuity benefits.

The Retirement Report undertook a Q&A with Pension Committee Chairperson (and Academy Board member) Bruce Cadenhead about the practice note.

The practice note states it is the follow-on from an exposure draft released initially in late 2015. Could you give an overview of the committee’s efforts to develop this practice note since then, and how much has the practice note changed since its exposure draft?

The practice note discusses two main approaches to valuing variable annuity plans. We describe these as “Indexing Assumption Consistent With Discount Rate” and “Indexing Assumption Independent of Discount Rate,” and make a strong case for the first approach from a theoretical perspective. However, many actuaries believe that from the perspective of the qualified single-employer plan funding rules, the second approach is more compatible with existing IRS guidance. Commenters expressed concern that the exposure draft did not sufficiently acknowledge this view. We tried to be very careful in the final version to reflect this concern. This change required a significant amount of rewriting.

The practice note states that while variable annuity plans have been around in some form for more than 60 years, they have only been explicitly recognized under the Internal Revenue Code since 2006, and notes that while they offer certain characteristics of both defined benefit and defined contribution plans, they are regulated as defined benefit plans. Why or how is this regulatory status significant?

These are clearly defined benefit (DB) plans—they’re intended to provide lifetime income benefits, so from a regulatory perspective that’s the right place for them given that they have to be in one bucket or the other. It would be nice if there was a regulatory status that sat in between the two, but there isn’t. We note that they have certain characteristics of defined contribution plans—in particular the financial risk posed to employers is greatly reduced because most of the financial variability is passed along to participants in the form of benefit adjustments. The main concern with the current regulatory status is that the funding rules may not appropriately reflect this reduced risk profile in the measurement of liabilities.

What are some of the variations on the so-called pure variable design that the practice note covers—and which are most likely to be encountered in the real world?

There are what I would characterize as small variations and more significant variations. Just about every variable plan out there has at least some small variations from the pure variable design. In the pure variable design, you would need to adjust benefits every payment period; i.e., monthly. All of the plans that I am aware of adjust benefits no more than annually. This timing difference creates modest disconnect between assets and liabilities. What we are seeing more significantly is that a lot of the new variable plans being set up have more complex mechanisms to limit the year-over-year volatility that participants will experience in benefit levels. That’s particularly important to retirees, because it can be more difficult once you’ve started paying somebody a monthly check to tell them their benefits are being reduced, even if they may go back up again the following year. These mechanisms can introduce additional risk to the plan sponsor and takes the plan design further away from the pure variable model.

The practice note cites key aspects of several actuarial standards of practice (ASOPs) as being helpful, namely No. 27, Selection of Economic Assumptions for Measuring Pension Obligations, and No. 4, Measuring Pension Obligations and Determining Pension Plan Costs or Contributions. How effective are the ASOPs in providing “guideposts” to practice notes generally and this one in particular?

Actuarial standards of practice are always a consideration in drafting practice notes. We have to make sure that what we say is consistent with the ASOPs. In this practice note, one of the particularly challenging issues is how to set the assumption for future changes in benefit levels, which is tied to the return on plan assets. In particular, can or should this assumption be set independently of the discount rate (which is a prescribed assumption under the single-employer funding rules) or is it a function of the discount rate, in which case any rules relating to setting the discount rate might also apply to this assumption. These are concepts that are discussed in the ASOPs, but the ASOPs don’t give definitive answers.

There has been little formal guidance on accounting for variable annuities from regulatory bodies—the IRS and the Department of Labor, among others. Why do you think that is?

From the IRS perspective, it’s probably a combination of the fact that there are still not a lot of large plans with variable benefits and that these plans do not fit the traditional defined benefit model, raising some challenging issues from a valuation perspective. The practice note attempts to address these issues.

The end of the practice note cites some issues that are beyond its scope, while noting they could be addressed in the future, including by IRS guidance. Would you put any of these items at the top of the list for revision, and/or offer any potential timeframe by either the committee or IRS to further address them?

The practice note talks a little bit about embedded options—design features that have an asymmetric effect on benefits, or really any significant deviations from the pure variable design. But we don’t really get into a discussion of how to put a value on these features. We are starting a project that will extend beyond variable plans and will look a little more deeply at hard-to-value plan provisions in general. That will likely include some of the variations on the variable annuity design that are coming into play, as well as some issues for other types of plans that are out there. I don’t expect IRS guidance on this topic anytime soon.

Annual Meeting Plenary Session Looks at Women & Retirement Issues

ChatzkyPersonal finance expert and author Jean Chatzky gave a keynote address at the Academy’s Annual Meeting and Public Policy Forum in a session that led into an expert panel discussion about women and retirement issues.

Chatzky— founder and CEO of HerMoney, and a bestselling author and award-winning journalist whose résumé includes financial editor for NBC’s Today show, columnist for the New York Daily News, host of a daily show on the “Oprah & Friends” channel on XM Radio—spoke about women’s relationships with money and the effects of upbringing and societal factors that affect it.

Prefacing her discussions by asking what women really want from their money, Chatzky answered later in her presentation that it’s often safety, security, and stability. She noted that many women are heads of households and providing care not just for children but also for aging parents.

Today, more than 38 percent of women are higher-earning family breadwinners, more than half are single and de facto heads of households, almost half of U.S. millionaires are women, and for every 100 men who graduate college, 132 women graduate, Chatzky said. With a larger share of inheritance from both parents and outliving their husbands, by the year 2028, women will control 78 percent of global discretionary spending, and by 2030, two-thirds of U.S. wealth, she said.

Chatzky spoke about the difference between being an investor—with a more stable, long-term approach to markets—versus traders, who are more short-term focused (and more often men). “The financial playbook that men have used for decades doesn’t quite work for women,” she said. “Before getting the things we want, women have to focus on getting the things we need.”

Chatzky was followed by a panel discussion on women and retirement issues that was moderated by Academy Senior Pension Fellow Linda K. Stone. Panelists Cindy Hounsell, president of the Women’s Institute for a Secure Retirement; Gretchen Livingston, a demographer and senior researcher at the Pew Research Center; and Elaine Weiss, lead policy analyst for income security at the National Academy of Social Insurance, looked at demographic and other issues affecting women’s retirement and financial security.

(L-R) Stone, Livingston, Weiss, and Hounsell

Stone noted there are 5.7 million more women than men aged 65 or older, and that wage gaps mean women have to save more to make their money last longer. Livingston pointed out that more women are having children later than a generation ago, and that marriage rates are declining and people are getting married later.

Weiss noted women’s wage and caregiving gaps—particularly for women of color—which leads to less retirement security, though she said the wage gap has narrowed from 41 cents 50 years ago to about 21 cents today. Hounsell noted increasing numbers of women who are saving money, although women face financial challenges including living longer and attendant higher health care costs.

Steps to improve financial security could include help with decision-making, such as when to begin collecting Social Security, she said—later is better. Other things that would make a positive difference would be improving caregiver credits (under consideration by Congress) and better paid family leave, or family leave that could draw on people’s Social Security.

Pension Breakout Sessions

Pension breakout sessions at the Annual Meeting and Public Policy Forum covered a range of pension and retirement issues. Following are summaries of the three sessions.

Multiemployer Plans—A Multitude of Challenges for Plan Sponsors, Participants, and Policymakers

ShapiroThe first pension session dealt with terrain that, while perhaps familiar, is as foreboding as the session’s title suggests. The recent historical basis of the multiemployer crisis and possible paths forward were explored from all three vantage points by the experts on stage.

The session was moderated by Josh Shapiro, outgoing Academy vice president, pension. The panel included Mary Petrovic, Pension Benefit Guaranty Corporation detailee with the House Ways and Means Committee; Vince Sandusky, CEO of the Sheet Metal and Air Conditioning Contractors’ National Association; and Chris Heinz, principal at Grossman Heinz, a public affairs firm representing labor unions, corporations, and trade associations.

Shapiro opened the session by providing background on the multiemployer system and the outlook for remediation, highlighting unresolved questions that must yet be addressed. Petrovic expanded on the causes that brought the system to its perilous status quo and provided a detailed look at the House-passed “Butch Lewis Act”—legislation that seeks to address the most urgent shortfalls and mitigate the worst effects threatened by the crisis. Sandusky detailed how employee advocates have managed strategy and expectations over the past two decades, and shared insights gained from those experiences concerning the path forward. Heinz gave a retrospective of the interplay between labor and management with respect to federal advocacy in the multiemployer space over the same time frame, as well as his assessment of provisions necessary to garner support for ongoing legislative efforts.

Public Plan Innovations and Plan Design

Hittner (at podium) and panelistsThis session featured a panel representing the cutting edge in public pension administration, with the chief authorities of two states joined by an experienced investigative researcher specializing in the state retirement sector. Scott Hittner, vice chairperson of the Academy’s Pension Practice Council, served as moderator.

David Draine, senior researcher with Pew Charitable Trusts, charted out the national plan design landscape, indicating commonalities and distinctions across states, while also characterizing the design tendencies of healthy plans. Sandy Matheson, executive director of the Maine Public Employees Retirement System, recounted how she confronted the specific challenges of her state’s system by looking beyond the traditional means of plan reform. Bob Conlin, secretary of the Wisconsin Department of Employee Trust Funds, followed with his own account of how the Wisconsin system’s approach implements risk sharing and other design features to meet the expectations of both public workers and the public at large.

The crowd eagerly started up the Q&A section, with audience members focused on gleaning insight from the two plan directors and the subject-matter expert. Diving into specifics of plan design as well as underlying rationale, they interrogated the two case studies represented on stage and probed the panel for insights about the circumstances facing other less successful state plans.

ERISA Retrospective—Have We Arrived at Our Intended Destination?

Geddes (left) and ERISA session panelistsChairperson of the Pension Accounting Resource Group and incoming Academy Pension Vice President Tim Geddes served as moderator for this final pension session, which culminated in a robust Q&A that continued even after the audience and panel exited the crowded room.

Professor James Wooten of University of Buffalo Law School led off by introducing the legal and economic origins of private pensions, as well as detailing how they developed over the decades in response to the pressures of contemporary legal, regulatory, and social policy and considerations, leading up to the passage of the Employee Retirement Income Security Act of 1974 (ERISA). Russ Mueller, a former staffer with the House Ways and Means Committee who had a hand in drafting ERISA, provided a vivid narrative account of his own experiences with regard to both his technical role and the politics and players that shaped the legislation’s development and passage, with an eye to how those decisions continue to shape the present state of affairs. Kelly Lapin, director of benefits finance at Raytheon Company, provided a practical employer perspective of ERISA, putting emphasis on some of the headwinds faced by those in her position and distinguishing how those relate to the law itself.

The panel presentations elicited passionate response from the audience, and strong convictions were expressed in a wide-ranging and fast-moving dialogue.

PPC Releases Issue Brief on Pension Plan Maturity

The Pension Practice Council (PPC) released an issue brief, Pension Plan Maturity—Why Big Plans Mean Big Risk, that reviews measures of plan maturity, examines the resulting challenges, addresses potential strategies to ensure benefit security, and provides a framework to mitigate the risks associated with a mature plan.

This issue brief notes that:

• Increasing plan maturity has become a significant issue for many pension plans, making it harder to recover from current and future deficits. Once mature, plans often have difficulty reducing their current level of investment risk.

• Measuring and monitoring risk-related indicators is critical, but the crucial role for actuaries is to help plan sponsors anticipate and mitigate risks, with the goal of assuring full payment of the intended pensions.

• However measured, a plan’s level of maturity affects its ability to recover from a negative shock, so different levels of funding and investment risk may be appropriate.

Issue Brief Covers Retirement Approaches

The Lifetime Income Risk Joint Committee released an issue brief, Actuarial Observations on Retiree Income Approaches, on how actuarial methods and solutions apply to the risk management inherent to retirement income planning. Released in conjunction with the relaunch of the Academy’s and Society of Actuaries’ jointly developed Actuaries Longevity Illustrator, the issue brief provides an overview and context for understanding how these tools can be used to mitigate risk and optimize retirement income.

Capitol Hill Briefing Looks at Multiemployer Issues

Iwry, Shapiro, Stone, and NaughtonThe Academy’s Pension Practice Council hosted an Oct. 7 briefing on Capitol Hill on “Multiemployer Pension Reform—Bringing Balance to the Pension Funds.” The briefing included a panel discussion moderated by Academy Senior Pension Fellow Linda K. Stone, with panelists Josh Shapiro, the Academy’s vice president, pension; James Naughton, assistant professor of accounting and management at Northwestern University’s Kellogg School of Management; and J. Mark Iwry of the Brookings Institution.

Committees Comment on Exposure Drafts of ASOP No. 27 and No. 35

The Pension Committee, Multiemployer Plans Committee, and Public Plans Committee submitted comments to the Actuarial Standards Board regarding the exposure drafts of Actuarial Standards of Practice (ASOPs) No. 27 and No. 35. The letter included comments applicable to both ASOPs and individual comments on each ASOP.

Notes Released From PBGC, Treasury/Labor Department Meeting

The Multiemployer Plans Committee released notes from its spring meeting with representatives of the U.S. Department of Treasury, the Pension Benefit Guaranty Corporation (PBGC), and the U.S. Department of Labor pertaining to applications by plans in critical and declining status to suspend benefits or partition liabilities as permitted under the Multiemployer Pension Reform Act of 2014 (MPRA), withdrawal liability, mergers and transfers, and possible multiemployer pension reform legislation.

Lifetime Income Risk Committee Comments to EBSA

The Lifetime Income Risk Joint Committee sent a letter to the U.S. Department of Labor’s Employee Benefits Security Administration providing comments on the ERISA Advisory Council report, Lifetime Income Solutions as a Qualified Default Investment Alternative (QDIA)—Focus on Decumulation and Rollovers.

The committee noted it was generally supportive of the three recommendations being made, while noting several comments to address some issues that might aid in the provision of lifetime income within defined contribution (DC) plans, such as 401(k)s.

Committee Comments on Pri-2012

The Pension Committee submitted comments to the Society of Actuaries Retirement Plans Experience Committee regarding the Pri-2012 exposure draft.

The committee cited “a number of substantial concerns regarding the data that was used to produce the proposed Pri-2012 tables and the methodology that was used to gather it,” and asked for certain clarifications and/or additional information and disclosures.