PPA Funding I Measuring Assets and Liabilities

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PPA Funding IMeasuring Assets and Liabilities

• 2007 Enrolled Actuaries Meeting
• Sessions 101 202
• March 26, 2007
• Presenters - Bruce Gaffney and Amy Viener

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Todays session building blocks

• Measuring liabilities
• Assumptions
• Options
• Unanswered questions
• Measuring assets
• Measuring funded status

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PPA lingo

• Out with the old
• Actuarial Assets
• Actuarial Accrued Liability
• Current Liability
• CL Normal Cost
• Unfunded CL
• Funded Current Liability Percentage
• Credit Balance

• And in with the new
• Plan Assets
• -----
• Funding Target
• Target Normal Cost
• Funding Shortfall
• Funding Target Attainment Percentage (FTAP)
• Carryover and prefunding balance

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Calculating the Funding Target

• Liability Method present value of accrued
  benefits
• Valuation date beginning of year
• Plans with 100 or fewer participants may select
  another date
• Assumptions
• Discount rate prescribed with a few variations
• Mortality prescribed with an option to use
  substitute table
• Other assumptions
• Actuarys best estimate
• Some actuarial discretion taken away if plan is
  at-risk

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Accrued benefit

• Reflect benefits accrued as of the beginning of
  the plan year
• If valuation date is some other date (small plan
  option), still look only at benefits accrued as
  of the beginning of the plan year

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Discount rate

• Rate based on 24-month average of high quality
  corporate bond yields
• Similar to PFEA rate, except PFEA used 4-3-2-1
  weighted average
• Rates vary during deferral period based on when
  benefits expected to be paid
• First segment within the next 5 years
• Second segment within the 15-year period
  starting when Segment 1 ends
• Third segment at any time after Segment 2 ends

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How segments work

• Assume segments are 4, 5, and 6
• Assume retirement at age 65
• If employee is age 40 on valuation date
• All payments will be made more than 20 years in
  the future
• That means all future benefits are discounted at
  6 (from assumed payment date back to age 40)
• If employee is age 65 on valuation date
• Payments to be made from 65 to 70, discounted
  back to age 65 at 4
• Payments to be made from 70 to 85, discounted
  back to age 65 at 5
• Payments to be made after age 85, discounted back
  to age 65 at 6

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Example

• Valuation as of January 1, 2010
• Participant age as of January 1, 2010 55
• January 1, 2010 accrued benefit 1,000/yr
• Segment rates 4, 5, 6
• Valuation assumptions
• Retirement at age 65
• Pre-retirement decrements only mortality (i.e.,
  no early retirement, turnover, etc.)
• Payment of entire annual benefit at beginning of
  each year

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Example (continued) Amount of liability
attributable to age 65

• Benefit payable 1,000
• Probability of survival to age 65 93.38
• Assumed payment date January 1, 2020 (10
  years from valuation date)
• Applicable segment rate 2nd segment
• PV is 1,000 x .9338 1.0510 573

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Example (continued) Amount of liability
attributable to age 66

• Benefit payable 1,000
• Probability of survival to age 66 92.19
• Assumed payment date January 1, 2021 (11
  years from valuation date)
• Applicable segment rate 2nd segment
• PV is 1,000 x .9219 1.0511 539

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Example (continued) Amount of liability
attributable to age 75

• Benefit payable 1,000
• Probability of survival to age 75 74.80
• Assumed payment date January 1, 2030 (20
  years from valuation date)
• Applicable segment rate 3rd segment
• PV is 1,000 x .7480 1.0620 233

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More examples

• See handout 2

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Transition to new discount rate

• Instead of using actual segment rates
• For 2008, use 2/3 PFEA rate, 1/3 segment rate
• For 2009, use 1/3 PFEA rate, 2/3 segment rate
• For 2010 and later use actual segment rates

• Sponsor may elect to disregard transition rule
• Treasury consent required to revoke such an
  election

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Which months segments?

• Treasury/IRS to publish 3-segment rates each
  month
• For each month through 2009, Treasury/IRS will
  also publish PFEA rate
• Will Treasury publish applicable blend of PFEA
  rate and segment rates ?
• Sponsor selects applicable month - valuation
  month or up to four months earlier
• Example - January 1, 2008 valuation date choose
  Jan 2008, Dec 2007, Nov 2007, Oct
  2007, or Sept 2007
• Once applicable month elected, cannot be
  changed without Treasury consent
• Need guidance on election procedures

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Option to use full yield curve

• Rate varies based on year payment is expected to
  be made
• No smoothing (based on current yields, not
  24-month average)
• No phase-in (i.e., transition rule)
• Electing option
• If option elected, cannot be changed without
  Treasury consent
• Appears that election can be made after 2008 w/o
  approval (its just switching back to segments
  that requires approval)
• Need guidance on how to elect

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Option to use full yield curve - cont

• Treasury/IRS will publish yield curve each month
• Same rules apply for selecting an applicable
  month
• Warning PPA says yield curve option is solely
  for purposes of determining the minimum required
  contribution
• Does that mean you also have to calculate the
  3-segment funding target and use it for
  maximum deductible limits, benefit restrictions,
  etc.?
• Which funding target do you report to
  participants in the annual funding notice?
• Is it worth it?

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More examples

• See handout 2

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One more discount rate

• Value of vested benefits for PBGC variable rate
  premiums
• Three-segments used for funding, but without
  24-month average
• No transition
• No choice re applicable month
• Use rate for month before plan year begins
• Example for calendar year plan - December 2008
  rate used for 2009 VRP
• Treasury/IRS will publish these three segments on
  a monthly basis

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Mortality - prescribed mortality table(s)

• Expectation is that table will be similar to 2007
  current liability table
• Option to use full generational mortality
• Self updating tables can be used to approximate
  generational table (i.e., project table a bit
  further each year)
• Different tables based on whether benefits have
  commenced
• 2007 option to use one table for all will likely
  be limited to smaller plans (lt500?)

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Mortality - prescribed mortality table(s)

• Expectation for prescribed tables

• For active employees and TVs, table changes
  during
• projection period
• Employers can choose to use different tables
  for
• disabled retirees
• Treasury to review table at least every 10
  years
• (and update as needed)

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Mortality option to use substitute table

• Large plan sponsors may seek approval to use
  plan-specific mortality
• Criteria for using substitute table
• Must be based on sufficient, credible experience
• Must reflect actual plan experience and projected
  trends in general mortality
• All plans of the sponsor must qualify for and use
  a substitute table
• Request due 7 months before valuation date
  (May 31, 2007 for January 1, 2008 valuation)
• Expect guidance soon

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Other assumptions - selected by actuary

• Other assumptions include
• Salary increases (for Target Normal Cost)
• Retirement
• Termination
• Form of payment
• Assumptions must
• Be individually reasonable, considering plan
  experience and expectations
• Offer, in combination, actuarys best estimate of
  expected experience
• Reflect inherent subsidies
• Changes that significantly decrease shortfall may
  require Secretarys approval

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Effective interest rate

• Once you calculate the funding target, back into
  the single rate that would have resulted in the
  same answer.
• That single rate is the effective interest rate
• Used to adjust contributions to valuation
• Important for minimum funding requirements
• See handout 2

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Valuing lump sums - example

• Plan provisions
• Accrued benefit is reduced 3 per year before 65
• Lump sum conversion 4, unisex GAM94
• Assumed retirement age 55
• Assumed payment form lump sum
• Sample employee Joe
• Age 48
• Accrued benefit (payable annually at 65) is 1,000

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Example continued

• Calculating lump sum payable at age 55 (use plan
  provisions)
• Accrued benefit reduced for early retirement is
  1,000 x .70 700
• Expected LS at 55 is 700 x N55/D55 11,389
• Discounting future LS amount from age 55 to age
  48 (use funding assumptions)
• Discount rate Joes only payment is expected to
  be made 7 years after the valuation date, so use
  second segment rate for entire discount period
• Mortality non-annuitant mortality table

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Example continued

• What if Joe was over 50?
• Lump sum to be paid w/in 5 years of valuation
  date, so use Segment 1 rate for the entire
  discount period
• If Joe was 55 , no need to discount, LSPV
• What if plan pays only 417(e) minimum lump sums
  ??????

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Valuing 417(e) lump sums

• 417(e) assumptions
• Still 3 segment approach, but with spot rates
  instead of smoothed over 24 months
• Mortality similar to prescribed funding table,
  but unisex (also to be prescribed by Treasury)
• Yield curve concept - if same basis is used for
  converting annuity into LS as is used for
  discounting, then PV is the same whether you
  value annuity or lump sum

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Valuing 417(e) lump sums - example

• But, theyre not the same
• Mortality basis differs, especially if substitute
  table used for funding
• Discount rate basis
• Spot vs. smoothed
• Transition short term difference
• No yield curve option for LS conversions
• Additional complication for deferred lump sums
• Actual lump sum will be based on the three
  segments in effect at payment date
• Guidance needed

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Additional rules if plan is at-risk

• Assumptions
• Retirement - earliest possible date (only for
  employees eligible to retire within 11 years)
• Form of payment - highest PV (only for employees
  retiring within 11 years)
• Expense load (doesnt always apply) - 4 of
  funding target plus 700 per participant
• Transition rule
• For details, go to PPA-III on Tuesday at 200 and
  400

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Target normal cost

• Present value of benefits expected to accrue
  during year
• Assumptions - same as used to determine funding
  target
• Benefits expected to accrue during year include
  increase in past service benefits for FAP plan
• Expense load PPA says nothing

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Target normal cost example

• Example
• 1 FAP Plan
• Employee with 10 years of service and FAP of
  25,000 at BOY
• 3 salary increase assumption
• Funding target based on BOY accrued benefit
• .01 x 25,000 x 10 years 2,500
• Target normal cost Based on expected accrual
  during year
• Expected EOY benefit is .01 x 25,750 x 11 years
  2,832.50
• Expected accrual is 2,832.50 minus 2,500
  332.50

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Plan assets

• Based on market value as of valuation date
• Averaging permitted no more than 24 months
• 10 corridor around market value
• Treasury to issue guidance on acceptable methods
• What does averaging mean?
• What options will be available?

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Plan assets - continued

• Contributions made after year-end for prior year
• Still counted as receivable and included in
  next years asset value
• Starting in 2009, discounted back to valuation
  date using prior years effective interest rate
• Example
• January 1, 2009 market value is 100,000
• 100 contributed on Sept 15, 2009 for 2008 plan
  year
• 2008 effective rate is 5
• 100/1.05(8.5/12) 97
• For valuation purposes, January 1, 2009 market
  value is 100,097
• Special rule for small plans with valuation dates
  after beginning of plan year

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Funding method

• Term is not defined, but still applies (in
  theory)
• Method includes
• Asset method
• Discount rate method yield curve vs. segment
  rates and applicable month
• How to estimate benefits accruing during the year
• Valuation date (for small plans)

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Credit balances

• Still permitted, but in some cases, cant be used
  to reduce funding requirement
• Future interest based on market rates
• Credit balance divided into two parts
• Carryover balance (COB) what's left at end of
  2007 (plus interest)
• Prefunding balance (PFB) newly created (plus
  interest)
• Sponsors can choose to eliminate credit balance
• PPA includes incentives to do so
• To be discussed in PPA-II (minimum) and PPA VII
  (strategies)

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Funding shortfall

• Excess, if any, of
• Funding target, over
• Actuarial assets reduced by entire credit balance
  (COB and PFB)
• Many cases where PPA refers to some other measure
• Plan could be 100 on some measure and still have
  a funding shortfall
• Plan might have a funding shortfall and yet not
  have to amortize it

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Funding target attainment percentage

• Ratio
• Numerator - Plan assets reduced by entire credit
  balance (PFB and COB)
• Denominator Funding target (without regard to
  at-risk assumptions, even if plan is at-risk)
• Commonly called FTAP
• Comparison to funding shortfall measures
• Plans that are not at-risk asset and liability
  measure are the same as whats used to determine
  for funding shortfall
• At-risk plans asset measure is the same, but
  liability measure differs

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FTAP continued

• FTAP is a defined term, but surprisingly, it
  rarely comes into play.
• Annual notice to participants,
• To determine if 4010 filing is required, and
• One prong of test to determine if plan is
  at-risk (to be discussed in PPA III (Tuesday at
  200 and 400)
• FTAP will be reported on Schedule SB
• Other funding percentage measurements used for
  different purposes

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Funding percentages other than FTAP

• Assets - reduce assets only by the PFB or not at
  all
• Funding target - Use applicable target (i.e.,
  at-risk plans use at-risk target)
• Measurement date prior year
• Other - add past two years annuity purchases for
  NHCEs to numerator and denominator
• Most variations dont get official names, but
  they come into play in various places
• Benefit restrictions
• Whether quarterly contributions are required
• Whether credit balance can be used to offset the
  funding requirement
• Whether amortization bases need to be set up
• PBGC premiums
• To be discussed in other sessions
• PPA-II Monday at 230, Tuesday at 1100 and
  Tuesday at 200
• PPA-III Tuesday at 200 and 400

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All references to applicable target on this
chart refer to the target that is used to
determine required contributions. For a plan
that is at-risk, it reflects the applicable
at-risk assumptions and the phase-in if it has
been at-risk for fewer than five consecutive
years. All references to assets on this chart
refer to actuarial assets, unless otherwise
indicated
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All references to applicable target on this
chart refer to the target that is used to
determine required contributions. For a plan
that is at-risk, this reflects the applicable
at-risk assumptions and the phase-in if it has
been at-risk for fewer than five consecutive
years. All references to assets on this chart
refer to actuarial assets, unless otherwise
indicated