Compliance February 12, 2020

Outdated Mortality Assumptions Case Survives Motion to Dismiss

A U.S. District Judge's decision suggests pension plan sponsors should periodically review the reasonableness of actuarial assumptions used to calculate benefits.

Reported by

A new decision issued by the U.S. District Court for the Eastern District of Wisconsin denies dismissal of a would-be class action complaint, rejecting Rockwell Automation’s allegation that a retired pension plan participant failed to adequately state a claim.

The plaintiff in the lawsuit alleged Rockwell has harmed participants, in violation of the Employee Retirement Income Security Act (ERISA), by incorporating outdated actuarial assumptions that resulted in certain alternative pension payments being less than the actuarial equivalent of the normal default pension benefit.

Get more!  Sign up for PLANSPONSOR newsletters.

As is essentially standard procedure in such cases, Rockwell moved to have the complaint dismissed for failing to state a claim, but the District Court has now sided with participants and has agreed to at least allow the case to move forward to the discovery phase.

Background in case documents shows the Rockwell pension plan allows participants to choose from a variety of annuity types once they claim their pension benefit. One such optional annuity is a “certain and life” annuity, under which payments are made for the life of the participant or for at least a specified number of years. If the participant dies before receiving payments for the specified period, the remaining payments are made to the participant’s beneficiary.

According to case documents, when the lead plaintiff in this case, referred to as “Smith,” retired some years ago, he elected to receive his pension in the form of a 10-year certain-and-life annuity, with his son as the beneficiary.

Case documents show the Rockwell plan’s governing documents specify that, to calculate actuarial equivalence for the annuity that Smith elected to receive, the plan must use a specific mortality table, known as the 1971 Group Annuity Mortality (GAM) Table for Males. The governing documents further detail that the applicable discount interest rate is 7%.

According to the complaint, the 1971 GAM is nearly 50 years old and reflects life expectancies of retirees in 1970. In 1970, a 65-year-old had a life expectancy of 15.2 years, the plaintiffs suggest. However, in 2010, a 65-year-old had a life expectancy of 19.1 years, a 26% increase.

“Thus, in 2010, the average retiree receiving a single life annuity would have expected to receive more payments than a retiree in 1970,” the complaint states. “By using the 1971 GAM to calculate actuarial equivalence, the plan’s optional annuities assume that the annuitant will die sooner than average and thus receive fewer payments than is likely. This, in turn, causes the value of the optional annuity to be less than the actuarial equivalent of a single life annuity, in violation of ERISA.”

In its motion to dismiss, Rockwell contended that a plan pays actuarially equivalent benefits so long as it calculates actuarial equivalence using actuarial assumptions that were reasonable at the time they were written into the plan. “The conclusion that the defendants would like me to draw from these provisions is that Congress could not have intended to require that plans periodically review their actuarial assumptions to ensure that they are reasonable at the time benefit calculations are made,” U.S. District Judge Lynn Adelman wrote in his opinion. He decided that nothing in the provisions of law the company pointed to suggests that the term “actuarial equivalent” means “actuarial equivalent as of the date the plan adopted its actuarial assumptions.”

For example, Adelman pointed out that Section 401(a)(25) does not prohibit employers from amending a plan’s actuarial assumptions to bring them up to date. It places no constraint whatsoever on an employer’s discretion to amend the plan for any reason. “And it is easy to draft an amendment that incorporates updated actuarial assumptions but does not also grant the employer discretion to manipulate those assumptions,” he wrote.

Adelman suggested that “the plan could adopt a variable standard that is self-updating, such as one of the variable standards identified in Revenue Ruling 79-90.”

Adelman also noted that plans can minimize conflict between the actuarial-equivalence requirement and ERISA’s anti-cutback rule by adopting variable actuarial assumptions that self-adjust to reflect changes in mortality and interest rates. Under Revenue Ruling 81-12, “in the case of a variable standard, any variation in accordance with the plan standard is not subject to” the anti-cutback rule. He agreed with the defendants’ contention that nothing in ERISA requires plans to use a variable standard. However, he said the point is that a plan that is concerned about having to “continually increase benefits” has the option of adopting a variable standard. Once the variable standard is adopted, the plan will not have to continually increase benefits to comply with the anti-cutback rule—only those employees who accrued benefits under the old, fixed standard would potentially be entitled to increased benefits.

The defendants also contended that, to accept the plaintiff’s interpretation of “actuarial equivalent,” the court “would have to legislate a detailed set of rules … specifying when a plan must change the actuarial assumptions it used to determine its contractually promised annuity benefits, how a plan should decide which mortality tables and interest rates to use and for which plan participants.” But Adelman disagreed, saying ERISA already contains the relevant rule: Plans must ensure that any optional annuity forms are actuarially equivalent to a single life annuity.

“This means that plans must use the kind of actuarial assumptions that a reasonable actuary would use at the time of the benefit determination. A court does not have to specify further details to enable plans to comply with the rule. They may comply by periodically consulting with professional actuaries who will review the plan’s actuarial assumptions for reasonableness and recommend whether changes to mortality tables or interest rates are needed,” Adelman wrote.

In rejecting the motion to dismiss, he found that the Rockwell plan’s actuarial assumptions do not provide actuarial equivalence and that the complaint adequately alleges that the plan did not provide Smith with an actuarially equivalent annuity.

The full text of the ruling is available here.
Administration February 12, 2020

Low Interest Rates, Coronavirus Deal Blow to DB Plan Funded Status

Plans with the greatest exposure to equities will generally see the largest funded status declines, according to River and Mercantile.

Reported by

Legal & General Investment Management America (LGIMA) estimates that pension funding ratios decreased throughout January, with changes attributed to decreasing Treasury yields.

LGIMA’s calculations indicate the discount rate’s Treasury component fell by 38 basis points while the credit component widened 10 basis points, resulting in a net decrease of 28 basis points. Overall, liabilities for the average plan increased 4.56%, while plan assets with a traditional “60/40” asset allocation increased by approximately 0.12%.

For more stories like this, sign up for the PLANSPONSOR NEWSDash daily newsletter.

River and Mercantile says in its monthly Retirement Update that discount rates for the typical pension plan fell 30 basis points in January. The FTSE Pension Discount Rate Index ended the month at all-time lows (2.8% for an average duration plan).

However, in addition, equity markets started the month strong but took a dive in the final week of January as investors worried about the potential economic impacts of the coronavirus outbreak, River and Mercantile notes. High quality fixed income investments posted the highest returns for the month.

The company says funded status movements will depend on equity allocations, and plans with the greatest exposure to equities will generally see the largest funded status declines. Allocations which are largely liability matched should see a relatively stable funded status for the month.

“January was shaped by the effects of the coronavirus, which caused markets to fall, and a flight to safety, which pushed interest rates towards historic lows the latter half of the month. Currently, equity markets are starting to shrug off the coronavirus, but fixed income markets are still showing signs of caution. Both sides won’t be right, so we expect to see some volatility as the effects of the virus continue to play out,” says Michael Clark, managing director at River and Mercantile.

“Pensions got clobbered in January, as stock markets mostly lost ground while interest rates reached new all-time lows,” says Brian Donohue, partner at October Three Consulting. Both model plans it tracks saw funded status declines last month, with Plan A dropping 4% while the more conservative Plan B lost 1%. Plan A is a traditional plan (duration 12 at 5.5%) with a 60/40 asset allocation, while Plan B is a largely retired plan (duration 9 at 5.5%) with a 20/80 allocation with a greater emphasis on corporate and long-duration bonds.

According to Wilshire Consulting, the aggregate funded ratio for U.S. corporate pension plans decreased by 2.3 percentage points in January to end the month at 86.3%. “January’s decrease in funded ratio ended four consecutive months of funded ratio increases and began 2020 with the largest monthly decline in funding levels since August’s four percentage-point decline,” says Ned McGuire, managing director and a member of the Investment Management & Research Group at the firm.

He explains: “January’s decrease in funded ratio was driven by the increase in liability value resulting from a nearly 40 basis point decrease in Treasury yields partially offset by a low double digit basis point increase in credit spreads.”

The aggregate funded ratio for pension plans in the S&P 500 has decreased from 86.6% to 85.5%, according to the Aon Pension Risk Tracker. Aon says pension asset returns were positive throughout January, ending the month with a 1.6% return. The month-end 10-year Treasury rate decreased by 41 basis points relative to the December month-end rate and credit spreads widened by 19 basis points. This combination resulted in a decrease in the interest rates used to value pension liabilities from 2.86% to 2.64%.

“Given a majority of the plans in the U.S. are still exposed to interest rate risk, the increase in pension liability caused by decreasing interest rates offset the positive effect of asset returns on the funded status of the plans,” Aon says.

The estimated aggregate funding level of pension plans sponsored by S&P 1500 companies decreased by 4% in January to 84% as a result of a decrease in discount rates and equity markets, according to Mercer. As of January 31, the estimated aggregate deficit of $402 billion increased by $101 billion, compared with $301 billion measured at the end of December.

“January saw a decline in pension funded status, mainly due to underperforming equity markets, lower interest rates and high-quality corporate bond yields dropping to an all-time low,” says Scott Jarboe, a partner in Mercer’s wealth business. “If low rates persist, risk transfer activities such as lump sum windows may be attractive during 2020. As we continue into the new year, plan sponsors should review their pension risk toolkit and explore all of their options.”

«