Understanding the Actuaries

Pension Funding Overview for Attorneys & HR Professionals

October 16, 2014

Agenda

Role of the Enrolled Actuary 3

ASOPs 8

Funding Requirements 19

Government Forms and Filings 40

Recent Legislation/Hot Topics 47

Role of the Enrolled Actuary

There are several different actuarial societies and organizations from which a U.S. actuary may hold a credential:

• Society of Actuaries (SOA)

• Casualty Actuarial Society (CAS)

• Joint Board for the Enrollment of Actuaries (JBEA)

• American Academy of Actuaries (AAA)

• Conference of Consulting Actuaries (CCA)

• American Society of Pension Professionals and Actuaries (ASPPA)

U.S. pension actuaries typically hold one of more of the following designations:

• FSA – Fellow of the Society of Actuaries

• ASA – Associate of the Society of Actuaries

• MAAA – Member of the American Academy of Actuaries

• EA – Enrolled Actuary

• FCA – Fellow of the Conference of Consulting Actuaries

• FSPA - Fellow, Society of Pension Actuaries

• MSPA - Member, Society of Pension Actuaries

Actuarial Credentials Cheat Sheet

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• What is an enrolled actuary?

• Any individual who has satisfied the qualifications of the Joint Board for the Enrollment of Actuaries (JBEA) and has been approved by the Joint Board to perform actuarial services under the Employee Retirement Income Security Act (ERISA) of 1974

– Actuarial services is defined by the JBEA as “performance of actuarial valuations and preparation of any actuarial valuation reports”

• How can I find out whether a practitioner is an enrolled actuary in good standing with the Joint Board?

• Review the roster of enrolled actuaries in active status at:

www.irs.gov/PUP/taxpros/Active%20EA%20Roster.pdf

Role of the Enrolled Actuary

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U.S. Qualified Defined Benefit Plans must meet certain criteria to maintain their qualified status

An EA is needed to meet some of these criteria, for example -

• Internal Revenue Code (IRC) section 412 – Minimum Funding Standards

– An enrolled actuary must certify the minimum required contribution for a plan for a plan year

• Internal Revenue Code (IRC) sections 432/436 – Actuarial Zone Certification for Multiemployer Plans and Funding-Based Limits on Benefits and Benefit Accruals Under Single-Employer Plans

– An enrolled actuary must certify to the funded status of a plan for a plan year which will govern how the plan is operated for such plan year

• An EA must sign Schedule SB/MB of Form 5500 setting out the plan's funded status

Role of the Enrolled Actuary

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• Some other relevant IRC sections

• 404 Deductible employer contributions to a deferred-payment plan

• 412 Minimum funding standards

• 413 Collectively bargained plans, etc.

• 418 Multiemployer plan reorganization rules

• 430 Minimum funding requirements for single-employer defined benefit pension plans

• 431 Minimum funding requirements for multiemployer defined benefit plans

• 432 Additional funding rules for multiemployer plans in endangered status or critical status

• 436 Funding-based limits on benefits and benefit accruals under single-employer plans

Role of the Enrolled Actuary

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ASOPs

• Enrolled Actuaries must ensure they follow ASOPs pertaining to pension plans as issued by the Actuarial Standards Board (ASB)

• To name a few….

• ASOP 4 – Measuring Pension Obligations and Determining Pension Plan Costs or Contributions

• ASOP 27 – Selection of Economic Assumptions for Measuring Pension Obligations

• ASOP 35 – Selection of Demographic Assumptions and other Noneconomic Assumptions for Measuring Pension Obligations

Actuarial Standards of Practice (ASOPs)

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The actuary may be required to make judgments or recommendations on the choice of actuarial assumptions, actuarial cost methods, assetvaluation methods, and amortization methods

• The actuary may have the responsibility and authority to select some or all assumptions

or • The actuary may be asked to advise the individuals who have that

responsibility and authorityor

• The actuary may perform actuarial calculations using assumptions or methods prescribed by applicable law or selected by others

ASOP No. 4 addresses actuarial cost methods and provides guidance for coordinating and integrating all of these elements of an actuarial valuation of a plan.

ASOP 4 – Measuring Pension Obligations

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Actuarial Assumptions

Actuary’s best estimate of occurrence of future

events and those prescribed

Reflects sponsor’s knowledge of special

situations

Reflects past experience

Used to determine funding and accounting

requirements

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• Pension obligation values incorporate assumptions about pension payment commencement, duration, and amount

• They also require discount rates to convert future expected payments into present values

Economic assumptions are covered under ASOP No. 27

Noneconomic assumptions are covered under ASOP No. 35

Actuarial Assumptions

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ASOP 27 - Economic Assumptions

• The actuary should consider the following factors when identifying the types of economic assumptions to use for a specific measurement:

– the purpose of the measurement

– the characteristics of the obligation to be measured

– materiality of the assumption to the measurement

• Each economic assumption should be consistent with every other economic assumption for the measurement period

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ASOP 27 - Economic Assumptions

Some examples of economic assumptions that affect the measurement of pension obligations are the following:

Discount rate – rate used to calculate the present value of expected future plan payments, this may be a single rate or a series of rates

Inflation rate – general economic inflation, defined as price changes over the whole of the economy

Investment return – anticipated returns on the plan’s current and, if appropriate for the measurement, future assets

Compensation increase – assumed year-to-year change in compensation, generally,

a participant’s compensation will increase over the long term in accordance with inflation, productivity growth and merit increases

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ASOP 35 - Demographic Assumptions

• The actuary should use professional judgment to estimate possible future outcomes based on past experience and future expectations

• Reasonable demographic assumptions based on the particular characteristics of the defined benefit plan should be selected

• A reasonable assumption is one that is expected to appropriately model the contingency being measured and is not anticipated to produce significant cumulative actuarial gains or losses over the measurement period

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ASOP 35 - Demographic Assumptions

Some examples of demographic assumptions that affect the measurement of pension obligations are the following:

Retirement rates – probability that a participant will retire at any given age once eligible to do so under the plan provisions

Termination rates – probability that a participant will terminate employment at any given age prior to becoming eligible to retire under the plan provisions

Mortality rates – probability that a participant will die at any given age

Optional Form of Benefit Election rates – probability that a participant will elect a

specific form of payment upon commencement of benefit from the plan

Input from the plan sponsor is critical in helping to set these assumptionse.g., the introduction of an early retirement subsidy could influence the plan’s incidence of retirement

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• Comparison of actual plan experience with actuarial assumptions

• Generally performed every 3 to 5 years

• Watch for trends (e.g. improving mortality, changes in retirement patterns)

• Adjust for special events which occurred during investigation period (e.g. early retirement windows/reduction in force)

• Modify assumptions as needed

Auditors have been asking more frequently for the basis of demographic assumptions and specifically whether and when an experience study

has been done

Purpose of Experience Studies

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Effect on Liabilities and Contributions Due to Changes in Major Assumptions

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Assumption Action Usual Liability Effect

Discount Rate

Inflation Rate

Retirement Rate Retire younger

Turnover Rate More terminations

Funding Requirements

Governed by laws in the Internal Revenue Code (IRC) which determine the annual minimum required contribution and maximum tax-deductible contribution

• Pre-funding required under IRC to secure benefits and maintain a US tax-qualified plan status (IRC 430 and IRC 431)

• Maximum tax-deductible limit to prevent the “pension piggy bank” (IRC 404)

Actuarial method and certain assumptions prescribed by IRC

Introduction to Pension Funding

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The Pension Protection Act of 2006 (PPA) was signed into law on August 17, 2006

• Most comprehensive reform of pension laws since the enactment of ERISA

• Designed to increase the minimum funding requirements and strengthen the pension insurance system (PBGC)

• Effective for plan years beginning in 2008

• Changed the landscape of funding rules

Introduction to Pension Funding

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Actuarial Accrued Liability (AAL): present value of a plan’s accrued benefits based on the plan’s funding method

Funding Target (FT): mandated AAL for single employer plans

Normal Cost (NC): present value of benefits expected to accrue during the plan year based on the plan’s funding method.

Target Normal Cost (TNC): NC for single employer plans using mandated funding method.

– Includes effect of expected increases in compensation and estimated expenses during the coming year

Actuarial Value of Assets (AVA):

• Market Value of Assets (MVA) unless averaging elected

• Single Employer: Averaging up to 24 months; must fall within a corridor of 90% to 110% of MVA

• Multiemployer: Averaging up to 5 years; must fall within a corridor of 80% to 120% of MVA

Funding Shortfall: excess, if any, of the funding target over the value of plan assets as of the valuation date

Key Definitions/Terms

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Yield Curve: Each month the IRS publishes its yield curve, segment rates, and 24-month average segment rates based on yields of high quality corporate bonds rated A or better

– Segment rates are the average of spot rates for the first 5 years, next 15 years, and after 20 years

– Can elect to use full yield curve (without 24 month average)

Effective interest rate: single interest rate that produces the same funding target as that produced in the valuation using segment rates or full yield curve

Key Definitions/Terms (continued)

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Funding Comparison

Assumption& Methods

Single Employer Multiemployer

Interest Mandated: Segment Rate or Yield Curve

Actuary’s Assumption: Long term expected return on plan assets

Mortality Mandated: Generational/Static(can use plan specific)

Actuary’s Assumption

Funding Method Mandated Varies

Asset Method Up to 24 month averaging with 90%-110% corridor

Up to 5 year smoothing with 80% -120% corridor

Lump Sum Interest Same as funding Actuary’s Assumption

Amortization Period 7 years 10 or 15 years depending on type of base (can have extensions)

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Key Elements of Funding Rules

Single Employer Multiemployer

Minimum contribution Minimum contribution

Maximum contribution Maximum contribution

“At-Risk” Status Reorganization Status

AFTAP Certification Actuarial Certification

Benefit Limitations Zone Statuses

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• Minimum contribution is the sum of:

– Target normal cost : funding future liabilities year by year

– Shortfall amortization charge (seven-year amortization): funding past liabilities

• If asset value exceeds funding target, the target normal cost will be reduced by this excess

Single Employer FundingMinimum Required Contributions (MRC)

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• Quarterly Installments

– Required if plan is less than 100% funded

– Each required quarterly installment equals 25% of the lesser of A and B:

A = 90% of the MRC for the current plan year

B = 100% of the MRC for the prior plan year

– Installments for a calendar plan year are due by April 15th, July 15th, and October 15th of the current year and January 15th of the following year

• Final Installment

– Due no later than September 15th following the end of the plan year

– Remainder of MRC not paid via quarterly installments

Single Employer FundingMinimum Required Contributions (MRC) – Timing

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• Amount to bring assets up to funding target, plus “cushion”

– 50% of funding target

– Expected increase in funding target for:

• Salary increases in pay related plan

• Benefit increases in non-pay related plan

• Increases in maximum benefit and compensation limits

Single Employer FundingMaximum Tax-Deductible Contributions

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• Plan is deemed “at-risk” if the funded status for the preceding year falls below certain thresholds

• Must use the “at-risk” assumptions for valuation

– Assume employees eligible to retire in next 10 years will retire at earliest possible date and elect most valuable option

• Results in higher minimum required contribution

– Goal is to get the plan’s funded status up more quickly

• At-risk status of plan must be disclosed in Annual Funding Notice

• Funding of deferred compensation plans during periods when the pension plan is considered “at-risk” results in adverse tax consequences to deferred compensation plan participants

Single Employer FundingAt-Risk Plans

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• Adjusted Funding Target Attainment Percentage (AFTAP) is generally the ratio of plan assets to the funding target

• IRC Section 436 places restrictions on certain benefits when a plan’s AFTAP falls below certain thresholds

• Each year the plan’s enrolled actuary must sign an AFTAP certification which determines whether any benefit restrictions apply to the plan year

Single Employer FundingAFTAP Certification

Condition Benefits Restricted

AFTAP ≥ 80% Amendments that improve benefits cannot take effect unless plan sponsor makes a contribution to bring the AFTAP back up to 80% after the amendment

80% > AFTAP ≥ 60% Accelerated benefit distributions (i.e. lump sum payments) are partially restricted

AFTAP < 60% Accelerated benefit distributions (i.e. lump sum payments) are fully restrictedBenefit accruals are frozenShutdown benefits cannot be paid

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Minimum Required Contribution = Charges - Credits

• Charges: Credits:

Funding Deficiency Credit Balance

+ Normal Cost + Amortization Credits

+ Amortization Charges + Full Funding Credits

+ Interest to end of year + Interest to end of year

• For plans in critical status (not endangered), excise taxes waived in event of funding deficiency

• Shortfall Funding Method - Multiemployer plans generally cannot assess employers for additional contributions to meet minimum funding requirement. Adoption of shortfall method is a funding method change.

Multiemployer FundingMinimum Required Contributions

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Maximum Tax Deductible Contribution =

1) Normal Cost + 10 year Amortization of Unfunded AAL.

2) Full Funding Limit = Greater of RPA and ERISA Full Funding Limits

3) Lesser of 1 and 2

4) 140% RPA Unfunded Current Liability, not less than MRC

5) Greater of 3 and 4

Multiemployer Funding Maximum Tax Deductible Contributions

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Reorganization Status

• Definition of reorganization: Vested Benefit Charge > Net Charge to FSA

– Vested Benefit Charge = 10 year amortization of unfunded pays status benefits + 25 year amortization of non-pay status benefits

• apply assets to pay status benefits first

• Consequences of Reorganization

– Minimum Contribution Requirements

– Potential reductions in vested benefits

– Post-PPA ’06: projected insolvency determination every 5 years

Multiemployer Funding Reorganization Status

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Under IRC 432, fund actuary is required to certify annually to a multiemployer plan’s zone status by the 90th day of plan year.

Multiemployer Actuarial Certification

• Not Critical or Endangered • No Waivers for MRCGreen Zone

• Endangered/Seriously Endangered • Funding Improvement PlanYellow Zone

• Critical/Seriously Critical• Rehabilitation PlanRed Zone

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Actuarial Certification is based on projections using:

• Liabilities from most recent valuations completed (prior valuation results) reflecting any significant changes that have occurred during the year

• Current asset information

• Projected Industry Activity from Trustees

• Contribution rates and benefit accruals under current Collective Bargaining Agreements (CBAs)/Rehabilitation Plan/Funding Improvement Plan

Funding percentages based on Unit Credit

Multiemployer Funding Actuarial Certification

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Red Zone (Critical Status):

I. Funded % less than 65% AND

(MVA + contributions over next 7 years) <(benefits and administrative expenses over next 7 years)

OR

II. Projected to have funding deficiency within 4 years (5 years if Funded % <= 65%)

OR

III. (Normal Cost + interest on unfunded liability) > contributions AND

PV inactive benefits > PV active benefits AND

Projected to have funding deficiency within 5 yearsOR

IV. (MVA + PV 5 years of contributions) <(PV 5 years of benefits + administrative expenses)

Multiemployer Funding Actuarial Certification

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Yellow Zone (Endangered Status):

Not in Critical Status and

I. Funded % < 80%OR

II. Expected to have funding deficiency within 7 plan years

Seriously Endangered Status:

Meets both conditions I. and II. for Endangered Status

Multiemployer Funding Actuarial Certification

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Red Zone (Critical Status):

• Automatic removal of non-increasing annuity forms (lump sums) with exception of corrective retroactive payment

• Adjustable Benefits – Trustees can remove benefits otherwise protected under 411(d) but cannot :

– Change normal retirement age / Reduce normal retirement benefit

– For retirees in pay status, benefits payable based on amendments in effect for less than 5 years may be adjusted, but only after retirees have received required notification of Actuarial Certification of initial year of Critical Status

– Limitation on reduction to future accruals under default schedule –accrual rate cannot be less than smaller of:

– Monthly normal retirement benefit equal to 1% of contributions or

– Pre-Rehabilitation Plan accrual rate

Multiemployer Funding Zone Statuses

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Yellow Zone (Endangered Status):

• Can reduce future benefits • Can reduce/ remove unprotected benefits for those not currently in

receipt (always an option) • No plan amendments increasing liabilities by: increasing benefits,

changing accrual rates or accelerating vesting schedule – Amendments permitted if actuary certifies:

i) amendment consistent with Funding Improvement Plan and

ii) additional contributions were made to pay for cost

Multiemployer FundingZone Statuses

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Government Forms and Filings

Form 5500 – Actuarial Report

The plan’s enrolled actuary must complete the Schedule SB / MB with attachments for a qualified defined benefit plans which summarizes actuarial results

Schedule SB • Single employer and multiple employer plans

Schedule MB• Multiemployer plans• Report progress of funding improvement /rehabilitation plan

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ERISA 104(d) Notice (Multiemployer)

Summary of Plan Information for Employers and Unions:

Plan must provide report to each union and contributing employer:

Description of contribution and benefit schedules

Information reported on the Schedule R of the Form 5500

Endangered or Critical Status Information

Notice of right to copy of Form 5500

Summary plan description

Summary of any material modifications

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PBGC – Annual Premium Filings

PBGC is the insurance agency for defined benefit pension established in 1974. Separate trusts for single and multiemployer plans.

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Single Employer Plans Multiemployer Plans

Year Flat Rate Variable Rate Flat Rate

Premium(Per Participant)

Premium(% of UVB)

Cap (Per Part.)

Premium(Per Participant)

2016* $64.00 2.9% $500 $12.00

2015* $57.00 2.4% $412 $12.00

2014 $49.00 1.4% $412 $12.00

Select Historical Premiums

2007 $31.00 0.9% -- $8.00

2005 $19.00 0.9% -- $2.60

1984 $2.60 -- -- $1.40

1974 $1.00 -- -- $0.50

* Subject to indexing

PBGC – Coverage

Coverage for basic benefits at normal retirement age, most early retirement benefits, annuity benefits for survivors of plan participants, and disability benefits.

Maximum monthly benefit guarantee varies by age and form of payment. Varies by years of service for multiemployer plans.

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Single Employer Plans Multiemployer Plans*

Year Maximum Monthly Guaranteed Benefits

2014 $4,843.18 $1,072.50

Select Historical Maximum Monthly Guaranteed Benefits

2007 $4,125.00 $487.50

2005 $3,698.86 $487.50

1984 $2,556.82 $487.50

1980 $2,164.77 $487.50

*100% of first $11/month per year of service, plus 75% of next $33/month per year of service with a maximum of $35.75/month.

PBGC Filing Requirements – 4010 Filing

• An FTAP that is less than 80% for any plan sponsored by the Company triggers an ERISA §4010 filing for the plan year

• Exempt from filing if aggregated unfunded liability is less than $15M

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Notices to Participants – Annual Funding Notices

PPA requires the administrator of a ALL defined benefit plan that is insured by the PBGC to provide an annual notice of plan funding to all participants and beneficiaries under the plan

• Provided to active participants, current retirees, beneficiaries of deceased retirees, and terminated participants with a vested right to future benefits

• Provided to all labor unions representing any participant or beneficiary

• Provided no later than 120 days after the end of the plan year, which is April 30th for plans with a calendar year plan year

• Includes information about the Plan’s assets and liabilities, how Plan assets are allocated among different categories of investments, the Company’s investment and funding policies, and participant rights and protections

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Recent Legislation/Hot Topics

Effective January 1, 2012 the Moving Ahead for Progress in the 21st Century Act (MAP-21) added collars to segment rates

– Based on 25 year average of each of the segment rates as of September 30 of the preceding calendar year

• Collar is based on the valuation year

• Only applies to the minimum contribution, FTAP and AFTAP

Funding Relief

Valuation Year Min Max

2012 90% 110%

2013 85% 115%

2014 80% 120%

2015 75% 125%

2016+ 70% 130%

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The Highway and Transportation Funding Act (HATFA) was signed into law on August 8, 2014– The 90 to 110% corridor under MAP-21 was extended through 2017, with the 5%

adjustments beginning in 2018

Plan Year Beginning MAP-21 HATFA

2012 90 to 110%

90 to 110%

2013 85 to 115%

2014 80 to 120%

2015 75 to 125%

2016

70 to 130%

2017

2018 85 to 115%

2019 80 to 120%

2020 75 to 125%

2021 and later 70 to 130%

Plan sponsors are permitted to delay using the new rates to 2014 plan years to avoid revising valuation work and plan operations during 2013

As with the original MAP-21 choices, employers are permitted to limit the delay to only section 436 benefit restrictions

Funding Relief

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Funding relief and the Annual Funding Notice (AFN)

• MAP-21 Supplement

• Required when

– A plan’s funded ratio without regard to MAP-21 is less than 95%, and

– Funding shortfall is greater than $500,000, and

– There are at least 50 participants in the plan

• Not required for plan years beginning on or after January 1, 2015

• Supplement shows the plan’s MRC and funded status without regard to MAP-21

• DOL issued Field Assistance Bulletin (FAB) No. 2013-11 on March 8, 2013 containing a model MAP-21 Supplement

No guidance has been issued for HATFA yet, expectation is that supplement will be required beyond 2015 and model language will be updated to cover HATFA

Funding Relief

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Mortality assumption used to determine how long plan participants are expected to live and collect their pension. Also used to determine the value of lump sum payments.

Society of Actuaries (SOA) studies US mortality trends and develops tables for pension plan actuarial valuations

SOA has been working on updated tables for uninsured pension plan experience since 2009

Current IRS prescribed mortality table uses 2000 as the base year with projected improvements

Mortality Table Update

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RP-2014 and MP-2014 Background

Current study used participant data for years 2004 through 2008

• Over 10.5 million life-years of exposure

• Over 220,000 deaths

• Results of study projected to 2014 based on observed rates of annual improvement

Study also analyzed improvement in mortality over time

• Finds that mortality is improving faster than expected based on prior studies

• Finds that rates of improvement are accelerating

e.g., people now age 50 are expected to have more improvement after age 60 than a person now age 60

Mortality Table Update

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Impact and Timing

New tables will generally increase pension liabilities by 6-10%Final tables expected to be published by the end of October 2014

• Audit firms are likely to expect/question/push for adoption for 2014 year-end disclosure

• IRS unlikely to adopt new table for funding until 2016, due to drag in required regulatory process

• New table will likely take effect for qualified plan administration (417(e) lump sums) at same time as funding

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Mortality Table Update

PPA is set to sunset at the end of 2014

Written into the act is sunset provisions which state that plans operating under a rehabilitation or funding improvement plan upon expiration of PPA will continue to do so upon the sunset of the law.

1 year extension has been included as part of legislation considered during 2014, but nothing passed. Currently unclear whether Congress will act before the end of 2014.

PPA Sunset – Multiemployer Plans

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NCCMP “Solutions, Not Bailouts”

• itemizes the severe funding deficiencies of multiemployer plans and the multiemployer PBGC fund that insures these plans

• outlines several potential solutions including encouraging plan mergers, alternate plan design…

• but most controversial the ability to reduce the benefits for those currently in receipt of benefits

NCCMP Proposal

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Q&A

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José M. Jara, JD, LLM Shirley Cheung, FSA, EA, MAAAPrincipal, National Practice Leader Multiemployer Plans Director, RetirementWealth Practice Wealth PracticeBuck Consultants, LLC, A Xerox Company Buck Consultants, LLC, A Xerox CompanyJose.Jara@xerox.com Shirley.Cheung@xerox.com212.330.1114 212.330.1029

Suzanne Hughes, ASA, EA, MAAA Melissa M. ConklinDirector, Retirement Senior Consultant, RetirementWealth Practice Wealth PracticeBuck Consultants, LLC, A Xerox Company Buck Consultants, LLC, A Xerox CompanySuzanne.Hughes@xerox.com Melissa.Conklin@xerox.com201.902.2615 201.553.6317

Presenters

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